Renewable energy a strategic driver, enabled by tax credits

Inflation Reduction Act adds incentives to a growing sector

Energy giants, private equity and other investors have been pouring money into renewable energy production and adjacent industries in recent years, as the U.S. Energy Information Administration forecasts that wind and solar sources will account for 16% of total electricity generation in the United States in 2023, up from 8% in 2018.

Renewable energy tax credits are expected to strengthen the already growing commitment that many businesses have shown to this sector, according to Grant Thornton Managing Director for Growth Advisory Services Adam Bowen.

“People are rethinking the role of energy as a source of opportunity, not just a cost of doing business,” Bowen said during a recent Grant Thornton webcast on renewable energy.

The U.S. government has provided hundreds of billions of dollars of renewable energy tax credits through the Inflation Reduction Act of 2022 and other incentive programs. With the help of these credits, what began as experimental spending on emerging technologies has grown into an interconnected ecosystem that spills across sectors, the panelists said. More than just the deployment of solar panels, there’s widespread interest in energy storage, transmission and efficiency — with financial opportunities for almost any business.

“No matter where you are in your decarbonization journey, one thing’s for sure,” Bowen said. “Companies are always looking for a way to move up the ladder — to lower costs, improved reliability and resilience, accelerated through the use of digital solutions and distributed energy resources.”

Digging further into the opportunities that are being created, a lot more in the renewables industry should be considered in addition to energy generation. Sectors that enable renewable energy’s widespread adoption, improve efficiency, and develop innovative technologies for a sustainable future include:

Sustainable construction: Wind turbines and other clean energy infrastructure items need to be built.

Energy storage: Batteries, capacitors and other energy storage products need to be built and distributed.

Electric vehicle (EV) manufacturing: The transition to electric transportation relies on the development and manufacturing of EVs, including cars, buses, trucks and bicycles.

Smart grid and energy management: Renewable energy integration requires efficient grid management and energy distribution systems. The development and implementation of smart grid technologies, energy management software and demand response systems enables renewable energy generation and consumption.

Solar panel manufacturing: The production of solar panels, including photovoltaic cells, modules and associated components, is a huge driver of renewable energy projects, and the declining cost of solar panels makes solar energy a more affordable and attractive option for residential, commercial and utility-scale applications. 

Hydrogen production and fuel cells: Companies involved in hydrogen production through electrolysis or other methods, as well as fuel cell manufacturing, are seeing growth.

Environmental consulting and services: These services addressing environmental impact, regulatory compliance, and wildlife protection are crucial in ensuring that renewable energy projects are implemented responsibly.

Together, these sectors comprise an efficient, interconnected and profitable renewable ecosystem, with major commercial gains expected not only for the first and fastest movers, but also for well-established companies and organizations focused on maintaining relevance into the future.

M&A opportunities abound

The growth of renewable energy coupled with government support through tax credits has created incentives for substantial investment — and numerous M&A opportunities. Major legacy players are making multibillion dollar investments, including BP, ExxonMobil, and major utilities NextEra Energy and Iberdola. Meanwhile, dedicated private capital providers such as New Energy Capital, Quantum Energy Partners and Angeleno Group are devoting extensive resources to this sector.

“We’ve seen a number of corporate and private equity buyers become more active in solar, energy storage and onshore wind, as well as the adjacent companies,” said Grant Thornton Managing Director for Transaction Advisory Services Tim Douek.

The heavy interest in renewable energy also is driving mergers and acquisitions. The most active subsectors for deals from an M&A standpoint have been energy infrastructure (which includes site development and large-scale solar and wind projects) and electrical equipment (which includes storage, transmission and energy management), Douek said.

“A number of the deals we’ve seen are starting to reference the Inflation Reduction Act in their deal materials…Clearly the IRA is factoring into portfolio strategies for many firms,” Douek said.

How to use IRA renewable incentives

The IRA is designed in several ways to make investment in renewables more attractive and feasible. The IRA enhances and extends existing tax credits and creates new ones while also encouraging M&A by making credits easier to use and monetize. To receive full credit amounts under the IRA, employers will generally need to meet prevailing wage and apprenticeship requirements. Three of the credits in the package are refundable — meaning they can be paid out in cash even if an entity doesn’t have a tax obligation — and the rest are generally transferable, allowing them to be sold for cash to third parties, an incentive that could prompt M&A activity. Tax-exempts can generally claim all the credits as refundable direct payments.

“The IRA is expected to significantly expand the pipeline of investment flowing into renewables and energy, and it promises to provide a more practical approach to monetizing the credits,” said Grant Thornton Managing Director for Corporate Tax Services Tracey Baird.

Larger companies will be hungry for the credits, while smaller businesses will be better able to use them because they have the option to take them in cash or sell them. This shift to transferrable credits could allow organizations to use simpler corporate and tax structures while pursuing projects. Baird predicted that fewer companies will turn to tax equity partnerships, which have been popular in recent years.

“That’s going to mean less need for expensive and complex tax structures,” Baird said of the new IRA approach.

The Grant Thornton panelists highlighted the IRA’s effects on the following credits:

• Sec. 45 Production Tax Credit and Sec. 48 Investment Tax Credit for renewable energy and utilities: These two credits offer alternative options: a credit based on the cost of the property or a credit based on the amount electricity generated for 10 years. Solar, wind and biogas property seem to be major targets right now for investments, although the credits apply to other property as well. Projects that began construction before January 2023 can avoid the wage and apprenticeship rules, but there are specific rules for determining when construction began. For projects that may qualify for both credits, companies will have to choose the one that provides the most benefit based on their desired return.
• Sec. 45Q Tax Credit for carbon oxide sequestration: This provision offers a credit per ton of carbon oxide captured and sequestered, and can offer significant benefits to power plants, refineries, chemical plants and carbon-intensive manufacturers. The amount of credit will be determined by how the company captures the carbon, the amount of carbon that is captured and sequestered, and what is done to sequester the carbon once it’s captured. The highest credit rates are available for direct air capture, but Baird said that technology isn’t yet cost-effective, even with the higher credit rates.
  
• Sec. 48C Investment Tax Credit for advanced energy projects: This credit is available for investing in the capacity to manufacture many components in the energy supply chain, but can only be secured through an application process.

Companies are interested in projects ranging from just a few hundred thousand dollars — such as to electrify the boilers of a building — into the hundreds of millions to build wind or solar plants. Documenting how your organization meets the requirements for the credits, including wage and apprenticeship requirements, is going to be vital, especially with regard to transferring the credits on the open market, Baird said.

Seeking clarity on the IRA

Despite growing momentum and renewed excitement, crucial details of the federal investment package remain unclear. First, there’s the question of the credits’ value when transferred. The Grant Thornton panelists predicted that smaller, higher-risk projects might fetch tax credits that sell for 80 to 90 cents per dollar of tax credit, while larger, more conservative projects could get stronger prices.

In some cases, companies must navigate the application and approval processes for the new and expanded credits — which requires both an understanding of the government’s overarching priorities and a strong base of data and technical expertise in the relevant topics. For example, the Section 48C credit has resumed in 2023 after being frozen for lack of funding since 2019.

“Section 48C is a very popular credit right now, and clients ask us lots of questions about it,” said Grant Thornton Managing Principal of Credits & Incentives Services Mike Eickhoff.

The IRS has allocated $10 billion to fund the Section 48C credit in two rounds in 2023. Concept papers were due July 31 for the current round — requiring companies to distill their vision into just four summary pages for the initial application.

“You have a lot of information to pack into four pages, which can be very difficult for many organizations, as some of these projects are quite complex,” Eickhoff said.

And at least for the Section 48C program, eligibility alone does not guarantee credits will be granted. Eickhoff urged applicants to understand and emphasize how their projects connect to the larger priorities of the federal government. A second round of allocations will open in 2024.

“Theoretically, you could be eligible for this program under statute … but if your project doesn’t align itself to the current administration’s agenda, it may impact your ability to be approved,” Eickhoff said.

Investors should look beyond the federal tax credits and examine the full slate of state and local tax incentives for renewable projects.

“Some folks will think of things in isolation,” Eickhoff said. But the state and local options range from free land in Missouri to reduced utility costs in Alabama and major property tax abatements in Texas — making them potentially valuable additions to the renewable financing equation.

Be aware of new tax credit complexities

Understanding and taking action around the new tax credits is sure to come with new logistical and financial challenges for companies, even as the opportunities are substantial. The various credits can interact in complex ways — and in some cases, the U.S. government hasn’t yet clarified those interactions. One example: Some companies applied for the Section 48C credit because of the time-limited application window, but may instead pivot to the Section 45X advanced manufacturing production credit for domestic manufacturers of energy components if it proves more favorable, Baird said.

For now, companies should model multiple options and enlist experts to ensure a full view of their options.

“There are a lot of questions impacting the financing of projects, whether transferability is going to help and what structuring may be needed to be done to ensure the greatest return on investment, which is why modeling these different financial arrangements and impacts is going to be really important,” Baird said.

The credits also come with strict requirements for the labor employed on qualifying projects. Companies will have to verify that workers are paid prevailing wages and that the projects offer a certain amount of work through apprenticeship programs. It’s the first time that the IRS has been responsible for enforcing such requirements, which creates uncertainty about how entities will document compliance by their general contractors and subcontractors.

“This is a bit of an unknown right now, and that’s where a lot of the tax planning and getting some outside tax help can really be helpful,” Baird said.

The labor requirements apply to projects with a construction start date on or after Jan. 29, 2023, although a “safe harbor” provision is available for those that incurred at least 5% of their total cost by that date. The labor requirements also may apply to repairs for up to a decade after the completion of construction. Failure to meet those labor requirements could slash the value of credits by up to 80%. Eickhoff gave an example of a Grant Thornton client applying for a $60 million credit — putting up to $48 million at risk if the project falls short of labor requirements.

Similarly, domestic sourcing requirements on some credits could prove onerous, requiring companies to know, understand and document supply chain of components under a complex set of rules, Baird said. But even with some questions unresolved, the panelists and many in the audience were bullish about the renewable market under the new federal incentive regime.

“The IRS is actually encouraging people to take” the credits, Baird said. “While other countries have taken more of a stick approach … punishing offenders with taxes and charges … the U.S. is attempting to encourage good behavior.”

She added: “It’s making the return on investment extremely attractive.”