The latest US$680m tax equity financing for Danish renewables developer Orsted's US projects is one of the largest transactions stemming from the Inflation Reduction Act to adopt a hybrid structure that is expected to become the norm for clean energy deals under the Biden administration's landmark climate law.
Orsted said on May 23 it had secured US$680m in tax equity investment from JP Morgan for two US solar and storage projects in Texas and Arizona, supported by new tax credits granted by the IRA.
The 600MW Eleven Mile Solar Center project in Pinal County, Arizona, will receive a one-off investment tax credit for its battery storage system, while its solar farm and the 250MW Sparta Solar project in Mineral, Texas, will generate production tax credits over the next decade.
This innovative partnership also allows JP Morgan, which effectively becomes a joint owner of Orsted’s two projects, to transfer some of those tax credits to other firms and make a profit as a broker.
“We gain an enormous increase in liquidity as a result,” said Alex Lowe, senior director of project finance at Orsted. “It’s a structure that we’d like to replicate.”
The agreement builds on JP Morgan's investments in 1.8GW of Orsted’s total 5.7GW onshore portfolio in the US.
As many clean energy developers generate more tax credits than they can offset in their tax bills, selling excess tax credits is key to securing financing and bringing down project costs.
Before the IRA's introduction in August 2022, investors had to take stakes in renewable projects through complex tax equity structures to claim tax credits, but a new provision under the climate law allows project owners to transfer those credits directly to any third party.
This will create a much larger market that all of corporate America can participate in, as any corporate buyer can support clean energy projects and optimise their federal tax bill by buying tax credits.
A total of US$47bn of clean energy tax credits could potentially be transferred through the new IRA scheme this year, and the total addressable market could reach US$100bn in 2030, according to estimates by investment bank Evercore.
That would dwarf the US$20bn annual tax equity market, which is limited to experienced investors that take on project risks and are able to navigate sophisticated deal structures.
Hybrid deals
Although the new tax credit transfer market is more accessible to a wider pool of investors, tax equity still enjoys a pricing advantage as investors can monetise asset depreciation as project owners.
Lowe said the market is now settling on a hybrid structure where tax equity investors – usually large banks – provide initial financing while retaining the flexibility to transfer part of the tax credits to other parties. JP Morgan is looking to transfer about half the investment tax credits from the Orsted deal, a person familiar with the transaction said.
These deals will require terms and financial incentives that allow banks to sell tax credits at a premium, the person added.
As banks are concerned about holding concentrated assets, having the option to transfer tax credits will allow them to finance more clean energy deals by recycling capital into new projects more quickly.
“The option to transfer tax credits is going to be a feature that most deals are going to have,” said a senior banker specialising in tax equity. “It serves as a way to downsize the transaction and manage it to a level that tax equity investors might be more comfortable with.”
However, many investors are worried that some green incentives under the IRA will be rolled back if Donald Trump wins the US presidential election in November. Some favour more commercially established renewable projects, such as wind and solar, which are less reliant on policy support.
“We believe the IRA provides very strong economic signals that will continue to drive private investment and bolster the demand for tax credits, irrespective of the administration post elections in 2024,” a spokesperson at Orsted said. “We expect the market to continue to grow.”