Basis Climate’s first-mover experience provides unique insight on price setting in this new market
Last Updated on October 27th, 2023
With the passage of the US Inflation Reduction Act of 2022 (IRA), clean energy tax credits are now transferable - meaning they can be sold by project developers to entities that are looking to offset a corporate or (individual) passive income tax liability. Transferability is new, and it compliments an existing market of tax credit investments, but the relative simplicity and basic value proposition of this new mechanism has quickly catalyzed transactions. One year into the IRA, both sides of the market have already constructed price expectations. Our role is to help tax credit buyers understand the risks and rewards associated with these transactions.1
In the past year, we have completed over $100M of tax credit transfer transactions, and presented over $1 billion of pre-vetted tax credits from developers and installers, putting them directly in front of tax credit buyers with billions of dollars in annual tax liabilities. Through this market making, we have gained a unique perspective on the pricing dynamics of transferable tax credits. In this client insight, we share our findings on initial pricing expectations from both buyers and sellers, and where we expect deals to happen.
Last updated on June 28th, 2023
Mechanics of the tax transfer discount
The basic mechanics of clean energy tax credit pricing are simple. Tax credit buyers can purchase a tax credit at a discount to its total value and make a profit from the difference between price and value. For example, a $100 tax credit might be sold at a 10% total discount, allowing the buyer to pay $90 and reduce their tax payment by $100. These prices can also be represented as cents on the dollar, where the same 10% discount would equate to a 90 cents (per dollar) tax credit price.
How do you measure the financial return of these tax credit transfers? Aside from the discounted figure, a common method is to measure the simple Return on Investment (ROI). In the 10% discount, the ROI for the buyer would then be 11.1% (the $10 savings divided by the $90 investment). An alternative approach is focusing on the timing of payment for the credits and the buyer’s quarterly estimated tax payment date. This can lead to inordinately high IRRs since the ROI vs “return period” is so short, but does help make a compelling argument for the transaction. Alternatively, many corporate buyers ignore the deal-specific return and look at their business KPIs, which may be enhanced with a lighter tax burden.Regardless of how you calculate the economic benefits, tax credit buyers can avoid cash flow concerns by negotiating cash payment just before their estimated tax payments are due.2
Proprietary pricing observations from Basis
Tax credit prices are influenced by market dynamics — supply from clean energy project developers and demand from corporate and individual (passive income) federal income tax liabilities. However, we’ve seen, through our first-hand experience, that the size of a tax credit strongly correlates with the price discount — smaller tax credits trade at larger discounts.
One-off commercial projects and small residential PPA portfolios
85-90c 11-17.5% ROI
Larger commercial solar & battery projects, one-off community solar projects
88-92c 9-13.5% ROI
Small portfolios of community solar and commercial solar that have tax equity options
90-95c 5.25-11% ROI
Established players, with many tax equity monetization solutions, often running auction processes
93-96c 4.2-6.4% ROI
Established players with a preference for tax equity, often running auction processes; Current-year PTC credits (i.e., sold on an as-generated basis)
†Purchase price is buyer's discount on the tax credits. Transaction costs, insurance, and other diligence fees are normally paid by the seller, therefore reducing net proceeds.
Smaller tax credits (less than $1 million) typically trade between 84-86 cents per dollar, generating a 16-19% ROI. This occurs because smaller project developers usually have less operating experience and financial backing to indemnify the buyer from IRS recapture risk. Furthermore, there is consideration for the time and energy required to achieve the absolute return. On the other side of the spectrum, Production Tax Credits (PTCs), volume typically greater than $50 million, typically trade at a discount between 94-96 cents per dollar, and have a different risk profile due to the volume and nature of the credit.
Basis has identified 3 primary pricing drivers In addition to the tax credit’s underlying project and seller profile, there are a few reasons for the relationship between credit size and expected discount:
Market Maturity While there is a mature market of tax equity investors for large tax credits, there is no similarly deep market of tax credit buyers looking to do sub $2m transactions. Developers with large tax credits can choose between tax equity and tax transferability, while smaller credits can’t access the tax equity market and instead are often evaluating the credit sale vs holding the credits on their own books.
Opportunity Cost The option for a project to utilize tax equity creates upward pricing pressure as credit sizes go up. Because tax equity structures have additional economic benefits - depreciation can also be monetized - the business case to opt for tax equity overrides the overhead costs as project investments get larger. The opportunity cost from tax equity structures creates increased pricing leverage for tax credit sellers as project and credit sizes expand.
Risk Profile Smaller projects often come from smaller developers that may be considered as riskier counterparties from a buyer’s perspective. In the event that the IRS seeks tax recapture, it is more likely that a smaller developer simply won’t have the financial liquidity to cover indemnities. Insurance can resolve this, but you must be able to place it on the small credit itself.
Similarly, smaller projects themselves can be perceived to be more risky. Whereas large, highly capital intensive, projects require sophisticated financing and undergo high scrutiny and diligence during underwriting, one-off projects and small PPA portfolios may not have undergone the same level of examination. Project-level risks can impact the probability of operational or performance issues rising to the level of major loss or forfeiture, and therefore potentially triggering recapture, again putting downward pressure on prices for smaller projects.
Conclusion — you can expect favorable risk adjusted returns
Generally, buyers moving early find compelling economics when considering the overall profile of available tax credits. Since the central risks that concern buyers can be addressed through price setting, payment timing, risk allocation in the commercial terms defined in contracts, and insurance, buyers that are moving forward find that the 5%-15% tax credit discount range delivers compelling risk-adjusted benefits. As a result, new tax credit purchasers are ramping their knowledge of these instruments to quickly follow the first wave of buyers.
____________________ 1 The IRS confirmed in its June 2023 guidance on transferability that the savings in taxes (in this case, $10) is not taxable income. 2 In June 2023 guidance on transferability, the IRS stated that a “transferee taxpayer may also take into account a specified credit portion that it has purchased, or intends to purchase, when calculating its estimated tax payments…” From a cashflow perspective that is valuable to the purchaser. However, many sellers resist significantly delayed payment terms, and therefore will push for higher pricing in these cases.