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08DEC 2017

How will the new tax reforms impact future solar projects?

The new Tax Cuts and Jobs Act was introduced on November 2nd in the U.S. House of Representatives by the Chairman of the Ways and Means Committee, Texas Representative Brady. The original bill outlines key changes that may drastically affect the fast growing U.S. solar market, which is currently the star-performing industry that has generated 17x the jobs growth rate of the overall U.S. economy in the past year.

Will solar remain king?

Currently, the House and Senate bills differ on when precisely the corporate tax rate change is applied. Our analyses have shown that the bill offers two critical changes, the corporate tax rate reduction and first year full depreciation tax write-off of equipment placed after September 27, 2017. As the negotiation unfolds, these two main tax reform points are unlikely to be taken off, albeit, they remain somewhat controversial. From the perspective of a solar investor, these changes provide even more favorable terms which would spill over to the overall solar market activity.

The decrease of the corporate tax rate from 35% down to 20% has a paramount effect on the economy by altering the flow and value of goods and services. Fundamental market behavioral changes are expected from the magnitude of these tax cuts. 100% bonus depreciation will make infrastructure investments more attractive due to the increased time-value of immediate tax write-off benefits. It is reasonable to predict the following highlighted outcomes from a preliminary assessment of supply and demand markets affect by these changes:

Total tax partnership investments from corporations will decrease in the short-run. A tax investor, first and foremost, evaluates a project based on the project's tax benefits. Therefore, when the corporate tax rate is decrease from 35% to 20%, the tax benefits from depreciable assets would decrease by 42.85%. The sensitivity of even a slight tax rate decrease will impact the tax equity market. This will make infrastructure investments far less economically attractive as a vehicle for corporate tax optimization which has traditionally pushed effective tax rates down towards 15-22%.

Infrastructure projects will go small. Immediate tax write-off of equipment and project costs will lead to a demand for smaller projects overall. Non-corporate profit are less easily syndicated than corporate profits. Therefore, any un-pooled source of tax liability is more easily sated with smaller and less-costlier infrastructure projects. The barriers for establishing additional syndicate funds are still very high. Thus, our assumptions are that this change towards 100% bonus depreciation counteracts the need for syndication to achieve bigger scale projects by making smaller projects efficient on their own.

Solar projects will go smaller and more. Solar projects are unique because they generate investment tax credits in addition to the 100% bonus depreciation. When the two mechanisms interact, the size of an ideal project for any given tax liability is reduced even further resulting in system sizes and costs 60-80% of the current market's. This means solar project developers need to better gear themselves for smaller projects as those will be better fit to serve the needs of the market equilibrium between finance and customer demand. This will be the best opportunity for growth in the C&I solar space as the remaining tax equity investors are looking for a new equilibrium sweet spot for an ideal solar project and in all likeliness, it will shift downwards from utility size to C&I.

Projects with tax credits will be the most attractive investments for offsetting tax liabilities. Tax benefits of depreciation and tax credits are fundamentally different in how they translate to tax benefits. Tax credits will be even more valuable for corporations due to the decrease in corporate tax rate. This means, dollar for dollar, solar will yield even better returns for investors than other comparably priced infrastructure projects with reduced tax rates.

Fair Market Value will increase in all revenue-generating assets. This is self-evident from the decline in corporate tax rates that passively generated income and long-term energy contracts will benefit/appreciate significantly in fair market value by 15%.

Solar prices will continue to decline 10-15% per year citing improving manufacturing technology and efficiency improvements. While 15% per year cost decrease is more heavily cited in the industry, silicon solar wafer cells are closing in on the theoretical maximum (Shockley-Queisser limit) for a single junction solar cell.

Solar profit margins will increase 25% YoY citing combination of cost decline and revenue increase.

Total solar capacity deployed will experience downward pressure due to the above investment uncertainty. Other factors such as higher operating margins and increased competition will offset and might even overcome forecasted downturn as they depend on competing grid electricity prices.


O3 Energy

Matt Ji

Financial Analyst