➤ Tax equity investors are hesitant to finance new technologies like geothermal energy.
➤ Transferability is less attractive than tax equity partnerships but serves as a "worst-case backstop."
➤ Financiers are sitting on the sidelines until the US Treasury Department clarifies Inflation Reduction Act incentives.
Fervo Energy co-founder and CEO Tim Latimer |
Tim Latimer is co-founder and CEO of Texas-based geothermal energy production startup Fervo Energy Co., which launched a first-of-a-kind pilot project in Nevada using horizontal drilling technology to access a deep thermal reservoir through two wells. The reservoir's heat will power the steam-fired Fervo Geothermal Energy Project, a 115-MW generation facility in Washoe County. Fervo Energy is also developing a 33-MW facility in Beaver County, Utah.
S&P Global Commodity Insights spoke with Latimer about the tax equity finance market for newer technologies like geothermal. He said the big banks that provide tax equity are hesitant to underwrite those developers' projects and that access to Inflation Reduction Act (IRA) incentives depends on whether financiers are open to taking on less-conventional tech. The following is an edited transcript of the conversation.
S&P Global Commodity Insights: What is the tax equity market like right now for renewable energy companies involved in newer technologies like geothermal?
Tim Latimer:
The idea of a first-of-a-kind tax equity investor that's willing to do projects just doesn't make sense for a lot of reasons, so it creates a situation where there's a major financing barrier to getting new technology to market, which is not the intent of the policy goal but it's what happened in practice.
Could Fervo utilize the new transferability option instead and monetize tax credits directly?
That definitely is something that creates a worst-case backstop, but there's a couple of things about it that make it less effective. I think one is just the timing because you can't monetize the credits until they accrue, so there's a huge challenge there where rather than a tax equity investment coming in before a project's commercial operations date or early in the development cycle, there's a lag of 12 to 24 months after the project's commissioned. That again becomes a big working capital barrier for new technology.
The other thing with transferability is you're leaving money on the table because you can't use the methodology that allows you to incorporate the depreciation of the assets in the tax value, which is pretty standard for tax equity transactions.
Are there funding options for companies like Fervo outside of these tax credit vehicles?
I talk with a lot of other CEOs of growth-stage startups that are either in the middle of or have finished their first or second large-scale deployment, and by and large, people are solving this with one of two things. The first is just over-equitizing the business and raising more corporate equity, which is certainly not an ideal situation because that puts an extraordinarily high cost of capital on infrastructure projects, which is never a good mix.
The other one is looking at either more creative concessionary or philanthropic capital sources or government financing. The fact that the US Department of Energy's Loan Program Office has been reinvigorated actually creates one of the very few ways new technologies can access funding. I think they're working on innovative methods to try to create things like bridge loans ... as a way to fill this gap, although it's all very early stage.
Could private equity step in to fill any funding gaps?
It's not tough for us to access venture capital or private equity ... but private equity is really just that step between venture capital and more structured financing.
It just doesn't close this gap on the tax equity market, even though they're interested. It doesn't address the project-level financing issues.
What do you think it will take for banks to get comfortable with funding more nascent technology?
I think it's going to take some education and willingness. If banks choose to look at the post-IRA world for tax equity just like they did in the pre-IRA world then this is never going to get solved.
The market for traditional wind and solar projects has so much capital available that they're all competing with each other and really just pushing down rates of return they can get, whereas it's such an illiquid market [for new technologies] that if any groups figure this out in terms of how to finance these projects, there's going to be a much more attractive return profile as a result.
Even if you were to discuss with them a higher return profile in exchange for doing the work to understand new technology, the traditional funds and banks don't find that appealing. It would take them likely creating separate funds or investment vehicles outside of traditional tax equity.
Which IRA tax credits does Fervo have access to?
For geothermal it's a 6% base investment tax credit with a 24% addition if you meet prevailing wage requirements and eligibility for being in an energy community and using domestic content, so it mirrors solar pretty closely.
I will note that geothermal is not included in the domestic manufacturing tax credit. Right now if you want to build a battery or solar facility in the US to manufacture panels or battery components, there's a tax credit accessible for that. If you want to build a facility to manufacture geothermal turbines or well components, there's no tax credit available for that.
Can developers like Fervo use any of those credits now?
I think the provisions in the IRA will be beneficial to incentivizing the right policy outcomes, but in the short term, no one knows what the rules are and everyone's waiting for US Treasury guidance, and that's had a chilling effect on the tax equity market too. Everyone wants to know what the rules are and it's a lot of unproven incentives, so people are taking a wait-and-see approach.
The preliminary maps for energy communities were recently released ... and when you dig into the provision's definition for accessing that additional 10% credit, it's complicated. You have to show that your census tract has an unemployment rate that is below the national average, and then you look at how they define that and it's the year before the in-service date of your project. For a project like ours, geothermal has lead times of three to five years for starting construction until a project is online, so we need to make an investment decision this year for something that's going to be online in 2027, 2028. But we won't actually figure out if we're in an energy community or not until 2027 because ... that's when we'll get the unemployment rate for the counties we work in.
If you take that level of uncertainty and try to find a financial institution to underwrite it and they're already super risk-averse, the expectation is going to be that the operators take on all of the risk. We've created an incredibly complicated system, and the fact that it's taking as long as it is for Treasury guidance to come out on these issues is really leading a lot of the tax equity market to sit on the sidelines.
If you're a small startup, you're probably not going to have a lot of in-house people who understand all of the labor laws and provisions, so understanding these interpretations is much more difficult to do, and it ends up creating a bigger challenge for new technologies.
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