Inflation Reduction Act may spark more municipally owned clean energy

Public power agencies notched a long-sought victory with the new climate law, which for the first time grants them access to tax credits for renewable energy projects.

“This will be a sea change in how states and local governments and other tax-exempt entities approach the development of new and existing technology, including wind, solar, storage and hydropower,” said John Godfrey, senior government relations director at the American Public Power Association. “The number of new money projects financed by public power utilities has really declined in recent years. This will change that.”

Signed into law by President Biden on August 16, the IRA features a lengthy list of incentives for public and private entities to help push the country toward Biden’s goal of reducing greenhouse gas emissions by 50% by 2030.

Among the sweeteners is a provision long sought by the public power sector: direct-pay tax credits for clean energy projects.

Prior to the IRA, tax-exempt entities like states and cities that own power agencies as well as rural electrical cooperatives could not take advantage of tax credits for renewable energy projects because they had no tax liability. That’s led to most renewable energy projects in the U.S. being owned by private entities, with public power agencies typically buying their renewable energy from the third parties through power purchase agreements.

Wind and solar projects accounted for nearly 14% of total U.S. generating capacity in 2020, but only 0.9% and 0.5% was owned by public power systems or electric cooperatives, respectively, according to Fitch Ratings, which used American Public Power Association data.

Now, public agencies can take advantage of the tax credits and get up to 30% of their project costs covered. They can still issue tax-exempt bonds to finance the projects, although the tax credits will be reduced by 15%.

The IRA features two types of direct-pay tax credits, including an investment tax credit, based on a percentage of a project’s cost, and a production tax credit, which is an annual payment based on the amount of energy produced and sold by a project over 10 years. Projects that are already in construction may also qualify for direct payments, according to Orrick, which published an Aug. 26 brief on the topic.

After Orrick published the brief, clients called to say they had been monitoring the new incentives, said Orrick partner in tax and public finance John Stanley.

“Their external lobbying groups have been pushing for this, and there are definitely aspects of the public power market that are looking forward to this,” Stanley said.

The drafters tried to protect the credits from sequestration by using different language than the Build America Bonds’ payment rule, he said. The credits are structured less like a BABs payment and more like a tax refund, which is generally not subject to sequestration, Stanley said. But he added that it remains to be seen if that will be effective in protecting against sequestration.

Fitch said it expects the law will spur more public power borrowing for clean energy facilities.

“The ability to monetize production tax credits pursuant to the IRA will improve the economics of direct ownership and could help reverse a trend of declining investment in the sector,” Fitch said in an Aug. 16 brief. “Higher capital spending will drive increased borrowing but is unlikely to materially weaken credit quality,” because ratings already incorporate purchase power obligations, analysts said.

The subsidies will be the most beneficial to systems operating in the 24 states with clean energy goals that apply to publicly- or cooperatively-owned systems, Fitch said.

Public entities financing their own renewable facilities still face some obstacles, like depreciation issues or supply chain risks, said Stanley and Fitch.

Godfrey said public power agencies represent roughly 15% of retail customers and cooperatives another 13%.

“That’s close to 30% of all electric power customers who are served by utilities that couldn’t get access to these credits,” he said. “We’ve been working on this for a very long time.”