The peculiarities of the US renewables incentive regime have created a growing class of tax investors that have been asked to take on greater and more complex project risks. The first requirement of the production tax credit is that the user of such a credit must have a tax bill. For the small band of utilities with extensive wind operations, FPL foremost among them, this is not a problem.

For all the other developers there is the tax equity market. This consists of a small number of institutions with either their own tax capacity or access to institutions with tax bills. For a time the market was roughly the same as the market for equity in leveraged leases, before that market withered.

New investors have moved into the space in recent years, drawn by the wind industry's ability to burnish green credentials. But the renewable energy market is undergoing profound change, as foreign buyers take larger positions in the industry, offtake agreements get messier, and yields get lower.

Now, a cross-section of developers is likely to tap the market. Those that have recently approached the market include AES, a thermal developer aching for green kudos, Irish start-up Airtricity, and Iberdrola, which bought Horizon Wind from Goldman Sachs, but does not face as large a US tax bill.

Participants in Project Finance's virtual roundtable include institutions with roots in both the project debt and equity markets. They are:
• Mark Dennes, a director in the global energy and utilities group at Fortis
• Grant Davis, managing director of the private finance group at New York Life Investment Management
• Lance Markowitz, senior vice-president, Union Bank of California
• John Eber, managing director, energy investments, JPMorgan Capital Corporation

Project Finance: What was your last tax equity investment?
Grant Davis, New York Life: We made an equity investment in a 200MW US wind project.
Lance Markowitz, Union Bank of California: An un-levered wind equity investment.
Mark Dennes, Fortis: We have made three tax equity investments to date
John Eber, JP Morgan: We have been awarded five transactions for 1,300MW in 11 wind farms in the first half of 2007.

PF: What in your opinion has been the most significant tax equity transaction for renewable energy in the last year?
GD: There were a significant number of tax investment transactions during the past year in wind, solar, geothermal and biomass. By a wide margin, wind attracted the largest amount of tax equity dollars. I feel the most significant tax transaction for 2006 was a 500+MW wind project portfolio.
LM: Fenton. Union Bank's structure provided optimal leverage and economics for both construction and the project term. The construction debt, term debt and passive equity were all structured and underwritten by Union Bank. The optimal nature of our structure and the convenience we provided in arranging the transaction was quite unique and attractive.
MD: The syndication of EDP's acquisition of Horizon Wind. It opened the
syndicated tax equity investment market.
JE: The large portfolio transactions for multiple wind farms like the PPM Energy and Horizon deals.

PF: What has the effect of the expansion in participants on returns in the market?
GD: The increase in the number of tax investors over the past three years has put significant downward pressure on tax equity returns. This has been driven both by the increased interest in the renewable sector, but also by limited alternative investments in other tax sectors.
LM: Returns have dropped significantly
MD: In our experience, returns have fallen precipitously over the last few years as more investors have entered the market and have made larger investments. Returns seem to have stabilized recently.

PF: Is there room for tax equity yields to drop further? Might structural changes to tax equity deals facilitate this?
GD: I would not be surprised to see some further weakness in returns as investors "reach" for volume. I would expect, however, that increased Treasury rates and higher returns in the low income housing sector will put a floor under wind equity returns and ultimately push returns higher.
LM: Not sure what will happen, however, I would not be counting on material yield reductions going forward. There are a number of factors in the other direction that are weighing on investors including unprecedented project demand, rising interest rates and outstanding performance and equipment problems on existing projects.
MD: We see more aggressive tax equity structures rather than structural improvements. Perhaps there is a trade-off occurring between risk and reward (sponsors passing on more risk to investors without a commensurate improvement in return).

PF: Why have leveraged deals become more prevalent in the last year?
GD: With very favorable debt terms available in the wind sector, some sponsors have concluded that their economics are better with a leveraged structure, despite the higher return requirements for tax equity in a levered structure.
LM: Most deals are still un-levered. As transaction sizes have increased, developers may benefit from (depending on their drivers) more optimal structures, admittedly more complex, that take advantage of the benefits of both debt and equity. One structure does not benefit all.
MD: Levered deals are more aggressive than unlevered tax equity deals, reinforcing the trend towards more risk. The aggressive tax equity investing has also forced lenders to become more competitive on price and structure.
JE: I do not believe leveraged deals have not become more prevalent in the last year. According to our records, in 2006 there were only 3 of the 15 equity deals awarded in the U. S. wind market that had project level debt. Additionally, so far in 2007, none of the 7 deals awarded have had project level debt; and none of the 6 deals, either in the market or due in the market over the next few weeks, will have project level debt either.

PF: How receptive is your institution to working with newer turbine manufacturers?
GD: We are open to considering newer turbine manufacturers. We would need to be able to assess the performance history and installed base of the turbine. We would also have to evaluate the manufacturer's ability to support the performance and would expect a strong warranty.
LM: We are open to looking at transactions with some of the newer manufacturers. This is a total package question.
MD: Proven technology remains an important consideration for a widely syndicated non-recourse project financing. We have seen newer turbine manufacturers supplying turbines to projects that form part of a much larger portfolio financing, reducing the risk of the new technology. We do see increasing acceptance of other turbine manufacturers beyond GE, Siemens, Vestas and MHI. Depending on the region, Enercon, Suzlon and Gamesa are financeable.
JE: We are generally receptive. Our portfolio currently has turbines from at least six manufactures and I estimate that by year end we will add two others.

PF: How has the recent interest of overseas owners affected the tax equity market?
GD: At this time, the foreign acquirers generally do not have a tax base in the US, so they are likely to seek tax equity transactions.
LM: They have greatly expanded the need for our products.
MD: Overseas investors have in most cases included highly experienced energy companies or energy industry investors. Adding experienced and knowledgeable sponsors and investors should improve the quality of the market. Those sponsors and investors also bring their banks ergo the increased presence of Spanish banks following Iberdrola, Acciona, Gamesa etc.
JE: It has clearly expanded the need for institutional equity investors in the wind market in the U.S.

PF: Does a move by US municipal offtakers to control their own capacity offer any opportunities?
GD: I think that we will continue to see municipal and coop utilities taking a keen interest in renewables. This is likely to include transactions that "lock-up" the renewable capacity and utilize the PTCs in a structured financing.
MD: Municipal offtakers taking control of wind power assets provides opportunities for traditional wind lenders to provide construction financing and tax equity investments.

PF: Do you think that the quality of wind forecasts has improved in recent years?
GD: It is difficult to have a definitive position on this topic. There is anecdotal evidence of some short-term weakness in particular project wind regimes, but there probably has not been enough long term data to draw a conclusion on quality. One of the challenges is that wind/turbine data is often treated as proprietary, making it more difficult to assess industry-wide projections versus performance.
LM: Not necessarily. A bubbling issue in the market is that most portfolios are performing well below P50.
The quality of wind forecasts has improved with the entrance into the market of new wind forecasters, like Global Energy Concepts/RW Beck. The greater number of forecasters should improve the knowledge in the market and so the quality of the forecasts.
JE: The jury is still out. We are studying this issue closely.

PF: Does the growing use of wind hedges hold any challenges for investors such as yourselves?
GD: For either a tax investor or a lender, one of the issues with hedges or non-utility offtake parties is the significant requirement for project collateral or credit support.
LM: We have not been involved in any transactions with "wind" hedges. I'm somewhat doubtful that their benefit outweighs their cost. Energy hedges are becoming popular to mitigate price risk on energy sales. The challenge is to make sure they are properly structured and don't create additional risks.
JE: We are seeing more hedges this year and in multiple forms. Generally we have been able to work through any additionally issues they may raise in our transactions.

PF: Does tax risk present a substantial risk on current deal structures?
GD: Generally speaking, particularly with some of the guidance coming out of Washington, a well structured transaction does not have substantial tax risk. There are some structures being promoted in the market, however, that do have greater tax risk.
LM: Tax risk is always present, however, we like to think that deals that we are involved with would be favourably viewed by the authorities because of their purpose and relatively conservatively structuring.

PF: What do think the most important structural development in the tax equity market will be?
LM: Possibly the IRS establishing some sort of safe harbor guidelines for these transactions.
MD: The ability of tax equity investors to arrange construction finance and/or turbine finance.

PF: What, other than wind, do you find the most attractive renewable energy technology and why?
GD: Our most extensive experience has been in the wind and geothermal sectors. We also have an interest in the solar, bio-fuels and biomass markets.
LM: The market seems to be aggressively pursuing geothermal.