Despite the urgency of the crisis gripping Wall Street, the Senate stepped up yesterday to resoundingly pass HR 6049. The bill must still be reconciled with the competing House version, HR 6899, particularly on the pay-go issues associated with energy measures. The White House released an administration position on HR 6049 suggesting that, while the President opposes the revenue raisers in the bill which raise taxes on the oil and gas industry, the President does not plan to veto the bill. The Senate is pushing the House with this leverage to coalesce behind the Senate version. 

Kudos to renewable energy leaders like Senator Cantwell and Representative Inslee who have steadily advocated for the industry. Unless one of the pending bills is successful, the sun will set on the Production Tax Credit, Investment Tax Credit and several related measures that have proven highly effective in the expansion of the wind, solar and biofuels industries. Congress is scheduled to adjourn on September 26th for the electoral season and perhaps the remainder of 2008. Absent a quick Congressional action compromise behind a unified bill, these renewable industries will suffer from lost investment, delayed projects and the dark cloud of future uncertainty.

The Production Tax Credit (PTC) applies to facilities utilizing wind, open and closed-loop biomass, landfill gas, geothermal, hydropower and waste to produce energy. The “placed in service date” in the PTC determines whether qualifying facilities will be eligible for crucial federal subsidies to improve their project economics. The solar energy and fuel cell Investment Tax Credit (ITC) provides powerful subsidies to these promising industries. The biodiesel blenders excise tax credit is crucial to the growth of this industry that is seeking to diversify into next generation feedstocks. While not strictly in the renewables sector, carbon sequestration, energy efficiency, plug-in vehicles, smart grid expansion and incentives for idling reduction units in heavy duty trucks are other promising energy programs awaiting extension or approval.

As referenced above, it is not the renewable energy sources, efficiency measures, or energy innovations that create the central dispute but the issue of “pay go” or “pay as you go”. A broad consensus has emerged that a diversified energy policy is an imperative. The problem arises from the price tag. The simple concept of “pay as you go” is that Congress should simultaneously appropriate or otherwise pay for any expenditures that it includes in a particular piece of legislation. The price tag for the comprehensive new energy package has been in the range of $17 to $18 billion dollars over the next 10 years. Notably, even the use of the 10 year cost evaluation period has caused recurring problems for the renewable energy industry as it encourages Congress to pass shorter term measures that cost less under the pay as you go accounting rules.

The two key pending bills in Congress illustrate the controversy vividly. The “Comprehensive American Energy Security and Consumer Protection Act” (HR 6899) passed the House on September 16th. The “Energy Improvement and Extension Act of 2008” (HR 6049) is the bill that was passed in the Senate with the sponsorship of Senators Baucus, Grassley and Reid. The two bills would both address the price tag issue by repealing some oil and gas domestic production tax subsidies and changing the rules for the calculation of foreign oil and gas extraction income. Renewable industry proponents had recently been encouraged that tentative compromises would allow one of the bills to be passed, thereby extending the sunset dates on the energy programs.

The hurricane and the crisis in the financial markets have shortened the time opportunity for Congress to work out the details of the compromise. There is speculation that even if Congress fails to act this year, a compromise will be reached next year that will be retroactive to January 1st. In other words, If Congress fails to act this year to extend the credits, they will act sometime next year and provide credits to the respective industries for the time when no credits were in place.

The problem with such an approach is that the damage to these industries has already commenced, will continue to expand and cannot be retroactively remedied. Renewable energy projects that generate significant energy or produce significant quantities of fuel are substantial projects that require planning and investment. As new energy projects, they carry substantial uncertainties in calculating returns for investors. The underlying premise of the federal subsidies for these projects is that the tax and production credits make the projects commercially feasible on a shorter timeframe with a higher level of certainty. By supporting projects that are just becoming commercially feasible, the federal government empowers the industry to expand; to achieve innovation and efficiency breakthroughs; and to begin to reduce America’s reliance on imported fossil fuels.   Once the efficiencies, expansion and innovations occur, the subsidies are no longer required for future projects.

This role is particularly critical in the new energy sector. Unlike the sector to which it is often inaccurately compared, the new energy sector requires substantial investment, hard asset infrastructure and downstream compatibility. Successfully penetrating the energy sector necessitates competition with the commodities and products of some of the largest, most successful and most profitable companies in the world. Six of the ten of the largest companies in the world derive their revenues primarily from fossil fuel discovery, extraction, refinement and marketing. These industries have been in existence for 100 years, have solved daunting challenges, and have built the most expensive and remarkable distribution infrastructure in the world.

Renewable energy businesses that seek to penetrate this market must develop their energy source; make it compatible with existing downstream demand or create a new demand market; and compete on price. The PTC, ITC and other government programs have been great successes in leveling this playing field and enabling success. Solar installations have increased by double digit figures annually in the US for the last several years. Wind power has grown by factor of four over the past four years from 5,000 MW of installed capacity to 20,000 MW.  Biodiesel production in the US has increased by a factor of twenty over the three years that the incentive has been in place.

From an overall contribution to the America’s energy portfolio, wind has made the greatest inroads, now providing 1.5% of the nation’s massive energy needs and ramping up on schedule. As stated by the Executive Director of the American Wind Energy Association, Randall Swisher, “Wind energy installations are well ahead of the curve for contributing 20% of the U.S. electric power supply by 2030 as envisioned by the U.S. Department of Energy. However, the looming expiration of the federal renewable energy production tax credit (PTC) less than four months from now threatens this spectacular progress.  The PTC has been a critical factor in wind’s very rapid growth as a part of the nation’s power portfolio.”

In our practice, we have already begun to see the impact of the lack of extension impact on our clients’ development and investment activities. For some time, developers have been attempting to speed projects to completion to ensure that the wind turbines would be placed in service within the scope of the existing PTC. With the deadline approaching, forward wind turbine sales in the US have declined substantially. Given the dramatic growth in wind energy globally, many of these wind turbines have already been committed overseas and will no longer be available for 2009 US projects. In other cases, developers and investors have sought to assign the risk of a PTC termination in the contract negotiation to one party. As one might anticipate, neither party has been enthusiastic about taking on what has sometimes been labeled the “political risk”.

Similar challenges have beset the biodiesel industry. While wind turbines are the focal point in the wind sector, vegetable oils such as soy oil (known as feedstocks) are the dominant cost component in biodiesel. When there is a longer time horizon on the federal blenders excise tax credit, biodiesel producers are able to buy feedstock forward at a fixed number or based on a discount to a commodity index. They can then sell their finished product forward on the same basis and lock their margin. Such forward procurement and sales enables planning, stability and expansion. With the blenders credit expiring in three months, the opportunity for long-term procurement and sales are severely hindered. This challenge is faced not just by existing industry participants but also by those who seek investment to develop additional production capacity.

In the area of solar photovoltaic distributed generation, problems have also begun to arise due to the lack of extension. Some developers in the industry are demanding that integrators indemnify the developer against loss of project value if the ITC for a project is lost due to the project not being completing by the sunset date. This indemnification includes assuming the risk that the project is not placed in service due to a matter outside the integrators control: the inability of the local utility to timely inspect and approve the interconnection.   As one might expect, some prudent and responsible larger integrators are unwilling to take on this risk. As a result, integrators which are undercapitalized or otherwise less qualified, but who are willing to take on the political risk, are getting some projects. 

The US renewable energy industry has made great strides in the last decade to achieve feasibility and scale sufficient to make an impact on the nation’s energy needs. In many respects, federal programs in this area have been a success story. In the wind, solar and biofuels industries, the US has emerged as a leader but federal political support has been a key component of this success. Already, wind turbines are being diverted away from the US due to the delayed extension of the PTC. With the immediate action of Congress, the short term political risk to these industries can be addressed. Longer term, the incoming administration and Congress will have the opportunity to expand the timeline on these programs and reap greater benefits from the same investment.