The Future For Renewables

Friday, March 23, 2012 - 15:21

The Editor interviews Annemargaret Connolly, Partner and Leader of Weil Gotshal’s Climate Change Practice Group, and Thomas Goslin, Associate and Editor of Weil’s Climate Change Update.

Editor: What impact has the Solyndra bankruptcy had on federal programs to promote renewable energy development?

Connolly: The Solyndra bankruptcy and the collapse of a handful of other loan guarantee recipients really turned the whole idea of government support for renewable energy into a political issue. This is particularly true given that the President and his team had been closely associated not only with the company but with the concept of providing loan guarantees. The Department of Energy loan guarantee program was created in 2005 during the Bush administration to provide incentives for funding innovative, clean energy technologies that were taking risks in their development. As any venture capitalist might tell you, for every successful company marketing a new technology, there are a number of failures. So Solyndra was the headline-grabbing failure that has cast a pall over the policy of issuing loan guarantees, making it unlikely the DOE program will be reauthorized.

Editor: The Obama Administration has placed a lot of emphasis on renewable energy development as a means towards achieving sustainable job growth. What, if anything, has the Administration been able to accomplish with respect to this goal?

Connolly: One of Obama’s biggest accomplishments was the passage of the American Recovery and Reinvestment Act of 2009, which provided substantial funding for government loan guarantees and direct investment over the last three years. Since then there haven’t been many new legislative successes. There have been some developments at the agency level that have had meaningful impacts. For example, Executive Order 13514 requires that all federal agencies increase energy efficiency through the use of renewable energy technology, reduce petroleum consumption, and leverage federal purchasing power to promote environmentally responsible technologies. At first glance this looks like internal housekeeping, but agencies like DoD that consume tremendous amounts of energy have taken a serious look at renewable technology, driving both the demand for large-scale and deployed renewable projects. DoD looks at renewables as a security issue. Should something happen to the national grid, having renewable sources like wind and solar at large bases will allow them to operate relatively unfazed. Recently the army actually announced that it would be entering into a renewable power purchase agreements worth approximately $7 billion over the next 30 years for the construction and operation of renewable energy facilities for which it plans to leverage another $7 billion of private investment.

Editor: Now that the Department of Energy loan guarantee program is winding down, what federal programs are available to help finance renewable energy projects, and are there any new such programs under consideration?

Goslin: One of the popular government programs has been a federal production tax credit that has technically been around since 1992. Under that program an owner of a renewable energy product that meets certain qualifications can obtain a tax credit worth a little more than two cents per kilowatt hour based on the amount of electricity supplied into the grid. There is also what is known as the renewable energy investment tax credit, which provides certain owners of renewable projects with tax credits of up to 30 percent of qualified capital investment in the renewable project. In addition, there was a very popular program operated by the Treasury Department known as the Section 1602 Grant Program, which allowed project developers to convert their investment tax credit into a grant obtainable at the outset of the project to help fund start-up costs. That program was set up to apply to projects that were underway by the end of 2011, and it has essentially run its course. The production tax credit for wind energy is due to expire at the end of 2012, resulting in a flurry of activity to get wind projects up and running before the tax credit expires. There have been some efforts in Congress to keep that tax credit alive, but if it does not survive, we would expect to see development in wind trail off.

Editor: Many states have enacted renewable energy portfolio standards, and while several bills have been introduced that would establish a federal standard, none has garnered much support. What arguments do proponents and opponents of renewable energy standards advance in support of their respective positions?

Connolly: A renewable portfolio standard (RPS) is a law that essentially requires a utility to obtain a set percentage of their electricity from a renewable source. The upside is that it creates demand for renewable energy, which in most cases still costs more to produce than energy generated by fossil fuel plants. The critics of RPS laws argue that the government is meddling with private enterprise, and that by forcing utilities to spend more to acquire electricity for renewable sources, the cost of energy for consumers will increase. The issue really comes down to whether state legislatures think it’s worthwhile to promote a renewable energy industry. Evidence seems to suggest that many states do because at least 27 states and the District of Columbia have binding RPS laws.

Editor: European countries, most notably Germany, have employed feed-in tariffs to promote renewable energy development. What impacts have such tariffs had in Europe, and have similar tariffs been considered in the United States?

Goslin: Feed-in tariffs (FITs) are somewhat similar to a renewable portfolio standard in that the law requires utilities to source electricity from renewable sources, but FITs also set a price at which the renewable electricity is purchased, often under a long-term contract. Germany has set the standard for feed-in tariffs. Due almost exclusively to FITs that have been in place for 20 years, renewable energy development in Germany, particularly wind and photovoltaic solar, has led almost all industrialized nations. In addition to Germany, Spain and Denmark have boosted domestic renewable energy development through the use of FITs. Germany is planning on reducing the feed-in tariff rate for solar specifically by nearly 30 percent at the beginning of April, leading to a rush to get solar projects approved under the existing program. Just to give you a sense of how important the FIT is to German solar, it’s estimated that nearly five gigawatts of solar capacity will be approved this year for development before the April 1 cut off, which is about 70 percent of the total amount of solar that was approved for development last year.

Editor: China was recently ranked the most appealing market for renewable energy investors. What makes China such an appealing place to invest in renewables?

Connolly: First, China provides immense subsidies to its renewable energy industry. It’s committed to sourcing more than 11 percent of its energy from renewable sources by 2015. Moreover, China has suitable geography and weather to take advantage of both solar and wind. Chinese renewable energy companies have been seeking investors from the U.S. and Europe to help finance the booming industry. In 2010 private renewable energy investment in that country grew by 39 percent from the previous year to $54.4 billion. (The amount is relatively small compared to the U.S., where investment in renewables topped $246 billion in 2011.) China is supposed to grow its renewable industry rapidly in the near term to meet its ambitious targets, thus presenting an attractive opportunity for a lot of venture capital and private equity investors.

Editor: In addition to financial assistance programs, what regulatory concerns do investors need to consider when assessing renewable energy projects?

Goslin: There are a whole host of regulatory issues that come up when you’re developing a renewable energy project: with wind, there is a lot of concern about bird kills from the spinning turbine blades and with FAA regulations that concern flight paths, depending on the height of the turbine; with large solar projects there are concerns that the habitat of some endangered species could be disrupted; with federal land or waters you have to contend with the National Environmental Policy Act (NEPA), which requires assessments of the projects potential environmental impacts. Also, any number of local ordinances and zoning issues come into play.

Editor: What unique issues do investors need to focus on when conducting due diligence on potential investments in the renewable energy space?

Connolly: If you’re investing in a specific project at an early stage, you need to worry about all of the regulatory issues just discussed. In addition, you have to get a handle on the project’s ability to actually generate power by looking at historical wind data or the average number of days of sunshine. If you are doing a commercial project, you need to look at the project’s ability to hook up to the grid, making sure that the infrastructure will be in place by the time you come online. To the extent that your project relies on tax credits, loan guarantees or demand created by renewable portfolio standards, the sponsors need to be comfortable that critical regulations will not be overturned when the political wind shifts. In doing these types of deals, it is important to work with an experienced multidisciplinary team made up of lawyers, tax advisors, technical consultants and those who understand the political winds of the local jurisdiction. A huge element is identifying who your opposition is and whether their grounds are legal or have a good PR basis, which in the end may make your project more costly and take much longer.

Editor: On the East Coast, the Cape Wind project has faced numerous legal challenges and other issues. What lessons can be learned from for those considering developing offshore wind farms?

Goslin: Cape Wind is the most advanced of the offshore wind farms in the U.S. It offers two good general lessons: the first is to lock up power purchase agreements (long-term contracts guaranteeing demand for the power). Cape Wind was able to enter into a power purchase agreement with National Grid to offload about 50 percent of its capacity fairly early on, but it’s taken a while longer to find buyers for the other 50 percent supply. The other issue is the NIMBY (“not in my backyard”) problem. Cape Wind has been held up by a significant amount of litigation filed by people who don’t want wind turbines impairing their views. You’re seeing similar NIMBY issues holding up the proposed wind farm off the coast of the Mid-Atlantic States. The main transmission line running through the wind farm is being opposed by some land owners in Delaware who live where the power line would come ashore. The line is simply a cable that runs from the ocean to the shore, but residents are worried about their safety when there is an electrified power line running through the waters where they swim.

Editor: There is a great deal of regulatory and technological uncertainty concerning renewable energy development. How do you advise clients considering investing in renewable projects?

Connolly: This is a hard one because we’re in an environment where there is not only regulatory uncertainty but also technological uncertainty, keeping many investors on the sidelines. Investors must weigh their own risk tolerance. There is no question that this is an industry that for a long time has needed government support. Without the loan guarantees, the FITs, the renewable portfolio standard and tax credits, a substantial number of these projects never would have gotten done. Complicating the analysis is that renewable energy has turned into a political football, making it hard to predict the fate of federal programs. It’s critical to work with a good team that understands the regulatory process and is able to anticipate changes that could impact a sponsor’s models. After performing due diligence, proponents of these projects should make sure their time frames are realistic as well as be cognizant of factors that may make these projects subject to legal or political challenge.

Goslin: It appears that the costs of actually developing renewable energy has come down significantly and are getting closer to parity with fossil fuel generators, thanks in part to government support. As these technological advances improve and the cost of generating electricity through renewables drops, renewables are going to make up a greater percentage of our national energy supply. So we think there are a lot of interesting companies that are either tinkering with new technologies or trying to commercialize a recently proven technology and that the renewable industry could very well produce the next Apple or Facebook.

 

Please email the interviewees at annemargaret.connolly@weil.com or thomas.goslin@weil.com with questions about this interview.