New MLP Bill: Can MLPs Reduce the Cost of Capital for Solar/Wind?

A new, bipartisan bill to expand the list of assets that can be dumped into a master limited partnership -- MLP -- was introduced today.  Find the bill here.

The solar/wind/geothermal industry has been pushing for the change in how investors in renewable energy projects access a tax-advantageous structure that currently is limited for the most part to fossil fuel-based energy projects.  In fact, similar bills have been introduced in the past.  See the 2013 version here.

But, does it advance the ball for renewables?  That is, does it reduce the cost of capital?

A master limited partnership, or MLP, is a business structure that is taxed as a partnership.  This means that there is no corporate level tax on the MLP's income.  Instead, all tax items flow through the MLP to its owners, who pay tax on their shares of the MLP's income at their own rates.  

At the same time, an MLP's ownership interests (called units) are traded like corporate stock on an exchange.  This means that interests in MLPs are more liquid than interests in other types of renewable energy financing vehicles, such as tax equity partnerships.  The combination of both these factors means that businesses utilizing the MLP structure are able to access capital at a lower cost.

There is a problem, however, that the proponents of this expansion keep omitting (perhaps inadvertently) year after year.

Renewable power projects qualify for tax goodies from the federal government that can be worth upwards of 50% of a project's cost.  These projects qualify for healthy tax credits and the ability to write-off the project cost on an accelerated basis.

Project owners rarely have a tax bill high enough to offset with these tax benefits.  In an effort to monetize the tax credits and write-off, project owners often barter away much of the benefit for cash infusions from banks and other large companies into the company that owns the project.  These investors are known as tax-equity.

An MLP is not a replacement for tax-equity.  

While an MLP is a pass-through vehicle, meaning its tax attributes flow directly to shareholders, most shareholders cannot use the tax benefits.  Many of the investors in MLPs are institutional investors (e.g., pension funds) that are not taxpayers.  Most others are individuals.  Individuals do not make for good tax-equity investors because they can only use tax benefits against income from the project at issue, and even then, only to the extent of their equity invested.  The are limited by two separate limitations -- passive loss rules and at-risk rules.

The result is that traditional tax-equity is still required.

So, does an MLP reduce the cost of capital if traditional tax-equity is still involved?  Probably not.

Special rules, known as the Pickle Rules, will degrade the value of tax benefits to tax-equity where non-taxpayers (pension funds, university endowments, etc.) are MLP shareholders.  Investment credits will be disallowed and tax write-offs will be slowed down to the extent of the high water mark of the interest these non-taxpayers hold in the project. 

To address these issues, the MLP Parity Act could be amended to turn off the Pickle Rules and the rules that make it hard for individual investors to claim tax benefits from renewable projects, in cases where the projects are owned by MLPs.

See more commentary on this an other issues on my blog at https://www.pfnewswire.com/.