Tax incentives like the Production Tax Credit and the Investment Tax Credit have had a massive impact on the growth of renewables, but the possibility of direct pay also looms on the horizon. Sean Moran, a partner at the law firm of Vinson & Elkins, is here to dive into what lies ahead for the tax side of the renewables industry, particularly as projects expand into the realm of offshore wind.
Offshore Wind — The Current State of Affairs
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(Note: This transcript was created using artificial intelligence. It has not been edited verbatim.)
Sean McMahon 00:08
What's up everyone and welcome to the Renewable Energy SmartPod. I'm your host Sean McMahon, and today I'm going to be joined by another person with an awesome first name. Sean Moran. Sean is a partner at the law firm of Vinson and Elkins, where he specializes in tax and renewables. Tax incentives, like the production tax credit, and the investment tax credit has had a massive impact on the growth of renewables. But the possibility of direct pay also looms on the horizon. So Sean is here to dive into what lies ahead for that corner of the industry, particularly as projects expand into the realm of offshore wind.
I hope you all got a chance to listen to our last episode featuring John Powers from Extensible Energy and CalFlexHub. John shared a lot of great insights about load flexibility, and technologies being deployed to help commercial buildings reduce their energy consumption, and save business owners lots of money.
Looking ahead on the schedule. Well, looking ahead, we're taking a break for the holidays. This is the last episode of the show for this year, but we're already planning some excellent episodes for 2022. So I can't wait to see you again on the other side of the new year.
But for now, I'll be right back with my conversation with Sean Moran from Vinson & Elkins.
Okay, everyone, thank you for joining me today. My guest is Sean Moran from Vinson & Elkins. Sean, how're you doing today?
Sean Moran 01:31
I am good. Sean.
Sean McMahon 01:35
We're gonna have a lot of fun today with Sean talking to Sean here. Don't you think so? Sean?
Alright, so you're one of the tax gurus at Vinson & Elkins, you know, I'm bringing you in because I want to ask you a few questions about you know what the renewable space looks like right now. But first of all, I understand that you recently moved from California to Austin. So my first really, really important question is, how's the surf in Austin?
Sean Moran 01:57
The surf in Austin leaves something to be desired, you know, as opposed to California. And it was a great couple of years in California, actually. The Golf scene in Austin is quite tremendous. So there's been a segue from my surfboard to my golf clubs, just to have something to do outside of the office.
Sean McMahon 02:18
One other question for you, though. So what's your preference between Southern California Mexican food and Texas barbecue? Do you have an allegiance to one or the other?
Sean Moran 02:25
So my wife is born and raised in Texas. So there's we've had Tex Mex kind of as a family cuisine for quite some time. So I was quite accustomed to it and expecting it. And we've been enjoying it. It's hard to really pick any winner there.
Sean McMahon 02:42
I gotcha. Alrighty. So getting on to the renewables conversation at hand here. I want to spend a little bit of time talking about wind, and particularly a bit of offshore wind. So let's just get right into it. You know, the byte administration has set a goal of having 30 gigs of offshore wind by 2030. From where you're sitting, you know, do you think we're going to get there?
Sean Moran 02:59
Honestly, it's pretty ambitious. You know, I probably should back up a little Sean, kind of when we first started doing wind, it was thought to be ambitious as well. onshore, you know, the first transactions we did were back in 2000 to 2003 took a year to get the first transaction closed in Sweetwater, Texas, previously known as the rattlesnake capital of the world. And that was kind of like groundbreaking. And once we got the first transaction closed, they actually followed quickly thereafter. That was in Texas, then we were in Oklahoma, where New Mexico, California opened up Oregon, then we kind of segued to the East Coast, ended up doing wind transactions on lands over 40 states. So once it got started, it really went in earnest, we have a long way to go onshore to achieve kind of any of the goals with respect to carbon neutrality. But it's it's a work in progress, and people at least understand it.
Sean McMahon 03:57
Well, then looking back what lessons from the early days of onshore, what were the early stumbling blocks that you might see offshore is confronting right now. You know, what are the biggest challenges? It sounds like once you get some momentum, then it can kind of get going. But what's in the way of that momentum?
Sean Moran 04:10
I mean, honestly, it was, it was kind of the things you would expect it was the land siting, understanding kind of the regulatory regime, kind of within the localities that we're sitting in. On the tech side, it took a long time for folks to come to grips with kind of the structures that were being proposed and the risks involved with investing in in wind onshore. So that was a work in progress. We probably brought 12 or 15 new investors into kind of wind, just the main investors, there was a lot of folks kind of sitting on the periphery as well. And that was an education process, not only with the internal kind of credit committee's just in terms of understanding kind of investment in a wind asset, kind of an intermittent kind of performing asset. How are we going to obtain our returns? There was a lot of analysis that needed to kind of be entered into kind of with respect to the modeling and kind of just understanding sensitivities. I guess, long story short, we also had to bring along this area of the tax law, you know, was was relatively unchartered, you know, so we needed to kind of educate both the commercial folks just in terms of what and what they could not do, but also the inside tax lawyers at many of the large institutions to educate them kind of on what the issues were, you know, how to analyze your way through them. And the obvious one was, what is it its production tax credit is how the US government has kind of subsidized when for a long time. What is it production tax credit? Is that a piece of cash? Is it a tax item? What what is it? Can you count it counted in terms of your your economic substance and your pre tax return and that type of thing? That was like a novel issue at the time that was kind of old news back then required a lot of work to kind of educate folks and get them comfortable?
Sean McMahon 06:01
Okay, yeah, I definitely wanna talk a little bit more about, you know, the ITCs, and the PTC ease and direct pay and things like that a little bit later. But first, the Interior Department recently rolled out its plan for kind of building out, you know, offshore wind in the US and stuff on the Atlantic coast and the Gulf of Mexico pacific coast. Which of those locations from a legal perspective, do you think will be easiest to start standing up turbines?
Sean Moran 06:22
Let's talk about the East Coast. First, on the east coast, there's, as you're pointing out, right, 30 gigawatts of kind of interest. And that's even on the low side, I would have thought just in terms of kind of the capacity, the issues with respect to kind of offshore on the East Coast, or not so much the issues that we've struggled with kind of in the United States, although there's some parallels, the more have to do with kind of, where can the facility be sited and kind of the permitting process with kind of the federal government and the BOEM. Which is just generally a long process and requires quite a bit of environmental and practical kind of taking into account the stakeholders issues with respect to a sighting, there's issues with respect to kind of how the facility is built, kind of in terms of getting materials out to wherever the facility is sited. And that's the Jones Act, kind of, obviously, kind of with respect to what's permissible in terms of kind of delivering and building the facility. And then once you kind of get by even those challenges, then you have, how do we get the power back onshore, the so the early movers have a terrific advantage just in terms of identifying interconnects on shore, that are capable of taking the power that's being produced by the facility. So if you take the vineyard as an example, that is a transaction involving a developer, that's kind of an early mover, with respect to kind of obtaining the rights to interconnect and accessing substations on Cape Cod, right. So there's already an infrastructure available to move the power onshore, and then either provide kind of power to kind of locally Cape Cod, or there's even the infrastructure to get it to Boston and the surrounding areas say, that's the early mover. Now, if we have, you know, 10, more transactions following the transmission issue becomes far more challenging. That substation is not capable of obtaining that much power. So significant upgrades are required, infrastructure needs to be built, not only, you know, to kind of receive the power onshore, let's just say on the Cape, but also the infrastructure required to build to provide transmission lines to kind of Boston in the surrounding areas. So those are kind of daunting at the moment in terms of kind of the meaningful large development, something that's just not obvious with respect to kind of just wind power facilities as we normally think about it. I mean, if you go back to kind of the theory of kind of offshore wind, let's cite it near large populations, so that we don't have to worry about the transmission kind of coming from remote areas where when facilities are normally sited, that's only so good is kind of you managing kind of process with respect to getting transmission onshore. So Massachusetts, that's one example with with vineyard, right? If you go to New York, it's at least at the moment, the early movers are accessing kind of substations and interconnects on Long Island. So they're, again, moving the power from Long Island, kind of if you build out to kind of the magnitude in which you're thinking into the city and stuff like that, again, significant infrastructure. The two things that Massachusetts and New York have going forward is it's within the state in a sense They can decide just in terms of what's fair in terms of kind of who shares the burden of the cost with respect to kind of all of these upgrades that would be required. Now, if you could down the coast a little, and you're dealing with New Jersey and Pennsylvania, Maryland, Delaware, it becomes far more challenging because now you're crossing state lines. And you have parties that are not sure that they're benefiting from kind of the delivery of the power, and who should be bearing the cost of kind of these these large upgrades. That's kind of on the state level, if you will show up, the Federal at the moment does not have the ability to kind of impose its will with respect to requiring kind of transmission, particularly as it relates to crossing state lines and things like that. Mike Wigmore just published an article on that on our website, which is terrific, just in terms of outlining kind of where things sit with the states, and the issues with respect to kind of the federal government and kind of the current law as it exists, the flaws in the current law, what really needs to kind of occur on a go forward basis to, you know, have success here.
Sean McMahon 11:13
Okay, and we'll be sure to put the link to that paper for Mike in the show notes for this episode. So it sounds like you're talking about the, you know, the build out of a lot of infrastructure, and we've got to build back better legislation, you know, working its way through Capitol Hill right now. So which aspects of that do you see having the biggest impact on renewables.
Sean Moran 11:29
So the way folks have been thinking about kind of offshore for a while now, given kind of the significant cost is take advantage of the investment tax credit, right, which is an upfront credit available, one on kind of the qualifying assets. And just a pause on that slightly for a moment, the allocation of within asset classes is relevant, and not all have kind of a wind facility that's offshore will qualify for the the ITC, as it might want short, there's just because of all that infrastructure, we've been talking about being allocation to non qualifying assets, there's proposals to suggest that those should be included. But that's not quite on the books yet, or nor is any of this. So anyway, so you get your ATC as your base, where this is the it's going to be a challenge with the offshore just given the size of these deals and the cost involved. That is a lot of tax credit for folks, for investors to put on their tax return. Right. So you can't just have one fellow on a billion dollar facility having $300 million of tax credits, they probably don't have the capacity. And they probably don't have the interest to have such a large investment just in one particular transaction. It's not diversified within multiple transactions, diversifying risk, diversify, and kind of who the off taker is the locality with respect to casualties, all that type of thing. Probably the most important provision in the new proposed legislation has to do with direct pay. And the fact that you can, you don't need to use somebody's tax return, you do in the sense that it's kind of a, a deemed payment of a tax and the refund there of, you know, as you would on your own return, but to not have to kind of go out and kind of exhaust the Tax Equity community. With this many transactions with this larger credit, to be able to kind of turn to direct pay could be just a game changer entirely with the success of kind of the build out.
Sean McMahon 13:35
Real quick, just jump in there. So so a lot of our listeners aren't experts on on the tax side of it, just you know, to be square. So what are the basics of how the ITCs and BTCs work and you know why the direct pay would be so much sounds like more beneficial?
Sean Moran 13:48
It's good question the so the investment tax credit, it's coming on in the tax code since the Kennedy administration type of thing, it's expired a bunch of times it's back in there is a credit against your tax. On the day a facility is placed in service. So and the credit is 30% of kind of the qualifying kind of assets. So billion dollar facility, let's assume that, you know, 100 million qualifies for the ITC, you put on your tax return on the day the facility is placed in service $240 million of credit against your tax liability. Inherent and all that right and obvious is you need extremely large tax payers, right, that have giant bills that are willing to kind of invest in these types of transaction. And there are no no's.
Sean McMahon 14:40
You don't have that kind of tax liability yourself there.
Sean Moran 14:45
And there are those institutions. There are some very large institutions that are extremely active in wind and solar these days that are candidates for this type of thing. But it does kind of exhaust their ability to invest in onshore and Other kinds of green kind of technologies, if you sum it all up kind of just in an offshore deal, the PTC production tax credit, which is also available for offshore is a credit that's generated as power is produced, right is kind of the name suggests. And that credit runs for 10 years. And it may or may not equate kind of, it's probably actually going to be larger given kind of how strong the wind would be the capacity offshore with respect to kind of wind and the production. So the PTCS are probably over the 10 year life of the PTCS in excess of the ITC, that 30% credit, but they come in over time. And when you're dealing with an extremely expensive asset, you know, time is not your friend, you really need to kind of come up with kind of enough the resources to kind of pay all the construction costs and the turbine suppliers, the shipping the infrastructure, we've been talking about all that type of thing. So the natural kind of thinking of folks on the developer side is that they prefer the EITC, they get all that money upfront, instead of having to wait for the 10 years for the ITC to be produced. So there's a bit of tension there, the investors would probably prefer the PTC because it doesn't use up so much of their tax capacity so quickly. So those are the two credits, the direct pay, if you're entitled to these credits, it doesn't matter if you're tax investor, or you're the developer, if you're entitled to these credits on the qualifying facility, you're entitled to treat the credit as if it's a payment of tax and obtain a refund on your tax more or less the basics. So it takes the pressure off of needing kind of that much attacks investor conceivably, as well as kind of the tax capacity. The weakness with the direct direct pay is it's not instantaneous, it can take quite some time placed in service, the filing of a return, it could be as much as 24 minutes, probably not 24 months, but kind of 18 months type of thing of time delay. And you don't take advantage of a lot of the other tax benefits that come along with kind of an offshore wind facility depreciation.
Sean McMahon 17:16
So what other kind of companies or industries and you mentioned how like, right now you're kind of limited to the firms that have this this tax liability with direct pay, what kinds of companies or industries does direct pay kind of bring into the fold in terms of investing in all these renewable projects,
Sean Moran 17:32
it broadens the market just in terms of opportunity. The tax investors, the big investors kind of that have the tax capacity are still going to be incredibly active. But they've only got so much to spend, which leaves kind of on on kind of the numbers we were talking about at the outset that that 30 gig, it leaves a lot of those transactions wanting for tax equity. And it being a bottleneck with the direct pay those developers at least and the construction lenders into those projects, can have confidence that, you know, once the facility is placed in service with this slight delay, let's say the 18 months or something like that, the cash will be coming into the transaction as a would happen with the tax equity investor. So it makes it the market a lot of transactions that just may not have kind of gotten close. Now you can kind of think about Yep, actually, we can do the transaction based we can have the model and the economics kind of all kind of support kind of the substantial investment. So it's on the developer side, in a way, Sean and the sponsor side, those are the fellows that you know, are going to most benefit from the direct pay in terms of just opportunity and not building, you know, held in need of a tax equity investor.
Sean McMahon 18:52
I understand. So now you want to pivot real quick, you know, we were talking earlier about, you know, the areas in the US where, you know, the Interior Department and by the ministration wants to build out offshore wind. And one of the things that caught my eye was that site from the Pacific, a lot of those other areas, there's either long standing or, you know, more and more hurricane activity. And so, research conducted and again, this is the most recent recent thing I found was probably like 2017 in terms of the strength of wind turbines, you know, these offshore wind turbines can withstand, like category three, maybe category four hurricanes, there's Category Five hurricanes that could come barreling through. And so how are these developers managing for risk like that? Cuz I mean, the nightmare scenario is, you know, you build out this farm and a year later hurricane comes through and footage of a busted up turbine is looping on cable news over and over and over again. So right so what kind of thoughts being put into that either the deal structure or you know, how our developers like I said, managing that risk,
Sean Moran 19:46
So I can't I can't really speak to the technology side of it and withstanding kind of the impact of the of the Category Five. What I can say onshore, both for solar and wind. We have been Spring seemed kind of some devastating storms, and where it's really kind of started to kind of open some eyes. And they're kind of in some situations, you know, the one in 100 year events, and now they're happening every five or 10 years type of thing is not only kind of revisiting kind of, you know, the quality of your turbans or your solar installation or something like that, what is what is available in the insurance market, frankly, and insurers have started to kind of step back, increase the deductibles and increase their overall exposure, that with limits and such, it's something that is, I think, fair to say, at this point, Sean is still developing in terms of how the insurance community is going to kind of participate kind of an ongoing basis. And then within the transactions kind of where the risk is allocated, the investors that are just coming in to provide the monetization of the tax credits or something like that, obviously have their view and want to kind of require repairs and reconstruction, if required, and the sponsors are just are just coming at this light, you can't require me to rebuild an entire facility type of thing, that that's just not practical. In the most extreme sense, let's just kind of deal with the commercial and the business reality. At the time. When this gets really super challenging, Sean, if an ITC is elected, or even the direct pay, they're running recapture provisions that come along with those type things. So a facility if a facility goes out of service within say, the five years in which a facility is placed in service, a recapture occurs, it's kind of on a declining basis. So here, you have a bad storm, it's bad enough, and now you're faced kind of, you know, with recapture liability to the government on top of that, so the stakes are high. So you're right to focus on it. I don't know if anybody has kind of the elixir here to get the kind of suggests that this is the easy path.
Sean McMahon 22:05
Alright, well, I appreciate you kind of least laying out the not the technical side, but the legal side and things like that. So, and we spend a lot of time talking about offshore wind, but also, you know, you're in a team at V&E. So you know, what types of projects? Are you seeing the most interesting from clients? Like they're coming to you with questions about solar, wind, hydrogen, what's what's the hot topic right now, with new clients that come to you?
Sean Moran 22:25
We've got investors and developers in all types of energy, if you will, they're the questions are kind of dealing with just a whole the whole energy transition spectrum, which is exciting and fun and everything like that. It's the one thing kind of just in terms of where all of this is going to go. Obviously, offshore is as hot topic, as you can possibly imagine, just in terms of the developers and sponsors and kind of the tax equity investors just in terms of this, this is just inevitable, right? Wind and solar is still kind of pretty much were flat out with respect to kind of helping investors for the most part, investors, finance those facilities. And now with kind of the legislative proposals, we've got another potential 10 years of those in the future, there's a tremendous amount of interest in its 45 Q is kind of the tax code provision, its carbon capture, right? If you think about kind of historic clients of vieni, and kind of the entire carbon intensive industry and the facilities and such, they are all trying to decide how they're going to become carbon neutral at some point in time. And whether they can take advantage of the subsidies that are available in 45 cuted, to capture carbon. So there's a tremendous amount of interest with respect to those type transactions, they're still it's still in the early stages, but those are happening. Hydrogen is if you think about how we're going to kind of become carbon neutral in the future, we need to deal with all the heavy transport industry, shipping, aviation, steel cement. And the thinking is, to an extent hydrogen could contribute this, you know, a significant amount towards kind of becoming more carbon neutral, again, that that's something kind of down the road. But there's quite a bit of interest these days, just in terms of the opportunity there.
Sean McMahon 24:33
Alrighty, and we were talking at the top of today's conversation about your relocation from California to Austin. And I saw when I was doing my research here that you're going to be teaching a class for the next generation of folks are going to try to finance all this climate infrastructure, and you taught me a little about that.
Sean Moran 24:48
Sure. The course is basically a lot of what we've been talking about. The name of the course is financing the energy transition, right. So if you think about this topic, Transition kind of any start to kind of step back and kind of start to run the numbers on what is involved with the transition, it's trillions of dollars, it's anywhere, if estimates on the conservative side, let's just call it $50 trillion. And then on the more realistic, it's in the hundreds 100,000,000,000,200 50 trillion, just staggering, right? That's larger than the US capital market, it's larger than the world capital market, just in terms of, you know, the US equity market is $40 trillion. So just so you have points of reference, kind of when you start playing with all those zeros, so how are we going to finance all of this stuff, and it's a lot of the things that we've been touching upon, right? Transitioning, wind and solar are only contributing kind of 8% of kind of the the energy usage kind of here in the United States at the moment, the thinking is that that needs to go to 45 to 55%, over the next 15-20 years. So what I'm hoping for is to educate folks just in terms of how, you know, when finance or finance works, offshore works, what the issues are, what they need to be mindful of what opportunities exist, things that need to be fixed that, you know, hopefully, they can lend a helping hand kind of with respect to improving the way we do things. But then also educating them on all of these other, you know, carbon neutral type things we've been talking about right, and we hit on hydrogen, we hit on carbon capture, we haven't talked about kind of all the innovative energy facilities that are part of proposed legislation, the nuclear facilities that are part of the proposed manufacturing facilities, all of these other things, the course is intended to just kind of folks open their eyes in terms of what's required, and then what's involved with that financing, and where they can kind of have a career or contribute one way or the other type of thing.
Sean McMahon 26:56
Well, that sounds like an awesome class. And obviously, you're dedicating your time there to educating the next generation of experts on how to how to manage the energy transition. So let me just ask you this, do you have any bold predictions about what the future of you know, the renewable sector looks like and say, 10, or 20, maybe 30 years down the road,
Sean Moran 27:14
I try to stay away from kind of the downside here, if we don't get this, right, because it's pretty gruesome, I do believe and follow the science. And, you know, we can kind of see it around us just in terms of the powerful storms. So I'm, I'm of the mind that this has to happen. And we have to do it kind of collectively. And we can't be just relying on kind of governments to provide, they can contribute and kind of maybe, maybe motivate behavior. But it's really all of us with respect to wanting to kind of improve the environment and preserve the environment. So it's a groundswell of activity that I believe this is, we have to do it. And we will do it that once we have the conviction, and we have an issue that we understand kind of collectively, that we will work towards it. We see it with all of our clients, they've really kind of actively transition for the last five years, really, it's not just happening today, that seeing this coming, realizing what's involved, but starting to position themselves to actually execute on the plan. So I'm very bullish, that will pull it off, it's gonna be a grind. There's a lot to occur.
Sean McMahon 28:22
And listen, I know we're about out of time. So I just want to thank you for all your insights today. I really appreciate it. I hope you continue to enjoy the the new sights and sounds of Austin.
Sean Moran 28:30
was my pleasure. Good talking to you, Sean.
Sean McMahon 28:34
Alrighty, well, that's our show for today. As I mentioned at the top, we're taking a break for the holidays. So I hope you get to enjoy some quality time with your loved ones, and I look forward to bringing you more episodes in 2022.
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