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Energy generated from renewable resources � such as wind, sun, waste, geothermal heat, and water � is one of the fastest growing segments of the energy industry. It is generating buzz in financial and legal communities and creating new challenges for energy and finance lawyers. The growth of this “green energy” sector is being fueled by a convergence of diverse commercial and legal factors, including the following: • Renewable portfolio standards. A growing number of states (19, at last count) have adopted “renewable portfolio” standards requiring that a minimum percentage of the state’s power be generated from green sources within established timetables. For example, New York requires that 25 percent of its power come from renewable sources by 2013, while California requires that 20 percent of its electricity be produced from renewable sources by 2017. • Tax incentives. Federal production tax credits were recently renewed for most technologies, including wind, closed-loop biomass, open-loop biomass, geothermal energy, solar energy, some small irrigation power, and municipal solid waste. The inflation-adjusted credit for wind, solar, closed-loop biomass, and geothermal projects in 2005 is 1.9 cents per kilowatt-hour, with the others listed receiving half that amount. A 10 percent federal investment tax credit is available to businesses that invest in or purchase solar or geothermal energy facilities in the United States. Yet owners who claim such an investment tax credit cannot also claim the production tax credit. In addition, some states have adopted state corporate income and property tax incentives that supplement the federal tax incentives. • Emissions reduction credits. Despite the failure of the United States to ratify the Kyoto Protocol, several states and regions are moving forward with greenhouse gas reduction programs, which may create additional revenue streams for renewable energy projects or utilities wishing to phase out plants with higher emissions. For instance, the Massachusetts multi-pollutant cap on utility emissions allows utilities to meet their carbon dioxide emission reduction targets with credits generated from the emission reductions achieved by off-site renewable energy projects. Regional greenhouse gas trading programs are being developed in the West and in the Northeast. The implementation rules have not yet defined the role that renewable energy can play in achieving these targeted reductions. • Fossil fuel prices. The recent increases in fossil fuel prices are making new projects that use conventional fossil fuels more costly. • Technological advances. New technologies have increased the efficiency, profitability, and competitiveness of key sectors of the green energy industry, including wind and solar. • Green corporate policies. Even traditional energy companies are finding public relations value in promoting themselves as “green energy” companies � in some cases despite decades of not-so-green conduct. FINANCIAL ENTHUSIASM Some industry analysts have touted the growth in the renewable energy sector as being comparable to the ramp up of the Internet in the 1990s. This exuberance is attracting the attention of equity investors and lenders from across the financial and political spectra. Equity players have included: large oil and gas companies like BP and Shell; major power companies like Florida Power & Light, GE Wind, and AES; major investment banks like Goldman Sachs (which recently acquired a wind-energy development company); and energy investment funds. In addition, both high-net-worth individuals and smaller investors have jumped in, driven in part by altruistic motives to help the environment and break fossil fuel dependence � while still seeking healthy returns. As in the early years of the Internet, it is difficult to tell which of the myriad startups will succeed. Renewable energy funds are being created to allow investors to diversify the risks by investing in baskets of such companies. On the debt side, private sector banks, export credit agencies, and multilateral lenders have also been working to position themselves in this sector. For example, both Citigroup and Bank of America have announced policies and programs supportive of renewable energy. The U.S. Export-Import Bank is actively promoting its program to support the renewable energy sector in a manner consistent with its pro-U.S. export mandate, including the possibility of offering longer repayment terms. In fact, under an international agreement effective July 1 (for a two-year trial period) among the members of the Organization of Economic Cooperation and Development participating in the Arrangement on Officially Supported Export Credits, the bank will be able to offer up to 15-year repayment terms in certain cases. The International Finance Corp. has also been developing special initiatives to accelerate the market penetration and commercialization of these technologies � possibly in some cases even using “concessional” (i.e., below market-rate) funding. SPECIAL CHALLENGES Financing renewable energy projects in many respects follows the same principles used in financing power projects burning conventional fossil fuels. But renewable energy also gives rise to special challenges: • Unpredictable revenues from intermittent resources. Lenders seeking to finance power generation projects typically look for a fixed revenue stream from committed power sales to support the debt service payments. For a fossil-fuel-fired power project, a power purchase agreement would ordinarily include a provision for “capacity payments” � fixed payments (often subject to escalation) for reserving plant capacity � which reflects in part a pro rata sharing of the facility’s fixed capital and operating costs. At the same time, a different agreement with a fuel supplier would also cover fuel supply risk. Some renewable energy projects rely on less-predictable intermittent resources, such as sun and wind, for which by definition there is no fuel supply contract to provide economic damages if such resource is unavailable. This translates into greater reluctance by utilities to offer capacity payments. The resulting lack of a fixed revenue stream may lead lenders to boost equity requirements, increase the cost of debt, or simply stay away. Some sponsors of renewable energy projects have tried to mitigate this uncertainty and to obtain capacity payments by combining intermittent resources with conventional fuel technologies (e.g., a solar or wind facility backed up by a natural-gas-fired system). But utilities have become increasingly wary of such combinations, fearing that plant owners might try to manipulate the system by choosing to produce “brown power” when it is more economical to do so even when they are capable of producing “green power.” • Uncertainty of tax incentive regime. Every dollar counts as the renewable energy industry claws toward competitiveness with conventional fossil-fuel-based technologies. In some cases, the availability of federal tax incentives can make or break a project. Unfortunately, federal renewable energy tax incentives over the last two decades have been subject to numerous cycles of short-term renewal and expiration � a real problem in an industry that typically seeks financing on the basis of 20-year power purchase agreements. Reflecting this inconsistency, some sectors of the industry, such as wind and solar, have suffered dramatic boom-bust cycles, with sponsors rushing to complete projects before the incentives expire, followed by lulls in development while waiting for new incentives. Even projects already on the ground can be at risk. In the 1990s, instability in the availability of federal tax incentives may have contributed to the drying up of credit that led to the bankruptcy of nine solar electric generating plants owned by Luz International in California. Unfortunately, the outlook for federal tax incentives remains uncertain. The current production tax credit is available only to facilities placed in service before Jan. 1, 2006. The new energy bill proposed by the Bush administration does not contain any increased incentives for large-scale renewable power. Sen. Lamar Alexander (R-Tenn.) has introduced, however, new legislation increasing the investment tax credit to 30 percent for the next five years for certain solar projects and extending the production tax credit to 2010 for solar and geothermal energy. • Uncertainty about emission credit regimes. The Kyoto Protocol would have pushed the United States to develop a national market for trading emissions reduction credits. The U.S. withdrawal from the protocol has thus deprived the renewable energy industry of a major potential source of revenue. In those U.S. states or regions where such credits are already available, such revenue potential can have a significant impact on financial prospects. And the value of these credits should increase as the rules become more certain and the prices become more predictable. Some utilities have recognized the potential value of these credits and are seeking ways to participate to the detriment of sponsors of renewable energy projects by requiring that producers share or transfer to them such credits. In an evolving industry where every dollar counts, such requirements can have the effect of suppressing new investment. In this way, they arguably run contrary to the objectives of the states’ renewable portfolio standards. • Technology and production risks. Rapid technological advances create their own challenges for investors and lenders. The risks of a renewable energy project relying on new technology can be addressed in three main ways: (1) legal due diligence (ensuring that technology is duly protected; e.g., by patents, copyrights, or licenses), (2) technical due diligence (ensuring that the technology works as represented in trials), and (3) review of historical performance. For emerging technology companies, historical performance presents a chicken-or-egg dilemma: A technology needs financing to prove performance, but it needs to prove performance to get financing. Even if the technology is proven, mass production might be required to make it economically competitive. This places even greater logistical and financial demands on the project sponsors, investors, and lenders. LOUD, LONG, AND LEGAL The optimal role of the U.S. government is perhaps best summarized by a policy statement published last year at the Bonn International Conference for Renewable Energy. The international advisory group representing the finance sector called for the governments of the Organization of Economic Cooperation and Development to adopt policies in favor of renewable energy that are “loud, long, and legal.” In other words, their policies must send loud and clear statements of support for the industry. They should provide financial incentives that last long enough to allow investors and lenders to rely on them. And they should establish statutory targets and implementation mechanisms for renewable energy use, as well as a supportive and stable regulatory environment. For the U.S. government, there is much room for improvement in all three of these areas. Although renewable energy is growing rapidly, it remains a small portion of energy production worldwide. Additional federal support can help propel it into the mainstream. Paul A. O’Hop is a partner in the D.C. office of Squire, Sanders & Dempsey, where he is co-chair of the renewable energy group. He can be reached at [email protected].

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