Why Savvy Corporates are Making Solar Tax Equity Investments

Securing a budget for sustainability initiatives can be challenging in the best of times, but it can become even more challenging when companies are stressed by inflationary pressures and economic uncertainty.

In times like these, companies tend to manage cash more tightly and seek predictable returns for any investment that’s not directly tied to operations. To continue making progress against targets, sustainability leaders must present a business case rooted in cost avoidance, budget certainty, and economic benefit.

Fortunately, the Inflation Reduction Act’s expansion of the solar investment tax credit (ITC) opened ample opportunities for renewable energy buyers to:

1. Source renewable energy certificates (RECs) for their carbon reduction programs
2. Achieve an 8-12% return on investment in approximately 5 to 7 years
3. Payback quickly (< 2 years) and exceed internal hurdle rates
4. Reduce tax liability to improve the bottom-line

While securing buy-in and achieving budget certainty can be a challenge, tax equity investments offer solutions to manage risk and achieve sustainability goals.

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The Challenges Securing Buy-in and Achieving Budget Certainty

Renewable Energy Certificates

At the end of 2020, there were 620 members of the Science-based Targets Initiative (SBTi) – 620 companies that had publicly pledged to reduce their greenhouse gas emissions in line with climate science. By March of 2023, that number grew 7.5x. There are now 4,600+ organizations that have made public SBTi pledges. The rapid expansion of companies with these pledges is a positive signal in the fight against climate change, but it is also an inflationary signal for the cost of RECs as more companies compete for scarce renewable energy resources. Companies that rely on conventional REC purchases to reduce their reportable emissions will remain price-takers in a market with exponentially growing demand and inelastic supply.

Power Purchase Agreements

Power Purchase Agreements (PPAs) and Virtual Power Purchase Agreements (vPPAs) have emerged as cost-effective tools to limit exposure to increasing REC costs. According to public PPA announcements tracked by Bloomberg New Energy Finance, 225+ companies have made public PPA/vPPA purchases in the US.

While these products have proven to be efficient and cost-effective renewable energy tools for many organizations, securing approval for 12+ year agreements that can render millions in negative cash flow can be challenging. What’s more, credit requirements and security postings are increasing as financiers for renewable energy projects have become more conservative during these economic headwinds.

The Solution: Managing Risk with Tax Equity Investments

For organizations challenged to secure a budget for decarbonization programs, tax equity investments may be an ideal solution.

Tax equity investors invest a portion of the cash needed to develop a solar project. In exchange for their investment, investors receive federal tax benefits and project revenues. Project RECs can sometimes be included in the investment; other times project revenues can be utilized for unbundled REC purchases to avoid unfavorable P&L impacts.

Tax equity can often be either a component or cornerstone of a successful renewable energy strategy, as it offers:

• Safe Investment: Tax equity investments typically return capital in less than 2 years with a defined ROI

• High Yields: With typical ROIs ranging from 8-12%, yields are often higher than risk-adjusted internal hurdle rates

• Emission Reductions: Project cash flows can be used to source renewable energy certificates that reduce the investor’s greenhouse gas emissions

With the expansion of the solar investment tax credit and the option of tax equity investments, companies can achieve predictable returns while reducing their carbon footprint. By aligning multiple and often competing business priorities such as tax, finance, and sustainability strategies, organizations can gain broader stakeholder consensus with fewer obstacles. As a relatively low-risk, high-return decarbonization solution, tax equity investments can help sustainability leaders present a solid business case that can achieve the speed and scale needed for ambitious decarbonization programs.