Solar energy is about to take a tumble in the U.S. At midnight on Dec. 31, 2011, one of the most creative financial incentives ever devised by the federal government will disappear. It is called "1603" and it allows developers to take a cash grant instead of an investment tax credit.
According to the U.S. Department of Treasury, Section 1603 of The American Recovery and Reinvestment Act provides cash grants, "To reimburse applicants for a portion of the cost of installing specified energy property used in a trade or business or for the production of income." For solar power projects, it amounts to 30% of the facility's capital costs.
Of course, conservative thinkers might believe the 1603 program is a government give-away program. However, that would be a mistake. The 1603 grant ultimately costs the taxpayers nothing. In fact, 1603 grants make money for federal, state and local governments.
So, how does the government get their money back?
It is simple: Solar facilities generate revenues without significant expenses. Without expenses, solar facilities become taxpayers in the highest tax brackets.
Look at the numbers: Solar farms have an operating life of approximately 25 years, throughout which, they have almost no operating expenses. A 25-megawatt unit, the size of a typical standby diesel generator for a local hospital, would cost approximately $90 million to build and would earn a 1603 payment or tax credit of approximately $25 million. Depending on geographic location, the annual revenue would be approximately $20 million against almost zero production costs (no fuel costs). After year five of the facility's life, most indirect expenses will have been fully depleted because accelerated depreciation will have been fully expensed.
Solar facilities have a life of approximately 25 five years. For twenty years, the facility will earn approximately $20 million in revenues, operating income and pretax earnings. Every year for 20 years, the facility will pay approximately $7 million in income tax to the federal government and another several million to the state government. On a cash basis, that initial $25 million cash grant provided by the 1603 program would generate $140 million in federal taxes (of course, the net present value decreases this number). This is a terrific deal for federal and state taxpayers, and facility owners.
The U.S. Treasury has reported that more than 3,780 companies have taken advantage of 1603 grants. Together, those companies received over $9 billion in cash grants. More are on the way as hundreds of companies try to beat the Dec. 31 deadline.
By continuing the tax credit and killing the 1603 cash grant, policy makers are changing the incentives. Those changes will cull a large number of investor-owners, primarily the small-to-medium-sized businesses.
Tax credits are not cash. For a company to use tax credits, it must have tax liabilities greater than the tax credit, or the unused tax credit is lost. In the solar power industry, only large, domestic and highly profitable companies are incentivized by tax credits.
If 1603 grants cease as scheduled, a large number of investors will exit solar projects. By killing 1603, Congress is picking winners over losers. The winners are mostly the highly profitable utilities that can successfully absorb the tax credits, such as NextEra Energy (NEE), Exelon (EXC), Duke Energy (DUK), and Dominion Resources (D).
The losers will most likely be the 3,780 small-to-medium-sized companies that can build renewable energy projects but will not have the income to offset federal tax credits. Of course, they could sell the tax equity to high-income investors. But, any sale comes with the heavy price of lost ownership because the only way to sell tax credits is to sell most of the facility's equity for the first five, or so, years. Any loss of equity clearly discourages investment by medium-sized companies and 99% of the nation's individuals.
Others lose, too. Domestic manufacturing companies, such as First Solar (FSLR) and SunPower (SPWRA) should see a drop in domestic sales starting in the first quarter of 2012 as main- street investors are forced out of the market.
Creative programs, like 1603 are widely misunderstood. They quickly yield to the rhetoric of politics. One unfortunate result is the big guys get their tax breaks at the expense of smaller companies. Another is that the solar industry falters and the needed investments in renewable energy are delayed.