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The Inflation Reduction Act (IRA) promises renewable energy incentives and unprecedented innovation, but producers can’t afford to turn on the lights. As new entrants and industry incumbents navigate an economic logjam, there are significant accounting and tax implications to consider.
New energy incentives are more plentiful, flexible and diverse
The passage of the IRA brings a wealth of opportunity to the renewables sector, including long-anticipated tax incentives, credit enhancements and related requirements designed to bolster investment in and production of renewable energy.
- Transferable energy tax credits, through which companies can choose to sell certain credits (or portions of credits) to third parties in exchange for cash;
- Provisions for existing investment tax credits (ITCs) and production tax credits (PTCs), including extensions, modifications and expansions for select credits;
- New energy tax credits applicable to standalone energy storage, clean hydrogen, zero-emissions nuclear power, sustainable aviation fuel and more;
- Direct pay features, through which taxpayers can receive a refundable direct payment of tax rather than claim certain credits;
- Credit enhancements (“adders”), potentially available for select project characteristics such as the use of domestically sourced steel and iron, domestically manufactured components and production in specified energy communities; and
- Prevailing wage and apprenticeship requirements for projects to be eligible for the highest available credit rates.
We’re looking at a very different ecosystem for renewable energy today than we were just last year. Before the IRA, ITCs and PTCs in the renewables sector were nonrefundable and nontransferable, and they largely focused on more traditional forms of renewable energy such as solar and wind power. Today, there are a host of new credits available related to emerging green technology and more flexibility in acquiring and monetizing those credits. In short, the IRA is a tremendous boon to renewable energy innovation.
But there are a few key problems: supply chain disruption, inflationary cost pressures and the increasing cost to finance capital projects.
Renewable demand outpaces global supply
Like companies in many sectors today, energy producers and suppliers continue to face rippling effects from global supply chain disruptions and inflationary pressures.
Consider offshore wind farms. Power production from offshore wind has the potential to help various stakeholders satisfy carbon reduction commitments. Interest in offshore wind has only increased given the recent and planned leases of coastal areas.
However, the steel required to construct wind towers is in short supply and being sold at an uncharacteristically high price point. Furthermore, there is a shortage of specialized vessels designed to construct these offshore wind towers.
These supply constraints are coupled with a rush of industry players competitively bidding on offshore leases and bringing new projects online to meet state-imposed deadlines. The result: Demand exceeds supply while the costs to finance projects skyrocket.
Similar scenarios are playing out across the industry. Lithium for battery storage plants, for example, has faced significant price volatility in recent months. Fluctuating prices for solar panel are further complicated by high import tariffs. High interest rates are increasing project costs even further. And on top of that, there are high barriers to entry for new suppliers.
With all these factors at play, renewable energy companies are finding themselves at an impasse. On the one hand, they have an array of new incentives encouraging them to accelerate the development of renewables projects. But on the other, they are unsure how to take advantage of them in light of the abnormally high financing costs, lengthy project delays or, in some cases, project cancellations. As for their finance departments, there are significant accounting and tax implications.
Supply chain, financing risks muddle accounting
The interplay between new energy tax incentives and existing supply chain and financing constraints is forcing energy finance executives to think critically about the value of their portfolios. Some top-of-mind questions we’re hearing include:
- What is the fair value of a project delayed by supply chain disruption, inflationary pressures or increased financing costs?
- At what point do project setbacks indicate impairments?
- What is the proper way to reconcile the fair value of a project eligible for new tax incentives but that incurs higher capital expenditures because of inflation and other external factors?
- With rising interest rates impacting the viability of offtake agreements, are certain projects becoming unfinanceable?
- For producers that have contracts with state governments to meet portfolio climate standards by specified target dates, at what point do project delays or cancellations become a compliance issue?
- Is there a point at which state governments or regulators will cease approving contracts on the grounds that heightened costs have made the resulting impact on ratepayers untenable?
Monetizing IRA tax incentives ambiguous
Even in a scenario where these constraints are resolved and projects progress on schedule, there are still pending questions about the application, monetization and accounting for the IRA’s energy tax credits, including:
- Who is verifying the validity of a credit that an entity wishes to transfer and how is pricing determined?
- Is insurance for the amount of energy tax credits a viable option?
- When thinking about the application of tax credit adders, how is domestic content measured and how are energy communities defined? Will the supply of credits ultimately outweigh demand, diminishing returns for project sponsors?
Further guidance from standard setters is expected down the road. In the meantime, KPMG has compiled resources based on existing accounting principles and is working with clients to determine potential tax implications. Until additional guidance is available, we anticipate that producers and investors will place a heavy emphasis on documentation, indemnification agreements and potentially insurance to make the most of the new incentives while minimizing risk exposure.
Breaking the logjam for a greener future
The incentives in the IRA have the potential to drive the next wave of renewable energy innovation, encouraging new entrants to join the market while creating new mechanisms for incumbents to diversify and monetize their portfolio of renewable assets. However, inflation, supply shortages, geopolitics, high interest rates, the COVID-19 pandemic and other market- and industry-specific factors have played a role in delaying the full realization of the IRA’s benefits.
That said, once the logjam begins to clear and market participants start monetizing these energy tax credits, it will be critical for finance executives to closely monitor and mitigate associated risks. While accounting for energy tax credits may look straightforward on paper, there are still gaps in the accounting guidance, and navigating complex transactions can get tricky. Ensuring that the operations, accounting and tax functions stay closely aligned and that all advisors are on board will be essential to instilling confidence in investors and securing a competitive advantage.
Todd Fowler is a leader in power and utilities; Kim Sucha is a renewables leader (tax) and Hannah Hawkins is a principal, tax, for KPMG LLP.
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