Over the past 20 years, the U.S. energy market has experienced a surge in renewable energy investment due to increasing climate change concerns and ever evolving regulatory and market environments. Meanwhile, government-sponsored financial incentives, such as tax credits, and legislative updates are playing a role in the transition to a greener economy, making these projects as lucrative as ever for investors.
Given recent regulatory changes meant to increase appetite for developers and investors, Carbon Capture, Utilization and Storage (CCUS) projects, and their associated tax credits, are garnering a lot of attention from firms looking to deploy capital into green assets. Section 45Q of the Internal Revenue Code (IRC) grants tax credits for these projects that play a key role in securing financing from banks and investors for development. However, compliance with, and monetization of, these credits can be complex. It is essential for firms to understand regulatory requirements, and the implications of non-compliance, and how insurance strategies can offer protection in the event claimed credits are challenged or recaptured by the IRS.
Background on Section 45Q
In 2008, the IRC was amended to include the Section 45Q provision through Congressional passage of the Energy Improvement and Extension Act. The intent of Section 45Q aimed to encourage investment in, and development of, CCUS technologies, offering businesses a flat rate credit per metric ton of CO2 sequestered.
The credit was expanded in 2018 with the passage of the Bipartisan Budget Act, which increased the credit amounts, broadened the scope to cover sequestration of all carbon oxide beyond just CO2, and lowered minimum sequestration capacity requirements for qualified facilities.
Impact of the Inflation Reduction Act
Congress further expanded the 45Q credits in 2022 with the passage of the Inflation Reduction Act (IRA). The credit amount substantially increased (assuming compliance with prevailing wage requirements) to $85 per metric ton for permanent storage and $60 if used for Enhanced Oil Recovery (EOR) or other qualified uses. Additionally, minimum capacity requirements were again lowered, and the beginning of construction deadline was extended to January 1, 2033.
Aside from the substantial increase in the underlying value of the credits, the IRA’s most impactful enhancement to 45Q centered on two new monetization mechanisms – direct pay and transferability. Traditionally, most developers turned to the tax equity market to monetize tax credits. Given that many developers do not have sufficient tax liability that can be offset with the credits, they would partner with a tax equity investor, typically a large financial institution, to realize their value. The tax equity investor would provide some portion of the development capital for a project in exchange for being allocated the generated credits, which the investor would then use to offset their own tax liability.
The direct pay and transferability mechanisms create two new and efficient avenues for 45Q developers to realize the value of their credits. Under direct pay, developers can elect to have the IRS treat the credits as an overpayment of income tax, making them eligible for a refund for the initial five-year project period. While transferability allows developers to sell the credits directly to an unrelated third-party for a cash payment.
An added benefit is the two may be used in a complementary fashion, where a developer can elect to take direct pay during the initial five-year period and then transfer credits for the remaining seven years of the credit eligibility period.
The addition of these two monetization mechanisms, along with the traditional tax equity structure, has given developers more flexibility in determining how best to monetize the credits for any particular project.
Potential Risks When Utilizing 45Q Credits
Because 45Q credits play such an integral role in securing financing and ensuring long-term profitability for CCUS projects, a proper risk management framework is key to overall success.
The tax insurance market has always played a role in securing investments in credit-generating assets. While solar and wind projects have been a mainstay in the tax insurance market, insurer appetite has since expanded to include newer products such as clean hydrogen production, advanced manufacturing and, of course, CCUS.
There are several risks developers and tax equity investors must consider when deploying capital into a project meant to generate 45Q credits. These include challenges to credit allocation in a tax equity structure, compliance with credit qualification requirements, credit recapture through a leakage event, and eligibility for credit transfer.
A successful challenge by the IRS in any of these areas can prove to be a minor hurdle at best and catastrophic at worst. Since IRA guidance was handed down, the tax insurance market has stepped in to alleviate these concerns for developers and investors by crafting a 45Q-focused insurance product.
Managing Risks with Tax Insurance
A 45Q policy mitigates the aforementioned risks and effectively shifts the exposure to an insurance company. Policies are bespoke in nature and can be tailored to meet the needs of any particular project.
In terms of policy size, the tax insurance market can absorb up to $1 billion in limits on a specific project. Policies are generally priced at a 2%–5% rate-on-line, or $20,000–$50,000 per $1M in coverage, and can usually cover a period of up to 10 years.
Purchasing a 45Q insurance policy serves to de-risk a project, help facilitate indemnification negotiations amongst counterparties and provide added comfort to lenders providing debt financing. This strategy is an innovative solution and should be an essential part of every developer and investor’s toolkit when they consider deploying capital in the space.
In addition to a tax insurance policy, an adequate property and casualty insurance program is a necessity in managing risk in CCUS projects. Environmental liability insurance can be considered a solution if the insured is only concerned with the risk around a potential leakage event and the recapture of tax credits.
Business interruption insurance is especially critical for unforeseen risks and the potential for supply disruption and delays. Risks covered by business interruption insurance include operational downtime due to equipment failures, supply chain issues, or natural disasters; income loss due to unforeseen regulatory changes that halt operations; and covering the loss of income if technological risks materialize.
Another type of relevant insurance coverage for carbon capture and sequestration projects is contingent business income (CBI) insurance. CBI insurance is designed to protect against losses arising from disruptions due to issues affecting the insured’s suppliers or partners responsible for the carbon storage.
During the construction phase, delay in startup (DSU) insurance is another vital coverage for CCUS projects, particularly for protecting the business income related to 45Q tax credits. This insurance addresses the risks and financial losses associated with unforeseen delays in the commencement of operations of a project, thus enhancing the overall financial resilience and attractiveness of the project.
In the context of 45Q tax credits and CCUS projects, some insurance policies may need to be manuscripted, meaning custom-tailored to fit the needs and risk profile of the project or company, rather than relying on off-the-shelf policies. Using manuscripted insurance policies helps CCUS project developers ensure that their specific risks and needs related to 45Q tax credits are comprehensively covered, supporting the overall success and viability of CCUS projects.
45Q and Risk Management Recap
It’s crucial that companies within the energy value chain, as well as industrial manufacturers seeking to reduce their carbon footprint with CCUS technologies, understand the challenges of, and solutions for, claiming 45Q credits.
Whether there are concerns around credit qualification and transferability, a desire to ringfence leakage recapture risk, or financing or indemnification requirements, a 45Q tax insurance policy is a cost-effective way transfer a project’s risks to a highly-rated insurance counterparty.
As capital continues to flow into the space and new assets come online, our expectation is that the insurance market will continue to be a valuable partner to investors and developers as we all work toward a lower-carbon future.
Mike Sharkey is a Vice President in NFP’s Transaction Advisory Group, and focuses on the structuring and placement of transaction insurance policies, including representations and warranties, tax, and contingent liability policies in connection with private equity and corporate M&A activity. Prior to joining NFP, Mike was a broker at JLT Specialty (acquired by Marsh McLennan), focused exclusively on transaction insurance. Prior to JLT, Mike was a private equity investment professional at TPH Asset Management, an energy-focused investment manager based in Houston, TX.
As Vice President for NFP’s Energy team, Seth Michaelson specializes in the placement of Property & Casualty insurance lines associated with Energy companies in the Upstream & Midstream, Power Generation, and Construction space. He is well-versed in complicated insurance placements, contractual risk transfer, mergers & acquisitions, and managing complex property and business interruption claims. Additionally, Seth has developed a strong specialty in large energy infrastructure and energy transition projects, overseeing both the construction and operational phases to ensure efficient delivery and adherence to stringent safety and regulatory standards. His expertise includes providing bespoke insurance solutions for IRA and renewable tax credits, enhancing project finance and stakeholder certainty.
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