For many renewable project developers, the end of 2010 brought back memories of the anxiety-filled days of the so-called "PTC cliff"—when developers would race to bring projects online before the latest year-end expiration of federal production tax credits. But this time, instead of having to push wind power projects into commercial operation, developers were rushing to start construction of their wind and solar projects before year-end to qualify for valuable cash grants from the Department of Treasury under an expiring program in the 2009 American Recovery and Reinvestment Act ("ARRA").
Generally, under Section 1603 of the ARRA, renewable project owners could receive a Treasury cash grant, in an amount equal to 30 percent of eligible project costs, as long as the project "commenced construction" prior to the end of 2010. A last-minute one-year extension of the cash grant program brought a collective sigh of relief from renewable project developers, but such relief is almost certain to be short-lived, as prospects appear dim for a further extension of the program. Absent another extension, the various methods devised by developers to qualify their projects under the cash grant program will surely be revisited for projects expected to enter the construction phase in 2011.
Jones Day was involved in several solar and wind power projects in late 2010 that sought to qualify for a Treasury cash grant. For example, the Firm advised KeyBank National Association on a $24 million project financing for Western Wind Energy Corp.'s proposed 10.5 MW combined wind and solar power facility in Kingman, Arizona. The Kingman project, consisting of 10 MW of wind energy and 500 kW of solar photovoltaic (PV) capacity, is believed to be one of the first "hybrid" wind and solar energy projects to reach financial close in the U.S.
The senior financing package included a $16 million, one-year construction loan, convertible into a seven-year term loan at commercial operation, and a $4.2 million bridge loan to be repaid with the proceeds of the Treasury cash grant. The KeyBank loans are secured by a first priority lien on the assets of the borrower/project owner (a wholly owned subsidiary of Western Wind), including all cash grant proceeds. The package also included a $4 million subordinated loan provided by a vendor, secured by a second lien on the cash grant proceeds and other assets of the borrower. Tucson Electric Power Company, a subsidiary of Unisource, is purchasing all of the energy and renewable energy credits from the Kingman project under a 20-year power purchase agreement.
Western Wind considered a variety of options for qualifying for the Treasury cash grant, based on the Treasury's published guidance on what it means to "commence construction" of the renewable energy project. One method for a developer to satisfy the "commenced construction" requirement under the guidance (referred to as having begun "physical work of significant nature") generally relies on actions, backed by contractual representations, from equipment vendors or construction service providers either to begin to fabricate the project's equipment or to perform substantial physical work at the project site during 2010. Ultimately, Western Wind opted to qualify by showing that the Kingman project owner and the project's wind turbine supplier had contractually agreed to begin fabricating the wind turbines prior to year-end 2010.
Under the Treasury's guidance, the second method by which to qualify for the cash grant involves a more objective, safe harbor test. Under this approach, a project qualifies for a cash grant if more than 5 percent of the project's eligible costs were paid or incurred by the project's owner (or by its contractor, under a binding written contract) prior to the end of 2010. For example, Jones Day represented Chevron Energy Solutions Company ("CES") in connection with its design and construction of approximately four MW of solar PV energy facilities at three campuses of the Los Angeles Community College District.
Citibank N.A., the owner and lessor of each solar project, required CES to demonstrate that it had paid or incurred in 2010 costs relating to each project equal to at least 5 percent of such project's costs. CES met this obligation by making payments in the required amounts to the PV solar panel vendor in December 2010. CES and the vendor carefully documented the arrangements for the purchase, payment, and delivery of equipment to the each project site (which had to occur within three and a half months of payment for the payment to qualify as having been "incurred" in 2010) to comply with the Treasury's guidance.
The "physical work of significant nature" test is somewhat subjective and presents a number of commercial, legal, and technical challenges to ensure it has been met. Most renewable project developers have opted to qualify their projects for the Treasury cash grant using the alternative "5 percent safe harbor" method.
Given growing doubts that Congress will pass energy policy legislation in 2011, many renewable project developers fear that the Section 1603 cash grant program will end this year. Developers' biggest fear is that the market for energy tax credit investing, though recovering, may not have the depth to provide the capital necessary for projects that are not due to enter construction until 2012. It is likely, therefore, that developers will be dusting off their Section 1603 compliance strategies in another push to "commence construction" of those projects by year-end 2011.