Using Federal PTC’s and Clean Renewable Energy Tax Credit Bonds in Financing Wind

Trintek Energy Consulting, Inc.

Creating Competitive Advantage Thru Intelligent Development

Native Renewables Energy Summit November 15-17, 2005

Discussion Outline

PART 1•PTC’s - Production Tax Credits•Qualification For and Use of PTC’s•Allocation of PTC’s in Deal making•Expected Returns and Disproportionate Allocation of PTC’s•Justifying Disproportionate Allocation•Implied Tradeoffs For Disproportionate Allocation

PART 2•Clean Renewable Energy Tax Credit Bonds

PART 1 - PTC’s - Production Tax Credits

•IRS Section 45

•1.9 cents/Kwh adjusted for inflation each year

•Turbines must be placed in service and produce electricity before the expiration date of the PTC then in effect.

•NPV value is worth about 33% of capital cost of a typical project

•The PTC gets IRS imposed “haircuts” for project subsidies such as: state credits, tax exempt financing, and some other kinds of credits

-The key is generally if it reduces “cost” or capital or is tied to output-Old PPA’s w/above market pricing-special cases-REC’s are tied to output-therefore, no haircut

Qualification For and Use of PTC’s•An entity must own the generating asset and produce and sell electricity to an unrelated 3rd party to qualify

•It is essential that one of owners have federal taxable income against which credits can be used

•If not in a taxable position, then a developer can sell a portion of the project to an investor with a tax appetite

Taxpayers may apply the credit against AMT only during thefirst 4 years of a new project

•Credits can be carried forward 20 years or carried back one year

Qualification For and Use of PTC’s

•Qualification for the PTC is subject to passive loss rules, limiting small individual investors S Corps and C Corps to offset income only from other “passive” investments

-(Hint, Most small individual investors do not have large amountsof “passive” investment income on a recurring annual basis) •The intent of the tax code is to prevent individuals from owning a passive investment which generates a credit against normal wage and investment portfolio income

•These passive loss rules do not apply to larger Corporations

Allocation of PTC’s in Deal Making•Project participants can allocate substantially all the tax benefitsin proportions ranging from a 90%/10% split to a 99%/1% split from the project to the partner/investor who can use them for 10 years or until a specified IRR is met

•After either a 10 year period or a specific IRR is met, ownership then flips to ownership interests which are in favor of other party ranging from 20%/80% to 5%/95%

•Probably should get a tax opinion on “residual interest” percentage that will withstand IRS scrutiny on audit. Some may say that 10% minimum residual interest is required

•The developer of the project, takes the risk of putting the project in service by the tax qualification date, and will have to give anindemnity if favor of the investor including reallocation of cash flows for failure to qualify for the PTC

Allocation of PTC’s in Deal Making•The investor/partner agrees to makes capital contributions in favor of the project company to secure the cash flow required to service debt and operate the project

• The investor/partner essentially supports the debt by taking tax law and change of law risk in return for the expected value of the the future tax credits it forecasts it will monetize

•The investor/partner must make contributions to support the debt even if:

-The investor ends up not being able to use the tax credits-Congress repeals the credits-The wind turbines do not get put on line in time to qualify

•The investor actually only has to make the contributions to the level needed to hit the specified DSCR’s

Expected Returns and Disproportionate Allocation of PTC’s

•The investors who participate in wind energy projects for the tax credits will expect un-levered returns of 8.5-10%

•If they are willing to take construction risk and to participate earlyin the project, their expectation will be 10-12.5%

•Proportionate vs. disproportionate cash and tax allocation

•Historically, many industry tax attorneys have been unwilling to give opinions on disproportionate allocations of cash versustax credits among partners and investors

•Some industry experts are now opining that if risks among theparties can be “significantly differentiated” then there may be flexibilityto allocate credits in a different proportion to a partner’s initial capitalcontribution

Justifying Disproportionate Allocation

•Federal tax rules require substantial economic consequences commensurate to the benefits attached to any special allocations of taxable income and deductions

• Upon audit, an investor must show there was economic justification for a disproportionate allocation of tax credits and be able to show“differentiated risks”

• The downside is to risk disallowance and unwinding of the structure entailing financial consequences to the investor and the project

Allocation of benefits in deal making can be tricky.Don’t get your deal “unwound” by the IRS and blown away

“Allocation of Benefits Back at the Ranch”

Implied Tradeoffs For Disproportionate Allocation

•Deductions that create a deficit in a partner’s capital account are not allowed unless the partner is obligated to restore that capital account in the event of a liquidation of the partnership

•Restoration of a deficit is the economic consequence for taking disproportionate deductions due to disproportionate allocation of depreciation or credits

•Over the long term, deficits will eventually be erased, but this underscores that longer term commitments and less flexibility/liquidity are also required to participate disproportionately, and may increase audit potential

•It may be best to get a letter opinion from the IRS

2008 2009 2010 2011 2012 2013 2014

Total Revenue 12,480,880 12,788,304 13,103,414 13,426,402 13,757,464 14,096,803 14,444,625Total Operating Expenses 1,905,165 1,928,245 3,076,674 3,133,146 3,195,204 3,262,532 3,334,951Operating Profit (Loss) Ebitda 10,575,714 10,860,059 10,026,740 10,293,256 10,562,260 10,834,271 11,109,675Depreciation 31,787,151 50,606,270 30,532,544 18,488,308 18,488,308 9,455,131 421,955State Tax 0 0 0 0 0 0 381,102Interest Expense 7,164,980 6,909,893 6,636,185 6,496,584 6,180,610 5,848,855 5,599,501Net Income (Loss) before taxes -28,376,417 -46,656,104 -27,141,988 -14,691,636 -14,106,658 -4,469,716 5,469,322

Operating Profit (loss) Ebitda 10,575,714 10,860,059 10,026,740 10,293,256 10,562,260 10,834,271 11,109,675Production Tax Credits 5,192,055 5,321,856 5,454,903 5,591,275 5,731,057 5,874,334 6,021,192Administration of Project(Subordinated) 150,000 153,750 157,594 161,534 165,572 169,711 173,954Total Cashflow Available For Debt Service 15,917,769 16,335,665 15,639,237 16,046,065 16,458,890 16,878,316 17,304,821

Total Debt Service 10,611,846 10,890,443 10,426,158 10,697,377 10,972,593 10,229,282 10,487,770

DSCR constraint 1.5 1.5 1.5 1.5 1.5 1.65 1.65

Example of DSCR Calculation Including PTC’s-BASE CASE

*For a 100 MW Project with 35% Capacity Factor

•Clean Renewable Energy Bonds are bonds issued by or on behalf of Electric Coops, State and local governmental bodies, or Indian Tribal Governments

•Must be issued to finance the capital expenditures of “qualified borrowers”

-I.e., governmental bodies and Electric Coops, and Indian Tribal Governments

-Therefore it appears these same entities must own the facilities-Appears there is room for joint ownership with private enterprise-No restriction on who can operate -Can sell output to anyone

PART 2 - Clean Renewable Energy Tax Credit Bonds

Tax Credit Bonds (Continued)

•A total capacity of $800 MM in bonds can be issued

• $300 MM reserved for Electric Coops

• If demand exceeds supply, the IRS will allocate/ration among the parties requesting permission to issue bonds

•An issuer, must have a “receipt of allocation” approval from the U.S. Treasury to issue the bonds

•Have to be issued in 2006 and 2007

Tax Credit Bonds (Continued)

•An issuer must spend the proceeds from bond issuance within 5 years from bond issuance

•But, an issuer may petition the IRS for a reasonable extension if reasonable cause can be shown

•95% of the proceeds have to be spent on the kinds of facilities that would qualify for the PTC

Tax Credit Bonds (Continued)

•Terms of bonds will be number of years that equates the present value of the principal repayments equal to ½ the amount of principal originally borrowed

•There is no interest payment made to bondholders on these bonds

•Instead they will receive a quarterly accruing tax credit from the IRS in lieu of interest

•Congress directed the IRS to calculate the minimum tax credit that bondholders would need to be offered to forego normal interestso that there is no discount to or interest paid by the issuer

Tax Credit Bonds (Continued)

•The U.S. Treasury already does an analogous calculation for “qualified zone academy bonds” which are bonds issued to finance improvements at public schools in low income areas.

•The credit term and rate in August 2005 on these bonds was 16 years and 5.3% interest rate

•Principal repayments must be level over the term

•Bondholders who receive the tax credit in lieu of interest must then report this as income and pay tax on its value

•More definitive rules coming 120 days from Aug 8th