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| Carl Fleming |
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| Edward Zaelke |
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| Seth Doughty |
While the speed and complexity of the virus make it impossible to know the full effects it will ultimately have on the world, what follows is what we know today about the impact of COVID-19 on the supply chains for solar, energy storage and wind developers, as well as the project finance market.
COVID-19's Impact on the Wind Turbine Supply Chain and Tax Credit Strategy
Wind developers are experiencing both immediate supply chain disruptions and potentially dramatic impacts of delay on construction timelines and financing.
In the best of times, 2020 was already an especially critical year because it is the last year for U.S. developers to complete projects that qualified for the full production tax credit, or PTC, under the four-year safe harbor guidelines for projects that commenced construction in 2016. As a result, even a minor delay may put projects at risk of missing the 2020 deadline, and thus threatening project economics.
Prior to the COVID-19 disruptions, there was already a tight supply of key components such as turbine blades and main bearings. Even though most production of wind turbine components occurred outside of Hubei, the Chinese quarantine and travel restrictions impacted all Chinese manufactured goods.
Since the disruptions have occurred, wind turbine suppliers have provided force majeure notices to most utility-scale wind developers. These supply chain disruptions may be on top of delays due to crane or other construction equipment availability and, now, the risk of worker availability at the project sites due to the effects of COVID-19 in the U.S.
We have already seen a large number of turbine suppliers issue notices of force majeure. We are beginning to see construction force majeure claims declared and expect to see more in the coming days.
Next Steps
Because of the immediate impact of both the time and effect of COVID-19 delays, it is critical that wind developers continue exploring their options for their projects. This review should begin with a review of force majeure clauses in turbine supply agreements and construction contracts, but should extend to a review of the force majeure protections that projects have in their offtake agreements.
While the phase three stimulus package passed by the Senate on March 25 did not include the tax credit extensions and direct pay provisions sought by the wind and solar industries, there remain various tax incentive proposals being discussed for a possible phase four stimulus package, including one to extend the PTC continuity safe harbor from four to six years for projects commencing construction in 2016, 2017, 2018 and 2019, and to secure a direct pay provision equal to 100% of the PTC value to address expected decreases in the availability of tax equity.
COVID-19's Impact on Solar Panel Procurement and Tax Credit Strategy
As a result of the solar tariffs put in place by the Trump administration, the U.S. solar market is likely to be less impacted by COVID-19 than other major markets throughout the world. As a result of these tariffs, most panels used in the U.S. still come from Chinese vendors, but they are now most often manufactured in Southeast Asian countries.
These countries have not faced the same impacts from COVID-19 as faced by manufacturing facilities in China, so there has not been as immediate a disruption to the supply chain for solar facilities. While Southeast Asian panels are often built from raw materials sourced from China, any effect upon raw material availability is more remote, and may more be more easily overcome than the impact of manufacturing reductions in China.
Further, the effect upon the U.S. solar supply chain, though likely to occur at some level, is not as immediate a threat to developers as other COVID-19 impacts. This being the case, those developers expecting to receive solar panels in the medium term should thoughtfully prepare now for a potential reduction in panel availability, either due to a short-term blip in raw material availability or a larger impact on Southeast Asian manufacturing.
Next Steps
Today's landscape for panel procurement and tax credit strategy is quickly shifting. Developers should consider their options now regarding panel procurement, project schedule, and tax credit and module safeguarding strategy.
Similar to the PTC tax incentive proposal discussed above, while Wednesday's phase three stimulus package did not include the tax credit extensions anddirect pay provisions sought by the wind and solar industries, there remain various tax incentive proposals for a possible phase four stimulus package to extend the solar project investment tax credit, or ITC, continuity safe harbor from four to six years for projects commencing construction in 2016, 2017, 2018 and 2019, and to secure a direct pay provision equal to 100% of the ITC value to address expected decreases in the availability of tax equity.
With the effects of COVID-19 disruptions now in the U.S., we expect to see more force majeure notices provided by construction and other companies. Developers should prepare now by reviewing their options in respect to force majeure.
Certain solar panel manufacturers operate at small margins and may be especially at risk of a loss of profits from a longer-lasting global economic impact arising out of the COVID-19 pandemic. Developers should assess the creditworthiness of their panel manufacturers and implement alternative procurement strategies with suppliers that are more certain to weather any forthcoming economic downturn and fulfill their commitments.
COVID-19's Impact on Energy Storage Procurement and Pricing
Historically, the global energy storage market has depended upon manufacturing in both China and South Korea. However, a recent increase in South Korean incentives has caused local manufacturers to shift more of their sales to their domestic markets, which has led to a greater reliance upon Chinese battery manufacturers. More than 60% of China's battery storage manufacturing was located in Hubei and surrounding provinces, where the virus outbreaks originated and were felt most strongly.
Prior to the onset of COVID-19, Wood Mackenzie Ltd. estimated that U.S. energy storage rose 523 megawatts in 2019, and could triple to 1452 MW in 2020, and then double to 3646 MW in 2021. But recent estimates are that China's battery storage production capacity will decrease by at least 10% in 2020.
This will have a major carryover effect on the ability of developers to purchase battery cells in the coming year, and is likely to cause delays in receipt of orders or an increase in price for these batteries. The brunt of these delays will be borne by the electricity market and the electric automobile market, but there is also a carryover effect on consumer electronics and other users of lithium-ion batteries.
Next Steps
Although recent reports are that Chinese manufacturing facilities are beginning to ramp up production, there is certain to be an impact upon battery storage availability in 2020. While this will certainly impact a number of U.S. developers, the impact may be reduced by the lack of looming tax credit or other regulatory deadlines, which may allow some projects to be postponed or the inclusion of energy storage in a project to be reduced.
Developers would be well suited to closely monitor the forthcoming increase or decrease in production and the resulting effects on storage pricing. In addition, they may be well served to evaluate their battery procurement strategies in light of certain tax incentives proposals that could extend to battery storage.
The U.S. storage industry continues to push for a full ITC cash grant for storage as part of any stimulus package. We will continue to monitor these proposals.
COVID-19's Impact on Project Financing
Governments and the Federal Reserve have taken steps to slash interest rates and ease bank rules, and this may have an effect on the availability of debt financing. With lower interest rates, refinancing projects — in addition to the demand for financing new projects — should become a priority for sponsors.
However, this demand is likely counteracted by lenders who will have a lower appetite for providing these loans when they provide less profit on lower interest rates. Further, additional uncertainty around a potential recession and credit crunch is also playing a role in diminishing loans.
It is impossible to read the news without finding a new article about a different industry that will face major bankruptcy risk in the near future if the COVID-19 situation remains unchanged, or a new prognosticator suggesting a recession is on the horizon. Anecdotally, we have been told that some lenders have already modified their internal requirements to provide greater scrutiny of potential loans.
With that said, we continue to monitor the debt market for liquidity. We currently see existing deals that are already in the pipeline moving to close. However, we see deals that are in their early stages being repriced to reflect new cost of money. Ultimately, deals are moving forward, but with a bit of a slower pace and, in certain cases, repricing. We will continue to provide updates as we see further movement.
We are also seeing a negative impact on the availability of tax equity financing. Some traditional tax equity investors are showing concern about how much income tax they will have the ability to shelter if a recession occurs. Also, uncertainty around government stimulus packages and their effects upon a tax equity provider's tax responsibilities may also cause a short-term reduction in the availability of tax equity financing.
We continue to monitor the tax equity market for risk appetite in light of the lack of any extension of the safe harbor time periods or further start of construction guidelines. We do not see any slowdown at the moment. Instead, we see tax equity moving forward with a large number of 2019 deals that have spilled over into 2020.
However, we anticipate tax equity's likely need for clarification on the impact of COVID-19 delays on the four-year safe harbor for 2016 start of construction or, better yet, the extension of the safe harbor from four years to five or six years due to the COVID-19 delays, once this first tranche of 2019 deals are closed.
The effects of COVID-19 are unprecedented, and it is difficult to definitively ascertain at this time what the results will be on the availability of debt and tax equity financing. We think it is likely we will see project financing remain stable, or undergo a quick bounceback, as occurred in the 1987 recession.
Long-term offtake arrangements and existing tax equity incentives help buffer the majority of projects from market spikes in the near term. Additionally, the potential tax incentive proposals and economic stimulus packages, while still speculative at this point, may even give a boost going forward. A less likely alternative, in our view, is that we see a more extended disruption as occurred in 2009. We have not yet seen any indicators of a liquidity crunch like we saw back then.
While the renewables industry had hoped for a boost in light of the above under the phase three stimulus package, the U.S. Senate passed the package without the extensions of the safe harbor time periods from commencement of construction under the PTC or ITC. It also does not contain a replacement of the PTC or ITC with direct payments to companies and investors that would provide an additional funding source if tax equity market is shaken by COVID-19 and there is less tax equity funding for wind and solar projects.
Despite this perceived setback to the tax equity market, the market remains optimistic that a proposed phase four stimulus package is on the horizon, and that the wind and solar industries will receive COVID-19 related relief for the tax incentives upon which the tax equity market relies.
It is noteworthy that the purchase of oil for the Strategic Petroleum Reserve sought by the petroleum industry was also cut from the phase three stimulus bill. Thus, there may be a trade to be made in a phase four stimulus package, and experts speculate that such a package will address both the oil and gas and solar and wind sectors.
Next Steps
Conduct a project (or portfolio) level of review for project risks that are exacerbated by COVID-19. Under normal circumstances, projects face risks related to supply chain risk, completion delay risk and change order risk. With COVID-19, each of these risks are heightened while labor risk and potentially stricter lending and funding criteria are introduced.
Conduct a critical review of all project, financing and acquisition documents. Under normal circumstances, owners/borrowers must remain diligent complying with the numerous obligations contained in their agreements, particularly financing agreements. With COVID-19, there are likely certain repayment covenants, information covenants, events of default and material adverse effect/change items that could be triggered indirectly due to cross-defaults under the project documents, or directly due to the virus' impact on the economics of the project.
Consider any impacts or developments with government meetings cancelled. With the general concern about person-to-person contact, we may see delays in permits, reports and even obtaining leases from landowners. This should be given careful scrutiny by developers.
Carl J. Fleming and Edward Zaelke are partners, and Seth B. Doughty is an associate at McDermott Will & Emery LLP.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
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