Supporting new investments in clean energy

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Evan Junek: Hey there. You’re listening to What’s the Deal?, our investment banking series on JP Morgan’s Making Sense podcast. I’m your host, Evan Junek, from the Corporate Finance Advisory team. Today we’re delving into the dynamic world of tax equity with my colleague Rubiao Song, head of energy tax equity at JP Morgan. Rubiao, great to have you on and welcome to the podcast.

Rubiao’s Song: It’s my pleasure, Evan, and I’m glad to talk to you today.

Evan Junek: So let’s get down to business. Maybe you could start by telling us a little bit about your career and your role at JP Morgan.

Rubiao’s Song: Sure, thanks, Evan. I lead a group within JP Morgan’s Commercial and Investment Bank, focused on making equity investments in renewable energy projects in the U.S. I started my career over 25 years ago at JP Morgan’s traditional bank, Bank One, which was based in Chicago. We started making equity investments in wind projects in the U.S. in 2003 and have been building a team ever since. It’s been a very interesting and rewarding journey.

Evan Junek: Great, let’s talk a little bit about this role. For those of us who are not familiar with tax equality, can you explain to us a little bit what exactly tax equality is?

Rubiao’s Song: Absolutely. Tax equity is essentially a form of structural capital that investors in renewable energy projects would derive returns from primarily the tax benefits that are available to them in renewable energy projects. U.S. policymakers tend to use the federal tax code to encourage private investment. In the renewable energy space, the two primary forms of federal tax benefits are tax credits and depreciation credits. So tax credits in the form of production-based tax credits or investment-based tax credits. Many renewable energy developers are either startups or growth companies that typically don’t have a large U.S. federal tax liability, so they can’t effectively leverage those tax benefits. Tax equity investors are coming in who will form joint ventures with these developers, and the primary form of that joint venture is a tax equity partnership. In a partnership, the tax equity investors would receive 99% of the tax benefits, a small portion of the cash distribution, while the growth partner would receive the majority of the cash distribution but 1% of the tax benefits. This has been the dominant structure for the last 20 years and has played a really key role in the development of renewable energy in the US.

Evan Junek: So, in summary, if we think about tax equity, it’s really a way for companies or specifically developers in energy transition investments to monetize tax breaks that they otherwise wouldn’t be able to take advantage of, certainly not in the time frame that most people are focused on in terms of their investments in these new projects. Is that a fair summary?

Rubiao’s Song: That’s a very good summary. But I would also add that some of the clients that we deal with are very large developers. In the U.S., that’s becoming a very large industry, so they would need billions of dollars of capital every year to get off lease projects, and the federal tax capacity isn’t growing as fast as their business pipeline, so they would need to have tax capital to monetize the tax benefits of their projects. That’s a big part of our business.

Evan Junek: So basically clients big and small are really taking advantage of this market. Let’s talk a little bit about JP Morgan’s role because I think JP Morgan’s position in this market is also incredibly important. Maybe you could talk about how JP Morgan’s tax equity business is positioned in relation to the market.

Rubiao’s Song: Sure. As I mentioned, we started this business over 20 years ago. In December of 2003, we made our first tax equity investment in a wind project in Sweetwater, Texas. Since then, we’ve been building this business for over 20 years. We’ve been consistently the leading equity investor in the country and we’ve built a team that takes that investment from start to finish in terms of opportunity identification, deal structuring, due diligence and documentation, and asset management, accounting, etc. So it’s very unique in the sense that we’ve built a full-capacity, full-capacity team that not only consists of originators, deal managers, pricing analysts, we also have a team of professional engineers on our team and they do 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 large role in. Can you share a little bit more about the types of projects we’ve been involved in over the years and the positive knock-on effects that’s had?

Rubiao’s Song: With pleasure, Evan. As a major provider of tax capital for over 20 years, we have invested over $47 billion of tax capital in renewable energy projects in the United States, including $40 billion of capital from JP Morgan. In 2003, as I mentioned, we made our first investment of $23 million in a wind farm in West Texas. Since then, we have invested in projects in over 40 states, 322 wind farms, representing almost 50 gigawatts of wind capacity in the United States. For comparison, the total installed wind capacity in the United States at the end of 2023 was 150 gigawatts. So that’s almost one-third of the total installed capacity in the United States. Over the last 10 years, we have also started investing in utility-scale solar, commercial and industrial solar, and rooftop solar. These investments not only enabled renewable energy projects to be implemented, but also had a major impact on the local economy in terms of job creation, royalty payments to landowners, and property taxes to local districts, including schools and other public facilities.

Evan Junek: And so shifting gears to the current market climate, what are the latest trends shaping the tax equity sector? As I understand it, the Inflation Reduction Act had some pretty big implications for tax equity and perhaps the future of tax equity.

Rubiao’s Song: The Inflation Reduction Act is a watershed event for renewable energy development. It not only expanded tax credit support for renewable energy development, such as wind and solar, but it also included new technologies that will now be available under the tax credits—stand-alone batteries, green hydrogen, and other production tax credits. There’s also a very important provision in the IRA called transferability of tax credits, which allows developers, owners of these credits, to transfer credits to third-party purchasers, which could include banks or corporations that have large tax liabilities to corporations. This development significantly expands the universe of potential investors in renewable energy. The investors in tax capital are primarily banks, and banks provide about $20 billion of annual tax capital in this space. With the passage of the IRA, the tax capital needs are expected to grow from $20 billion to $30, $40, $50 billion over the next few years. Bank investors alone would not be able to provide this amount of capital, and we expect U.S. companies to leverage tax credit carryover provisions to support renewable energy development.

Evan Junek: What challenges do we face in terms of tax equality?

Rubiao’s Song: So the challenges are many and we see that some of the challenges on the supply chain side are COVID-related and while some of the supply issues are subsiding, is there still a shortage, for example, of some key equipment like main power transformers. But also in addition to higher capital costs, always inflation and high interest rates, as well as global tariffs and trade issues continue to be a drag on this industry.

Evan Junek: Given the current market dynamics, what are your predictions for tax equality in 2024? How can JP Morgan help clients navigate these challenges and complexities?

Rubiao’s Song: Well, we see strong, ongoing demand, so we’re talking about a lot of headwinds, but the tailwinds are just as strong. We’re seeing a lot of companies looking at IRAs as one way to leverage the incentives to make their own clean energy transitions to reduce their own carbon footprint. So many companies are looking at ways to join that space and we see a lot of opportunities for JP Morgan to play a role, particularly with our large corporate clients. One thing I would point out is that IRAs actually introduced a new provision that is unprecedented in the sense that now the energy tax credits are available for transfer instead of having to engage in equity partnerships to transfer those credits and that IRAs, those credits can be transferred between the developer and the purchasers that are involved in what we call transfer credit transactions, and we’re seeing a lot of interest from corporations that are looking at those transfer credit provisions as a way to first reduce their federal tax liability, but also look for ways to support renewable energy.

Evan Junek: So that’s a great point. That’s another aspect of IRAs that’s really going to have a significant impact on how both renewable energy developers do their business, but it also sounds like a lot of other companies are looking at potentially acquiring these credits in a more dynamic and active market.

Rubiao’s Song: Yes, we see the market growing very quickly. Last year, which was really the first year that these tax credit transfers were available, we saw five billion tax credits done by the end of the year, and this year we see that number continue to grow. At JP Morgan, we rely on our own capabilities to take on these projects and help potential corporate clients get comfortable with taking on that risk and broaden that investor base.

Evan Junek: Obviously, it’s a really exciting time to be exposed to these tax equity dynamics. It ties in very closely with not only the overall energy transition that’s happening, but of course JP Morgan’s role in the broader energy transition. So thank you, Rubiao, for taking the time to explain and explore the tax equity dynamics and talk about some of the strategies for success for the market and for our clients.

Rubiao’s Song: This was great. Thanks for the invite.

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

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