The Early Transferability Market & Why We Invested In Reunion Infrastructure

Segue recently closed an opportunistic seed stage investment in Reunion Infrastructure , a startup founded by two of the solar industry’s early pioneers who will focus on enabling accretive transactions that make use of the new “transferability” allowance included in the IRA.?

Segue traditionally provides development capital for clean energy infrastructure assets (to date for solar, storage, and large-scale EV charging projects).?This investment is different in that – at least on the surface – it’s an investment in a services company.

It’s no secret we’re particularly bullish on the impact transferability will have, and the market share it will soak up (to dive into that thesis, follow the link in the sub-header).

Market Size

But share of what market size, you ask? And then what’s the actual market opportunity for “market makers”?

Oooof…that’s a doozy to predict.?There are a lot of variables, especially in this “pre-regs” phase.?But hey, life is short, so screw it…let me give it the old college try:

To start, we need an estimate of the total tax equity market for the next decade or so.?I recently went on a hunt for such an estimate and was shocked at the lack of analysis on this point. ?Arguably the best piece of work out there is Cohn Reznick’s, so that’s what I’ll use as the “top line”.?

Next step is to reduce that down to the technologies for which transferability is in play.?Conveniently, this chops off the bit of Cohn’s analysis I find most questionable (the CCUS portion of this demand growth).??

This ~8-10% CAGR certainly feels conservative. Among other things, this seems to be missing the Section 48C manufacturing tax credit, and likely underestimates the portion of assets which achieve energy community and domestic content bonuses.?

But that’s fine; moving on from this (probably) conservative foundation, we reduce the portion of tax equity demand eligible for transferability to the sub-portion wherein transferability is accretive and likely to be utilized. For the solar sector in particular, Segue performed analysis and formed a view in our longform paper on the topic.?The headline finding was that the “point of indifference” from a project size perspective is likely around 200MWdc.?So, from there we must project out what portion of the solar market is likely to fall in that universe.?Wood Mackenzie has good data and projections on this (see below for one of their visual summaries, though not the full granularity).

Combining the Cohn Reznick total tax equity demand analysis with Segue’s transferability “breakeven point” analysis and Wood Mackenzie’s solar market projections by type/size, we can produce the following projection:

An astute observer may note that I’m – probably somewhat lazily – applying the same “percentage of solar where transferability is accretive” to other subsectors where transferability is in play.?I’m not confident that’s “right” but given the “directionally accurate” spirit of this analysis that is probably a decent extrapolation. I’d argue it’s conservative, if anything, given most of the other sub-sectors are less mature so will generally have smaller transaction sizes and healthier margins than the spectrum of project/transaction sizes in the solar subsector.

The last step is to convert the “transferability eligible and accretive” sub-category to a market size for intermediaries aspiring to generate revenue by enabling and facilitating purchases and sales of credits. That requires two steps: 1. Converting tax equity demand to the price paid for a dollar of tax credits, and 2. Applying fees to that number (because that’s the actual revenue to the intermediary).?For the price paid assumption, we will use the $0.87 per $1.00 of tax credit that we assumed in our longform paper.?Market activity to date suggests that was a decent swag assumption.?For fees, we will look at a range between 3-6%

Given the conservative points in the methodology, Segue is focused on the upper end of those ranges. My takeaway is that the transferability intermediary/market-maker market is a big enough prize to be interesting, and unlocks a massive opportunity that the right finance experts (e.g. Reunion) can access by simplifying financing structures for developers.?If you’re thinking “sure, but it feels like too many companies are popping up to chase a market of that size,” I’d have to agree. I’m not sure everyone’s really thought it through, especially those who try to go big out of the gates and drown their business in SG&A levels not supported by the market opportunity.

Early Signals

In any event, we’re already seeing some of the underpinning assumptions in the analysis play out with rather large players on both the supply (projects) and demand (capital) sides signaling major strategic shifts towards credit purchases/sales, and away (at least in part) from conventional tax equity structures. The large banks, for example, have already acknowledged a significant percent of their tax equity activity – whether direct or syndicated – will likely use the new transferability provision.??

Interestingly, most of these noticeable signals are coming from “up-market”, if you will: established players who mostly focus on larger assets.?While this is especially interesting in the context of supporting our early thesis that transferability will take a lot of market share (why? If any market segment were to eschew transferability, it would be the larger project/transaction segment, so the fact that many big players who do big projects are “in” is a particularly telling signal), it doesn’t directly say much about perhaps the most impactful aspect of transferability: the unlocking and streamlining of financing smaller or “messier” assets.

Proven technologies like solar, wind, and battery storage can reduce carbon emissions today, but many projects lack access to financing. Existing financing structures such as lease pass-throughs and partnership flips are complex and, thereby, expensive to set up and manage. As such, those who provide capital through those structures tend to have a very strong preference for larger projects and larger transactions. Sometimes smaller/messier projects never happened (or were severely delayed) because they couldn’t find a tax investor…at any price.?

Reunion is creating a simpler financing structure, enabled by the 2022 Inflation Reduction Act. They work closely with solar, wind, and battery storage companies to sell renewable energy tax credits, which fund up to ~50% of project costs. Over time, they will provide additional financial products to enable renewable energy developers to build more projects. While they aspire to service a wide swath of the asset market (including some larger assets and capital providers), initially their revenue and impact will likely be concentrated in the lower/middle market – C&I projects, community solar, etc.?The same theme will likely play out on the buy side.?

The accessibility of the transaction is already attracting entirely new classes of investors into the renewable energy and storage investment sector.?Risk adjusted tax equity returns have always been phenomenal.?For years it’s been the best deal in the game if A. you were up for the headache, B. you had access to large-scale projects, and C. you had the cash for lawyers, consultants, and accountants.?That A+B+C universe was small, and consistently a constraint on renewable energy penetration.?With Reunion + transferability none of A, B, or C is nearly as prohibitive.?It’s democratizing a huge piece of the clean energy capital stack while greasing up a perpetually “sticky gear” in the clean energy machine.?

Competitive Landscape

Much of the above is well understood, and not terribly difficult to see.?As such, many different firms, both new and old, will be making some sort of transferability “market maker” play. ?You’ve probably seen a bunch of them out there already.?Here’s how I see the landscape:

In the near term, businesses (or business units) will emerge from all these categories.?It’ll feel crowded for a while.?And then there is a bit of a “winner take most” phenomenon to consider – better, more reliable “matchmaking”, more efficient price discovery, transaction costs amortized more broadly, etc.?Eventually we should all expect a consolidation phase.?

So, against that backdrop, why did Segue back Reunion? Because saying something is “simpler” is different than saying it’s “simple”. The market winners will be those with the deepest and most applicable tax equity experience.?This new tool can’t be coded, it can’t be capital-moated, it can’t be won with sheer marketing muscle…it can’t be faked.

Transferability allows for a considerably easier, less complex monetization of the tax credit than any of the big three conventional tax equity structures.?But executing – let alone educating new investors on - those structures…well, it sucks.?The points of reference here are byzantine, illogical, booby-trapped, and expensive. So…while purchases and sales of credits through the transferability allowance will be substantially easier and cheaper to execute, they will still be hard to do properly, accretively, and within the confines of the law…. especially in the early implementation phase.?Simpler ≠ simple.

Anyone who’s never done a tax equity deal (and I mean really been in the trenches from soup to nuts) ?and thinks they can waltz over into this sandbox and successfully churn out a bunch of deals, hockey sticking their way to fintech glory using algorithms and fancy SaaS websites… is going to violently fall on their face.?In the process they will probably light a healthy pile of VC money on fire and hang a bunch of projects out to dry.?

Why Reunion Infrastructure

The Reunion team has deep expertise in renewable energy, and specifically tax equity transactions, having previously raised over $2B to fund solar energy projects around the world.?

The last “new paradigm” in renewable energy tax credit monetization came in the aftermath of the 2005 Energy Policy Act, when the solar ITC came to be. Like the IRA, the law was passed with broad brush strokes, necessitating further granularity in the form of regulations, private letter rulings, and market-participant-driven precedent setting (offering “stick with the herd and you’ll be ok” unofficial safe harbors). There were a dozen or so individuals holding the chisels that sculpted that market. A handful of them were attorneys, a few of them were accountants/consultants, and the rest were the project finance leaders at SunEdison, and MMA – the two solar firms doing most of the third party project financing at the time.?Reunion’s President, William Lee , was the head of project finance at SunEdison and holding one of the aforementioned chisels during that market formation.?He waded through the murky regulatory waters and educated would-be tax investors on this new game of tax equity, building trust with banks, insurance companies, accountants, appraisers, and attorneys…gluing together transactions that would be replicated and built upon for years to come.

A few years – and one global financial crisis later – another highly disruptive moment arrived for renewable project financing.?The 2009 American Recovery and Reinvestment Act (“ARRA”) included a handful of new arrows for project finance folks to put in the quiver.?The most impactful was the 1603 grant-in-lieu which allowed a party to take the ITC in the form of cash from the US Treasury.?There were, however, others: The DOE loan program, Recovery Zone Facility Bonds, Clean Renewable Energy Bonds, and more. SunEdison recruited Reunion’s CEO, Andy Moon , out of McKinsey to help unlock both volume and margin by sifting through these various tools. He had a lot of success doing so through bringing in new equity investors into the sector and figuring out how to parley those other de novo programs into closed, accretive transactions.

With the passing of the IRA, this “market creation” mindset is, once again, required. It is going to be gritty, unglamorous, hard work for a little while.?There will be false starts, wasted time and money, and hypotheses that seem na?ve in hindsight.?This calls for resilient, creative, humble individuals who’ve no issue burying themselves in the weeds of transactional problem solving.?We know Andy and Billy to be exactly these kind of people because we’ve gone through these industry experiences alongside them.?We also know they will hire folks of a similar ilk.

At the end of the day, developers and integrators with projects to capitalize care about execution certainty. Or at least they should. With that in mind, the group(s) that show results (closes) will gain momentum.?That momentum will feed on itself with increasingly more proof in the pudding to show both investors and project finance teams.?

Eventually transferability will become a market tool that benefits tremendously from technology and routinization. ?This team knows how to capture that parabolic growth – Andy brings relevant experience from his time at Y-Combinator and a couple of startups – while appreciating that is not the priority out of the gates. ?The time for “hockey sticking” will come, but we believe any group making a move on transferability must prove they can close before they’ve earned the right to pursue parabolic, tech-driven growth.?Some VCs may disagree; I’m betting they lose their shirt.?Our industry has learned to be extremely wary of emperors having no clothes. ???

So in the end the “Why _____?” answer is the same as always: the team.?

Segue is looking forward to supporting Billy, Andy, and the team to come as they build up the book of business on both the capital and credit side of the ledger.?Naturally, there are many potential synergies with our developer partners.?While they don’t need us to be successful, we aspire to serve as a catalyst to growth and execution support during this critical phase of market formation.