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Tax driven wind investment gets scarce in America -- But sudden impotency of production tax credit likely to be temporary say experts

The collective sigh of relief heaved by the wind industry when the $0.021/kWh production tax credit (PTC) underpinning the United States' market was passed by Congress early last month did not last for long. With the global economic crisis knocking a number of wind's major financial players out of the market, project developers looking for investors to make use of the incentive are facing a void where only a short time ago there was a large pool of what is known colloquially as "tax equity."

Some of the high profile financial services firms that helped drive a huge growth in equity investments in wind power over the past few years, motivated by the need to offset taxes, have been sidelined by "their own internal issues," says Jeff Lipton at Jefferies & Company, a New York-based investment bank with more than 25 offices in North America, Europe and Asia. "We've got kind of a near term dislocation and we are really waiting to see that shake out over the next several quarters," he says.

The PTC, which had been set to expire at the end of 2008 but was rolled over for another year after it was added to a controversial $700 billion Wall Street bailout bill just before Congress adjourned for its election break, has been the key driver of wind power development in the US. But the challenge for developers without large enough tax burdens to offset to make use of the PTC has been to find equity investors who can. In the past, they had to sell their projects to bigger companies such as FPL Energy or Shell, but over the last few years there has been a rise in independent wind plant ownership by so-called passive investors looking for tax shelters. Wind power has been a popular roof to shelter under, with its tax equity market growing from about $600 million in 2005 to more than $5 billion in 2007.

"Last year, there were about fourteen significant players on the tax equity side for large wind projects. Today, as a result of the financial crisis, that number is a little better than half that. Somewhere between seven and nine of those players are still in the market, so there has been a significant contraction, at least on the bank side," says Ed Zaelke, a partner at the law firm of Chadbourne & Parke LLP.

Joel Link, who heads Midwest development for Invenergy, says development companies are feeling the crunch. "Tax equity is a huge hurdle for the industry. If you go down the list, Lehman Brothers, GE, everybody that were the tax equity players, there's not that many left, and so I think you're going to see a big pull back in projects built next year and you're going to see turbines suddenly become more available in the market," he says. "Certainly nobody saw this coming but we're pushing ahead. It's one project at a time."

New appetites to tap

Although some of the traditional players have now withdrawn, that does not mean there is no investor appetite for the PTC, says Michael McNamara, a senior equity analyst with Jefferies. "It just means we have to find new buyers for the tax credit, which could simply lead to a delay in some of the projects procuring this form of financing," he says.

"A short way of putting this is that as long as people pay corporate taxes in the US, they will be looking for ways to offset that and the PTC is a very attractive and a relatively simple and straightforward way of reducing your tax bill," adds McNamara.

Zaelke agrees. "I think what we will see is that folks other than the traditional banks will begin to enter this space and will expand their role in this space. We certainly expect that the cost of financing will go up, and that we will have new market entrants. But it will take some time to find other investors that have a tax appetite that have comfort investing in wind projects."

The on-again, off-again history of the PTC and the series of short term extensions it has gone through has discouraged some potential players from entering the tax equity market in the past, says McNamara. "They don't want to spend six months getting comfortable with this particular tax investment only to see it disappear three months later." But he points out that by the end of 2009, the credit will have been in place for four consecutive years and hopes are high for a multi-year extension when a new administration takes over the White House next year.

"I think you're going to see, as wind is increasingly embedding itself not just in the US but in the global environment, a lot more tax equity investments come through." Among the most likely candidates to step in to fill the void are traditional energy companies like utilities or oil and gas firms, says McNamara. "Clearly you'd be looking for companies whose taxable incomes have been rising and that is where an oil company might fill that role quite nicely," he says.

Both McNamara and Zaelke expect returns on the money tax-motivated investors put into wind projects will rise. "This is simply a way of making this a more attractive investment to help try to lure some of these newer customers in. It is also likely a reflection of the fact that these newer consumers are well aware of the fact that some of the more traditional consumers have disappeared and therefore they are in a bit more of the driver's seat."

Zaelke says that "it wouldn't surprise anyone" if tax equity felt it needed a higher margin to be involved in these deals. "Risk profile has changed or it may simply be that that demand for cash has changed and therefore they are entitled to a higher premium."

One factor that could help lessen the impact in the near term is the growing presence of large players in the market who don't need to offload the tax credit to a third party, says McNamara. "Not only do they bring their strong balance sheets, but they bring their own internal appetite for that tax credit," he says.

Consolidation

In fact, the financial crisis and the impact it is having on the availability of credit is likely to lead to more mergers and acquisitions (M&A), not only in the wind industry but throughout the whole clean tech sector, says Lipton. "We are seeing more active discussions," he says. "Obviously the challenge right now, given the overall instability in the market, is that no one is rushing to do a transaction.

"Clearly the bigger players in all of the various sub sectors are evaluating M&A a lot more actively, given what's going on and the fact that valuations are down significantly," he continues. "Some of the smaller public and private companies who may not be able to access the capital markets will probably have no alternative but to explore a sale."

Ultimately, though, Zaelke believes the fundamentals behind renewable energy remain strong. He points to discussions he had with participants at a recent Chadbourne renewable energy event. "The sense in the room was that although it's a tough time right now and we may be headed towards a recession, if we're not already in it, the energy sector and in particular the renewable energy sector will be the first horse out the gate to lead the recovery," he says. "I think that if we do a good job bringing in new tax equity players, and we are successful in modifying some policies, that we could see this is as a temporary slowdown and move on to the next challenge."

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