Congress Should Embrace Favorable Tax Structures to Hasten Clean Energy Deployment

by Dan Watkiss

The Center for American Progress and the Coalition for Green Capital’s (CAP/CGC’s) “Cutting the Cost of Clean Energy” report recommends steps Congress can take to reduce the cost and speed the deployment of clean energy sources.

One recommendation would level the playing fields for investments in fossil fuels and renewable energy sources. This recommendation warrants Congressional consideration as a stand-alone enactment or as part of comprehensive clean energy legislation: Make income earned from investments in renewable sources of power generation eligible for purposes of a master limited partnership (MLP) or real estate investment trust (REIT).

Confronted with intractable political opposition in Congress, the Obama administration proposes to promote clean energy sources in the absence of direct economic controls on greenhouse gas emissions. The administration’s new clean energy strategy will promote investment in nonfossil generation, opening the nuclear renaissance and expansion for wind, solar, biofuels, tides and run-of-river microhydro. As the president articulated this change in approach, the earthquake and tsunami in Japan exposed the potentially disastrous–however unlikely–risks of nuclear generation. Within weeks of the radiation blight wrought at the Fukushima Daiichi Nuclear Power Station, representatives of institutional investors warned that the billions needed to build new nuclear power capacity would not be forthcoming in the foreseeable future.

If true–and it might be–then the prospects for a clean national energy policy with significantly reduced emissions of greenhouse gases and criteria pollutants will depend largely on the nation’s ability to induce investment in relatively clean natural gas and renewably sourced power generation. The former benefits from the investment-conducive MLP form of organization. According to the CAP/CGC, it’s time to extend those same benefits to investments in renewable generation sources that national energy policy targets for intensive development.

An MLP combines the tax benefits of a limited partnership with the liquidity of common stock in the form of units that trade on an exchange. The aggregate market capitalization of energy MLPs exceeds $160 billion. Because of how MLPs have been defined in the tax code since 1987, 90 percent or more of their income must derive from eligible investments in natural resources, commodities or real estate. This limitation has channeled most MLP investments into oil and natural gas production, associated pipelines and refining facilities. What, however, could be more of a natural resource than a renewable source of power generation, such as a wind, solar or biofuel farm? Explicitly extending in legislation MLP eligibility to these and possibly other renewable resources can be expected to attract investment dollars in deployment of new and improved technologies, making generation from those resources increasingly competitive with generation from fossil fuels.

CAP/CGC also proposes to make the REIT form of organization available for clean energy investments and deployment. Congress authorized REITs in 1960 to enable investors from all walks of life to own professionally managed, income-producing real estate through companies modeled on mutual funds. Comparable in result to MLPs, the REIT form of organization avoids most if not all entity-level taxation under the Internal Revenue Code. This distinguishes a REIT from Subchapter C corporations that are taxed at both corporate and shareholder levels. (A REIT is taxed as a C corporation, but it receives a deduction for the dividends of 90 to 100 percent that the REIT is required to pay to its shareholders.) Because of this favorable tax treatment and annuitylike earnings on property rents, the aggregate market capitalization of publicly traded domestic REITs exceeds $270 billion. Moreover, in a pair of recent private letter rulings (PLRs), the Internal Revenue Service has determined that electric transmission systems and natural gas distribution systems qualify as real estate that can be held within a REIT. Here again, it is a logical extension from networks of wires and pipes to facilities that arguably are more intrinsically real estate, such as wind, solar and biofuel farms. By doing so explicitly in legislation, Congress would eliminate the uncertainty and risk associated with having to petition the service for an independent PLR for each clean energy project to be held within a REIT.

Proposing MLPs and REITs as favorable new structures for investment in and deployment of clean energy is especially apropos in a report that invokes the revolutionary advances in telecommunications to chart a path forward. Often it is observed that if contemporaries Thomas Edison and Alexander Graham Bell were reincarnated today, Edison would look out on the power industry he helped pioneer more than a century ago and would find it familiar. Bell, in contrast, would find little familiar in the telecommunications industry he pioneered equally long ago. By facilitating investments in clean energy through investment-conducive MLP and REIT forms of organization, Congress can help leapfrog the power industry’s progress just as it did for telecommunications in 1996.

Author

Dan Watkiss is an energy partner in a Washington, D.C., law firm and represents clients in transactions, investigations, complex litigation and appeals in state and federal courts, and before administrative agencies, arbitral panels, the U.S. Congress and the executive branch. Reach him at jdw1954@gmail.com.

 

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