Catalyst with Shayle Kann - Frontier Forum: Diving into the booming transferable tax credit market

Episode Date: February 20, 2024

It's been a year and a half since the Inflation Reduction Act was passed. In that time, we've seen $110 billion in planned investments for factories that are pumping out electric cars, batteries, solar modules, and wind towers.  The upper end of 2030 forecasts show nearly twice as much zero-carbon generation getting built compared with scenarios without the law in place. Much of this activity is the result of a new shift in the US tax code that allows wind, solar, storage, hydrogen, carbon capture, and manufacturing tax incentives to be sold for cash. It’s creating a lot more deal volume as many more companies can now buy those credits to support new development. “This very rarely happens that a new market forms basically overnight. The private estimates on how big the market gets get it to something like $80 or $100 billion dollars by the back half of the decade,” said Alfred Johnson, co-founder and CEO of Crux, speaking at Latitude Media’s Frontier Forum. In January, Crux closed an $18 million Series A round led by Andreesen Horowitz – bringing the company’s total funding to $27 million to scale its sustainable finance platform. It’s been about a year since credits started trading, with activity really picking up in the last six months. Much of our understanding of how the market is performing comes from new research from Crux, which recently surveyed 150 buyers, sellers, and intermediaries – and found a mix of eagerness, hesitance, surprises, and lots and lots of questions. Stephen Lacey spoke with Alfred Johnson live during Latitude's Frontier Forum to address many of those questions – and riff on how this new market is taking shape. You can watch the full conversation, including questions from the audience, here.

This is a Frontier Forum, brought to you by Latitude Studios. It's been a year and a half since the Inflation Reduction Act was passed. In that time, we've seen $110 billion in planned investments for factories that are pumping out electric cars, batteries, solar modules, and wind towers. And the upper end of 2030 forecast show nearly twice as much zero-carbon generation getting built compared with scenarios without the law in place. Much of this activity is the result of a new shift in the U.S. tax code. Yeah, so first, starting at the beginning, Stephen, we have been using tax credits to incentivize

renewable energy and all kinds of energy before that for a very long time. The IRA supercharged that it increased the amount of credits that developers get for building all sorts of things, and then it created this new tool called transferability, where now you can sell the credits directly. Transferability could supercharge the financing of manufacturing, plants and a wide range of clean projects. It allows solar, wind, storage, hydrogen, carbon capture, and manufacturing incentives to be sold for cash. And it's creating a lot more deal volume, as many more companies can now buy those credits to support new development. This is a big new market, and this very rarely happens that a new market like this forms basically overnight.

The private estimates on how big the market gets, get it to something like $80 or $100 billion, by the back half of the decade. Alfred Johnson is the co-founder and CEO of Crux, a company that built a platform specifically for transacting and managing this new class of credits. Alfred was previously deputy chief of staff for Treasury Secretary Janet Yellen and VP of Financial Markets Advisory at BlackRock.

He also co-founded and sold a successful tech company. So when the IRA passed, he saw a clear opportunity to create software to support the coming surge of clean energy tax credit trading. We've gained additional conviction that this market needs a central platform at the middle of it, and it needs software that makes these transactions a lot more efficient, and be sure that we've got all of the tools that we need to invest as strongly

as we will into the technology that will make these transactions a lot more efficient. In January, Crux closed an $18 million series A round led by Andreessen Horowitz, bringing the company's total funding to $27 million to scale its sustainable finance platform. It's been about a year since credit started trading, with activity really picking up in the last six months. And we now have visibility into market volume, deal sizes, pricing, and the makeup of buyers and sellers. We were able to identify $3.5 billion of specific transactions. Some of that is transactions from our platform, some of that is publicly announced deals, and some of that is survey data that we were able to collect.

And using that, we were able to extrapolate and estimate that the total market was 7 to 9 billion of transfers for 23. Much of our understanding of how the market is performing comes from new research from Crux, which recently surveyed 150 buyers, sellers, and intermediaries, and found a mix of eagerness, hesitance, surprises, and lots and lots of questions. I spoke with Alfred Live at the end of January during Latitude's Frontier Forum to address many of those questions and riff on how this new market is taking shape. These are simpler transactions than prior versions, simpler than

tax equity, but they're not simple. They still have hundreds of underlying documents, many stakeholders around the table, some compliance obligations that need to be managed. Trust is absolutely essential in a brand new market and is certainly essential in this one. So you surveyed 150 tax credit buyers, sellers, intermediaries, as you said, that these parties represent about three and a half billion in transactions last year. Was there any difference in and what you expected to find versus what you actually found when you started to dig in

in terms of the vitality of the market, the types of participants, what did you expect to find versus what you actually found? Yeah, so first I'll talk about some things that surprised us. We did not expect to find $3.5 billion of transactions

or did not expect the data to show quite so authoritatively that the early market was as strong, is as strong as it is. didn't expect to find as much new technologies in the data set as we ended up finding. There's quite a lot of 45X in the data for our survey respondents and deals that we were able to gather data on in the crux platform.

We found that 45X was the second most broadly characterized or considered kind of transaction within the data set. And to be clear, 45X's advanced manufacturing credits did not expect that sellers would, would articulate quite so much that they were feeling like they were flying blind, particularly with respect to pricing. And there's a big issue that we identified in the data on market transparency. And frankly, that was one of the reasons why we did this report. At the highest level, we found five big things. One, the rapid growth in the market was achieved really quickly, right? We're talking about August to December where quite a lot of deals were priced

and closed. We found that transferability is leveling the playing field. So the majority of deals in the data set were less than 50 million, and many were associated with new technologies. We didn't expect, we found that pricing was quite better than we had initially anticipated in the market. So the average credit price that we found in the same. sample was 92 to 94 cents. And this is better average pricing than we see currently in the 37-year-old Litech market. So better pricing indicating confidence in the market. We found quite a lot of evidence in the data that technology intermediaries and competition drive better outcomes for people that are selling credits. We'll go into that in greater detail. And I have a slide that I can show on

And then we found that a clear majority of market participants expect this market to boom in 2024 and 2025. There's a lot of optimism there. So let's break down buyers and sellers a little bit more. We'll talk about buyers first. Is there a new class of buyer emerging and what are their motivations and concerns? Many of them are working through intermediaries. They're concerned about diligence, insurance, the time and cost of diligence. Break that down a little bit for me. What are their concerns and how do you characterize this class of participants? So there absolutely is a new class of buyers that are coming into the market. When you consider the baseline of traditional tax equity,

most of that capital is coming from 10 institutions, 10 of the largest banks. In the new market, we're seeing buyers that are more broadly distributed. So seeing people from all kinds of different industries, seeing companies of various sizes. It is the Fortune 50, but it's also the Russell 3,000. We see private companies that are looking to participate. But of course, when you have new buyers that are coming to the market, they come with a lot of questions.

It's a new product. Many have not participated historically in tax equities. Some have not participated in market. like state tax credits or low-income housing tax credits before. And so those buyers need a lot of education. They need to understand the risks that are at play in these deals. They are often advised by tax advisors and in all cases lawyers. And those intermediaries are playing a really critical role in buyers coming up the curve here.

And I think there was a dynamic. We found there was a dynamic where a lot of buyers were testing the water. in 2023. So many people were looking to do a pilot transaction in order to grow their strategy going into 2024. And I think we'll start to see the market stabilize and more buyers come in in 24 now that some deals have been done. And then in terms of sellers, you said that they're worried about price transparency. What sector is technology types do they represent? So sectors and technology types, all of them. We currently, on crux, have solar, storage, hydrogen, bioenergy, advanced manufacturing,

kind of all the types of credits that can be sold for cash. They vary a lot in terms of size. So people are looking to sell credits in the six digits. They're also looking to sell credits in the 10 digits. We have both levels of sizes offered on the platform. And sellers, as you said, are overwhelmingly concerned with the transparency. of the market and price, and the certainty by which they can assign whether or not they will be able to clear the credit, sell it, and get the price that they want. And there's a, there was a

huge finding in the data that that lack of transparency is inhibiting confidence and that they basically don't know whether they are getting a good deal or not. And that is particularly a problem when sellers are selling in bilateral kinds of transactions, because you don't really know what the market price is or should be. You're relying on your advisor or whomever is at the table with you telling you that, but you don't have clarity into price discovery in the same way that you may as the market starts to become a little bit more centralized. And what can we say about deals that are being executed? Are they, are sellers getting a good deal? Yeah, I think in the early market, sellers are getting a good deal. The report finds that

pretty clearly. So the pricing was better than anticipated on most transfer deals. The high end of the market is 94 to 96 cents. And we've seen some very large transactions like the first solar fyserve deal that priced at 96 cents on 45x credits. And as far as I know, that is the high water mark in the market or around 96 cents. But even for smaller deals, we found that, we found that, pricing was pretty strong. So at the smallest end of the market, the sub-20, sub-10 million kind of credit sizes, pricing does fall off a cliff. Like, it gets a lot worse, but it goes down to 89, 88, 87 cents on a gross basis. And so the sellers who previously were not able to access the tax equity market and would have found that kind of financing to be very expensive,

even at larger credit sizes, are able to access the transferability market and get reasonably good pricing. So what are you doing about transparency? So one big place that we started was this report, right? We wanted to give buyer, sellers, intermediaries, as much information as possible on the early market. The market's about six months old. So having data on pricing, on market sentiment, on deal sizing is very helpful we find to the market. We also, by virtue of what we do, which is to provide software for transactions in a marketplace where buyers, sellers, and intermediaries can transact, the platform delivers more real-time

price discovery. So we found that credits that are listed on crux in 37% of cases where a credit received a bid, they received multiple bids. And we saw a big impact on price for credits that receive multiple bids. And effectively what you are finding there as the seller is the market price, because multiple buyers may be looking to transact on your credit, and that leads to a more real-time discovery of what a fair price in the market is for that credit at that time. So let's talk a little bit about deal sizes and types. How are current deals different from traditional tax equity in size and project type. So traditional tax equity tended to be transactions at 50 or 100 million dollars or above. It just really didn't make sense to go through the legal work necessary and the transaction

structuring to do tax equity deals at less than those amounts. And the providers of tax equity have been the largest banks that are looking to, for the most part, participate in transactions that are much larger. We found in our data set that smaller deals, so 50 million and below, represented the majority of deals in the data set. And that is really encouraging, because what that suggests is that transferability is leveling the playing field and that those kinds of sellers are able to sell directly into the market without necessarily having to go through tax equity structures. And that's beneficial because on the margin then that brings in more incremental demand to the market. And we have found that tax equity has been limited in its ability to expand and somewhat vulnerable to market

shocks. I started my career, Stephen, at the Treasury Department in 2009, working in part on the Recovery Act, which included some incentives for clean energy, a grants program called the 1603 grants program when the market froze around tax equity, around the financial crisis. So it has shown that it is vulnerable to shock. And finding ourselves in a much broader market that includes transferable credits is just good for clean energy finance because it gives us more opportunities to be able to find buyers and monetization for credits. And we're seeing that at even smaller sizes than we have seen before, and that's a really positive dynamic. I'm curious about your thoughts on the bonus tax credits and how they're being monetized,

so you have bonuses for prevailing wages, for energy communities, for low-income communities. I mean, how many participants are claiming eligibility for these credits? Can you just explain what these bonuses are and how they might evolve with more clarity on rules and as more of them are monetized? Yeah, so this is a moving target and has evolved over the course of 2023. Treasury has been putting out and the IRS guidance on bonus credits and how they work. Buyers have been working to get their heads around the implication to the credit sizes. As far as I know, we have not seen a deal yet that has moved forward without the prevailing wage

and apprenticeship adder, so the adder that gets you to roughly 30% as a baseline or exactly 30% as a baseline on ITCs. We are seeing some deals negotiated such that the seller is making representation that they have the adders or qualified for the adders. And the buyer is looking for opinions from legal counsel, tax advisors to say, in fact, they do have them. And there's some deals that will progress where a part of the credit will transact, the base part of the credit will transact first, and then if the parties get comfortable that the adders are met, then the adder piece of it will transact as well. But we found in the data set that there were still a lot of questions around how adders will work, and there was some pretty meaningful guidance

that has been put out towards the end of last year by the department. Any other policy uncertainty or guidance uncertainty that you're keeping your eyes on? Yeah, there's a lot of guidance that still needs to be finalized, including the transferability guidance, the department's working really rapidly on all of that. I can't not point out that this program exists in the context of politics broadly, and there are implications from policy changes to the market. So, for example, this new tax bill that is winding its way through Congress and appears likely to pass has pretty extensive tax credits for R&D, to the extent that that is passed, and buyers can take benefit of those new retroactive R&D credits that limits demand that could

be otherwise allocated to these clean energy tax credits. So, you know, everything that happens in and around the policy that defines this early market will have implications to supply and demand. So let's talk about pricing a little bit more. What technologies and credits are priced the highest? What are the lowest? And how do you think pricing is going to change over time? So the biggest deals priced the best. We found this decisively in the data. The mega deals, call it the $100 million plus kinds of deals are transacting at $94, 95, $0.96. And the trend of size impacting price is true across credit types. So it may be that the 45x credit does not trade as a rule as high as wind production tax credits do, but larger 45x credits, price better than

smaller 45x credits, just like larger wind production tax credits, price better than smaller wind production tax credits. In general, we find that the new technology type, are not transacting at quite as high of prices as the more established ones. We are also finding, and I haven't talked about this dynamic yet, but it's important, that there's often this desire in the market to segment entirely traditional tax equity from the transferability market. That is not borne out by reality. We are seeing an increasing amount of so-called hybrid deals where a tax equity partnership

is formed and then credits are sold out of that partnership. And we are seeing, we do see some evidence that pricing on those kinds of deals where a bank is at risk, a bank or somebody else is at risk in the transaction in the tax equity, that kind of credit is attractive to the by side of the market. And do you expect that to make up a significant share of tax financing, those hybrid deals? I do. Yeah, I think especially with the largest ones, the ability that the tax equity provider has to sell the credits out of the partnership as the first owner of the credits, just opens more flexibility to those tax equity partnerships. And that may be particularly important in consideration of some of the Basel three rules that the banks are watching quite closely.

Can you explain a little bit more about how those deals will work or how you foresee them working? Yeah. So the credits can only be sold once, but by virtue of the structure of tax equity, when a tax equity partnership is formed, it is interpreted to be the first owner of the credits. And as a result of that, the tax equity partnership can be a mechanism by which the credit basis is stepped up. It is the mechanism by which depreciation is monetized, in part because depreciation cannot be sold or because depreciation cannot be sold. And it also internalizes the credits. But the credits can then be sold, by the partnership into the market. And we saw quite a lot of that in 2023,

and I think we're going to see a lot more of it in 2024, because it's just a good product, right? On the sell side, it allows you to monetize the depreciation, and if it's appropriate, step up the basis. On the buy side, you're buying a credit that has been underwritten by somebody. And so I think for the largest deals, you're going to see that dynamic in the market. And that is one thing that crux,

accommodates. We work quite closely with banks on both the buy and the sell side, and banks will use crux to manage transactions. And that supports that kind of dynamic where a bank may be performing a tax equity partnership, putting one in place, and then looking to sell credits into the market. So you say that for 2024, you think there will be a reset. What's a reset? What does that look like? So I think first, just holistically on pricing, I think there is, an assumption in the market to assume that pricing is monolithic, and it won't be. There will be a large number of factors. I talked about the tax law a moment ago. There are also factors like the supply of projects in the market, interest rates, macroeconomic factors. So a recession that

impacts the taxable income of U.S. corporates would impair the tax base and therefore the demand side of the market. And so all of those factors are playing. out in real time. The economy is still quite strong. We are coming off of a very strong 23 early market in the transferable credit sales. The market shows a lot of health, but we no longer have the same time pressure on 2024 credits as we did and do on 2023 credits. And that is leading the market behavior, the bidding behavior on 24 credits to extend a bit longer. It may lead to pricing, adjusting somewhat here. Because if you just think about it in a pure supply demand sense, there was only so much 2023 credit volume that was available. If you trust our numbers, then it's

something like $7 to $9 billion that will transact, but it's capped. And there was more demand than supply. There is still more demand than supply on those 23 credits. But as you look towards 24, the market doesn't know exactly how much supply of 24 credits will be in the market. And there is still a need to develop a lot more demand. So I think you're going to see supply and demand adjust over the course of the year. And you may see a bit of a reset on pricing as we go into a more of a larger market from the one that was in 2023. What are the biggest factors that you think will impact deal sizes and pricing?

I think the question of where hybrid deals are performed and how is one of those factors. So are people doing partnerships at just $100 million checks and above? Are they doing them somewhat smaller? I think that will impact deal sizes here. I think there's a lot that has to do with the supply that comes to the market and how quickly, how quickly projects can be placed into service, how quickly they can be turned on. I think there is also an interesting, dynamic here where in one sense you've got one market where there are 12 credits that can be sold for cash but there are lots of there are 12 different markets that underlie that right so the 45x market is in some sense a a different product than the storage ITC market and in that sense if you see a lot

of supply of 45x come into the market then there will be an implication to market pricing on that. And though we're seeing some convergence, there is, we are seeing some sign that buyers are more comfortable with the existing technologies that they have seen in the past, like wind and solar, then they may be with some of the new technology types. And the supply side of the market will influence how the market forms on some of those new technology types. So let's take a look ahead and recap what we talked about here. Any other big predictions you want to make about what the market will look like next year and by the end of the decade even? I think by the end of the decade is a fun question. You know, you take the level of IRA investment

and extrapolate it into the amount of renewables and decarbonization facilities that will be built. And the numbers, frankly, get pretty astonishing, right? Goldman has an estimate that there will be, $3 trillion worth of energy infrastructure and decarbonization infrastructure that's built over the decade. And that's just like a, that's a hard number to get your head around, right? Like it's hard to envision the level of infrastructure that's associated with $3 trillion of investment. And when you think about the tax credit market, the tax credits will represent something like a third of the development and the capital that is raised by these projects. And the tax credits, you know, And in the world where we're at a $100 billion a year annual tax credit market that is five years, six years advanced from where we sit today, I think that market will be a lot more standardized.

I think technology will sit at the center of it. I think volume will aggregate in a defined number of places. And I think that you're going to see a lot of vibrancy in the market, in part because it's a great tool, right? It allows buyers to both invest in sustainability and to manage their tax liability, and it allows the developers to more efficiently monetize it. And in that sense, I think it's going to be a great enabler of the energy transition, and I think it's a very important development. Alfred Johnson, co-founder and CEO of Crux, thanks so much. This was fun.

Thanks, Stephen. Thanks for having me. This conversation was recorded live as part of Latitude Media's Frontier Forum with Crux. This was only half the interview. We spent another 30 minutes taking questions from the hundreds of participants. So if you want to watch the full video and hear Alfred's answer is about political risk, financing structures, diligent, the impact on tax equity, and more, head on over to latitudemedia.com slash events, and you can click watch recording. And if you want to read the full Crux report that we talked about, head on over to cruxclimate.com. And you can find the links to both of those resources in the show notes. Thanks for listening.