The True Price of Tax Credit Transfers: Introducing Adjusted Payment Rate
A hot topic in the industry today is the current and future price of transferred tax credits for clean energy projects. As background, the Inflation Reduction Act of 2022 introduced transferability to the market, thereby providing a new path for the monetization of 11 types of clean energy tax credits. With transferability, eligible tax credits can now be transferred (i.e. sold) to eligible taxpayers in return for cash consideration(1). For wind, solar, and storage developers, these payments offer a viable financing option either on a standalone basis or as paired with traditional or "synthetic" tax equity structures(2).
Transferability pricing is something that all of us want to understand better so that we can observe if the numbers pencil for new projects. For the first time, there’s a potential alternative to the non-transparent pricing constraints we’ve seen in the traditional tax equity market. There’s a collective expectation that transferability pricing will be more transparent — something that we can box up and use as the basis for future development and financing decisions. The industry can surely benefit from pricing certainty, but what’s really behind the numbers we hear about, and will there eventually be a clear way to compare pricing bids? For discussion, let’s use scenarios for a solar project where a developer is transacting with a single credit buyer.
Terminology
The four basic payment terms to think about when evaluating tax credit transferability pricing are described below and one important new term is introduced later.
Payment Rate is the cash consideration paid by the credit buyer divided by the face value of the transferred tax credit.
Reference Dates are the dates the credits are earned within the eligible period. For production tax credit (“PTC”) transactions, this represents the end dates of the calculation periods for which the project's electricity generation is accumulated and grouped for purposes of the PTC calculation (see below for payment periodicity groupings). For ITC transactions, it’s the single date on which the project was placed in service for tax purposes (”PIS Date”).
Payment Periodicity represents the frequency of cash payments in relation to reference dates. This can be monthly (“MO”)(3) , quarterly (“QT”), semi-annual (“SA”), or annual (“AN”). Payment periodicity is generally applicable to PTC transactions only, which are earned over 10 years.
Payment Dates Lag is the amount of time after the reference date that the credit buyer pays cash for the transferred tax credit. For project finance modeling, time periods are typically observed in months, so lag can be expressed as 1mo, 2mo, 3mo, etc.(4)
Note: Payment terms may vary based on circumstances for a particular transaction. Good faith upfront payment deposits are ignored for modeling purposes.
Scenarios
Now let’s dive into a few examples to understand why there's more to transferability pricing than the stated payment rate.
We’ll start with a Solar PTC scenario where a credit buyer bids to make quarterly cash payments to the developer after the credits are earned each quarter.
Scenario 1: PTC Buyer with quarterly payment periodicity
Let’s assume a 1-month payment date lag to start (0.95 QT 1mo). The payment total is equal to the aggregate tax credits multiplied by the payment rate. The credit buyer can apply the purchased tax credits to its quarterly tax estimate payments. For tax equity modeling, we typically use Mar 31, June 30, Sep 30, and Dec 31 as the credit earned dates and the convention has typically been to spread the forecasted credits for the calendar year over the remaining quarterly tax estimate dates(6). Taking the NPV of payments (using a discount rate of 8.5%(7)) and dividing that by the NPV of earned credits (using the same 8.5% rate) gives us our important new term, a metric we call the “Adjusted Payment Rate”. A developer evaluating this bid should understand that the credit buyer’s payment rate of 0.95 $/credit, once adjusted, is actually worth 0.9381 $/credit sold. Similarly, if the credit buyer’s bid was for payment with a 2-month or 3-month lag, the adjusted payment rate would fall to 0.9318 $/credit and 0.9255 $/credit, respectively.
Next, we’ll observe what happens when a credit buyer bids to make semi-annual and annual cash payments to the developer after the credits are earned each semi-annual and annual period, respectively.
Scenario 2: PTC Buyer with semi-annual payment periodicity
A developer evaluating these bids should understand that the credit buyer’s payment rate of 0.95 $/credit, once adjusted, is actually worth 0.9301 $/credit, 0.9240 $/credit, and 0.9177 $/credit with 1-month, 2-month, and 3-month lags, respectively.
Scenario 3: PTC Buyer with annual payment periodicity
A developer evaluating this bid should understand that the credit buyer’s payment rate of 0.95 $/credit, once adjusted, is actually worth 0.9110 $/credit, 0.9053 $/credit, and 0.8990 $/credit with 1-month, 2-month, and 3-month lags, respectively.
In summary, while each of the credit buyers’ bids was quoted as 0.95 $/credit, the adjusted payment rate can vary significantly (from ~0.8990 to 0.9381 $/credit). In fact, a credit buyer’s bid of 0.91 $/credit might easily be dismissed when compared to a competing bid of 0.95 $/credit. A closer look shows that 0.91 QT 1mo and 0.95 AN 3mo have nearly identical adjusted payment rates.
Next, we’ll move to a Solar ITC scenario where credit buyers bid to make a single cash payment to the developer after the credit is earned.
Scenario 4: ITC Buyer with a single payment
A developer evaluating these bids should understand that the credit buyer’s payment rate of 0.91 $/credit, once adjusted, is actually worth less than the stated amount. If the credit buyer’s bid was for payment with a 1-month, 2-month, 3-month, 4-month, 5-month, or 6-month lag, the adjusted payment rate would fall to those shown below.
In summary, while each of the credit buyers’ bids was quoted as 0.91 $/credit, there can be a wide variance in adjusted payment rates (from ~0.8739 to 0.9037 $/credit). In fact, a credit buyer's bid of 0.88 $/credit might easily be dismissed when compared to a competing bid of 0.91 $/credit. But a closer look shows that 0.88 1mo and 0.91 6mo have identical adjusted payment rates.
Wrap Up
The use of clear payment and pricing terms for transferability can benefit all the stakeholders involved. At CapeZero, we use the Adjusted Payment Rate to integrate the tax equity market’s tax credit recognition methodology with the evolving landscape of transferability payment terms. The Adjusted Payment Rate can help developers to compare bids and make choices using a standardized approach. To learn more about how our software can help you evaluate your options, contact us.
2 Financing: The Keystone of Clean Energy Deployment
3 Monthly payments can deliver cash sooner to the developer but require more administrative coordination between buyer and seller. We’ve removed them from this analysis.
4 Full payment on or prior to credit earned date, while possible, is unexpected and not modeled.
5 Assumes election of Section 45 Production Tax Credit (PTC), with no adders, and in compliance with prevailing wage and apprenticeship requirements.
6 There is some variance in market convention for treatment of ITCs for modeling. See David Burton’s The right way to model the timing of recognition of ITC.
7 While cost of capital can vary over time and between developers, we’ve selected 8.50% as the current benchmark for this calculation.
8 Assumes election of Section 45 Production Tax Credit (PTC), with no adders, and in compliance with prevailing wage and apprenticeship requirements.
9 Assumes election of Section 45 Production Tax Credit (PTC), with no adders, and in compliance with prevailing wage and apprenticeship requirements.
10 Assumes election of Section 48 Investment Tax Credit (ITC), with no adders, and in compliance with prevailing wage and apprenticeship requirements.
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