Utilities could feel pain from PTC extension
Even though an extension of the Production Tax Credit (PTC) was estimated to cost more than $12 billion over 10 years, the PTC was extended as part of the American Taxpayer Relief Act of 2012 (the bill that averted the fiscal cliff), which passed in the Senate early on New Year's day.
Credit: U.S. Department of Energy.
The wind energy PTC and an extension of the Investment Tax Credit (ITC) -- important to small community and offshore projects -- will allow continued growth of the wind industry, which has totaled 35 percent of all new electric generation in America over the past five years.
Utilities and Bonus Depreciation
The fiscal cliff deal also extended bonus depreciation for another year, which allows taxpayers to deduct in 2013 more than 50 percent of the cost of projects and equipment placed in service in 2013 for an extremely accelerated write-off.
It is common for public utility commissions to require utilities to claim bonus depreciation, and pass the tax benefit through to the rate base. Public utility commissions often require this whether the utility needs the additional depreciation deductions or not.
"For instance, NextEra is carrying hundreds of millions of dollars of unused tax credits on its books. It would prefer to offset its tax liability with those tax credits, but the Florida PUC will make it claim bonus depreciation. Other utilities have appetite for the bonus depreciation and find it to be a low cost tax planning strategy and are pleased to see it extended," said David K. Burton, an attorney with Akin, Gump, Strauss, Hauer & Feld LLP.
An important part of the legislation is that the extension of the PTC applies to facilities that began construction before January 1, 2014, as compared to the prior requirement that the facility be placed in service as of a certain date.
The details of how the IRS will apply the "start of construction" deadline are not yet known. The hope is that rules similar to those implemented by Treasury for the Cash Grant program will be adopted. Such rules would require only that 5 percent of the cost of a wind project be incurred in 2013 in order to be deemed to start construction. If the 5 percent approach is adopted by the IRS, it is not clear if that will be applied based on a whole wind farm or on a turbine-by-turbine basis.
"For instance, if a 100 turbine wind farm is being developed, is it sufficient that 5 turbines be purchased in 2013? Or must 5 percent of each of the 100 turbines be purchased in 2013? The industry hopes that a common sense approach is used, so that developers do not have to spend resources tracking the 5 percent test on a turbine-by-turbine basis," said Burton.
If energy tax credits end, some states will still impose RPS requirements. To meet them, utilities will still need to buy renewable energy. For this to be economic, everyone will feel some pain.
Utilities and the PTC
For utilities with state renewable portfolio standard (RPS), the PTC will make those mandates and standards easier to meet. Without the PTC, the price for wind power would have had to increase significantly in order to provide developers an appropriate return on their investment in on newly constructed wind farms. Those utilities would have had to pay more for wind power purchase agreements to meet their RPS requirements.
"The PTC creates an advantage for utilities with tax appetite versus utilities without tax appetite," said Burton. "For instance, Exelon and MidAmerican have significant tax appetite and can buy wind projects outright and use the PTCs themselves. That gives them an advantage over utilities that are not able to do that either due to a lack of tax appetite or regulatory reasons."
The fiscal cliff package also maintains parity between the tax rates on dividends and capital gains.
"We are pleased that the final agreement recognizes that our tax code should not pick winners and losers -- that we should treat dividends and capital gains equally," said EEI President Tom Kuhn. "While there is still more work to be done to reform our tax code, Congress and the Administration took the necessary steps to prevent the largest tax increase in history from occurring, a tax increase that would have affected virtually every American."
Utilities traditionally offer dividends as a way to attract investors and raise capital in the equity market. A pronounced shift away from dividend-paying stocks by investors would hurt the share values of these companies that stretch across many industries. Lower share values weaken the economic -- and retirement -- security of millions of Americans who hold those stocks directly, or own an interest in the shares indirectly through retirement plans, life insurance policies or other savings vehicles.
In 2012, the electric utility industry spent a projected $94 billion to build a cleaner generation fleet; reinforce the nation's transmission and distribution systems; meet environmental requirements; deploy smart grid technologies; and improve the ability of the electric grid to respond to emergencies and cyber threats. These long-term investments produce jobs and create significant, positive impacts for the economy and the entire country.
PTC Pain Points
If energy tax credits end, states like California and New Jersey are still likely to impose RPS requirements. To meet those RPS requirements, utilities will still need to buy renewable energy. For this to be economic, everyone will have to feel some pain.
"Utilities will need to pay higher power purchase agreement rates, manufacturers will need to accept lower profit margins and developers will need to accept lower IRRs," said Burton. "Utilities should be trying to get ahead of that math and think about how they can keep PPA prices low by facilitating cost reductions in the development and construction process."
Transmission and siting are two areas in which utilities could advocate for policy changes that could lead to lower development costs, according to Burton.
Extension Implies an End
"The wind industry has been reinvigorated by this much-needed signal from Congressional leaders," said Rob Gramlich, interim CEO of the American Wind Energy Association. "Billions of dollars of investment sat idled by uncertainty that now can flow into new wind projects and our manufacturing sector."
But all good things must come to an end -- as the term "extension" implies. To some, this is a good thing.
"This yo-yo, sort of start-stop, start-stop, isn't good for the long-term stability," Laura Ann Arnold, President of Indiana Distributed Energy Advocate, told the Associated Press. "The credit expired in 1999, 2001, and 2003 and was always renewed, but each time it expired, jobs plummeted as energy producers held off on planned projects."
The PTC was also extended with the economic stimulus bill signed by President Barack Obama in February 2009.
Although the PTC will inevitably end up on the chopping block again at the end of the extension period, the reprieve does bide some time while the debate over tax policy rages on.