Ep353: Navigating FEOC and Tax Credit Uncertainty

Welcome to Currents in North and Rose Fulbright Podcast. Today we're recording with Dorian Hunt of Leo Berwick. Dorian joins us today to discuss the current state of the renewables market and in particular some of the regulatory aspects, tax and other legislative matters. Dorian, welcome to the podcast. Thanks for having me here Todd. It's a pleasure. All right, so we just did a podcast on this because we get so many questions on it, so I'll take your view on it as well. The recently enacted, fairly recently enacted FIAC restrictions have caused a lot of uncertainty in the market. People aren't sure exactly how to comply with them and what they need to do and bunch of the regs aren't out yet. The developers that you're consulting, what are they doing given the uncertainty and maybe you can explain also the implications for not complying so that people can understand the magnitude and importance of complying. Sure, sure. Yeah, and it is really an important issue that has ramifications for the availability of tax credits for these renewable and energy transition projects. So what we're seeing is our developer clients, of course, many of them accelerated start of construction as fast as they could in order to at least avoid what they call the material assistance prong of the FIAC limitations. So FIAC limitations have three prongs as material assistance, which has to do with your supply chain, where you're sourcing your equipment and your components, but also the other two prongs are ownership and effective control. Now the guidance that came out recently, notice, 2026, 15 gave us more clarity on how we can approach compliance with material assistance for those projects that did not begin construction prior to January 125. So I'm seeing lots of my developer clients think carefully about the certifications they're getting from their vendors and whether they have reason to believe that those are not accurate or if they're missing information. And what I'm seeing is kind of an evolution of development of the market standards around the documentation required for the cost safe harbor, the identification safe harbor that's outlined in that notice. Now that guns really did help with the supply chain considerations, equipment, and whatnot, but then we're still wide, you know, out in the open and all really only have the statute from the one big beautiful bill act in order to allow us to interpret what what the implications might be for ownership and effective control. So we have lots of theories about how it's going to shake out and you know, the some curious wording at least to me in the statute around, for example, the ownership considerations, which make reference to 318 A2, the attribution rules for stock ownership and having that inform what is going to be considered a prohibited foreign entity under the FIAC rules. And you know, normally this 318 goes both ways when you're doing attribution. It's up and down upstream and downstream, right? But here these rules only make reference to the principles of one of those directions. So you know, we're trying to understand what that could mean in terms of ownership. But a big picture, most developers and kind of stakeholders I talked to are optimistic that the complying with those ownership prongs, you know, maybe, maybe achievable and we're optimistic that the forthcoming guidance will be favorable. But I think the third prong that effective control, you know, is broader than just that strict ownership. And I think that it deserves a more inclusive and broad examination of your arrangements across, you know, the entire project life cycle to understand whether it's going to limit the availability of these incentives. Do you feel that the lack of clarity is at all impeding development? Or do you think that people understand that it's there and they're kind of putting it to the side for the moment and charging ahead and kind of monitoring it? Yeah, it depends. I mean, I think some situations are, you know, there's very little risk based on all the known information that you're going to run a file of these rules, right? So there's some projects that are in that bucket and there are some that, you know, maybe there is a little bit more uncertainty. And while I wouldn't say that development on those projects has halted, it has really put some friction into the system that can make it more difficult to get deals done. So, you know, for example, tax credit insurance has become really popular over the past few years, right? And we're seeing most tax credit carriers, tax credit insurance carriers not wanting to, you know, buy and coverage in connection with these FIAC limitations until that guidance comes out. So we have this, this situation where, you know, perhaps the binding of insurance is a condition precedent for, you know, other, other, you know, aspects of the project financing to move forward and, you know, that coverage won't, won't be bound until, until that guidance comes out. Yeah. Like I said, I wouldn't say that it's halting the development of projects because these projects need to get built. Like we just have power demands, right? And, and this is renewables are the fastest way to get kilowatt hours on the grid. But it's certainly in, from my perspective, adding friction onto these deals and will continue to do so until we get that, get that clarity that allows us to eat, at least know the rules of the game. Do you see that the FIAC rules are impacting whether people elect to take the PTC or the ITC? Well, so, so I think that the recapture implications, right, of the FIAC rules, I see those as implicitly discouraging ITCs just because of the open-ended risk there. And you know, for these, for those technologies where it's possible, right? I think that, and for those developers that can withstand waiting for the delivery of the PTCs, you know, I think that, you know, they may be, I am seeing some developers kind of kind of take a second look at those PTCs and wonder if they can make it work, if they can make it pencil out. And, and like I said, you know, would stand the timing implications of a 10-year delivery schedule, for example. Okay, so let's move into the tax credit market a little bit. You know, we talked about FIAC, but these are huge tax credit transfer market out there. One towards the end of last year, the market seemed like it was softening. And as the market firmed up again, what do you see for pricing? What do you see in general for the markets? It's still healthy. And how do you think it's going to change over the next year to 18 months, given the change in the availability of credit? Yeah, yeah. So I think that the, I think the market is healthy, right? But there are, you know, that's softening in price we observed, you know, at the end of, at the end of last year. I tend to think that might be just more of a signal of a maturing market, right? Because I think the prior to the one big, beautiful bill act, there was the expectation that those transferability provisions weren't going to be retained. And the ability to purchase credits under Code Section 6418 was going to dry out. But I think once it became clear, after the passage of the one big, beautiful bill act, that wasn't going to be the case, then, then maybe that, you know, that urgency around participating in the market, die down a bit, right? And, you know, with that at least reduction in punctuated demand, right? It's just naturally going to have a softening effect on the pricing. But there are other factors too, right? So we have research and development, expensing and bonus, more bonus depreciation opportunities, which I think, you know, would are having the effect of just more broadly reducing the tax appetite of those would be tax credit purchasers. So I think that it's issues like that in maybe a handful of others that, that I think are driving that, that's softening in the market. But I'm still seeing, you know, anecdotally from where I sit, lots of lots of activity across the spectrum, whether it be ITCs or PTCs, you know, lots of 45X manufacturing, 45Z sustainable fuels, plays and transfers in that space. And I really think that because it can be such a rich opportunity, particularly for those tax credit purchasers, buying those credits at a discount that, that I expect the market to to persist and, and, and transactions to keep taking place. You mentioned one thing that facilitates the market is the availability of tax credit insurance. So that the purchaser doesn't have to get into the same level of diligence, they just shift that risk onto the insurer. Given things like the uncertain nature around FIAC and just the general basalations in the market is, is the tax credit insurance market available for most deals? And how are you seeing that market adapt to the changing risks in the market? Yeah, so I mean, what I'm seeing is the tax insurance carriers are really eager to, to be able to provide the type of coverage that the developers of these projects are looking for. It's just that, you know, they need to be prudent and, and, and they can't, they can't enter into these arrangements with a significant uncertainty and they can't, they can, you know, aggregate a bunch of risk on, on a particular issue on their books. So, but, but I do think that, you know, there is some friction in the system to the extent that the lack of clarity in things like FIAC guidance are slowing deals down. But I am optimistic that once we do, again, know the rules of the game that, that the insurance carriers are going to, are going to step up and offer the product that, that the market wants, which is, you know, oftentimes it's these full wrap policies that, that cover, you know, any sort of potential downside with respect to the credit. So, I tend to think it's just a matter of time before the ground is stable under everyone's feet and, and we know the moves to make. And I do, I do, I do expect that to stabilize, right, and reintroduce that confidence in that type of transaction. Okay. Talking about risks in, in terms of the structures, one thing that's very common is, for ITC transactions to have a sale from a DevCoSide to a tax equity partnership to create a step up in the basis and then money has to flow from the tax equity partnership side to the DevCoCeller to fund or might mean money doesn't have to flow, that's kind of where my question's going. There has been a way to justify that step up in basis and show that it's real. There have been some recent developments there. What do you think is accepted practice today and maybe you could tell us about some of the recent developments? Yeah, sure, I do have it to you. It's really, you know, it is an important issue that appears in any almost any every variety of tax equity structure that involves investment tax credits, you know, whether that be traditional tax equity or hybrid or prefect equity structure, there's an appetite typically in a willingness to sell the asset at a fair market value that was in excess of its cost to build. But as you mentioned, those transactions between say a development company and an operating company or a tax equity partnership are effectively have entities that are owners in both. So this is a related party transaction aspect to those transactions and those can I'm over the view that there's a right way to do those things and a more risky ways to do those things. But to me, it boils down to the perception of economic substance. So I always try to say, okay, what is the rationale for doing these transactions apart from the realization of more investment tax credit? Right? What is the real business purpose for these transactions taking place? And you can think of things like, okay, you have a different DevCo and OpCo silos and they don't have the same type of ownership. They have different risk profiles. So different businesses, you know, developing assets is one thing owning and operating assets, monetizing credit is another thing. It's the reason that those should have different expectations around the delivery of benefits, the realization of value from the projects with the DevCo being, you know, from the sale, you know, build and sell and the op-go, being from the ongoing operations and the credit monetization. So if you have that kind of differentiated ownership and a real story, right? Not just checking the boxes, but a real narrative around, okay, what's really happening here that goes above and beyond the obvious desire to have more tax incentives in the mix and being able to build out that narrative and that story, I think is crucial. But then, you know, there are other mechanical components that I think make it less risky, you know, including things like avoid circular cash flows, right? You don't want the money going left pocket, right pocket, same day, same guy, right? With, you know, straight no strings attached, right? I think there's better ways to do that. So if the cash goes over to the DevCo, is that going to be used for, you know, have a policy in place that that's used to the development of a pipeline of assets as of the DevCo is living up to that premise that it's its own standalone, you know, business that that operates of its own accord, of its own volition with its own goals that are separated apart from the op-code. And if there is a need to kick cash up, maybe an acre dividend is in the right way to do it. Maybe you institute things like shareholder loans, right? Doing, I think it goes a long way in addition to the narrative to to kind of build up those features that break that circularity. But even in a lot of cases, you know, the circularity, it may be the case that a developer doesn't have that cash on hand or can't raise it to even circle the cash, right? So what do you do in situations like that? And then, you know, maybe you start looking at at other structures like notes payable that are exchanged in part for the acquisition of an asset. And, you know, is that a bona fide piece of debt? You know, how do you show that that's, you know, really going to get going to get paid over reasonable timeline, does every reasonable terms, and is the economic drag implied in something like that worth it for the additional, you know, tax incentives that we expect to extract. So I think that this has always been an issue, right? Ever since the old days, so I've been doing tax equity for like 20 years now, right? And it used to be cash basis developers doing deferred development fees, avoiding the income on one side and gradually recognize the basis on the receipt of cash on the other side. Then we had things like California Ridge, Bishop Hill that just some words in there, you know, caused the market to move over to this kind of Devkoopco structure in large part and the sale transactions. And what, well, I think there's more more clarity and more opportunities for the value to be realizing those types of transactions. Like I said, there's a right way to do it and, you know, ways that that might introduce more risk into the transaction. And while it's not perfectly on point, you know, I've been looking at this Liberty Global Inc. kind of a basis case, you know, not really to renewables, but, you know, it's an economic substance kind of adjacent case that the way I read it, it could be used as a platform for taxing authorities to reconsider, you know, historical approaches to either disregarding or respecting situations where you have, you know, circular cash flows or related party transactions or the like. So I don't think it's an issue that's going away. And I do think that it's in the best interest of all stakeholders in the industry to be careful about it. And again, for me, the primary point is that narrative. I could be the justification of the business purpose for why you're doing this. And it should be about more than the credits. All right. In the time we got left here, let me ask you a few questions you can answer quickly here. One is based on the big, beautiful bill, some of the credits are surviving some are not. And how have you seen credit eligibility change the focus on the types of technologies that people are looking to develop going forward? Yeah. So, so I think that I have seen a kind of uptick in transactions that are for credits that didn't get truncated or curtailed in the one big beautiful bill act, you know, or damaged in large part. So things like 45Z sustainable fuel transactions, fuel cells, which can be really compatible with these behind the meter, you know, data center type of installations, more flexibility on geothermal. Like heat pump leasing, right? An exemption from the limited use rules. And also 45Q carbon capture kind of that equality between, you know, the credit pricing for permanent sequestration and the commercial use pathways. So I have seen kind of an uptick in those types of credits, oh, as well as, you know, advanced manufacturing, right? 45X. How about repowering? You know, some of the wind turbines now that's been around time. Yeah. So repowering, I also, you know, I think that I am seeing more appetite at least investigating wind repowering and I think that's driven a little bit by the maybe difficulty in getting, you know, for example, wind projects with rich, you know, resource quality or, or they can be developed in a way that works in our modern, you know, permitting environment. So I think that I am seeing more of an appetite for, you know, making the most of those sites that you already have and potentially pursuing repowers to, you know, potentially get the additional stream of credits to. And again, you know, those repoweres is right way to do it and ways that they carry more risk. And it's very, it's a very nuanced type of analysis. And I think we just, you know, every time you look at one, it shouldn't be stamped out. Every deal needs to hang out its own facts. All right. Last question for you. Asked to speculate a little bit. Yeah. What's your view on the recently introduced American Energy Dominant Act? Well, that's interesting, right? I mean, it's all kind of coming out of what happens in midterms, right? But I was, I can't say I was surprised that, you know, those introduced by the House Republicans just because before the one we beautiful bill act, we all knew that that's so much of this IRA money was going into, you know, red districts, right? And I think maybe it's becoming clear with project cancellations and slowdowns and the job is not being there that maybe this, this kind of curtailment, this, this clawback of these incentives is really not what their constituents were after. And I do think it's a, it's a glimmer of hope that for those that benefit from incentives for renewables that that we saw that that bill introduced. But, you know, we'll see how it goes, I mean, it really just probably obvious to say, but shakes down to what happens in midterms. All right. Thanks for joining with us today, Dorian. And we'll get back at it here maybe once we get some fiat guidance. All right. Yeah. Yeah. I'd love to talk again if we get the chance. Thanks so much, Sean. You can find us online at www.projectfinance.law or send us an email at [email protected]. Please rate, review and subscribe on Apple podcasts, Spotify or your preferred podcast app. Our show today was produced by Emily Rogers. Stay ahead of the currents.