The Impact of Tax Reform on Wind and Solar Assets: How Much Does Their Value Increase and Who Benefits Most?

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______________________________________________________________________________

Eric Selmon Hugh Wynne

Office: +1-646-843-7200 Office: +1-917-999-8556

Email: eselmon@ssrllc.com Email: hwynne@ssrllc.com

SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

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January 9, 2017

The Impact of Tax Reform on Wind and Solar Assets:

How Much Does Their Value Increase and Who Benefits Most?

Lower corporate tax rates will have a material impact on the value of existing wind and solar assets. In this note, we model the impact of the Trump and House tax plans on the after-tax cash flows of wind and solar projects built in each of the last 15 years, allowing us to estimate the change in value of each renewable developer’s existing wind and solar fleets.

Portfolio Manager’s Summary

  • U.S. wind and solar power plants are generally built and operated on a competitive basis and are not subject to cost of service regulation. The PPAs under which the output of these plants is sold allow the owners to enjoy the benefit of reduced taxes. Lower corporate tax rates will thus have a material impact on their value.
  • It is difficult to assess the impact of lower tax rates on renewable projects due to marked changes in how these assets have been financed over time. To quantify the impact of lower taxes, we have built pro forma cash flow models of the wind and solar projects brought on line in each year since 2001, taking into account for each vintage of project:
    • the installed cost of wind and solar generation capacity in that year;
    • the extent, tenor and cost of the project financing available;
    • the availability and terms of tax equity;
    • the terms of tax incentives, including renewable energy credits and bonus depreciation.
  • We used these models to calculate how the annual after-tax cash flows of each vintage of wind and solar project would change under the Trump and House GOP tax plans. A key finding is that the NPVs of these cash flows rise for wind and solar projects built in each year since 2001.
  • We also found that the cash flows to tax equity investors in existing projects are not reduced by the reduction in tax rates. Therefore there is no risk that owners will have to make up for any lost value to tax equity investors.
  • Based upon this analysis of the impact of the proposed tax reforms on each year’s vintage of wind and solar plants, and knowing the annual additions of wind and solar capacity by each of the principal U.S. developers, we have estimated the increase in value of each renewable developer’s wind and solar fleets.
  • We summarize the results of our analysis in Exhibit 10. We expect the primary beneficiaries to be the major renewable owners such as NextEra Energy, which we estimate could enjoy an increase in value of its wind and solar portfolio equivalent to 1.5% to 2.0% of its market capitalization; ALLETE (1.3% to 1.7%); and Avangrid (0.7% to 0.9%). Depending on the scale of their net operating loss carry-forwards and future taxable income, NRG Energy, AES and yieldcos, such as, NRG Yield, Pattern Energy, NextEra Energy Partners, Atlantica Yield and 8point3 Energy Partners could also benefit.

Exhibit 1: Heat Map: Preferences Among Utilities, IPP and Clean Technology

Details

Lower corporate tax rates will have a material impact on the value of existing wind and solar assets. U.S. wind and solar power plants are generally built and operated on a competitive basis; they are not included in the rate base of regulated utilities and thus are not subject to cost of service regulation. The power purchase agreements under which the output of these plants is sold, moreover, allow the owners of these assets to enjoy the benefit of reduced tax rates. The reduction in corporate taxes proposed by the Trump and House GOP tax plans (to 15% and 20%, respectively) will thus increase the after-tax cash flow of renewable portfolios and raise their value to their owners.

Over 95% of U.S. wind generation capacity has been built since 2001, and over 95% of the nation’s solar fleet since 2010. (See Exhibits 2 and 3.) While a relatively short period of time, these last 15 years have seen significant changes in the installed cost of wind and solar capacity (see Exhibit 4); the availability and terms of tax incentives, including the investment tax credit for solar, the production tax credit for wind, and bonus depreciation (Exhibit 6) the availability and terms of tax equity (Exhibit 5); and the availability, tenor and cost of non-recourse project financing (Exhibits 5 and 7).

To capture this diversity, and estimate more accurately the after-tax cash flows of the U.S. wind and solar fleets, we have constructed pro forma models for the wind and solar projects brought into commercial operation in each year since 2001. We then compared the annual after-tax cash flows to the owners of the common equity of existing wind and solar projects under the current tax code and the Trump and House GOP tax plans. On this basis, we calculated the impact of the proposed tax reforms on the present value of these projects’ remaining cash flows, estimated through the end of a hypothetical 30-year useful life.

Exhibit 2: U.S. Wind & Solar Capacity (MW) Exhibit 3: Wind & Solar Capacity Added (MW)


Source: EIA, SNL, SSR estimates and analysis Source: EIA, SNL, SSR estimates and analysis

Exhibit 4: Estimated Cost of Wind & Solar Capacity Installed by Year ($/Watt)

Source: Lawrence Berkeley National Laboratory, National Renewable Energy Laboratory, SSR estimates and analysis

Exhibit 5: Estimated Capital Structure of Wind Projects by Year, 2001-2016

Source: Lawrence Berkeley National Laboratory, SSR estimates and analysis

Exhibit 6: Bonus Depreciation Rates Exhibit 7: Merrill Lynch BB Bond Yield Index

Source: EIA, SNL, SSR estimates and analysis Source: Bank of America Merrill Lynch, St. Louis Federal Reserve

Our most important finding is that, regardless of a project’s commercial operation date, owners of the common equity in U.S. wind and solar projects should enjoy an increase in the present value of their remaining project cash flows due to the lower tax rates proposed in the Trump and House tax plans. As can be seen in Exhibits 8 and 9, the expected increases in present values are materially higher under the Trump plan, with its 15% corporate tax rate, than under the House plan (20%).

We also found that the cash flows to tax equity investors in existing projects are not reduced by the reduction in tax rates. Therefore, project owners face no risk of having to extend the term of the tax equity investment, or otherwise increase the cash flows to tax equity investors to assure they hit their targeted returns. The value of wind and solar tax credits, which represent a dollar-for-dollar offset against the tax liabilities of tax equity investors, are not affected by a reduction in tax rates. The value of the tax deduction for depreciation is reduced, but with 50% bonus depreciation and 5 year accelerated depreciation of the remainder, this deduction is realized so quickly that even projects built in 2016 are not materially affected. Finally, lower tax rates reduce increase the after-tax value of the operating cash flow received by tax equity investors.

The proposed tax reforms affect the value of wind and solar projects differently, primarily reflecting differences in the structure of tax equity financing for the two types of projects. Wind projects benefit from the production tax credit for the first ten years of operation, and these tax benefits (as well as those derived from the deductions for bonus and accelerated depreciation) are shared with equity investors for the first ten years of the projects’ life[1]: over this period, tax equity investors are allocated 99% of the tax attributes of the project, but only 1% of its after-tax cash flow.[2] At the end of year ten, the status of these tax equity investors “flips;” from that year on, they enjoy 5% of the project’s after-tax cash flow. At the end of year ten, the owners of the projects may buy out their tax equity partners at the discounted present value of their forecast after-tax cash flow over the project’s remaining useful life.

Thus, if corporate tax rates are cut before year ten of a wind project’s life, the value of the buyout of the tax equity increases, reflecting the expected increase in the after-tax cash flows of the project due to the lower tax rate. The increase in the cost of the buyout is borne by the common equity. By contrast, if corporate tax rates are cut after the buyout date, the buyout calculation is not affected, and any subsequent increase in after-tax cash flow is enjoyed solely by the common equity.

In our models, we assume that tax reform legislation is passed in 2017 and goes into effect in 2018, which would be the first year during which the lower rates would apply. Equity investors in wind projects whose commercial operation date is 2007 or earlier would thus have been bought out before the new, lower rates go into effect, and we assume therefore that the benefit of the tax cuts is not reflected in their buyout price. Projects entering service in 2008 or later, by contrast, would see their taxes cut before the buyout of tax equity occurs. In these cases, we assume that the buyout price is raised to reflect the new, lower tax rate.

Exhibit 8 illustrates the increase in value, expressed in $/Watt, of wind projects that entered commercial operation from 2001 through 2016, give the reduction in tax rates contemplated by the Trump and House tax plans. As can be seen there, this increase in value differs markedly for wind projects of different vintages. Thus, projects brought on line from 2001 through 2007 show an increase in value that tends to rise with each passing year; this reflects the fact that newer projects have longer remaining useful lives, and therefore more years of operating cash flow whose value will be enhanced by lower tax rates. The exception to this uptrend is 2004. This was a year in which the average installed cost per watt of new wind projects fell by ~7.5% (see Exhibit 4), and the percentage of project cost funded with common equity fell from 13% to 12% (also a decline of some 7.5%; see Exhibit 5).[3] Measured in dollars per watt, the amount of capital invested by wind project sponsors fell by ~15% that year, and the project cash flow allocated to common equity to recover their investment fell by a similar amount. This is reflected in the smaller increase in value, measured in $/Watt, enjoyed by the sponsors of 2004 vintage projects under the Trump and House tax plans.

We once again see an interruption in the upward trend in value increases in 2008. Recall that projects that entered service in 2008 will be the first for which the buyout of tax equity in year eleven will reflect the lower tax rates that we assume come into effect in 2018. Rather than enjoying 100% of the increase in the project’s after-tax cash flow, therefore, the common equity owners of 2008 and later vintage projects must share 5% of this increase with their tax equity partners.

While the uptrend in value increases resumes in 2009, thereafter the increase in value attributable to the tax cuts is lower with each passing year. This primarily reflects a secular decline in the installed cost per Watt of new wind projects: from $2.15/Watt in 2009, this fell to $1.65 per Watt in 2015, a decline of almost a quarter. From 2010 through 2014, moreover, the share of wind project costs generally funded with sponsor equity dropped from 13% to 8%, a 40% decline. As occurred in 2004, the amount of capital invested by wind project sponsors fell dramatically, and the project cash flow allocated to common equity to recover their investment fell by a similar amount. This declining capital commitment is reflected in the smaller increase in value, measured in $/Watt, enjoyed by wind project sponsors from 2010 on.

Exhibit 8: Increase in NPVs of Wind Projects by Commercial Operation Date, in $ per Watt

Trump Tax Plan (15% Tax Rate) House Tax Plant (20% Tax Rate)

Source: Lawrence Berkeley National Laboratory, Federal Reserve Bank of St. Louis, IRS, SNL, SSR estimates and analysis

Solar projects, by contrast, benefit not from a 10-year production tax credit but rather from an investment tax credit whose benefit is taken in the year the project is built. Solar projects also benefit from bonus depreciation and accelerated depreciation on the five year MACRs schedule. As these tax benefits end in the sixth year following the commercial operation date of a solar project, the equity “flip” generally occurs at the end of year six; from that year on the tax equity investors are allocated 5% of the project’s after-tax cash flow. The common equity holders can also buy out their tax equity partners at the time of the flip at the NPV of their expected cash distributions over the remainder of the project’s life. In the case of solar, therefore, it is projects that entered operation in 2012 or earlier whose buyout calculation is not affected by the 2018 cut in tax rates. Projects whose commercial operation date is 2013 or later, by contrast, will see an increase in the value of the buyout to reflect the cut in tax rates. The increased cost of buying out the tax equity reduces the benefit that the common shareholders enjoy from tax reform.

Exhibit 9 shows the increase in value of solar projects brought on line from 2010 on as a result of the lower tax rates contemplated by the Trump and House tax plans. As in the case of wind, this increase in value declines with each passing year, and for largely the same reason: the installed cost of new solar projects fell from $3.82/Watt in 2010 to $1.40/Watt by 2016, a drop of over 60%.

Exhibit 9: Increase in NPVs of Solar Projects by Commercial Operation Date, in $ per Watt

Trump Tax Plan (15% Tax Rate) House Tax Plant (20% Tax Rate)

Source: Lawrence Berkeley National Laboratory, Federal Reserve Bank of St. Luis, IRS, SNL, SSR estimates and analysis

Given this analysis of the impact of the proposed tax reforms on each year’s vintage of wind and solar plants, and knowing the annual additions of wind and solar capacity by each of the principal U.S. developers, we have estimated the increase in value of each renewable developer’s wind and solar fleets. In Exhibits 10 and 11, we list the ten firms that we expect to benefit most from the increase in value of wind and solar projects due to lower tax rates.

Exhibit 10: Estimated Increase in the Value of Wind & Solar Fleets Due to Tax Reform, Expressed as % of Market Capitalization

Source: Company reports, SNL, SSR estimates and analysis

Exhibit 11: Estimated Increase in the Value of Wind & Solar Fleets Due to Tax Reform, Expressed as % of Market Capitalization

Trump Tax Plan (15% Tax Rate) House Tax Plant (20% Tax Rate)

Source: Company reports, SNL, SSR estimates and analysis

Unsurprisingly, the firms that we expect to benefit most are the companies for whom investments in renewable energy comprise the largest proportion of total corporate assets. Principal among these are major renewable owners such as NRG Energy, which we estimate could enjoy an increase in value of its wind and solar portfolio equivalent to 4.9% to 6.6% of its market capitalization; NextEra Energy (1.5% to 2.0%); ALLETE (1.3% to 1.7%); AES (0.8% to 1.1%); and Avangrid (0.7% to 0.9%).

A second group of potential beneficiaries suggested by our model are yieldcos, such as NRG Yield, which we estimate could enjoy an increase in value of its wind and solar portfolio equivalent to 6.3% to 8.5% of its market capitalization; Pattern Energy (5.3% to 7.1% of market cap); NextEra Energy Partners (2.8% to 3.8%); Atlantica Yield (1.9% to 2.6%); and 8point3 Energy Partners (1.0% to 1.4%).

The result of our screen should be treated with some caution, however, due to the difficulty of estimating how long each company’s net operating loss (NOL) carryforwards will last, given it future taxable income, and therefore its ability to enjoy the full benefit of lower tax rates. In particular, we note that the yieldcos have been designed to create substantial tax shields, in part by writing up the value of the assets acquired from their sponsors, on the basis of which they can enjoy subtantial deductions for bonus and accelerated depreciation. For the yieldcos, therefore, the actual value of the benefits from tax reform should be lower than our project-level models suggest; although still significant, they will not be monetized until several years into the future. The same is likely true of NRG Energy, the parent of NRG Yield, due to its substantial operating losses, and AES, due to its domestic operating losses and foreign-sourced income (it is unclear at this time how changes in the treatment of foreign income under tax reform would affect this). By contrast, NextEra Energy, the parent of NextEra Energy Partners, should be able to monetize the benefit of lower tax rates much sooner, as it should consume its NOLs quickly once bonus depreciation expires in 2020.

Other factors not captured by our screen include variability in the economics of the projects from the assumptions in our models, which were based on industry averages for areas with strong wind regimes, such as Texas and the Midwest, and high solar insolation, such as the Southwest. For example, if the pricing of the PPAs or the capacity factors were higher or operating costs were lower, the increase in value would be greater because the project would be generating higher taxable income, but if the reverse were true, the increase in value would be smaller.

The same would be true for idiosyncratic deviations by project sponsors from the assumptions in our models as to the financing structure of wind and solar projects. For example, the levels of tax equity assumed in our models could be too high for developers that were able to absorb the benefits of renewable tax credits internally, as NextEra was able to do for a long period of time. The same would be true of developers that chose to take advantage of the Treasury’s cash grant program. In these cases, our estimate of the increase in value of these sponsors’ projects (based at it is on a lower assumed level of sponsor equity) could be far too low.

The same would be true for project sponsors that chose to rely less heavily on non-recourse project debt than we have assumed in our pro forma models. In these cases, our models would over-estimate the tax shield available to the sponsors from the interest expense on project debt, causing us to underestimate the increase in value of their project cash flows due to lower tax rates.

The one calculation we have not made is the impact of tax reform on the GAAP earnings of wind and solar projects. We believe that, for renewable projects with tax equity, GAAP earnings is an ineffective measure of the fundamental change in the value of the sponsor equity, but we also recognize that GAAP earnings form the basis for the market’s valuation of many of the project owners. Due to the complexity introduced by tax equity, however, the GAAP accounting for renewable projects is not transparent. We are therefore seeking expert advice on the GAAP earnings impact of tax reform on renewable projects, and hope to publish a follow up note on this subject when we have completed our analysis.

 

©2017, SSR LLC, 225 High Ridge Road, Stamford, CT 06905. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

  1. We assume a 3rd or 4th quarter online date, so for purpose of modeling the tax equity covers 11 years, with a partial year at the beginning and end.
  2. For wind projects in 2015 and 2016, we assume a “PAYGO” structure, in which 30% of the value of the PTCs are paid out to the owner in each year, thus reducing the up-front proceeds from tax equity (see Exhibit 5), but increasing the cash flows to the owner over time. This improves the returns to owners by reducing the capital invested by the tax equity investor at inception.
  3. We assume that the project is financed by a mix of tax equity and common equity, but that the sponsor then back-levers its investment by adding non-recourse project financing at an intermediate entity that owns the sponsors stake in the project. We assume that the additional debt is equal to 70% of the common equity, leaving the sponsor contributing just 30% of the project cost not financed with tax equity.
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