The US wind industry's reliance on tax incentives almost caused it to seize up. While banks did rein in lending commitments, and have increased pricing and fees to high levels, debt markets remained open throughout the credit crunch.

But the tax equity market evaporated. The federal government granted wind producers a credit of $0.019 per kW hour of production, but attached so many conditions to receiving the credit that an elaborate sub-market emerged to monetise these benefits. Financial services firms had the expertise – and taxable profits – to dominate the market. When their profits dropped, so did their appetite for tax equity.

The wind industry spent the last several years lobbying for piecemeal extensions to the PTC, rather that its restructuring, suggesting that more far-reaching reforms would be difficult to push through Congress. The recession, and widespread support investments in renewable energy as an acceptable form of economic stimulus, has eliminated that obstacle.

The stimulus, unpacked

The American Recovery and Reinvestment Act, as the stimulus is known, extended the production tax credit until 2012 for wind (and till 2013 for other technologies), and extended the Department of Energy's woefully underused loan guarantee programme from less-proven renewable technologies to proven types.

But the most promising change is to the tax credit system. A wind producer can now choose either the production tax credit regime, or an investment tax credit, a transferable credit worth 30% of the installed cost of a wind project. The developer can even receive this credit, which vests over five years, upfront as a cash grant from the Department of Energy.

Developers will need to move fast, because the provisions are only valid for wind projects put in service in 2009 or 2010, or started in these years and operational by 2013. Nevertheless, the implications for the US wind industry are profound. One developer is ecstatic: "Finally this industry won't be dependent on people whose expertise lies mostly in bifurcating cashflows."

The US wind market traditionally divided into developers and owners, with a crowd of turnkey constructors building wind farms for sale to large utilities or independent power producers with the tax appetite to absorb their credits. The advent this decade of tax equity structures obscured this divide, and access to non-tax equity still kept some developers from owning assets, but the introduction of the ITC threatens to erase the divide completely.

Turnkey developers, foreign utilities, power funds, and independent power producers could all benefit. Competition for development sites and development-stage projects with power purchase agreements attached will be intense. The most obvious beneficiaries are the creditors of Babcock & Brown, which sparked the development of the tax equity market, but now has its US wind portfolio on the auction block.

The devilish details

This bonanza for developers will have complications. The US Treasury has yet to formulate guidelines for how developers will apply for the ITC, or decide what costs will be eligible for the credit. Transmission costs are not included, but financing fees and other soft costs probably will be. Taking the ITC makes it difficult for a sponsor to sell the project during the five-year vesting period.

The cash grant may not bring in as much as a production tax credit, depending on the availability of the particular wind project. One study, by the National Renewable energy Laboratory, indicates that projects with costs of under $2,000 per kW and availability factors of higher than 32% might be better off with the PTC. All other things being equal, taking the ITC might be an admission that a project's fundamentals are weak.

But the wind finance market is far from equilibrium. Tax equity investors, of which a small number are left, are asking for high returns, and will not provide extended advance commitments to projects in construction. These uncertainties make developers nervous, and several of them are either opting to take the ITC or trying to put the tax risk back onto the offtakers.

Wind Capital Group, a Missouri-based developer, is branching out into owning and operating wind assets after a start as a turnkey operator. It is close to mandating a roughly $250 million construction loan, and is likely to opt to take the ITC. "There are several other benefits to taking the ITC, so it's not just a question of the availability and capital cost," notes Ciaran O'Brien, chief financial officer at Wind Capital Group, a developer.

In the second camp is First Wind, formerly known as UPC, which recently closed the $376 million construction financing for the Milford Corridor wind farm. That one-year construction deal, led by Royal Bank of Scotland, brought in commitments from nine banks, even though it has no tax equity or debt refinancing lined up in advance. First Wind achieved this by being prepared, if necessary, to build the plant on a turnkey basis.

First Wind has obtained a commitment from the offtaker, the Southern California Public Power Authority, that it will buy the project if the developer cannot line up the needed tax equity. The authority may have achieved very attractive pricing on the 20-year power purchase agreement as a result, or it may have been scrambling to meet California's renewable portfolio standard, which mandates that utilities buy a certain proportion of their power from renewable sources.

Debt markets

Wind finance lenders will probably wait to take their cue from sponsors' decisions about their preferred tax option, but grant recipients will have a lot more leeway in structuring debt, and have to spend less time and money dealing with the concerns of tax equity providers. "We've seen Europe develop a market in products like mezzanine debt strips and preferred equity strips. There's no reason why we can't see that emerging here now," suggests Wind Capital's O'Brien.

Senior debt market conditions have the same bittersweet flavour that developers in other markets experience – high margins tempered by low base rates. Banks' fees have also increased markedly, eliminating many of the transaction cost savings of discarding tax equity. Margins of 350bp over Libor are typical, fees of the same size are typical, and banks are wary of exotic deal structures. Sponsors hoping to put in place a leveraged lease on ITC projects (PTC projects still cannot be leased) will need to be patient.

Banks have been prepared to cope with different risks in one respect, however. Clipper turbines have featured in both of the financings that First Wind closed this year. Project lenders have preferred to finance a small number of trusted suppliers – Vestas, Siemens and in particular GE – based mostly on their time in the US market. EDF subsidiary enXco financed REpower turbines when it closed a $350 million financing for its Shiloh 2 farm with Nord/LB in November 2008.

Newer manufacturers need to try much harder to keep developers happy, whether by locating manufacturing and operations facilities in convenient locations or by offering greater flexibility on delivery dates. In the second respect even the established manufacturers have become more accommodating. Manufacturers might have once extracted hefty progress payments for turbines, but during the current slowdown have been willing to wait. The development is welcome, particularly because the market for turbine supply loans, which typically financed these payments, essentially dried up in late 2008.

Banks are now less tolerant of wind developers that bring them financial hedges in place of power purchase agreements. This has served to slow the pace of development in areas like Upper New York state and West Texas where producers typically sell their output into spot markets. These two regions have faced transmission bottlenecks and a sharp reduction in the quality of sites, as Noble recognised when it halted development at several NY sites.

The new landscape

The stimulus and credit market conditions should allow for wind development to be spread more evenly around the US. Partly this is the result of sponsor and lender fears of being too reliant on a small number of markets. Well over 30 states now have renewable portfolio standards, with a variety of goals and timelines, but which all force utilities to procure additional renewable power capacity. The extension of the ITC, which is not dependent on power production, to wind projects may allow more projects in locations with lower wind levels to be built. However, as more than one developer suggests, since sponsors tend to have projects in development for several years, it is unlikely that sponsors would be able to rush lower-quality sites into construction within the window of the stimulus. "They still want to achieve the highest production levels possible to maximise their returns," notes one.

Perhaps more important for developers than utility interest is the flexibility that they now bring to negotiations with developers. The Southern California Public Power Authority, for instance, was prepared to agree to the lender-friendly put option on First Wind's Cohocton farm in the interest of guaranteeing the capacity would come online. Western Wind, a Canadian developer, has managed to extend several time the in-service date for its 120MW Windstar farm, in Tehachapi, California with offtaker Southern California Edison.

The sponsors with the most to gain in the current market conditions are probably turnkey developers, which own a large number of promising sites, have experience negotiating power purchase agreements and are indifferent to the long-term financing plan for their projects. The list of potential buyers, thanks to the incentive regime's relaxations, is much larger, and takes in foreign utilities, energy and infrastructure funds, public power entities, independent power producers, and any other market participant that was not previously paying a large amount of tax on its profits.

Several utilities moved to acquire development pipelines early on. Duke Energy acquired Tierra Energy, and its 1,000MW pipeline, in May 2007. ArcLight bought a 3,100MW potential resource in Tehachapi from Allco Finance Group when Allco collapsed to add to the portfolio that it acquired when it bought Caithness Energy's thermal and renewable assets in 2007.

Several turnkey developers have been to market recently, including Cannon Power, which closed a $340 million construction financing for its Windy Point project in Washington State in the middle of 2008. The deal was structured as a pre-payment transaction, where cash contributions from the offtaker are structured as pre-payments to allow the offtaker more control over the asset.

First Wind's Cohocton might be refinanced in a similar fashion if the demand exists for the project's tax equity. Orion Energy, a turnkey developer recently bought by BP, is believed to be looking for a $100 million construction financing for a project in Indiana, though its long-term plans for the asset are as hazy as BP's long-term interest in the US wind market.

All's well that blends well

The Treasury's rules for how the ITC cash grant will be applied are not likely to appear before July. This hasn't stopped several developers from sending in applications regardless, using forms of their own devising, according to Jeffrey Davis, a partner at Mayer Brown. "The Act says that grants must be made 60 days after the application is received or the plant is in service, so several developers are taking the initiative."

Sponsors may also have the option of using loan guarantees from the Department of Energy to finance projects at an extremely low cost. The loan guarantee programme had been designed to cover emerging renewable and conventional generation technologies, but has now been extended to proven renewables technologies. The department, however, has been extremely slow in establishing and staffing the programme office, and many sponsors will prefer to deal with the certainty of high-priced bank financing.

Whatever happens, the tax equity is likely to become even more of a niche product. The number of providers has become smaller, and providers are unwilling to provide large advance commitments. The PTC will live on for small number of producers with the patience and the resource necessary to raise tax equity. These producers will also have a balance sheet large enough to support construction financing unaided.