US Production Tax Credit (PTC)

US PTC TAX CREDIT 

Overview

This is a video from our online courses. In this lesson, we’re going to focus on renewable energy tax credits, something which is unique to the US market. This lesson reflects the changes in the Inflation Reduction Act (IRA)

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Video

Video Transcript 

The production tax credit or the PTC is another type of tax credit available. This credit is not tied to project costs as with the ITC but rather the amount of energy produced and sold over a 10 year period. Historically, the PTC has been the predominant tax incentive for wind projects in the us. Notably, solar did not qualify for the PTC for many years but this change recently with the Inflation reduction Act. Similar to the ITC, the list of eligible technologies extends beyond wind and solar. It also includes biomass, landfill gas, geothermal hydropower, tidal, and municipal solar waste. In this course, we will focus on the application with wind and solar. The tenor is a key distinction between the PTC and ITC. The PTC tenor is based on production volumes sold over the first 10 years after the project is placed in service. The ITC however, is earned right front, but the recapture risk effectively creates a five-year tenor. The credit amount is a function of the energy produced and sold. If the wind blows less than expected during the first 10 years of the project you earn a lower tax credit than forecasted. Similarly, if the power plant is curtailed and not able to sell electricity into the grid this will also negatively impact tax credits earned. The credit can be applied towards the quarterly estimated taxes paid by businesses and if ownership changes during the PTC term the original PTC term of 10 years under the first owner still applies. The PTC credit value currently ranges between 0.55 and 3.30 cents per kilowatt hour. It’s a rate per unit of energy sold. The range of values are based on bonuses which we’ll explain later. The PTC rate escalates over time to account for inflation. The latest inflation adjustment factor was published in June, 2023, and that equals 1.8909. The inflation factor is published annually by the IRS, and in some cases corrections are even made throughout the year. In other words, the tax credits earned will fluctuate based on the output of the plan and the rate. In our financial models. We will estimate the inflation increase for the PTC based on past trends. It’s obviously impossible to perfectly forecast the PTC earn 10 years in advance but if properly modeled, you’ll at least have a good idea.

Wait, I run the numbers here, and 0.55 divided by 1.8909 is 0.29 plus some decimals. Either Congress does not like nice round numbers as a base or you’re rounding here. What’s going on?

Let me give you the step-by-step guide to arrive at the inflated rate. The initial base is 0.30 cents per kilowatt hour with no inflation applied. Multiply 0.30 cents with 1.8909. Our inflation factor to retrieve 0.57 cents per kilowatt hour. This number is then rounded to the nearest 0.05 cents, which is 0.55 cents. We now multiply 0.55 cents with five to get 2.75 cents. This is considered a relatively common value for the PTC in 2023. We’ll explain the exact dynamics behind the five times multiplier and bonuses and a lesson on the credit structure.

All the ranges, adjustments, fluctuations it’s quite a roller coaster. Call me wild, but I need more numbers to follow. First, let’s convert our cents per kilowatt hour to dollars per megawatt hour. We multiply by a thousand to convert megawatts and divide by a hundred to get to dollars or just multiply by 10. This will make the units consistent with the financial models used in our course. The $27.50 per megawatt hour is the starting point for our annual tax credits earned. Assuming generation of 225,000 megawatt hours annually, the project earns tax credits worth six point 19 million in year one. In year two, we assume a 2% PTC rate increase. The inflation adjusted increases the PTC rate from 27.5 to $28.10 per megawatt hour. With generation at the same level the rate increases is the driving force behind the higher tax credits earned in year two. When adding the remaining years of the PTC period notice the impact of the inflation adjustment. The rate is forecasted to increase from 27.5 to $32.90 per megawatt hour. Generation stays exactly the same across all years. The rate increase alone contributes to earning an additional 1.2 million worth of tax credits when comparing year one and year 10. Similar to the ITC the PTC can be carried forward 22 years and back three years. In other words, I can take the PTC of six point 19 million in year one and apply the credits to my taxes in year 11, if not used in a prior year.

The production tax credit also phases out just like the investment tax credit. So take a look back at our lesson on the investment tax credit to understand the mechanism behind the phase out of the production tax credit.

Here’s the main takeaway. The PTC is production based. It’s quantified in terms of performance and for solar and wind, that’s cents per kilowatt hour. The amount of tax credit you earn is directly correlated with the output sold from your project. If you produce less than planned the tax credit earned is smaller and vice versa. With this tax credits, Arizona is probably a better solar project location than Alaska.