What’s The Deal? | How can tax equity spur the energy transition? 

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Evan Junek: Hi. You're listening to What's the Deal?, our investment banking series here on J.P. Morgan's Making Sense podcast channel. I'm your host, Evan Junek, from the corporate finance advisory team. Today, we dive into the dynamic world of tax equity, with my colleague Rubiao Song, head of energy tax equity investments at J.P. Morgan. Rubiao, great to have you and welcome to the podcast.

Rubiao Song: It's my pleasure, Evan, great to be speaking to you today.

Evan Junek: So let's jump right in. Maybe we start with you giving us a glimpse into your professional journey and your role here at J.P. Morgan.

Rubiao Song: Sure, thank you, Evan. I run the group within J.P. Morgan's Commercial and Investment Bank, focusing on making tax equity investment in U.S.-based the renewable energy projects. I started my professional career over 25 years ago at the legacy J.P. Morgan bank, called Bank One, which was Chicago-based. Since 2003, we started making tax equity investment in wind projects in the U.S. and have been building the team since. It has been a very interesting and rewarding ride.

Evan Junek: Excellent, so let's talk a little bit about that role. For those of us who are unfamiliar with tax equity, can you give us a little bit of a breakdown of what exactly tax equity is?

Rubiao Song: Sure. Tax equity is essentially a form of structured equity that investors in the renewable energy projects would derive its returns primarily from the tax benefit that's available from these renewable energy projects. U.S. policymakers have a tendency to use federal tax codes to incentivize private investments. In the renewable space, the two primary form of federal tax benefits are tax credits and depreciation benefits. So, tax credits in the form of production-based tax credits or investment-based tax credits. Lot of the renewable energy developers, they are either startups or they are in the growing company that they typically do not have a lot of U.S. tax federal liability, therefore, they cannot efficiently use these tax benefits. There comes in the tax equity investors who will form joint ventures with these developers and a primary form of this joint venture is called tax equity partnerships. In a partnership, the tax equity investors would receive 99% of the tax benefits, a small portion of the cash distribution, where the develop partner will receive majority of the cash distribution but 1% of the tax benefits. That has been a predominant structure over the last 20 years, and has really played an instrumental role in the development of renewable energy in the U.S.

Evan Junek: So to recap, if we think about tax equity, it is really a way for firms or specifically developers in energy transition investments opportunities to monetize tax credits that they might otherwise not be able to take advantage of, certainly not on the timeframe that most people are focused on in the context of their investments in these new projects. That a fair summary?

Rubiao Song: That's a very good summary. But I also add that some of the clients we are dealing with are very large developers. In the U.S. it's becoming a very large industry so they would require billions of capital each year to give up lease projects and the federal tax capacity does not grow as fast as their business pipeline, so they would need to have tax equity to monetize the tax benefits from their projects as well. That's a big part of our business.

Evan Junek: So basically big clients and small clients, really, are availing themselves of this market. Let's talk a little bit about J.P. Morgan's role here because I think J.P. Morgan's position in this market is also incredibly important. Maybe you could talk about how J.P. Morgan's tax equity business is positioned relative to the market.

Rubiao Song: Sure. As I mentioned, that we start this business over 20 years ago. In December 2003 we made our first investment in tax equity in a wind project out of Sweetwater, Texas. Since then, we have been building this business over 20 years. We are consistently the leading tax equity investor in the country and we've have built a team that making this investment from end-to-end in terms of opportunity identification, transaction structuring, due diligence, and documentation, as well asset management, accounting, et cetera. So this is very unique in the sense that we have built a full-capacity, full-capability team that comprised of not only the originators, transaction managers, of pricing analysts, we also have a team of professional engineers on staff and they are leading the technical engineering due diligence for us.

Evan Junek: So two decades is incredibly impressive to be in any market, especially one that we play such a big part of. Can you share a little bit more about the kinds of projects that we've been involved with over the years and the positive ripple effects that they've had?

Rubiao Song: Happy to, Evan. As a core tax equity provider over 20 years, we invested a range over $47 billion of tax equity for renewable energy projects in the U.S., which include $40 billion of J.P. Morgan's capital. In 2003, as I mentioned, we made our first $23 million investment in the wind farm in West Texas. Since then, we have invested in projects over 40 states, 322 wind farms, representing almost 50 gigawatts of wind capacity in the U.S. As a comparison, the total install the wind capacity in the U.S as of year-end '23 was 150 gigawatts. So, that represents almost one-third of U.S. total installed capacity. We also start investing in utility scale solar, commercial and the industrial solar, as well as the residential rooftop solar over the last 10 years. These investments not only made these renewable energy projects possible, it also provided large impact to the local economies in terms of the job creation, royalty payments to the land owners, as well as the property tax to the local district, including schools and other public utility functions.

Evan Junek: And so shifting gears towards the current market climate, what are the latest trends shaping the tax equity sector? As I understand it, the Inflation Reduction Act specifically had some pretty major impacts on tax equity and maybe the future of tax equity.

Rubiao Song: The Inflation Reduction Act is a watershed event to the renewable energy development. It not only expanded tax credit support to renewable energy developments like wind, solar, it also included new technologies now will be available for tax credit — standalone battery, green hydrogen and other manufacturing tax credits. Included in IRA was also a very critical provision called tax credit transferability, which allows the developers, owners of these credits, to transfer the credits to third-party buyers, which may include could banks or corporates that have large corporate tax liabilities. This development significantly expands the universe of potential investors in renewable energy. The tax equity investors are primarily banks, and the banks have been providing around $20 billion annual tax equity in this space. After passage of IRA, tax equity needs are expected to grow from $20 billion to $30, $40, $50 billion in the next few years. Bank investors alone would not be able to supply this amount of capital and we're expecting U.S. companies will utilize the tax credit transfer provisions to support the renewable energy development.

Evan Junek: What are some of the challenges that we're witnessing in tax equity?

Rubiao Song: So the challenges are numerous and we are seeing that some of the challenges existing on the supply chain-side came out of COVID and albeit some of the equipment supply issues are abating, whether there still are continue to be a shortage, for example, some key equipment like main power transformers. But also as well as the higher capital cost, always the inflation and the high interest rate as well as the global tariff and the trade-related issues continue to present headwind to this industry.

Evan Junek: Given those current market dynamics, what's your outlook for tax equity in 2024? How can J.P. Morgan assist clients in navigating these challenges and complexities?

Rubiao Song: Well, we're seeing a strong continued demand, so we talk about a numerous headwinds, but the tailwinds are as strong as well. We see a lot of companies are looking at IRA as one way to tap into the incentives to make their own clean energy transition, to reduce their own carbon footprint. So many companies are looking at ways to join in this space and we are seeing a lot of opportunities for J.P. Morgan to play a role, particularly with our large corporate clients. The one thing I would point out is, the IRA actually introduced a new provision, which is unprecedented in the sense that now the energy tax credits are available to transfer instead of you have to engage in tax equity partnerships to transfer these credits and that the IRA, these credits can be transferred between the developer and the buyers engaged in what we called, tax credit transfer transactions, and we are seeing a huge interest from corporates looking at these tax credit transfer provisions as a way to firstly, reduce their federal tax liability, but also looking at ways to support renewable energy.

Evan Junek: So that's a great point. That's another aspect of the IRA that really is gonna have a significant impact on the way in which both renewable energy developers are operating their businesses, but also it sounds like many other companies are going to think about potentially acquiring those credits in a more dynamic and active market.

Rubiao Song: Yeah, we see that market has been developing very fast. Last year, which was really the first year these tax credit transfer are available, we see it by year end there were five billion of tax credit being executed, and this year, we can see that number continue to increase. At J.P. Morgan we rely our own capabilities in terms of underwriting these projects and helping the potential corporate clients to get comfortable with taking such risk and expand that investor base.

Evan Junek: So obviously, really exciting times to be exposed to this tax equity dynamic. Ties in very closely to not just the overall energy transition that's taking place, but obviously, J.P. Morgan's own role in the broader energy transition process. So thank you, Rubiao, for spending some time both explaining and exploring the dynamics of tax equity, and discussing some strategies to success for the market and our clients.

Rubiao Song: This has been great. Thanks for having me.

Evan Junek: And a big thank you to our listeners for tuning in. We hope you found this conversation enlightening. This is Evan Junek, your host, until next time, goodbye.

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