Understanding the Tax Credit Marketplace with Reunion
Andy Moon is CEO and co-founder of Reunion, and in this episode, we're diving into clean energy tax credits. Tax credits may not be the most exciting topic, but they play a crucial role in financing clean energy projects. The Inflation Reduction Act has given a significant boost to tax credits in two key ways.
First, it has expanded tax credits to cover various project types, including solar, wind, battery storage, biogas, hydrogen, and carbon sequestration, among others. This broadening of eligibility creates more opportunities for tax credits. Second, it has made tax credits transferable, which means they can change hands. This change is expected to bring more capital into play, making it easier to finance these projects. Andy and Reunion estimate that the pool of clean energy tax credits in the U.S. currently stands at around $20 billion per year and could grow to $75-80 billion per year in the next five years.
Reunion serves as a marketplace for clean energy tax credits. They connect buyers and sellers, making it easier to purchase and sell transferable tax credits to support various clean energy projects, such as solar, wind, battery, biogas, and more. During our conversation, Andy discusses his extensive background in clean energy, starting with his work at SunEdison in 2009 and founding SunFarmer in 2014. Most importantly, we explore how tax credits function and how transferability can boost the clean energy financing market.
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Episode recorded on Sep 5, 2023 (Published on Oct 5, 2023)
In this episode, we cover:
[02:48]: Andy's background in renewable energy finance
[06:28]: Overview of investment tax credits (ITCs)
[11:52]: Overview of production tax credits (PTCs)
[13:07]: Other types of tax credits opened up by the IRA
[14:19]: What tax credit transferability means
[16:21]: Diverse group of potential buyers interested in tax credits
[17:49]: Example of a $100M solar project with $50M in ITCs
[21:29]: Market size and growth projections for tax credits, new buyer profiles
[23:36]: Using tax credit savings to fund corporate sustainability initiatives
[29:24]: Reunion's role connecting buyers and sellers, streamlining diligence process
[32:25]: Reunion's growth and the volume of credits on the platform
[35:49]: The role of tax credits in corporate finance and potential buyers
[38:02]: Expansion into different clean energy technologies
[39:17]: Reunion's financing and future business model
[40:46]: Who Andy wants to hear from
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Cody Simms (00:00):
Today on My Climate Journey's startup series, our guest is Andy Moon, CEO and co-founder of Reunion and we're talking about clean energy tax credits. You may not have woken up this morning appreciating the importance of tax credits, but they are a powerful lever in how clean energy projects get financed and the Inflation Reduction Act turbocharged tax credits in two ways. One, it expanded tax credits across multiple project types, including, of course, solar and wind, but also battery storage, biogas, hydrogen, and carbon sequestration among others, which in theory should increase the surface area of tax credit opportunities. And two, it enabled the transferability of tax credits, which in theory should increase the depth of capital that can be put to work to help these projects get financed. Indeed, Andy and Reunion believe that the universe of dollars in the US that are subject to clean energy tax credits is around $20 billion per year today and could expand to $75 to $80 billion per year within the next five years.
(01:17):
Andy's company Reunion is a marketplace for clean energy tax credits, connecting buyers and sellers and helping to facilitate the purchase and sale of transferable tax credits to support solar, wind, battery, biogas, and other clean energy projects. Andy's got a long history in the space having worked in clean energy product development and project finance at SunEdison starting in 2009, and then founding SunFarmer in 2014. He traces this history during our conversation and then we spend most of the time talking about how tax credits work and how he expects transferability to support market expansion of clean energy financing. But before we start, I'm Cody Simms.
Yin Lu (02:01):
I'm Yin Liu.
Jason Jacobs (02:04):
And I'm Jason Jacobs and welcome to My Climate Journey.
Yin Lu (02:10):
This show is a growing body of knowledge focused on climate change and potential solutions.
Cody Simms (02:15):
In this podcast, we traverse disciplines, industries, and opinions to better understand and make sense of the formidable problem of climate change and all the ways people like you and I can help. Andy, welcome to the show.
Andy Moon (02:30):
Thanks, Cody, for having me. Really excited to be here.
Cody Simms (02:32):
Well, Andy, I am excited to dive into the probably underappreciated and might not sound exciting, but I think kind of exciting, world of renewable energy tax credits.
Andy Moon (02:43):
Who would've thought that tax credits were such a hot topic these days, but we're really enjoying it.
Cody Simms (02:48):
I love it. Well, why don't we start with you explaining a little bit about your background and how you came to be one of the world's foremost experts on renewable energy tax credits?
Andy Moon (03:00):
Yeah, sure thing. So I'm co-founder and CEO of Reunion and we're a marketplace for financing clean energy projects through the sale of tax credits. Tax credits have always been a very large part of how solar, wind, and other clean energy technologies have been financed. And the big change here is that with the Inflation Reduction Act, those tax credits have gotten much larger and now they're much easier for clean energy developers to use because they can now freely sell the tax credit to any third party. So it's a big deal. Every solar, biogas, battery conference we go to, everybody wants to talk about how do they sell their tax credits.
Cody Simms (03:38):
And how did you become the guy to have that conversation?
Andy Moon (03:41):
So my co-founder, Billy Lee, and I met 15 years ago actually working at SunEdison, which was one of the pioneers of early solar C&I development, and we have been dealing with tax credits and project finance for the last 15 years.
Cody Simms (03:56):
C&I being commercial and industrial, yes?
Andy Moon (03:58):
Commercial and industrial seller, yes, thank you. Billy Lee was head of project finance and tax equity, and in fact structured many of the initial tax equity transactions with large banks such as JP Morgan and Bank of America. And I was leading a finance team. I joined in 2008, so there wasn't much financing to go around then. So my job was to run around and convince investors that had never considered solar before to invest their dollars into solar. And we were successful in convincing the first major US private equity firm to invest a billion dollars in a portfolio of US and European solar projects. We also did the first tax-exempt bond financing where we had to create bond documents from scratch, and we also convinced a lot of other first time investors such as European infrastructure funds and others to invest in solar.
(04:47):
So we have a lot of experience bringing new financial products for clean energy and really convincing new investors to come to the table and that's what this is. Clean energy tax credits or the sale of tax credits are a completely new product and one that will require a lot of education and a lot of handholding to come across the finish line.
Cody Simms (05:03):
And then you and Billy sort of went off in your separate ways, still working in the industry for a little while and then it looks like kind of came back together I assume around the time of the Inflation Reduction Act making this new transferability of these tax credits a reality. Maybe share a little bit about the work you've done for the last decade or so before deciding to start Reunion.
Andy Moon (05:26):
Yeah, for sure. So while I was at SunEdison, I was also volunteering with a nonprofit that was actually running a large hospital and dozens of health clinics in Nepal. And they approached me and said, look, one of our biggest problems is actually electricity. In Nepal in the rural areas, there's no access to an electric grid. And so hospitals and health clinics are often powered by diesel energy, which is expensive, it's unreliable, and you can imagine if you don't have consistent electricity, it's very hard to treat patients or do operations at a hospital.
(05:55):
So while at SunEdison, I helped install a small three kilowatt solar system at the hospital and just realized how transformative even three kilowatts was. So I went off and started SunFarmer, which we've now done 1500+ solar installations across South Asia, health clinics, farms, manufacturing, et cetera. And so I ran that as founder/CEO for about five years. We went through Y Combinator and went through the whole startup journey from start to finish. And then for the last few years I did some early stage investing when I worked at a Series B climate tech company and Billy and I came back together because we wanted to start another company.
Cody Simms (06:28):
All right, so before we get into what Reunion is and does, let's set the landscape by describing what some of these tax credits are. As I understand it, there are kind of two main buckets, maybe there are more, but two main buckets of tax credits. There are investment tax credits and there are production tax credits. And I have now hit the limit of my understanding on tax credits, so I'll hand them the mic back to you.
Andy Moon (06:52):
Sure. So let me start with the investment tax credit. So historically, if you're a clean energy developer, say a solar developer, and you're developing a $100 million solar project, you would get an investment tax credit that was worth 26% to 30% of that capital cost. So the tax credit would be worth $26 to $30 million. Typically, a solar developer doesn't have $30 million of tax liability in order to take advantage of that tax credit.
Cody Simms (07:19):
So the tax credit, just so I understand, and I assume the same as when you're doing your personal taxes, tax credits are really only valuable if you have that amount of taxable liability that you need to offset on your tax return as a corporation.
Andy Moon (07:33):
That's right. So $1 of tax credit will offset $1 of federal tax liability. And so historically, in order to take advantage of that tax credit, you had to actually own the solar energy project. And so what that created is this cottage industry called tax equity where a project developer would then have to partner with a large bank, and tax equity investors are primarily large banks, JP Morgan and Bank of America account for more than 50% of the tax equity market and probably the top 10 tax equity investors, which are all large banks, account for probably 80% to 90% of the market. And essentially what would happen is the clean energy developer would have to enter into a legal partnership with a large bank to co-own the project and there's a very complicated sort of structure whereby the tax equity investor is allocated 99% of the tax benefits and the cash for the first five years of the transaction and then it flips to the project developer afterwards.
Cody Simms (08:33):
Let me take a step back before we get into the nuance of the challenge there, but so what I understood was the solar developer themselves, as the originator of the project, would be the group that would earn the tax credit. It wouldn't necessarily be the corporation that was buying the solar panels or the utility that was building a grid scale solar farm. Both of those would presumably have lots of tax liability on their books already, but it was actually this development company that is primarily a financial services firm, which doesn't necessarily have a heavy expense line to their business. Am I understanding that correctly?
Andy Moon (09:09):
That's correct. The solar developer will be the owner of the project, but in order to take advantage of the tax benefits, they would co-own the project or enter a partnership with a tax equity partner that could then take the tax benefits for the project.
Cody Simms (09:22):
And those tax equity partners would tend to look like, you said major banks?
Andy Moon (09:27):
That's right. The majority of tax equity historically has been large banks and financial institutions. You can imagine setting up this structure is very complex from a legal, from an accounting, from a due diligence standpoint. As a co-owner of the project, the tax equity investor, they're taking real risk on the project, they're taking an equity position in the project. So they have the diligence, will the sun shine, how much production will there be, what will this look like? And as a result, the cost of setting up a tax equity partnership can be a million dollars or could be more than that.
Cody Simms (10:00):
So let me back you up before we get into the nuances of the sort of how transferability used to work and just make sure I understand it. So the organization that would typically be earning the tax credit today would be the solar project developer, but these solar project developers are needing some form of organization that has lots of cash profit and lots of tax liability to essentially partner with them so that this credit could actually be properly used to offset the cost of something. Is that an accurate way to think about it?
Andy Moon (10:33):
That's right. Prior to the IRA, the tax credits could only be used by the owner of the project. And so in order to take advantage of the tax credits, historically a clean energy project developer would have to partner with what's called a tax equity investor that would be a co-owner of the project and would then be able to take advantage of the tax benefits because a clean energy project developer usually doesn't have tens of millions of dollars of tax liabilities that they're able to offset.
Cody Simms (10:59):
Yeah, that makes sense. And then these investment tax credits are specifically directly related to, I guess it's a flat percentage tax credit on the total cost of the project, is that right?
Andy Moon (11:12):
That's correct. So historically it's been 26% to 30% of the cost of the project, but with the Inflation Reduction Act, the percentage could reach 30%, 40%, 50%, 60%, or even 70% of the cost of the project.
Cody Simms (11:28):
There are these things called adder credits I was maybe reading about?
Andy Moon (11:32):
That's right. So on top of the base 30% credit, there are adders if the project uses domestic content, if it's located in what's called an energy community, where previously there was fossil fuel infrastructure, and if it's located in a low income area, then those are all reasons to add additional tax credits to the project.
Cody Simms (11:52):
And then there's another bucket of credits. And it sounds like it's an either/or, you can either take this investment tax credit or you can take a production credit on your project. If that's true, what is a production tax credit?
Andy Moon (12:03):
Yeah, so the production tax credit is actually based on a 10-year production of electricity that's coming off of the facility. And so with the production tax credit, you would get a fixed tax credit amount for each kilowatt-hour of electricity that's generated by the facility.
Cody Simms (12:18):
And so how does a developer tend to choose which of these two pathways to go down?
Andy Moon (12:23):
It's a great question and one that the market is I think still sorting out. I think that when there's very high production levels, it's very sunny, for example in the southeast, there could be a reason to sort of go for the production tax credit. Now that said, if you have a lot of adders, so for example if you have the energy community adder, it can be more advantageous to go for the investment tax credit because it's a nuance of the legislation, but it sort of adds more economic benefit on the ITC side versus the PTC side.
Cody Simms (12:50):
And that's presumably attempting to get more renewable energy projects built and developed in, I think you said lower income neighborhoods, in areas that maybe have more energy poverty, et cetera.
Andy Moon (13:01):
Yeah, exactly, and for areas where they've been impacted by closures of coal plants or fossil fuel infrastructure.
Cody Simms (13:07):
Okay, that's helpful. Are there any other sort of buckets of tax credits that we need to make sure to address?
Andy Moon (13:13):
There are 11 types of tax credits that are eligible to be transferred. So not only did the Inflation Reduction Act increase the amount of the tax credit, it also opened up tax credits for many new technologies. Some of the nearest term examples are standalone battery storage never had an ITC, it always previously had to be attached to a solar installation. But now standalone battery storage, which is a rapidly growing sector of the clean energy economy, is eligible for tax credits.
Cody Simms (13:39):
ITC meaning investment tax credit?
Andy Moon (13:42):
Generally investment tax credits, that's correct. Biogas is also eligible for tax credits, and you also have future technologies like hydrogen, advanced manufacturing, nuclear, CCS, these are all tax credits that are now eligible to be transferred directly to third parties.
Cody Simms (14:00):
So we've talked a lot on the show about the expansions of 45Q and this $180 a ton for direct air capture or $80 a ton tax credit for point source capture. These would also presumably be included in this bucket of transferability, is that correct?
Andy Moon (14:17):
That's right.
Cody Simms (14:19):
Okay, so that's a helpful overview and definitely expanded what I even understood sort of the scope of these tax credits to be. You explained a little bit about how they used to work where you had to actually bundle in the financing partner at the project financing phase in order to take advantage of the tax credits. What does this transferability actually mean?
Andy Moon (14:39):
Yeah, so in the previous incarnation of financing, the tax equity partner would have to enter into a legal partnership to be a co-owner of the project, and as I mentioned, that requires a lot of legal, accounting, due diligence expense. It also presents complexities for the investor because they need project finance professionals to manage the portfolio. The accounting is quite complex, especially for publicly traded companies, so there's a lot of reasons why it has always been a very small pool of investors on the tax equity side. Congress's intent was really to broaden the pool of investors in clean energy by making virtually any corporation that has US tax liabilities can now be an investor in clean energy projects.
(15:20):
So I think that's a huge innovation where many more investors are expected to be involved in really helping spur this clean energy transition. A lot of the goal of transferability is to make that process simpler. The way it works is that a clean energy developer has to register their project under a pre-registration portal provided by the IRS, which will provide them a pre-registration number. And then the buyer and the seller both have to file a transfer election form with their tax return. That creates a transfer of the tax credit between the clean energy developer and the corporate buyer.
Cody Simms (15:51):
How did this come about in the first place? Was there precedent for this in other industries or other forms of project development, et cetera?
Andy Moon (15:58):
There are some forms of tax credits in other industries, so there's of course the low income housing tax credit, there's historical tax credits, film credits, so there is some precedent for other types of tax credits that can be freely sold. I think what's exciting is that the scale and the size of this tax credit program under the IRA is just really large. It's really going to have a huge impact on clean energy development.
Cody Simms (16:21):
And so you talked about who the pool of, essentially, recipients of these would be traditionally prior to the IRA. What do you expect to happen in terms of the pool of potential interested buyers of these tax credits going forward? What kinds of organizations are starting to look at this opportunity and what does that capital stack tend to look like?
Andy Moon (16:45):
That's a great question. We are seeing a very diverse group of buyers coming to the table with interest. So in our world, we have manufacturing, specialty finance, retail, hospitality, insurance, these are all corporates that we are currently working with that are looking to purchase credits in 2023, so in the very near future. That said, there's a very long tail of buyers that have never looked at a tax credit or have never considered solar or wind before, and so there is a longer education process with many of the buyers where we have to explain what is a tax credit, what's the benefit, what are the risks, and that's expected. This is a completely new market and a new product that was open for business essentially as of June of this year. So there will be some time required to educate CFOs and tax teams on what this new opportunity is.
Cody Simms (17:34):
And are they typically selling some form of discount to the actual credited amount?
Andy Moon (17:40):
That's right. There has to be a discount to incentivize these tax credit buyers to come to the table.
Cody Simms (17:45):
So maybe walk through what a sample transaction might look like.
Andy Moon (17:49):
Yeah, for sure. So let's take our $100 million solar project that has a investment tax credit of, call it $50 million. If you have a very well capitalized and experienced solar developer that's building a fairly straightforward project without any sort of complexities on the-
Cody Simms (18:06):
Just to make sure I understand, so you got a $100 million project, you got a $50 million tax credit, that means you're presumably taking the standard 30% investment tax credit and then you found two 10% adders to add onto your project because you're developing it in an area that's maybe had its form of fossil fuel energy retired and it's in a low income neighborhood as an example.
Andy Moon (18:28):
That's right. So say you have a $100 million solar energy project with $50 million worth of tax credits and that's generated because you have the base 30% tax credit plus, call it domestic content and energy community. So it's got $50 million worth of tax credits.
Cody Simms (18:42):
Oh wait, domestic content, we didn't go there yet. This is good. Domestic content means the solar panels were manufactured in the USA?
Andy Moon (18:48):
That's right, equipment was manufactured in the United States. And so let's assume we have a $50 million tax credit. The way the transaction would work is that the developer puts this project on say a platform like Reunion and we have a pool of buyers that we would take the projects to. Let me share kind of what the market price is for a project like this. So assuming that the developer is an experienced and well-capitalized development company and assume the project is fairly straightforward, it doesn't have complexities such as lots of project level debt or other things like that, that would typically trade at a 7% to 8% discount to the buyer. And 7% to 8% discount to the buyer means that for $1 of tax credits they would pay, call it 92 or 93 cents.
(19:30):
It's important to note two things. One is that that discount for the buyer is not taxed. So whereas a different investment might they have to pay taxes on it, they don't have to pay taxes on that return. And second, they can use that tax credit or the intention to buy the tax credit to offset their quarterly tax payments. If you think about it from a time value of money perspective, the return is actually much greater than 8% because they can be getting their cash savings earlier in the year.
Yin Lu (19:59):
Hey everyone, I'm Yin, a partner at MCJ Collective, here to take a quick minute to tell you about our MCJ membership community, which was born out of a collective thirst for peer-to-peer learning and doing that goes beyond just listening to the podcast. We started in 2019 and have grown to thousands of members globally. Each week, we're inspired by people who join with different backgrounds and points of view. What we all share is a deep curiosity to learn and a bias to action around ways to accelerate solutions to climate change.
(20:24):
Some awesome initiatives have come out of the community. A number of founding teams have met, several nonprofits have been established, and a bunch of hiring has been done. Many early stage investments have been made as well as ongoing events and programming like monthly Women in Climate meetups, idea jam sessions for early stage founders, climate book club, art workshops, and more. Whether you've been in the climate space for a while or just embarking on your journey, having a community to support you is important. If you want to learn more, head over to mcjcollective.com and click on the members tab at the top. Thanks and enjoy the rest of the show.
Cody Simms (20:59):
And so then they're making a decision obviously of am I just using excess cash on my balance sheet to buy these credits or am I going to go figure out if I can pull my own financing for these? And I mean, it's a bad interest rate environment right now, so maybe less interest in that. But can I do the math such that even if I go pull financing for this, it still gets me with a near term positive ROI on the tax credit because I can apply it to this quarter's taxes.
Andy Moon (21:23):
Yeah, so being able to apply it to earlier quarter tax payments just adds to the return if that's how the buyer thinks about it.
Cody Simms (21:29):
And how big of a market is this today? Roughly how many dollars worth of tax credits are being generated now and with this new transferability, do you have any sense of how much expansion of that you see coming over the next five, 10 years?
Andy Moon (21:46):
Yeah, so there's been a lot of analysis from third parties on how big this market will grow. The volume of tax credits being generated is expected to reach $50 billion by the end of 2024, and that's mainly solar, wind, and battery storage. And once you add all these new technologies like manufacturing and hydrogen, many observers are anticipating $80 to $100 billion a year of credits being generated annually by 2027. Now, tax equity will provide some financing for these projects, but the tax equity market is currently about $20 billion a year and it's not expected to grow meaningfully larger than that given that tax equity investors are constrained by how much tax liability they have to offset.
Cody Simms (22:26):
The tax equity buying market though it sounds like is primarily constrained, at least historically, to these large banks. So you're sort of banking on a new market of buyers emerging and expanding that pool of buyers.
Andy Moon (22:38):
Correct. And those new buyers will be needed to fill that gap between the $20 billion a year current tax equity market and the projected $80 to $100 billion a year of credits that will be generated and will need a home.
Cody Simms (22:49):
What do you think they look like?
Andy Moon (22:50):
In terms of how much of that will be transferred?
Cody Simms (22:52):
No, in terms of what the profile of those buyers looks like.
Andy Moon (22:55):
So I think it will be medium to large corporations, but eventually small corporations will get involved as well once they see that this is a product that works and is low risk. But the buyers that are coming to the table for us right now run the gamut. They're all over the map in terms of industry. So we have manufacturing, retail, hospitality, specialty finance. I would say that we have a bit of a bell curve where we have quite a few buyers that are interested in offsetting $30 to $50 million a year in tax liabilities, but we have a handful that are $200 million plus or $300 million plus. And then we have also sort of a longer tail of smaller buyers that are looking at offsetting $10, $15 million a year in liabilities.
Cody Simms (23:36):
Historically, a corporation to offset their taxes would be doing things like creating a foundation, sending money to various 501(c)(3) nonprofits opportunities, setting up corporate responsibility armed to do all of that. This sounds like an alternate view of ways to do that. As these corporations have their own net-zero or clean energy pledges and whatnot, are there benefits to them of investing in these types of projects in terms of what they're able to articulate in that regard toward meeting their own Scope 2 emissions goals, et cetera?
Andy Moon (24:12):
I think that there's a variety of motivations from the corporations on why they would do this, and I think a lot of it is being able to be innovative in terms of providing this financing for projects that otherwise may not get built. Because many projects that we're talking about here are things like commercial rooftop solar, which has long lacked easy access to financing. I do think that there is a strong story that investing tax credits will help enable projects that often are not able to get financing otherwise.
(24:42):
In terms of being able to offset Scope 2 emissions, that usually does require RECs, and so there's a very small portion of these projects where RECs are available, but RECs are typically tied up with the power purchase agreement on the other side of the transaction. So often it can't be used directly for offsetting Scope 2 emissions, but that said, we see a lot of large corporations invest in things like community solar, which also doesn't deliver RECs, but it's a great impact story for ESG reporting and MSCI applications and things like that to basically explain part of their sustainability efforts.
Cody Simms (25:14):
So interestingly, presumably you would start to have the buying organizations here be some internal conglomeration of a sustainability team, an energy procurement team, a tax team, a corporate finance team kind of working together to determine that this is a good opportunity for their company?
Andy Moon (25:33):
For sure. I think there's a lot of different champions within the organization that can really push this forward. Often the final decision maker is someone in the finance team because it does require some investment. But one thing that I will mention is that we have heard of a number of corporations that are very excited about using the cost savings that are generated by making tax credit investments to fund some of their ESG efforts. As I'm sure you're aware, RECs and VPPAs have gotten very expensive. And so for many ESG departments, it's been a struggle recently to pull the trigger on going into these arrangements that are going to cost real dollars. And so if you can actually make an investment in a tax credit and realize $10 million in savings, that's actually important budget that could be used to enable ESG initiatives.
Cody Simms (26:20):
That's a super compelling and interesting argument to say, hey, your sustainability team may catch grief internally for being perceived as, rightly or wrongly, as a cost center. Here's a way to actually create a value back into the organization that can have direct dollars attached to it as well.
Andy Moon (26:38):
That's right. And in this economic environment, I think there's a lot of interest in if you can do well and do good, that's the ultimate great story to be able to achieve that.
Cody Simms (26:46):
On the counter argument side, what are the risks here for corporations or for any buyer, I guess. Is there a risk that if the project doesn't come to fulfillment or if it's a production tax credit doesn't deliver according to the modeled out energy delivery that you're owning a tax credit that actually gets pulled away from you, gets clawed back by the IRS? What else would I be worried about if I bought one of these things and I had already filed my corporate taxes assuming that it was real?
Andy Moon (27:15):
So it's important to note that buying a tax credit is an investment in a tax credit and it's not a true equity investment in a project. So the set of risks are much narrower. For example, if the project underperforms a little bit because the sun's shown less or the project equipment didn't deliver quite as much as was promised, that should not affect the tax credit investor in any material way. And as a result, the set of diligence and set of risks is narrower than making a full investment. With production tax credits, if you're buying it in the current tax year, there's generally very little risk because there's no recapture and you're purchasing the credits after they've been generated. So in other words, when the credit is generated and they've calculated the number of kilowatt-hours, you are getting the credit after that. The energy was validated to be generated and therefore there's not much risk that there's a recapture event, and as a result, those trade at a narrower discount.
(28:08):
With the investment tax credit, there is a five-year recapture period during which the IRS could challenge the tax credit, either to say that you didn't properly validate that this project was turned on and you didn't properly calculate the cost basis of the project and therefore the tax credits were inflated, the value was inflated. So the IRS could challenge that and sort of come back. Secondly, if the project is abandoned or foreclosed on within five years, then that also could trigger a recapture. So the way we mitigate that risk is we have a standard way to diligence these projects. We can ensure that the project was placed into service because we'll always collect permission to operate letter from the utility that validates the project was constructed. We will always require a cost segregation study from a third party accounting firm to really validate these pieces of costs are valid for calculating the amount of tax credit.
(29:00):
And furthermore, the project developer always has to sign a very comprehensive indemnity, so if there's any recapture by the IRS for any reason, the project developer is on the hook to compensate the buyer for that shortfall. Finally, if the seller is not able to compensate the buyer for any reason, there is also tax credit insurance available to backstop that risk, and that's a very mature market. Tax credit insurance has been around for many years.
Cody Simms (29:24):
It sounds like we've almost started to move into some of the value that you're trying to deliver with Reunion into this problem space, which is being the connective tissue between buyers and sellers and helping to create that streamlined diligence process on both, I'm guessing, project discovery and then all the way through ultimately looking to transact a project. Is that the place where you're planning to play?
Andy Moon (29:48):
Yeah, absolutely. I think that for buyers, it's very important to be able to navigate picking which project makes sense for them and to really ensure that there's a low risk transaction. And so a huge value that we add is we've talked to all the developers on our platform, we were able to identify risks and sort of put all that in diligence package that's very clear for the buyer, and we can help them do things like place insurance and really ensure that their risk is fully mitigated.
(30:16):
On the developer side, I think it's important for them to go through an intermediary like us because you can imagine if they go directly to a buyer, it's very hard to find the pool of buyers, identify them, and then negotiate the deal documents and the diligence and the insurance from scratch. And so our aim is to really be a platform where this can be done in a very repeatable streamlined way. Now that said, these are real transactions, and so I think that having a lot of experience doing these types of financings before is just really critical because it's not the type of transaction where you can just throw it on a website and expect the deal to get done. There's a lot of complexity still, and our mission is to really guide buyers and sellers through that process.
Cody Simms (30:59):
We've had clean energy marketplaces on the pod before. The one that comes to my mind is LevelTen Energy, they're actually an MCJ portfolio company, and sort of play this role in the connecting of buyers and sellers and sort of diligence around power purchase agreements in particular. How different do you think the process here is around tax credits relative to actually scoping out purchasing power?
Andy Moon (31:24):
Yeah, it's a great question. We've always viewed power purchase agreements as fairly bespoke contracts, like there's a lot of points to be negotiated in negotiating a power contract. And what drew us to the tax credit space is that we do feel that many elements of the diligence process can be standardized in some fashion. It's going to take quite a bit of back and forth to get there, and that's not where we imagine things will be in the next six to 12 months, but we do imagine that over time we will have a way to sort of do these transactions in a more standard fashion.
(31:55):
I do think that the tax credit investment side is quite different from the PPA side because PPA is more of a energy procurement side, whereas we're focused on the how do you get the financing for the project. And so where we will expand from here is how do you guarantee to a project developer that somebody will buy their credit when the project is completed? How do you guarantee the pricing? How do you ensure that they can get access to construction loan or a bridge loan? And I think even moving towards the tax credit insurance side, how do you mitigate risk in a way that's cost-effective for the developer?
Cody Simms (32:25):
Give us a sense of scale today. You guys just launched in 2022. You mentioned that the whole market today is around $20 billion annually in tax credit volume per year and may grow to upwards of $75, $80 billion a year by 2027, 2028, 2029, somewhere in there. What's the volume of credits that are available or floating through Reunion right now?
Andy Moon (32:50):
Yeah, so we launched a marketplace for the tax credits in July with a billion dollars of near term credits, and we're already at $2.5 billion worth of credits on the platform, and that represents well over $6 to $7 billion in project value. The $2.5 Billion really is the volume of the credits looking to be sold. And so yeah, it's been fascinating to just see the level of interest from developers up and down the size spectrum. So all of the developers on our platform we've spoken to, and they tend to be very experienced medium to large development companies. And I think there's a realization that there's just a shortage of tax equity. The tax equity market has shifted in a meaningful way in the last six to 12 months where we're talking to developers where previously getting tax equity financing on $150 million solar project was not a huge challenge, but it's become very challenging where we're seeing developers even put projects of that size onto our platform for transfer.
Cody Simms (33:47):
Of the credits being bought and sold today were they, the IRA is new, it's just kind coming online, frankly, were they originated with this transferability in mind? Is that priced into the credits? Were those transferability of credits priced into the project financing of these projects to begin with?
Andy Moon (34:05):
That's a great question. No, most projects that are being placed into service in 2023 were being developed a year or more before that. So many of these projects that we are working on are ones where the project is nearly complete. They've already lined up the construction financing and they've already built the project, and so the projects do tend to be simpler in 2023 because we are mainly focused on helping the clean energy developer find a home for the tax credits and structure that and insure it properly.
(34:33):
When you get to 2024, 2025, you now have developers that are saying I'm going to build a project that's going to come online in late 2024 or 2025, and I need a commitment today from a tax credit purchaser so I can take that agreement to the bank and get a bridge loan against it. So I think there's more complex derivative contracts that will be coming into play in 2024 and 2025, which we aim to be a part of as well. So to answer your question, yeah, in 2023, a lot of these projects are just ones that they were planning to get financing and they didn't or they're ones where a developer owns the project maybe on their balance sheet, and they're looking to finance it to raise money to build more projects. There's a variety of use cases for why developers are trying to transfer the credits.
Cody Simms (35:14):
When you describe these credits as financial instruments that can have essentially immediate tax benefit on your quarterly taxes for any given year and offset profits or tax liability and are fairly liquid, my brain immediately goes to hedge funds, energy trading desks, basically folks that are trying to use this as some form of cashflow arbitrage. I don't know if that's the right way to think about it or not, but what is the role that you play as a marketplace on sourcing the kinds of buyers in this system that are healthy for the ecosystem overall?
Andy Moon (35:49):
So one important item is that the credit can only be sold once.
Cody Simms (35:53):
Got it. So there's a retirement upon sale essentially?
Andy Moon (35:56):
Essentially. Yeah, essentially it's been transferred to a new taxpayer and they're using that and it's essentially theirs. So these credits will not be traded multiple times, so that's one important distinction. I think in terms of the universe of buyers, there are a lot of buyers that are looking at this from, candidly, a strictly financial lens. They see a good opportunity to reduce their tax payments, to reduce their effective tax rate, and that's very motivating to finance departments at certain companies. And I think the sustainability angle of it is in some ways a bonus. And I don't think that's a bad thing because I think really the intent of Congress here was to say there's no way we're going to hit our energy transition goals if there's only a handful of banks that are doing the majority of clean energy financing. We really need to open this up and have a very broad group of corporate investors investing in these credits to finance projects.
Cody Simms (36:48):
What are you all looking for in running Reunion as signs that this pool of buyers is expanding? How are you identifying these interim KPIs to say, yeah, this message is getting out, we are attracting more folks looking into this?
Andy Moon (37:04):
Yeah, we've signed about a dozen term sheets from buyers. So we do have early adopters that are ready to move today, and I think that's been a huge vote of confidence in the market that folks understand this, they're motivated, they want to get in on this in 2023. I think there's a larger pool, so we're talking to 60, 70 buyers that plan to do this for sure, but it's a question of when. At these large institutions, as you mentioned, it's not a single decision maker. Often they need to consult the treasurer and the accounting staff and the CFO, so there's a number of different stakeholders that need to sign off on this and to be educated on it. So I think that's going to take some time. But I think as we see more large transactions happen, as we see more key names start to purchase these credits, we think it's really going to be a bit of a flywheel the way that you saw it in PPAs. Really complex product, and then all of a sudden you have Google and Amazon and all the big tech companies purchasing PPAs.
Cody Simms (38:02):
And we talked about solar and wind obviously, but as you mentioned, this applies to battery tax credit, it applies to biogas tax credits, it applies to potentially even hydrogen and things coming out of 45Q. Do you all have a sense of how each of these markets are going to grow independently of one another? You don't have to share your secret sauce if you do, but I'm curious how you all are modeling out the market potentials of each of these individual clean energy provisions.
Andy Moon (38:26):
Yeah, what's interesting is each of those different technologies almost is a bit of its own market, even though the credits are very similar in mechanism, because you have to understand what is the supply and demand of the buyers. Right now, there's a lot of interest in solar, wind, battery storage because a lot of corporate buyers understand those technologies. They've interacted with them before. So when you talk about biogas, there's some buyers that are very interested, but the pool is a little bit smaller. And so as a result, there's a little bit less demand and so the yield or the discount that would be demand is just a little bit larger. As you get to these very new technologies such as hydrogen or carbon capture, it remains to be seen. The majority of projects that we're dealing with right now are solar, wind, battery, and biogas, but we're very interested in these other technologies as well, and I think it's going to be very interesting to see what level of buyer demand materializes there and what price they're willing to pay.
Cody Simms (39:17):
And for you all at Reunion, you announced your own financing in late 2022. Share a little bit more about that.
Andy Moon (39:25):
Yeah, we raised $3 million in January 2023, and that was led by Segue Sustainable Infrastructure, which they're longtime colleagues of ours that are just real experts at providing development capital to developers. And so that's been great in getting the flywheel started. I mean, we've been in conversation with close to 400+ developers, and so we've had a lot of conversations on the development side, and so that's been very exciting. We also have about a dozen great entrepreneurs and CEOs on our cap table as well.
Cody Simms (39:53):
From a business model perspective, is it a SaaS company? Are you charging a transaction fee? What's the engagement model look like for you?
Andy Moon (40:01):
We are focused on a transaction fee, which really motivates us to get these deals closed. The way we view ourselves is a tech enabled finance platform. We're really a financing company at our heart. And I think a lot of the challenges and a lot of the hard work in these early days is really how do you put together the financings the proper way with the right documentation, the right structure, the right risk mitigation, and that's where we have a lot of expertise. We think technology will make the business very interesting though, because once we have the volume of transactions coming on the platform, we can use all of that data to then develop additional data-driven financial products such as connecting developers to other sources of lending, making the market and guaranteeing the price for these tax credit sales, and even going into insurance.
Cody Simms (40:46):
And who do you want to hear from right now? As folks are listening to this, they're interested in what you're doing, what are the kinds of introductions that are most helpful to the work you're doing at Reunion?
Andy Moon (40:56):
So our team is growing, and so we're always looking for folks who are passionate about climate and who have experience sort of selling into large enterprises, particularly on the finance side. So would love to, you can take a look at our jobs page, but we're always recruiting and looking to grow the team with great people. So that's number one. And then I think second, we are always looking to expand our conversations, especially with large corporations or medium-sized corporations that are interested in supporting clean energy while generating a really great return. So if there's corporate finance professionals listening that find this interesting and want to be part of the energy transition, please get in touch.
Cody Simms (41:31):
Andy, I came into this conversation only knowing what I know about tax credits, and so I'm sure there are questions I should have asked or could have asked that I did not ask. What should we have covered or what points should we have tried to make sure people leave fully appreciating?
Andy Moon (41:46):
I think that this is a completely new market that was created pretty much overnight and it's hard to understate how impactful a simpler financing process will be, both for project developers as well as getting more corporate investors involved in clean energy finance. I think what gets us really excited is, today in 2023, a lot of buyers are fairly conservative and they want to work on a very large and straightforward transaction still. So a $20 million credit transfer or $40 million credit transfer. But we do want to use technology to get to enabling all of these smaller projects, like there's many one megawatt projects on commercial rooftops that absolutely should be financed, but they've always struggled to attract financing because it's too complicated. The financing process is just too convoluted. And so we're very excited about enabling even the smallest projects to get financing.
Cody Simms (42:40):
Back of the envelope math says if you're expecting this market to be $75 to $80 billion by 2027, '28 and the tax credits are somewhere between 30% to 50% of the total project, doesn't take a ton of math to say, wow, we're talking probably $150 billion to $200 billion in project volume that these tax credits are coming off of. Am I doing the math right there?
Andy Moon (43:04):
Yeah, that's right. $80 to $100 billion dollars is the credit volume, so the actual project volume is two to three times higher than that.
Cody Simms (43:11):
Well, Andy, thanks so much for joining us today on My Climate Journey. I appreciate learning from you, and hopefully our listeners do too.
Andy Moon (43:19):
Thanks, Cody, appreciate it.
Jason Jacobs (43:20):
Thanks again for joining us on the My Climate Journey podcast.
Cody Simms (43:24):
At MCJ Collective, we're all about powering collective innovation for climate solutions by breaking down silos and unleashing problem solving capacity.
Jason Jacobs (43:34):
If you'd like to learn more about MCJ Collective, visit us at mcjcollective.com. And if you have a guest suggestion, let us know that via Twitter at MCJpod.
Yin Lu (43:47):
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Cody Simms (43:56):
Thanks, and see you next episode.
