EME 801
Energy Markets, Policy, and Regulation

Types of Subsidies and Incentive Programs

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Types of Subsidies and Incentive Programs

Before you get too deeply into this lesson, have a look at the Glossary page from the DSIRE website. Focus on the first section of the page, which defines a number of types of financial incentives. The definitions here aren't too in-depth, but reviewing them will get you familiar with the language of different types of incentives. If you are interested, the section of the page on "Rules, Regulations and Policies" is also worth a look to give you some appreciation for the truly dizzying array of ways that governments at various levels (state, federal, and local) are trying to encourage the use of renewable energy resources, particularly for the production of electricity.

In general, DSIRE is a very good resource for learning about renewable energy and energy-efficiency incentives in the United States. The following video provides a quick tour of some of the most useful information on the DSIRE website. (Note: as of this writing the DSIRE website was undergoing some major revisions, but the structure of the website itself does not appear to have changed that much. It is worth some time wandering around that website to see what information is available.)

Video: DSIRE Video (4:20)

Video describing the DSIRE website.
Click for transcript of DSIRE Video

SETH BLUMSACK: The Database of State Incentives for Renewables & Efficiency is one of the most useful online resources for information about incentives and subsidies available to renewable energy and energy efficiency in the United States. And it is limited to the US. But it's probably one of the best centralized locations for this information on the web. And so, the website is www.dsireusa.org. Or if you just go to Google and type in DSIRE, you'll probably find it. So, when you go to the Home page, the first thing that you will see is this map of the United States. And each of the states and territories within the US is clickable to get more information about incentives available in that state. So, for example, I'm going to click on my home state of Pennsylvania. And it brings up a page with a very long list of different incentives available for renewable energy projects and energy efficiency projects in the state of Pennsylvania. all of these different incentive programs are run by either the state or some area within the state, like a county or an electric utility or a town, or something like that. And so, at the very top of the page, you can find information about all sorts of financial incentives. And then, if you scroll down to the bottom of the page, you can find information on state policies that are relevant to renewable energy or energy-efficient development. And so policies don't include things that would directly affect the financials of a project, like a rebate or a tax credit, or something like that. And so, you can find this stuff for just about any state in the US. DSIRE also has a nice list of federal incentives. And there's a special page for federal incentives. And if you look for the little American flag icon, just about anywhere on the DSIRE's website, it'll bring you to the page for federal incentives. And again, the page is divided into a section for financial incentives. So, these would be things like tax credits and loan guarantees. And then, relevant to federal policies for the renewable energy and energy efficiency sectors. The last thing that I wanted to point out, which is really useful on the DSIRE website is this page of maps. So, if on the left hand side on the menu bar, you'll see a page that says summary maps. And they have a whole bunch of different maps available that give you information on different things. So, one of the most commonly used is the map showing which states in the US have renewable portfolio standards. And so, they have these in PowerPoint and PDF formats. And I'll click on the PDF one-- show you what it looks like. And here it comes up. And it highlights all of the states that have enacted some sort of renewable portfolio standard. And it gives you some information about whether certain technologies are eligible under the standard. So, if you see a little sun icon, for example, that means that there's a special solar power quota within that state's RPS. And so what you're looking at here is the map that is basically Figure 1 from the lesson.

Credit: S. Blumsack © Penn State University

We'll categorize subsidies and incentives into a few broad categories:

  • Tax incentives
    Tax incentives include credits, deductions and exemptions. Understanding the difference between the three is important. A "credit" represents a rebate on your tax bill, while a "deduction" represents a reduction in your taxable income. An "exemption" is simply an excusal from paying a certain category of tax (you could look at an exemption as a credit or deduction equal to 100%). There are relatively few tax exemptions for renewable energy as compared to the number of different tax credits or deductions. So, the difference between a credit and deduction comes down to whether the subsidy is applied pre-tax or post-tax. Recall our discussion of the pro forma profit and loss statement from Lesson 8. The depreciation allowance for invested capital is a good example of a deduction, since depreciation is subtracted from pre-tax net income. A credit is really no different than a direct payment since it is applied as a reduction to taxes paid, or as an adder to after-tax income (the two are mathematically equivalent).

    As a simple example, suppose that a project had a pre-tax income of $100 in some year, and faced a 35% tax rate. Without any subsidies, the tax bill for the project would be $35, and its after-tax income would be $65. Now, suppose that the project could take advantage of a tax deduction or a tax credit, both of which were equal to 20%. If the subsidy were structured as a credit, the 20% would be subtracted from the 35% tax rate, for a net tax rate of 15%. The tax bill for the project would fall to $15 (15% of $100) and after-tax income would rise to $85.

    Now, if the subsidy were structured as a deduction, the tax analysis would go like this:
    • The subsidy would reduce taxable income by 20%, so taxable income in this case would fall to $80.
    • The 35% tax rate would be applied to the reduced taxable income. So total taxes for our hypothetical project would be 35% × $80 = $28.
    • After-tax income would be $100 - $28 = $72.

    Because the credit is applied either to the tax rate itself or post-tax, tax credits are often more generous than tax deductions. In some circumstances, a company or project may even claim a tax credit if the income for the project during the relevant year was negative (so the project owner would get paid in the form of the tax credit, even if her project did not make any money and would not have paid any taxes in the first place).

    Video: Interview with Nicolle Natali (18:37) from AE 878

    If this video is slow to load here on this page, you can always access it and all course videos in the Media Gallery in Canvas.

    Video interview with Nicolle Natali (18:37).
    Click here for transcript of Nicolle Natali interview

    MARK KLEINGINNA: Hi everybody, this is Mark Kleinginna again, your instructor for EME 801, and today I'm joined by Nicolle Natali, who is actually a former student and a recent graduate of the renewable energy system and sustainability program at Penn State. And she's a great financial whiz and expert on all things Inflation Reduction Act, and I'm really, really pleased to have her here, and she's just a great, great individual. So hi Nicolle, how are things with you?

    NICOLLE NATALI: Hi Mark, thanks for having me. Things are good. Good to be here. I just moved from New York City to San Francisco, so definitely have been busy. How about you?

    MARK: I'm doing-- I'm doing very well. I'm doing very well, and as many people know, I move around quite a bit myself, so I'm in Boston as we do this interview and probably won't be when you guys see this. But anyway, it doesn't matter. Tell us a little bit about your career path and how you ended up doing what you're currently doing.

    NICOLLE: Yeah, sure. I guess I don't have a traditional career path, but I started by studying accounting for my bachelor's degree, and then I went on to get my CPA in New York while working in public and private accounting. And then I went back to school in the RESS program at Penn State to study renewable energy, and I also worked in corporate sustainability while I was there. Since I just graduated this past May, I had started a new role now in project finance at ForeFront Power, which is a smaller solar developer focused on solar and storage projects for commercial offtakers in North America.

    MARK: Excellent. Tell us a little bit about your RESS experience and how it shaped your current thinking. Yeah, so the program was great, and it taught me a lot about the energy industry and, more specifically, renewable energy and how it's always evolving. And the industry is ever-changing, and it's a really fast-paced field to work in. So this really drove home the point of also the interconnected nature of finance policy and the technical aspects of a lot of renewable energy projects, specifically focusing on wind and solar, battery storage, et cetera. And it was also interesting, I feel like, to study some of the ethical aspects of it, like ensuring sustainable and equitable outcomes with these systems.

    MARK: Excellent. So you're a financial professional, a CPA and so on. I think you majored in accounting, correct? What kind of work do you do today?

    NICOLLE: Yeah, so in my new role, I'm in a project finance function. So I work pretty closely with the sales team, the development team, the engineering teams, all at my company, and then also with external investors. And we basically try to ensure that the solar projects that we're presenting are economically attractive so that investors are comfortable with providing capital for these projects. And this is a really important project-- or important aspect-- of solar is being able to finance these projects with a large capital upfront cost. So our team basically ensures that we monetize the tax benefits available for solar, specifically the ITC, so I do a lot of financial modeling and also transaction due diligence.

    MARK: Excellent. Excellent. So let's dig a little bit into the IRA, or the Inflation Reduction Act, since that will certainly be driving some of the activity here in the US over the next 10 years. What's your overall impression of the IRA for renewable energy?

    NICOLLE: Yeah, so the IRA is very exciting. I think it's been recognized as a game changer for the energy industry because it extends and modifies the investment tax credit and the production tax credit, which really have played important roles in driving the economics for solar and wind projects in the US. And the IRA is also awesome because it includes tax incentives related to electric vehicles, clean hydrogen, clean energy manufacturing domestically. So overall, I think it just really helps provide regulatory certainty, which has been a challenge in this industry. So I think that's a really positive impact of it.

    MARK: Excellent. How about how about the IRA specifically to solar? Any thoughts there?

    NICOLLE: Yeah, a lot of thoughts. So the IRA, in regard to the ITC, it extends the credit at 30% for projects placed in service over the next few years, which previously, before the act was introduced, the ITC was set to phase down 26% this year, 22% next year, and only 10% thereafter. So that really impacts the economics of these solar projects. And it also introduces a couple of other new interesting aspects of the field, which one would be, I guess, the two-tier credit structure. So the ITC is actually at a base rate of 6%. And then you can claim a 30% rate if you meet these new prevailing wage and apprentice requirements, and a lot of other interesting aspects that I guess we'll dive into next.

    MARK: Sure. Absolutely. Well, I mean, before we go specifically into those pieces on the solar, what about storage and the IRA?

    NICOLLE: Yeah, definitely. Storage is another key component of this-- how exciting the IRA is-- because the ITC was previously only claimable for storage projects that were combined with solar. But now you can claim the ITC for standalone energy storage, which is a big difference in this field. There is a few caveats, though. It has to be at least 5 kilowatt hour system, and it's only available once-- after this year, for systems placed in service after 2022.

    MARK: Right. Right. So specifically, what is an investment tax credit?

    NICOLLE: So an investment tax credit is a federal tax incentive, which is part of the Internal Revenue Code, and it allows businesses to deduct 30% of the upfront cost for a solar project from their income taxes. But one aspect of this that's important is that not all businesses or solar developers can have the tax appetite to take advantage of this incentive. So a lot of times, these transactions are structured in a partnership where a bank or another tax equity partner that can take advantage of the full 30% benefit-- they'll partner with us so that they can take advantage of it more efficiently.

    MARK: Right. Right. And how does the Inflation Reduction Act change the current law?

    NICOLLE: So as I mentioned, it does change the ITC down to a lower base rate, but with the potential to have the full 30% rate, which is important because a lot of these projects are going to have to prove that they're meeting the new prevailing wage and apprentice requirements. And another part of the law that has changed is that the IRA introduces bonus credits or adders, which I think is really interesting because it can further increase the ITC amount past 30% after 2022 for projects that meet domestic content requirements or those that are located in energy communities or those that are built in low-income communities, which is a really important aspect of the energy transition, making sure it's equitable.

    MARK: Right.

    NICOLLE: So that's another really interesting change to the law. The law also introduces technology-neutral investment tax credits and also production tax credits in the future. So that will be really interesting, to expand the definition of what renewable energy technology can qualify for these incentives.

    MARK: Right. So tell us a little bit about this prevailing wage requirement that you spoke of. Yeah, definitely.

    NICOLLE: So these requirements-- the prevailing wage requirement essentially means that any laborers employed for the solar project-- if any of those laborers are paid prevailing rates, which are determined by the Department of Labor. And then the apprentice requirement entails that 10% to 15% of the total labor hours spent on project construction and also modifications to the project over the next few years, if any are required, are performed by qualified apprentices through a registered apprentice program.

    MARK: Right. And those-- do those wage requirements step up over time, I think?

    NICOLLE: Yeah-- Depending upon when they're-- The apprentice requirement steps up year over year. It increases, I think, from like 10% to 12 and a half to 15. And also, a key point would be that these requirements only apply to projects that are greater than one megawatt AC, and also if they start-- if a project starts construction before 60 days after the IRS issues guidance, which is still forthcoming, then they do not need to meet these requirements.

    MARK: Right. Right. And what about the domestic content requirement? What's in it for the developer in that case? Yeah, so this is an interesting credit. It essentially is that 100% of steel and iron ferrous ore facility is produced in the US, and there's also a designated other percentage for manufactured products that are also used as components for the facility. They must be based in the US, and this one is also a step-up. So before 2025, it's 40% of the manufactured content must be in the US. And then it steps up to 45%, 50%, and then 55%.

    MARK: OK. And tell us a little bit about the Energy Community opportunity.

    NICOLLE: Yeah, so this one's really interesting. I think the definition is a little complicated right now, because we need kind of a map resource, which a lot of groups, such as SEIA and others are working on. So you can overlay--

    MARK: Who is SEIA? ... So everybody knows who that is.

    NICOLLE: The Solar Energy Information Administration?

    NARK: Industry Association.

    NICOLLE: Industry Association. Sorry. I always use the acronym. But they're a great group. Definitely check them out for a lot of good webcasts on the IRA.

    MARK: Absolutely. Yep.

    NICOLLE: So an Energy Community in the act is defined as a brownfield site, as one option. And then it can also be a community with a recently retired coal mine or a coal-fired generating unit. And then thirdly-- these are all "or" options. They don't have to meet all of these criteria, but so a community with a certain percentage of unemployment-- or a certain percentage of employment, or local tax revenue related to fossil fuel extraction and processing. And they also must have an unemployment rate above the national average. So that last piece-- or last tier-- of the options can be kind of complicated because the percentage of employment and local tax revenue and the unemployment rate, those three variables, will all change year-over-year, based on ...data ..

    MARK: Right.

    NICOLLE: So it's always changing.

    MARK: Right. Right. Yeah, and with oil prices so high, it might be difficult to get the unemployment rate high enough in those areas. So it's--

    NICOLLE: Going to be a tricky one to-- It's

    MARK: A moving target, right, right. Exactly. And what about the low-income opportunities? What's going on there?

    NICOLLE: Yeah, so another point I guess I forgot to mention is the domestic content requirement, if it's met, it's a 10% adder on the ITC and then same with the energy community, a 10% adder. Those are both subject to the prevailing wage or apprentice requirement, so it's really 2% times a 5% adder to get to the 10. But for the low-income, it's structured a little differently. It is a 10% adder-- true 10%-- for projects that are less than 5 megawatts AC. And any project-- it has to be any project built in a low-income community or on Indian land. So for the low-income community definition, it refers to the Internal Revenue Code, which is a poverty rate of at least 20%. And then instead of that, if that can't be met, then it can be a census tract where the median family income is 80% or less of the statewide median income. So if those two are met, it's considered low-income.

    MARK: All right.

    NICOLLE: And then further, the credit could be increased to 20% instead of 10% if the project is also a part of a qualified low-income residential housing project or an economic benefit project, which is basically catered towards community solar because it's based on the offtakers of the electricity, if 50% of the benefits are provided to households with income below 200% of the poverty line or 80% of area median income, then the project can claim the 20%.

    MARK: Great. Great. So let's see here. What's a production tax credit, or a PTC?

    NICOLLE: So a Production Tax Credit is another federal incentive, part of the Internal Revenue Code, which is mainly used for wind projects, where the ITC is mainly used for solar projects currently. And the PTC provides a tax credit of a few cents per kilowatt hour of electricity produced by the solar project or the wind project during its first 10 years of production. So the ITC is based on the capital cost, whereas the PTC is based on electricity generated. And the production tax credit, like I mentioned, is mainly used for utility-scale wind projects at the moment.

    MARK: Right.

    NICOLLE: And the credit amount this year I think is 2.6 cents per kilowatt hour, but it's-- $26, yeah. Yeah, adjusted for inflation annually by the IRS.

    MARK: Right. Right. So how would you go about choosing between using the PTC or the ITC?

    NICOLLE: That's an interesting question, I think. After the IRA was brought about, a lot of people started asking that question. So the PTC is a credit earned over the first 10 years of production for a facility, whereas the ITC is claimed up front on the capital cost. So when determining if you want to monetize your project using one or the other, since now with the IRA, either can be used for solar or wind, which is really interesting, it's going to be a function of the capital cost, or more so used as a unit cost, like the dollar per watt of capacity.

    MARK: Right.

    NICOLLE: Compared to the net capacity factor, so projects with a high unit cost but lower capacity factors are going to benefit more from the ITC with that higher cost upfront, whereas those are the lower unit cost but higher capacity factors generating more electricity would likely benefit more from the Production Tax Credit. So there is an inflection point between benefits when one is more favorable than the other, but I think it seems that the ITC will still be used for really smaller-scale solar projects, with high cost, lower output, or located in areas with less solar resource available. But then the PTC for larger utility-scale projects, I think could end up being more [? accretive, ?] in some cases, than the PTC.

    MARK: Right. That's a great explanation. Thank you. Can you talk a little bit about the direct pay and the transferability options when it comes to the ITC?

    NICOLLE: Yeah, these are really interesting aspects of the act. So direct pay, one important point is that it's only for tax-exempt entities, which includes state and local governments, electric co-ops, and et cetera, a few other groups. So these entities, with the direct pay option, can elect a refund cash payment from the IRS for the value of the ITC in lieu of claiming a tax credit. So that's really monumental. I think, personally, for-- it could help decrease barriers to entry to adopt solar for some more non-profit entities that typically don't have access to these financing structures that-- like tax equity-- like that my company works with. And then transferability is for non-tax-exempt entities after this year. The ITC value can be transferred from one taxpayer to another in exchange for cash. However, I think one point here that is important, but also still under evaluation, I guess, is that the transferability provision probably won't let you monetize a project's depreciation benefits, which also usually depreciation helps increase the economics for solar projects in these typical financing structures that we use.

    MARK: Sure. Yeah.

    NICOLLE: So it might be more advantageous still to pursue a tax equity financing structure, which can be more complicated and complex and cost more, but it really will depend on what buyers are willing to pay for the credits when exchanged or transferred to each other. Right. So that's an interesting-- it'll be interesting to see how that plays out.

    MARK: Excellent. So anything else about the IRA that you want to cover?

    NICOLLE: Nothing specifically, but I would encourage everyone to-- oh, one other important thing, I think, is that the ITC definition also now includes interconnection costs, which I think previously were ineligible. So now that capital cost that the ITC can be claimed on can also include a bigger chunk of the cost associated with these projects. But I encourage everyone to read the other parts of the bill on electric vehicles, carbon capture, et cetera, because those are also really interesting, and I think they will complement the other changes to the ITC and the PTC.

    MARK: Right. Right. Excellent. Now, those interconnection costs can be very, very significant. So I would encourage as you guys work through your projects to think very hard about what kind of benefit that can actually be to the project, for sure.

    NICOLLE: Any further thoughts on the solar industry in general or your experience in it?

    MARK: It'll be exciting now, to say the least, over the next few years as all of these new aspects of the industry play out from a regulatory and policy perspective. But it's a really exciting industry. There's a lot of cross-collaboration involved, which is really nice to work with professionals in a lot of different areas. And I think there's something for everyone to do so, if you're interested, definitely take a look.

    NICOLLE: Excellent. Excellent. Well, thank you so much for your time today. Really, really appreciate it. It's been great to talk to you, and thanks for sharing your expertise with our students.

    MARK: Thanks for having me, and I wish you all a great semester.

    NICOLLE: Thank you.

    Credit: M. Kleinginna © Penn State University
  • Loan programs
    Loan programs are generally advantageous because they can lower the cost of debt faced by an energy project or investor, which in turn will lower the WACC, sometimes dramatically. There are basically two flavors of loan programs. Many governmental entities offer low-interest or zero-interest loans for renewable energy projects. There are also loan guarantees, which reduce the cost of debt by providing a sort of insurance in case the project does not perform as anticipated or if the project owner defaults on her debts. Loan guarantees are often used by governments to convince private investors to purchase debt being offered by companies promoting technologies that have not yet been market tested. Ultimately the loan guarantee has the same effect as the low-interest or zero-interest loan - it can lower the cost of debt and thus the WACC.
  • Rebates and Grants
    Rebates and Grants, although technically different, work much the same way. Both act to offset the capital cost of renewable energy technologies. There are some technical differences - for example in some jurisdictions a rebate is actually considered income that could be taxed, whereas a grant is exempt from any income tax.
  • Feed-in Tariffs
    Feed-in Tariffs (or what DSIRE calls "performance-based incentives") are payments to the owners of qualifying energy projects for each unit of energy produced from those projects. Feed-in tariffs actually have much the same effect on a project's financial position as a tax credit. Feed-in tariffs are not used very often in the United States, but have become quite common in Europe. Germany, for example, had for years set a very high feed-in tariff for solar photovoltaics. As a result, Germany became one of the world's largest markets for solar energy despite having a climate that, compared especially to hot desert climates, was not all that advantageous for solar.

The Renewable Portfolio Standard (RPS, sometimes called Clean Energy Standards) also deserves some mention, since it has been a popular mechanism to support renewable energy development in the United States in particular. Please have a look at Section III of "The Cost of the Alternative Energy Portfolio Standard in Pennsylvania" (reading on Canvas), which describes the RPS in one particular U.S. state, Pennsylvania. Pennsylvania's RPS is typical of how many such portfolio standards work. The reading also provides an overview of RPS policies in some other states. (You might notice that Pennsylvania qualifies some fossil fuels as "alternative energy sources" under its RPS, which demonstrates that RPS policies are not always equivalent to low-carbon policies.)

 29 states + Washington DC and 2 territories have RPS and 8 states and 2 territories have renewable portfolio goals
Figure 8.1: Renewable and Clean Energy Standards, 2020.

The RPS is basically a quota system for renewable energy and has been applied mostly to electricity. More than half of U.S. states have adopted some form of RPS, as shown in Figure 8.1, taken from the DSIRE website (note: look on the DSIRE web site for the most up to date version of this picture, as state programs change structure rapidly). Some countries have adopted policies for blending petroleum-based transportation fuels with biomass-based fuels (such as the Renewable Fuels Standard in the U.S., which you can read about through the U.S. Environmental Protection Agency, but our discussion here will focus on portfolio standards for alternative electricity generation technologies. Rather than subsidizing renewables through financial mechanisms as we have already discussed, RPS sets quantity targets for market penetration by designated alternative electricity generation resources within some geographic territory, like a state or sometimes an entire country. Typical technologies targeted under RPS include wind, solar, biomass, and so forth. The way that RPS systems typically work in practice is that electric utilities can either build the required amount of alternative power generation technologies themselves, or they can contract with a separate company to make those investments. Companies that build renewable energy projects can register those projects in a jurisdiction with the RPS to generate tradeable renewable energy credits (RECs). The RECs can then be sold to electric utilities who can use those credits to meet their renewable energy targets.

You can find more information on REC prices through the NREL REC report assigned as part of this week's reading. The data in the report makes a distinction between "voluntary" REC prices and "compliance" prices. Some states or areas have RPS targets that are not mandated by law, while in other states utilities face penalties if they do not comply with meeting their RPS targets.