Industry Players Buzz About Clean Energy MLPs

Not long ago, Pat Eilers, Managing Director at Madison Dearborn Partners, decided to raise $1.2 billion. Working together with his fellow board members of a master limited partnership (MLP) to fund a fossil-fuels energy project, they found debt with a 4 percent interest rate, and equity investors who took 7 percent. The whole process took “two or three weeks,” he says.Now imagine if Eilers tried raising $1.2 billion for a renewable energy project. He’d pay six percent for the debt. Next he’d have to find buyers for the project’s investment and production tax credits, “which is no small feat,” he says. They would expect returns of 11 to 12 percent. The project’s holding company would need its own mezzanine debt and equity, which currently cost about 17 percent and 20 percent respectively, Eilers says.

No wonder renewable energy still costs so much. Even as technology prices plummet, increasingly it’s these financing “inefficiencies” that prevent fair competition, says Eilers. That has many investors, analysts and policymakers talking about expanding master limited partnerships into the renewable energy industry.

Such funding mechanisms “are well-known, well-established, and I think would be vigorously defended by the traditional energy sector that has relied on them for more than 30 years,” Senator Chris Coons, who has introduced legislation to extend MLP’s for renewables, said at a press conference in December.

The advantages of MLPs come from their unique hybrid structure.  Like a corporation, they offer tremendous fundraising power, since ownership interests are shielded from liability and can be traded like stock. But unlike corporations, in which profits are taxed once at the company level and again at the shareholder level, MLPs are taxed just once, like other partnerships.

“While it always has its detractors, it has some real momentum, and makes sense for those of us in the financial community,” Hank Habicht, managing partner of Sail Capital, said at the recent ACORE National Renewable Energy Policy Forum.

Master Limited Partnerships could be a major improvement over the current investment landscape for renewables, which hinges on backers’ ability to find big corporations that are looking to buy tax credits to offset their big tax liabilities. That’s a small pool of possible investors buying assets they can’t easily sell. The obvious result: They can justifiably demand higher returns.

“It’s limited, expensive and illiquid, which is exactly what you don’t want,” says David Danielson, assistant secretary of energy.

All of this leaves renewables facing a conundrum: After a record-setting year for building new capacity in 2012, the industry faces something of an abyss, says Neil Auerbach, managing partner of Hudson Clean Energy Partners.

“Not only is the cost of capital high, but also equity valuations have been absolutely crushed,” Auerbach said during the ACORE policy forum. “We are an industry that has been in free-fall in public equity markets for the last several years, while installations have been building.”

Master limited partnerships draw interest from major green energy investors including Nancy Pfund, a managing partner at heavyweight cleantech firm DBL Investors, who believe that by reducing risk and attracting new investors, “MLPs could greatly reduce the cost of capital,” Pfund said during the policy forum.

Estimates of how much money this could save renewables projects vary widely. In a New York Times editorial, Dan Reicher and Felix Mormann of Stanford’s Steyer-Taylor Center for Energy Policy and Finance estimate that changing renewables’ tax structure “could help renewable energy projects reduce their financing costs up to fivefold.”

While still significant, the Department of Energy’s projections are much lower, says Danielson, who believes “you could lower the cost of finance by 30 to 50 percent.”

Either way, it’s still a major savings. That means it’s time for the Department of Energy to stop focusing so much on bringing down the cost of technology, Danielson says, and start focusing on reducing soft costs, especially financing. To help make that shift, the department is pushing for a standardization of securitization contracts across all investment vehicles and energy technologies, and it recently started gathering data energy project financing.  Standardization of contracts, he says, is needed to securitize the assets and more data will help investors understand their risk and return profile.

“To be quite candid, I think the department has been head-down on technology R&D,” Danielson says, adding that it now needs to apply the same attention to “addressing innovation in finance.”

The question of whether to expand the scope of MLPs now goes to Congress and the White House, where it faces both unexpected support and many barriers, observers say. In the strange bedfellows department, leading Republicans from oil-producing states including Sen. Lisa Murkowski of Alaska and Rep. Ted Poe of Texas recently sent a letter to President Barack Obama urging him to support an IRS decision that could extend another financing vehicle, Real Estate Investment Trusts, to cover natural gas and renewable energy.

“As they come on and support it, more and more Republicans or people who are from traditional oil-and-gas states and regions will recognize that this is a way that everybody can win,” Coons says.

But in the current fiscal environment, even ideas that enjoy broad bipartisan support face difficulty due to budget considerations. Republicans want a simpler tax code with fewer loopholes, and Democrats want to minimize the damage budget cuts cause to existing programs as much as possible.

The current investment and production tax credits will cost the federal government $11.6 billion from 2011 through 2015, according to The New York Times. Extending MLP financing to renewables would cost an additional amount, somewhat less than $1 billion over a ten-year period, according to Coons.

That leaves any proposal for new tax breaks in a bad position, said James Greenwood, CEO of the Biotechnology Industry Organization. “We’ll be swimming upstream because the general intent of members of Congress on both sides of the aisle is to reduce special treatments in the tax code, and thereby be able to broaden and lower rates,” Greenwood said during the ACORE forum.

Supporters can argue that it’s a simple matter of fairness.

“This bill is an excellent step toward leveling the playing field between renewable and incumbent energy sources by providing the solar industry with private capital in the same manner enjoyed by the oil and gas industry,” Rhone Resch, president and CEO of the Solar Energy Industries Association, said in a press release supporting Chris Coon’s legislation.

In the current political climate, however, even that may not be enough to sway policymakers or public opinion. That’s because tax credits are more effective the more they cost, says Douglas Holtz-Eakin, former Director of the Congressional Budget Office and current president of the American Action Forum, a conservative think tank.

“The broader is the subsidy, the more people who qualify, the better economic incentive it will be,” Holtz-Eakin said at the policy forum. “But it will also be more costly. And budget resources are scarce, and they will continue to be scarce.”

The idea of extending MLPs to renewable energy has been the subject of multiple meetings on Capitol Hill in recent weeks, according to Pavel Molchanov, an energy analyst at Raymond James. But any progress may take a while. Coons has yet to introduce his bill this session, and no committee hearings have been scheduled yet on the topic.

“We know there is at least some bipartisan support,” Molchanov says. “But this area is so narrow and technical that it’s not anywhere near the top of the agenda.”

Coons introduced his legislation, the Master Limited Partnerships Parity Act, during the last Congressional session. He told the Times that he plans to build support for the bill among fellow lawmakers before reintroducing it this year.

 

 

 

 

 

 

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