2022 IRA: ITC Death and Growth Spirals

The ITC “Death Spiral” is real. But thanks to the IRA, every mid-market solar developer now gets to realize the ITC “Growth Spiral.” This is the reason that just a 4% increase in the ITC value (26% to 30%) results in a 6-8% increase in project pricing. 

First, let’s unpack this Death Spiral. An unfortunate reality of mid-market solar project financing is that diligence often uncovers more negatives than positives. For example, it’s more common for someone to omit a tree which causes shading than it is for someone to errantly insert a tree that doesn’t exist. Whatever the reason, and despite best intentions, it happens (shameless plug: Conductor Solar reduces those odds). As project economics decline, development fees correspondingly decline to keep economics neutral for the investor.

Let’s keep things really simple: imagine that a projected $1M project ends up losing $5k in revenue per year for a twenty-year PPA as a result of unexpected shading. Using a 8% discount rate and a 21% tax rate yields ~$39k in project value that has been erased. So that means the development fee should decrease by $39k and that’s it, right? Wrong…Enter the ITC Death Spiral! 

When project value decreases by $39k, that means that the 30% ITC now declines by $11.7k and depreciation benefits also drop the value by ~$5k. So now the dev fee needs to decrease by another $16.7k. Rinse and repeat aka the ITC Death Spiral. The Death Spiral drives the value down by a total of $60k-$70k…ouch! 

Now the fun part: let’s see how the ITC Growth Spiral applies. Naturally, if the project revenues increased by $5k per year, you’d see an opposite effect on the project value. That doesn’t happen as frequently, but we did just see an increase in the ITC from 26% to 30% which provides a similar boost. In our $1M project example, the ITC just increased from $260k to $300k. If you add that $40k to the development fee, you now see an additional $13k of ITC benefits and ~$1.7k of depreciation benefits, which again get added to the development fee. Rinse and repeat aka the ITC Growth Spiral. Ultimately, the $40k boost in the ITC should justify $60-$80k in additional project value…much nicer!

I’ll note here that I’m simplifying A LOT as it relates to tax rates, tax investor structures, depreciation details, discount rates, etc. Also, while I assumed everything impacted the development fees, the benefits could also be shared with investors or passed along to offtakers for more compelling sales opportunities. 

Hopefully this helps frame up a not-so-intuitive concept that often occurs in mid-market project financing.

You can check out all of our Inflation Reduction Act analyses on the Conductor Solar blog roll.