Oregon Legislature Limits Energy Tax Credits, But Leaves Program Intact

Since 2007, Oregon’s popular Business Energy Tax Credit (“BETC”) has earned the state an enviable reputation as a leader in renewable energy, particularly wind energy. But the ballooning costs of the tax credit program, combined with a national recession, caused the state legislature this year to take a careful look at whether the state is getting its money’s worth from the program. In the final days of its February special session, the Oregon legislature passed a bill which places clear limits on total outlays for the program, and tightens up eligibility criteria.

BETC Basics

BETC (pronounced “Betsy”) is a non-refundable credit[1] against Oregon state personal and corporate income taxes. Generally taken over five years, it is measured as a percentage of the “certified cost” of a wide variety of energy-related projects.[2] A “pass-through” program allows the credit to be purchased and transferred.

Qualifying Projects

Efficiency initiatives such as weatherization, energy conservation, and even the purchase of fax machines (if used at least 45 days a year for telecommuting) can qualify for BETC credit. However, the program’s most important aspect is its incentive for construction of “facilities using or producing renewable energy resources” – particularly wind farms but also solar, biomass, geothermal and other alternative energy installations[3] – and “renewable energy resource equipment manufacturing” (“REREM”) facilities.[4]

ODOE Cost Certification

To obtain BETC credits, an applicant must submit documentation of the project to the Oregon Department of Energy (“ODOE”) for “preliminary certification” of the proposed project’s costs.[5] In theory, the agency has a substantial gatekeeper role at this stage – reviewing projects to ensure compliance with all applicable criteria, and rejecting those that do not qualify.[6] When the project is completed, the applicant submits a “final certification” application confirming all earlier representations, which again is reviewed by ODOE prior to final certification. The final tax credit amount is based on the final certified construction costs.

Monetization via Pass-Through

A non-refundable tax credit is a fairly limited incentive: if one has no tax liability, one cannot use the credit and so the development incentive is lost. To address this inflexibility, Oregon created a “pass-through option” that allowed credit holders (those who built the qualifying project) to sell the credit to a “pass-through partner,”[7] who would pay the credit holder for the right to take the credit.

If the credit is sold at a discount to a pass-through partner with adequate tax liability, the seller can use the funds as investment capital and the pass-through partner can take the credit as an offset against their tax liability for up to five years. The value of the credit to the pass-through partner depends upon the price it paid to the developer for the credit. ODOE rules established the payment methodology. In 2007, ODOE pegged the price of credits, without exception, to reflect a uniform 9.85% annualized rate of return if fully claimed. In other words, a pass-through partner purchasing the tax credit did so at a discount that, when recouped over the five-year life of the credit, could net an almost 50% return on investment, with very low risk.

BETC Broken

A boom in alternative energy investment and a major economic collapse coincided to focus attention on the economic impact of the credit structure on future tax revenues and state budgets. It became clear: BETC needed significant changes. These problems, coming during a major recession, seemed at the time to threaten BETC’s very existence.

Ballooning Costs

In July 2007, Oregon raised the certification limits on renewable energy and REREM facilities from $10 to $20 million, and from 35 to 50 percent of construction costs.[8] Prior to this expansion, the BETC program had cost Oregon about $23 million for the 2007-09 biennium.[9] In early March 2007, the increased limits were projected to increase the program’s 2007-09 costs by only about $1.9 million, and 2009-11 costs by only about $12 million.[10] Although by late March these cost projections had increased to about $18 million per year, in the relatively sunny financial days the state enjoyed at the time, the increases raised little debate and passed easily.[11]

Actual costs quickly exceeded even the revised projections – in early 2008 companies had already claimed $28 million in credits. Nonetheless, in March 2008 the Oregon legislature raised the certification limit for REREM facilities to $40 million, again with little debate.[12] In August 2008, an understaffed ODOE found itself faced with an unprecedented 4,000+ BETC applications, which might have given some indication of the program’s potential budget impact.[13] But energy companies were moving to Oregon – the costs were not under significant debate.[14]

This began to change in late 2008, as the effects of the national recession became fully apparent. In January 2009, amid the generally grim financial outlook, it was revealed that BETC’s costs had already risen to $69 million (actual) in 2007-09, and $144 million (projected) in 2009-11.[15] The 2009-11 cost projections were later updated to $168 million.[16] Meanwhile, Oregon faced a budget shortfall estimated in the billions.

Then, on November 1, 2009, the Oregonian published accusations that state employees had intentionally underreported the original, very low BETC cost projections to lawmakers.[17] Subsequent editorials portrayed BETC as a boondoggle that was diverting tax revenues from schools and police while primarily benefitting out-of-state companies, with little public benefit to Oregon.[18] Amid this, BETC’s 2011-13 budget impact estimate was released: $243 million if nothing was changed.

Systemic Flaws

Rising costs were not BETC’s only perceived problem: they came to light intertwined with a number of practices that lead to questions about the program’s investment value.[19] According to local reporting:

• ODOE approved 97% of the applications submitted to it, with few discernible criteria for rejection.
• To avoid the $20 or $40 million limits, applicants had broken up projects into pieces, and received multiple credit awards.
• Credits were awarded to projects that went bankrupt or never opened – no benefits thus accrued to the state, but pass-through partners had purchased the credits and could still cash them in for years to come.
• The program offered a guaranteed 9.75% annualized rate of return to pass-through partners, far above returns in most government programs and at very low risk while the budget was suffering. Many pass-through partners were large, out-of-state companies.
• Much of the power generated by the credits was committed by power sales agreements to loads outside Oregon, raising the questions whether the incentives were benefitting the state providing the credits.
• Although the program was viewed as necessary to incentivize development, no study had been made or consulted regarding the role such credits were actually playing in the decisions of companies to locate in Oregon, and whether the credits were really necessary to support the renewable energy industry. This was particularly the case for wind power, which, with the adoption of renewable portfolio standards in California, Oregon and Washington, was argued to have matured enough to phase out credits.

In the politically charged atmosphere infusing the budget debate, it was not clear how significant the Oregon legislature’s response would be, but it was clear that BETC would be reformed.

BETC Brought Back

The Oregon legislature’s response, made during its emergency session this February, was to pass HB 3680 (Feb. 23, 2010). The legislature declined to adopt several more drastic proposals – such as retroactive revocation of already completed pre-certifications, or scrapping the program entirely. Instead the bill addresses specific problems and places clear limits on the total outlays for program’s most popular (and expensive) components, while continuing to provide significant incentive for alternative energy programs.

For facilities using or producing renewable energy, preliminary certifications are capped at $300 million for the 2009-11 biennium,[20] and $150 million in 2011-12.[21] If applications exceed the cap (which they are almost sure to do), ODOE is to establish by rule a “tiered priority system” to distribute the available credits. ODOE must “subject facilities with higher projected costs to closer scrutiny, [and] compare similar costs against each other,” and must now develop selection criteria based within legislatively defined parameters.[22] To avoid single projects claiming multiple credits to exceed the limits, ODOE will also define standards for “what constitutes a single facility.”[23]

The bill also institutes a diminishing cap on credits available to large (10MW+) wind facilities. Only 5% (instead of 50%) of facility costs may be recouped, with a hard cap of $7 million per facility in 2010,[24] $5 million in 2011[25] and $3 million in 2012.[26] Solar, biomass and other projects are not affected, and the REREM program was actually expanded: REREM facility credits are capped at $200 million in 2009-11 and 2011-13 biennia,[27] but now include facilities that manufacture electric vehicles or specialized component parts (other than batteries), capped at $2.5 million per facility.[28]

Under the new law, most facilities must achieve final certification (completed construction and costs certified by ODOE) by July 1, 2012.[29] This limit does not apply to REREM facilities, which are eligible for preliminary certification until January 14, 2014, with no deadline for final certification.[30] The bill also specifies that preliminary certifications for REREM facilities are good for five years, while all other facilities must reapply for a two-year extension after three years.[31]

To avoid certifying projects that might not contribute to long-term development, ODOE will now require information showing that a proposed facility will “remain in operation for at least five years,”[32] as well as information on “the amount and type of jobs that will be created [and] … sustained,” including those attributable to construction and operation, and the “benefits of the facility with regard to overall economic activity in the state.”[33] Applicants must also demonstrate that the proposed facility will comply with applicable state and local laws and obtain all necessary permits,[34] and will likely be required to provide substantial additional information to allow ODOE to apply any selection criteria it develops under its new authority.[35] The bill excludes certain sensitive information submitted by applicants from disclosure under the Oregon public records law.[36]

Finally, the legislature left in place an earlier move by ODOE, pegging the pass-through return to five-year Treasury notes and the Consumer Price Index for the west region.[37] This change was effective January 1, 2010, and did not apply retroactively.

Conclusion

For the last three years, Oregon has provided unparalleled financial incentives to wind, solar, biomass and other renewable energy projects. Although significant problems were uncovered in the BETC program, the new reforms largely address them, while leaving the core of the program intact. Wind power has benefited greatly from the prior program, but the state is now shifting tax credit incentives to encourage other alternatives.

Arguments will continue about the program’s cost. The Oregonian has reported that, to date, $1.3 billion dollars in credits have been pre-certified.[38] But BETC, like any investment, entails risk and the possibility of reward. It remains to be seen whether the shifting of tax incentives will yield a result that Oregon’s taxpayers view as providing a net benefit to the state, but the program will clearly continue to encourage investment in renewable energy resources in Oregon.

For more information on Oregon’s Business Energy Tax Credit program, contact Adam Orford or any member of Marten Law’s Portland office.