U.S. Renewable Energy Sector Outlook For 2009

In 1859, Charles Dickens famously penned the opening lines to "A Tale of Two Cities": It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair…

Dickens was not, of course, referring to the outlook for the renewables sector in 2009, but he easily could have been. The outlook for the renewables sector is a remarkable juxtaposition of a rosy future and a grim present. On the one hand, the growing public and political consensus around the dangers of climate change coupled with the rousing endorsement from Congress in the broad renewables tax package enacted in October 2008 all bode well for the sector. On the other, the dramatic downturn in the financial sector suggests that obtaining project-level financing is going to be tough sledding throughout 2009.

This "best of times, worst of times" dynamic suggests the coming year may well be the year that the renewables sector proves its mettle to the market, showing remarkable resilience in the face of extreme financial uncertainty. To do so, it will need a little help from Capitol Hill— and Congress may well deliver.

Prospects for Climate Change Legislation in 2009

During the 2008 presidential campaign, President-Elect Obama endorsed a cap-and-trade program as the preferred approach to reduce global greenhouse gas emissions. Likewise, both the House and the Senate are poised to resume consideration of various cap-and-trade proposals early in 2009. While many economists, including the Congressional Budget Office, prefer the simplicity of a carbon tax, most observers believe that a cap-and-trade system is the most likely political outcome.

If a cap-and-trade regime is inevitable, the next question to ask is when it might be enacted. The answer to this question depends largely on the health of the economy. Many believe that the Obama Administration will be reluctant to burden an already soft economy with the higher energy prices that a cap-and-trade program would almost certainly bring. If the economy remains mired in recession throughout 2009 and 2010, comprehensive climate change legislation could be shelved until a possible Obama second term.

Renewable Energy & Energy Efficiency

If comprehensive climate change legislation is tabled for the short term, it seems likely that Congress and the Obama Administration will redouble efforts on more narrow policy goals or regulatory reforms that have long been at the forefront of environmental policy in the United States. Indeed, the appointment of Ken Salazar as Secretary of the Interior; Carol Browner as head of the newly formed National Energy Council; and appointments at the Environmental Protection Agency, the Department of Energy (DOE), and other agencies all point to a determined effort to chart an aggressive course on environmental policy. In particular, the likelihood for a federal renewable energy standard (RES) is enhanced by the convergence of large Democratic majorities in both chambers of Congress and a Democrat in the White House. President-Elect Obama was supportive of a federal Renewable Portfolio Standard throughout the presidential campaign, and the House of Representatives passed a similar RES on several occasions. The Senate, long a stumbling block to this legislation, will have a decidedly greener point of view in the incoming Congress.

The most recent House version of an RES, in H.R. 6899 from the 110th Congress, likely represents the jumping- off point for legislative efforts in the 111th Congress. Interestingly, that version allows for energy efficiency measures to be treated as qualifying under the RES standard. This would bode well for energy efficiency technologies, particularly in the Southeast where other renewable resources appear to be less abundant.

Likely, other areas to be considered will be modified Corporate Average Fuel Economy standards for the automobile industry and new and more flexible tax credits for clean and alternative energy. Likewise, the incoming Obama Administration had pledged to invest billions of dollars in infrastructure including areas such as smart grid, biofuels pipelines, and mass transit. This infrastructure spending could be authorized quickly in 2009 in the promised economic stimulus bill currently under consideration by House and Senate leadership. The stimulus bill could also include large grants, tax incentives, and other authorizations for renewable energy and energy efficiency projects and technology.

The Future of Renewable Energy Tax Incentives

To date, the principal approach to encouraging renewables development in the United States has been through the tax code. The production tax credit (PTC) has helped fuel remarkable increases in U.S. wind generation in recent years. Likewise, the energy investment tax credit (ITC) is largely responsible for the current boom in the solar sector. The same can be said of renewable energy tax credits for biofuels, biomass, geothermal, fuel cells, hybrid automobiles, and so on.

This approach has worked well… until now. The rapid decline of the financial sector throughout 2008 has all but eliminated the erstwhile renewables financiers from the marketplace. Even those financial institutions that still have cash on hand often have current financial and tax losses, making tax credits all but useless. Without these traditional sources of project-level financing, many planned wind, solar, and other renewables projects may never get beyond the planning phase.

It is against this backdrop that Congress is considering a revision of renewables tax incentives to make them more effective in the current financial climate. Congress will likely revisit energy tax legislation in 2009 to, at a minimum, extend the production tax credit for wind that expires on December 31 of that year. While considering that extension, Congress has indicated that it will consider making the PTC and possibly the ITC refundable. Unlike the current-law tax credits, the holder of a refundable tax credit need not have a tax liability to capture the value of the tax credit. Rather, the holder of the tax credit can apply for a refund from the federal government in an amount equal to the credit.

This approach would allow developers and project investors who do not have sufficient tax liability to capture the value of the tax credits to nevertheless do so in the form of refunds from the federal government. This change could significantly expand the universe of potential project investors from the handful (that have both the capital on hand and the tax liability to utilize the project tax credits) that exist today. Such an approach, if enacted, would push the United States a step closer to the feed-in tariff approach so common in Europe. One lingering complexity to be resolved is whether the accelerated tax depreciation (five years for wind and solar projects) would be refundable as well. On the one hand, this accelerated cost recovery represents a sizeable portion of the tax benefits that attract investors. On the other hand, Congress may be reluctant to set a precedent for other industries that depreciation and cost recovery can be a refundable item.

An alternative proposal put forward by the incoming Obama Administration would allow claimants of renewable energy tax credits to carry them back to the preceding five tax years. This would allow these project developers and investors to wipe out taxes paid in earlier years and claim a tax refund from the federal government. While this approach is likely to be helpful to many potential investors, it is unlikely to have the broader stimulus effect of a generally refundable credit.

Meanwhile, it seems likely that other industries will enter into the renewables tax financing market. In particular, public utilities appear to be a good choice to take up some of the slack. As regulated companies, utilities tend to have both cash and tax liability. In addition, the renewable energy sector is a natural fit for the core competency of these entities. Utilities know project development, power purchase agreements, transmission interconnects, and other fundamentals around power production (even if the underlying technology is new to most traditional utilities).

Conclusions

Despite momentum in public opinion, political circles, and discussions among strategic investors, the renewables sector faces a challenging year like most sectors of the economy. While comprehensive climate change legislation may have to wait for firmer economic footing, other help may be on the way. A federal RES would create demand for renewables on a national basis. This coupled with revamped refundable tax credits could shake loose project-level investment that has been lacking in recent months. These legislative changes could change the outlook from "A Tale of Two Cities" to another great Dickens book: "Great Expectations."

This article was first published by the KPMG Global Energy Institute in 2009 prior to the enactment of the American Recovery and Reinvestment Act of 2009. It is reprinted here with permission of the publisher.

About the KPMG Global Energy Institute This article is provided by the KPMG Global Energy Institute. The Institute’s goal is to provide an open forum where industry financial executives can share knowledge, gain insights and access thought leadership about global energy industry issues and emerging trends. To access a regularly updated library of thought leadership, video and audio Web casts, podcasts and conferences and events, please visit http://www.kpmgglobalenergyinstitute.com/.