The emerging market that is unlocking renewable projects

Passage of the U.S. Inflation Reduction Act (IRA) in 2022 was a game changer in the United States’ effort to address climate change. The hundreds of billions of dollars the IRA has made available for clean energy and climate mitigation projects will likely double the pace of U.S. decarbonization. While this rapid expansion in clean energy development is tied to the sheer scale of the IRA (it is the largest climate spending bill ever passed), how climate spending from this bill is taking place is also a critical.  

Most of the IRA funding for climate change mitigation is in the form of generous tax credits for developing a new project, or producing clean energy. But, most developers that could receive credits for large capital projects don’t have enough tax liability to use them. As a solution, for the first time ever, IRA tax credits for clean energy development were made transferable, meaning that the credits can be sold for cash to third parties. To understand what this finance rule change means, Climate Now sat down with Crux CEO Alfred Johnson, whose startup company provides a comprehensive platform for buyers and sellers in this new transferable tax credit market. Alfred explains how tax credit transfers work, why they are so important to unlocking the financing potential of the IRA, and Crux’s role in cultivating the clean energy tax credit ecosystem. 

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Transcript

James Lawler: [00:00:00] Welcome to Climate Now. I'm your host, James Lawler, and today I'm joined by Alfred Johnson, who is co-founder and CEO of Crux, a platform for people to transact and manage what are known as transferable tax credits related to the Inflation Reduction Act. We've already discussed on this show how the Inflation Reduction Act, or IRA, has led to massive changes in the way renewable and low-carbon energy projects are funded and developed.

One way that the bill is helping to unlock additional funding and incentives for clean energy projects is by allowing the transferability of tax credits that are related to clean energy and manufacturing. As explained by KPMG, one of the world's largest accounting firms, “the IRA allows entities who are claiming these tax incentives to sell, or transfer, these tax credits, which can provide additional financing options and can help incentivize investment”. 

As you'll hear in today's conversation, the transferability of these tax credits potentially [00:01:00] unlocks billions of dollars for clean energy investment. One of the first large transactions to take place happened in August 2023 when Bank of America purchased 580 million in wind energy tax credits from renewable power developer Invenergy, as reported by the Wall Street Journal.

Our guest today does a terrific job explaining the nuances and complexities around transferable tax credits. Alfred Johnson started his career working at the Treasury Department, where he helped write the 2009 Recovery Act signed by President Obama in response to the 2008 financial crisis. He's worked at the White House, BlackRock, and co-founded Mobilize, a company that helps people find issues they care about to volunteer for.

During the COVID 19 pandemic, Alfred worked on the federal government's financial response. And after the passage of the IRA, he co-founded Crux to help companies trade tax credits and stimulate clean energy investment. Alfred Johnson is here with me now. Alfred, welcome to Climate Now, it's great to have you on.

Alfred Johnson: Hey James, great to be here. 

James Lawler: So let's start with this notion of tax credits. So what exactly is a [00:02:00] tax credit in the context of, you know, renewable energy development and other forms of development that are applicable to the energy transition? Explain what a tax credit is, if you would. 

Alfred Johnson: Yeah, so a tax credit is sort of comparable to, like, a flight credit. So, you know, when you cancel your flight on Delta Airlines and they say that you've got a thousand dollars that you can apply towards a future flight and you can use the credit instead of paying the airline, right? The same principle applies to a tax credit. If you have a tax credit that is worth a certain amount, you can apply it against your taxes at that amount.

I have a tax credit of a million dollars. I can apply it against a tax bill for a million dollars. To, like, back up to the context and the political and economic history of this, we in the United States have used tax credits to incentivize energy for more than a hundred years since around the time of [00:03:00] World War I, usually around oil and gas drilling for most of the 20th century. Congress started using these incentives for renewables in the seventies, but, but really in large scale for wind and solar with the Energy Policy Act of 2005, they expanded that in the Recovery Act. 

They expanded that further in the IRA, and that the implication there is that when you build energy infrastructure, renewable energy infrastructure, wind turbines, solar plants of various sizes, battery storage facilities, you get tax credits, but in a lot of cases, you are paid for power produced over many years or decades, right? So the tax liability of the developer is much smaller than the value of the credit. 

And therefore, the developer has this credit that they can't use because, you know, back to the flight analogy, they've got a $10,000 [00:04:00] credit, but the flight's only a thousand dollars. So in the context of a community solar plant-

James Lawler: Mm-Hmm. 

Alfred Johnson: -an investment in a facility of $10 million, say that community solar credit associated with building the facility was at 30% of the CapEx in that facility, the developer would get a $3 million credit when that facility is placed into service. But the way that they make money on that facility is the sun shines on the panels for 40 years.

James Lawler: Right. 

Alfred Johnson: So their tax liability might be in the hundreds of thousands of dollars, but they've got a credit that they have at the front of the project worth three million.

James Lawler: Right.

Alfred Johnson: And they can't use it unless they sell it. 

James Lawler: Got it. Just a note for our listeners, CapEx stands for capital expenditures, which refers to any money used by a company to build or upgrade physical assets like buildings or, in this case, a community solar plant. Here, the company hits a 30 percent credit of their initial investment to build a 10 [00:05:00] million-dollar plant resulting in a three-million-dollar credit.

Were these tax credits saleable before the IRA? So could developers sell these credits to other parties?

Alfred Johnson: No, and this is weird. So it was illegal to sell them, not possible. So the only way that you could solve the problem that we just went through was that you needed to invite an investor into the ownership structure of the asset. 

So back to that community solar facility, you need to get a bank that pays taxes to be an equity investor at some level in the facility. And then you would allocate the tax attributes of the facility to that investor. That kind of structure usually achieved by creating a new partnership that owns the asset is known as tax equity. That market has been in place for decades. And it's roughly an $18 billion market currently.

It has [00:06:00] frozen meaningfully at two important points in the last 20 years. It froze around the financial crisis where the banks that were providing that tax equity just didn't have the appetite for it and the government had to step in via the Recovery Act to make sure that developers could still monetize their credits.

And it froze again during COVID. And so as Congress was five to 10 x-ing the supply of the market, the number of credits that developers were going to get from building all sorts of different energy infrastructure, they needed to create a mechanism to make sure that those developers could sell the credits and created this new mechanism of transferability, where now it is legal to directly sell it to a third party.

James Lawler: Right. So prior to IRA, you had banks, but then you also had sort of wealthy individuals or individuals with high taxable income that would basically be interested in becoming these tax equity investors and, by participating in some minority position in solar [00:07:00] development projects and other energy development projects, could then apply that tax credit against their tax liability from other income streams and gain that benefit.

But now, even if I personally wanted to build a solar project on my house, and there is a credit, I could take that and I can now sell it to somebody else. So how does that work? You know, when I'm transferring this credit to somebody else, I'm selling them the right to, you know, write off, let's say $10,000 of their taxes.

How much is that worth? I mean, is it worth exactly $10,000 to them to buy that for me since they're getting that gain or how are these things valued? And explain that transaction.

Alfred Johnson: So there are, there are a number of embedded questions in that that I want to break apart. So the first question has to do with who participates in the market.

So you talked about the potential for individuals to participate in the market versus corporates. I'll talk about that quickly. Then we'll talk about the kinds of [00:08:00] credits that are eligible for transferability. And then we'll talk about pricing. 

James Lawler: Okay. 

Alfred Johnson: So in the, in the prior market, the tax equity market, that was overwhelmingly the largest, banks.

So the, the 10 largest participants in the tax equity market, that $18 billion market, make up something like 85 percent of the market, JP Morgan, US Bank, and Bank of America together make up more than 50 percent of that market. While it was technically possible and people did participate as individuals in that market- they still do- it is a small part of the aggregate whole.

James Lawler: And that makes sense, right? Because not only do you participate in this sort of thing because you have a tax liability, but you have to be able to assess the quality of the investment. 

You are in fact investing money in that project and so you have to diligence it, you have to do all those things so it makes sense that that would be the big banks that would sort of own the majority of that space.[00:09:00] 

Alfred Johnson: That's a hundred percent right. These are complicated deals to transact, there’re lots of legal expenses that are associated with them. The banks that have capacities here have large and sophisticated teams that know how to do it.

To the extent that individuals have participated in the tax equity market, but this is mostly a corporate market on the buy side and has mostly been a bank and insurance market in terms of the participants in it. Now, what is happening with transferability is both the volumes that are going to need to go through the market are a lot larger, right?

We're going from something like $20 billion on an annual basis in tax equity up to 80 or a hundred billion dollars on an annual basis, according to private sector estimates. That is going to require many new buyers coming into the market. And they're going to be attracted to the market by what is a simpler product.

It is simpler to buy a tax credit directly than it is to participate in a [00:10:00] partnership as a part owner of a solar wind or battery kind of facility. So, so the, the buy side is going to fragment quite a lot, as is the supply side and new kinds of corporates are going to come into it. 

Now from a kinds of credits that are going to sell in this market perspective, there are 12 different credits that the IRA makes saleable for cash. They are the ones that are associated with energy infrastructure. So wind and solar, hydrogen and nuclear, things like that. There is also standalone battery storage, advanced manufacturing credits associated with the production of materials and components that are necessary to the energy transition, credits that are associated with carbon capture in various forms.

And those 12 kinds of credits can be sold to a third party. They will generally be larger credits. So to the extent that this hits [00:11:00] individuals, individuals generally receive a rebate for putting solar in place at your house to the extent that somebody like a Sunrun owns the system and is leasing it to you, then they would be selling that credit in the transfer market.

But the transfer market is mostly the larger business and infrastructural assets that are associated with the energy transition and will trade in larger pieces associated with larger facilities. The pricing that we are seeing is somewhere between 80 and 95 cents based on the size, the counterparties, the credit type, things like that.

And, and what that means, back to your initial question, is that somebody will buy a credit that can be applied against their taxes at a dollar, they'll buy that for 90 cents. So buy $10 million worth of credits for $9 million [00:12:00] and save $1 million that you would have otherwise paid while financing the energy transition.

James Lawler: Mm hmm. Got it. So what are the dynamics that set that price? Why does the price settle where it settles? 

Alfred Johnson: So a few dynamics. First, I'll talk about credit-specific dynamics, then market dynamics. So on credit-specific dynamics, the kinds of factors that buyers may be considering are what is the risk that is associated with this credit; in the case of investment tax credits, there is an allocation of risk to the buyer of the credit in the case of what's known as recapture, for example. 

So if it is later determined that the credit was taken at an inappropriate value, or the project is no longer in service because it gets hit by a meteor or whatever, the buyer bears that risk. 

James Lawler: So that's interesting. So maybe we could talk about what are the risks associated with this tax credit. When this project is commissioned, [00:13:00] starts producing electrons, that's the point at which the tax credit becomes available for sale, I believe. 

So is it that straightforward? What risks are associated with this credit? 

Alfred Johnson: So James, it's the US tax code. So not that straightforward. There are 12 different kinds of credits I mentioned that can be sold for cash. I oversimplified a moment ago that there are two main categories. There are investment tax credits that are associated with the CapEx in the project.

That was the example that I gave earlier in the conversation where I invested $10 million and I got $3 million associated with that $10 million investment. There are also production tax credits that have to do with units of energy or materials or components that are produced. And in the context of production tax credits, it's a pretty simple equation.

So I produce X in energy, I get Y in credits. There's not a [00:14:00] lot of, uh, controversy in that. It is a simple meter reading that determines the credit amount. With the investment tax credit, the way that the statute is written, the buyer is responsive to some of the risk associated with the project. Most specifically, the project needs to remain in service for 10 years and the credit amount needs to be an appropriate credit amount.

And so often what will happen is that the, the developer will seek a appraisal of the value of the credit and, and if the IRS later determines that the credit was valued on an inappropriate basis or too high, then the buyer wears some of that risk. The way that that is being handled in the market is that the seller is indemnifying the buyer of that risk.

And in many instances, you're [00:15:00] seeing insurance being used, procured by sellers to the benefit of buyers if something goes wrong with the project. And so back to your initial question of what are the sorts of things that are influencing price, one of those things is the perception of risk associated with owning the credit.

The objective, measured risk of recapture in the market- because that has been a dynamic, even in the tax equity market- is very low, right? That- incidents of that happening up to this point is pretty rare. So there is a pretty small risk if you're looking at historical experience of this, and there are ways to manage it via indemnity and insurance. But it is still a factor that is influencing price. 

Other factors that would influence price are size of the credit, what type of credit it is, what the track record of the developer is and, and you're basically seeing a crowding [00:16:00] of price. So higher prices associated with developers that are larger or public companies that are able to offer either production tax credits or tax credits that have really strong security against them so the buyer doesn't have to think very much about that kind of risk.

And those are the credits that are selling at 95 cents on the dollar versus the smaller credits or new technologies or other things like that, that are trading much less than that. 

James Lawler: Okay. So Alfred, I think now that we understand the basics here, tell us what is Crux and whom is it for? 

Alfred Johnson: So Crux is the new ecosystem created for the transferable credits that exist within the IRA.

We exist for developers who are looking to sell their credits, tax credit buyers, which will largely be companies that are looking to manage their effective tax rates while investing in the renewable energy and sustainable future of this [00:17:00] country and, pretty critically, we also provide software for intermediaries.

So banks, tax advisors, and other syndicators that may be looking to make markets in these new tax credits. We set out to build this company right after the passage of the IRA. We have billions of dollars of credits for sale on the platform. We are working on deals that add up to the hundreds of millions as the market starts to form in the first real quarter where deals are closing after the passage of the IRA.

James Lawler: What kind of transaction volume, Alfred, do you need as an exchange to be sort of running under your own steam, to be a profitable venture?

Alfred Johnson: Our vision here is to be the software layer that is used by the people that are looking to transact these tax credits. And we actually have a pretty broad ambition there, which is to be the rails that make these transactions much more efficient. [00:18:00] And we can be used by intermediaries who may be using our software to transact deals. 

And we see an opportunity to really make sustainable finance more efficient by creating an efficient market for these tax credits and see an opportunity to partner broadly with the tax advisors, the financial institutions, the people that are building really large pieces of infrastructure and looking to sell credits associated with it.

And I think the volumes that will be associated with that business will be a lot higher. I also think we're going to find lots of other opportunities to make sustainable finance more efficient once we have built that market because there are, there are other opportunities that those developers are going to need, for example, to further capitalize their business, to sell other tradable instruments alongside the transferable tax credits. 

And I think once we build this market for transferable credits, there's a pretty [00:19:00] significant opportunity to build a more diversified energy and finance company around that core offering.

James Lawler: So I'm clear, is the model then a SaaS model where you're selling your software or is it a broker model where you're taking a cut of each transaction or of each dollar of credit sold? 

Alfred Johnson: It's a little bit of both. So sometimes people are using Crux just for the software to transact, right? To manage the process of listing a credit, collecting bids against that credit, managing the nondisclosure agreement, managing the data room, moving through to close, people are using Crux in that capacity often in their brand, right? 

So they can use it in a white labeled sense to make markets and take full advantage of the functionality to manage deals without accessing the supplier demand that exists within the Crux network. When they're just using it as software, we charge a [00:20:00] fee that scales up based on volume, but looks a lot more like software revenue to the business.

When they are using Crux to access either supply or demand, then we charge transaction revenue associated with finding counterparties that you wouldn't have otherwise found. And that is another aspect of our revenue. 

James Lawler: What do you see as sort of the growth opportunities beyond that that would make sense for Crux?

Alfred Johnson: So we're in an energy revolution right now. I've talked about the catalytic importance of this law and its size. I've also referenced private sector estimates. To take one for a second, Goldman Sachs estimated that the cost of the law or the, the investment by the government associated with the IRA will be $1.2 trillion. And the, the 1.2 trillion would catalyze $3 trillion worth of investment [00:21:00] in renewable energy infrastructure, decarbonization of all of its forms. 

That level of investment, $3 trillion over a 10-year period, is unbelievably ambitious. The scale of development that is going to need to happen in order to achieve that is unlike anything we have previously done in the energy infrastructure buildout of this country up to this point. 

I'm not sure any country in the history of the world has ever done anything that ambitious with their energy infrastructure. Now, associated with that, we have this mechanism, this, like, core enabler, which is the tax credits. When you think about the projects, the projects will have about 30 percent of their capital come from tax credits that are associated with building the thing that they're building.

And so it is a massively important piece of the capitalization of the projects, but it is not the only piece. And these [00:22:00] projects also generate other renewable attributes, so they may generate renewable energy credentials in the case of decarbonization, carbon capture kind of projects, they may generate offsets.

They also have needs around financing and the insurance of things like the tax risk associated with the deal. And so there are lots of different pieces of the value chain that exists around building that scale of infrastructure. Our belief is that the credits are really fundamental and central, but they exist within this broader set of other mechanisms by which the, the project developers and the companies that are associated with the energy transition will capitalize that $3 trillion worth of investment.

And we see an opportunity to make that [00:23:00] capitalization a lot more efficient, drive more money into the activities that are going to change the composition of our energy infrastructure, and do it in a way that is much more efficient and drives it faster. 

James Lawler: Awesome. Well, it sounds like a great thing that you've started. Thank you, Alfred, for joining us. It's been great to talk to you.

Alfred Johnson: Thanks, James. Thanks for having me. 

James Lawler: That's all for this episode of Climate Now. Thank you for joining us. For a full transcript and resources on today's episode, please go to our website, climatenow.com. 

And if you'd like to get in touch with us, you can email us at contact@climatenow.com. We love to hear from our listeners. We hope you'll join us for our next conversation. Thank you.

Climate Now is made possible in part by our science partners like the Livermore Lab Foundation. The Livermore Lab Foundation supports climate research and carbon cleanup initiatives at the Lawrence Livermore National Lab, which is a Department of Energy applied science and research facility. More information on the foundation's climate work can be found at [00:24:00] livermorelabfoundation.org.