May 2, 2022

Jobs Act Directs Private Activity Bonds to Clean Energy, Carbon Capture

Holland & Knight Alert
Woody Vaughan | Peter Baumgaertner | Michael L. Wiener | Caroline Sage

Highlights

  • The Infrastructure Investment and Jobs Act provides a "once in a generation" investment into the nation's infrastructure, including $62 billion for clean energy, in addition to traditional infrastructure such as roads, bridges, transit and airports.
  • Direct funding is set aside for several important climate programs, including electrification of the transportation system, buildout of the nation's power grid and cleanup of abandoned mines.
  • Carbon capture, utilization and storage equipment, and direct air capture technologies are eligible for private activity bond financing through a new category of exempt facility bonds: qualified carbon dioxide capture facilities.

The bipartisan Infrastructure Investments and Jobs Act (IIJA), signed into law in November 2021, provides a "once in a generation" investment into the nation's infrastructure. In addition to making significant investments in traditional infrastructure such as roads, bridges, transit and airports, the IIJA made the largest single investment in carbon management provisions in U.S. history, dedicating $62 billion to clean energy efforts. This legislation provides direct funding to several important climate programs, including electrification of the transportation system, buildout of the nation's power grid and cleanup of abandoned mines. It also enacts the Carbon Capture Improvement Act (S.1829), which makes carbon capture, utilization and storage equipment (CCUS), and direct air capture (DAC) technologies eligible for private activity bond (PAB) financing under the tax-exempt bond provisions of Section 142 of the Internal Revenue Code (the Code) by adding a new category of exempt facility bonds: qualified carbon dioxide capture facilities. Historically, the combination of bonds with U.S. Department of Energy grant funding has been a significant driver for the CCUS market since these are complex projects that typically aren't financeable without government programs such as these.

CCUS facilities remove carbon dioxide from the emissions stream of industrial facilities or power plants, and DAC facilities use an innovative technology that removes carbon dioxide directly from the atmosphere. Together, these technologies are integral to reducing emissions in an effort to achieve the Biden Administration's current goal of carbon neutrality by 2050. Initial buildout of these facilities, however, is often cost-prohibitive, requiring upwards of $1 billion for first-generation facilities. The IIJA's addition of qualified carbon dioxide capture facilities to the list of eligible PAB projects will help facilitate power plants' and industrial facilities' purchase and installation of eligible CCUS and DAC projects.

What Is a PAB?

A "qualified" PAB is a tax-exempt bond issued by state and local governments that lowers the financing costs of several categories of private projects enumerated in the Code. In addition to lowering the overall costs of eligible projects, PABs make use of the efficiency of the private sector, both as to the time necessary to complete buildout of eligible projects and the economic efficiency of the projects selected.

What's Required of a Qualified Carbon Dioxide Capture Facility?

As defined in the IIJA, a qualified carbon dioxide capture facility includes 1) eligible components of industrial carbon dioxide facilities, and 2) direct air capture facilities. The legislation provides a broad definition of "eligible component" to include any equipment installed in an industrial carbon dioxide facility that is used for the purpose of capturing, treating, purifying and compressing carbon emissions or for transportation or on-site storage of the captured carbon. An eligible component may also be equipment that is "integral or functionally related and subordinate" to a process that converts certain energy or feedstock byproducts into "a synthesis gas composed of primarily carbon dioxide and hydrogen for direct use or subsequent chemical or physical conversion."

An industrial carbon dioxide facility is one that emits carbon dioxide (including from any fugitive emissions source) that is created as a result of any of several processes. This does not include any geological gas facility (one that produces certain raw gas or mixed-gas products, transports or removes impurities from such product, or separates such product into its constituent parts) or any air separation unit that does not qualify as gasification equipment or is not a necessary component of an oxy-fuel combustion process.

How Does a Qualified Carbon Dioxide Capture Facility Qualify for PAB Financing?

Eligible components must have a capture and storage percentage of at least 65 percent. The capture and storage percentage is the quotient of the total metric tons of carbon dioxide designed to be captured and injected into either a geologic storage facility or an enhanced oil or gas recovery well, divided by the total metric tons of carbon dioxide that would otherwise be released into the atmosphere if the eligible component were not installed in the industrial carbon dioxide facility. If an eligible component has a capture and storage percentage of less than the required 65 percent, the IIJA allows PAB financing for a percentage of the cost of the eligible components installed in an industrial carbon dioxide facility in an amount up to the facility's capture and storage percentage. That is, if the facility has a capture and storage percentage of 40 percent, up to 40 percent of the cost of eligible components within that facility can be financed with PABs. It should also be noted that this calculation only takes into account the emissions that the eligible component is designed to capture, which are not necessarily the emissions of the entire industrial carbon dioxide facility.

What Qualifies as a Direct Air Capture Facility?

"Direct air capture facility" is defined in Section 45Q(e)(1) of the Code as any facility that uses carbon capture equipment to capture carbon dioxide from the ambient air, but does not include facilities that capture carbon dioxide that has been deliberately released from naturally occurring subsurface springs or that capture carbon dioxide using natural photosynthesis.

Is Volume Cap Needed?

PABs for qualified carbon dioxide capture facilities are partially exempt from the volume cap limitation under Section 146 of the Code, receiving a 75 percent exemption from the limitation. In other words, only 25 percent of the par amount of the PABs financing a qualified carbon dioxide capture facility will apply to the issuer's PAB volume cap. This exception applies equally to private and government-owned facilities.

Benefits and Considerations

The benefits of PAB financing are somewhat negated by the loss of a portion of tax credits otherwise available to an issuer under Section 45Q of the Code. Issuers who finance any part of qualified carbon dioxide capture facilities with PABs will see a reduction in these tax credits of either 50 percent of the credits the issuer is eligible for or the percentage of PABs used for the project when compared to the total cost of the project through the taxable year in question, whichever is less.

As the demand for more climate-friendly technology and resources grows, many industries, both within the U.S. and abroad, have started to address this demand by shifting away from the use of fossil fuels and other high-carbon practices toward various low-carbon, renewable resources and technology. This shift is a potential cause of concern for issuers of municipal bonds, who may face so-called "transition risks," or the risks that arise from measures taken to further the transition to low-carbon technologies in order to achieve carbon neutrality. For example, the creditworthiness of state and local governments may be affected in several ways by measures these governments undertake in response to changes in federal policy and spending priorities.

Financial and debt instruments of many municipal issuers, particularly issuers in areas that depend heavily on carbon-intensive industries, may carry a more negative outlook, which in turn may affect investors' portfolio performance, making investment in municipal bonds a less attractive investment option. Municipalities may be all but forced to incur more debt to finance cleaner technology and facilities to satisfy demand or else incur a higher carbon tax burden. Alternatively, issuers who choose not to transition away from high-carbon practices may experience tax base erosion from outmigration and the associated loss of economic activity.

The IIJA mitigates the aforementioned transition risks by making the transition to low-carbon technologies more attractive through the expanded use of PABs, which should ultimately make it easier for power plants and industrial facilities to finance the transition toward carbon neutrality through the implementation of CCUS and DAC facilities. Further, decarbonization will create an array of new opportunities for municipal finance and, with careful planning, adverse effects of associated investments can be reduced. In any case, the impacts of transition risk at this point are mostly speculative. Further analysis on the stability of credit markets with the introduction of clean technologies is needed to assess the full extent of any such risk and will be crucial for regulators and banks in evaluating future policy decisions and investments.

The Need for Increased Carbon Capture

CCUS and DAC technologies are becoming increasingly common in the U.S. and abroad; however, the majority of the investment in this carbon capture technology over the past two decades has largely been the result of voluntary actions of private entities. The current administration has made the fight against climate change a top priority and set a goal of the U.S. achieving net-zero carbon emissions by 2050.

Transitioning our society from one that relies heavily on carbon-emitting resources to one that is net-zero is an ambitious goal, and the actions of the private sector alone may not be sufficient to achieve this goal. The public sector and the private sector must work together at all levels, and the IIJA's carbon reduction programs represent early examples of a shift in the federal government's approach to climate change toward market-based solutions. The adoption of other market-based solutions, such as a carbon tax, amendment of certain laws and regulations, and the increased use of "green" financial instruments similar to the IIJA's carbon capture PABs are under discussion in Congress and, should they pass, these solutions will work with each other to accelerate the nation's progress toward its midcentury goal. These provisions are currently effective and apply to all obligations issued after Dec. 31, 2021.

Please contact the authors of this alert if you have any questions regarding Jobs Act clean energy or carbon capture programs.


Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.


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