The Inflation Reduction Act made it much easier for companies to sell clean energy tax credits that they cannot make use of themselves. In this episode, CEO Alfred Johnson of Crux Climate explains how this seemingly wonky tweak has created a market that is already providing billions in new clean-energy investment.
Text transcript:
David Roberts
By now most clean energy nerds are aware that the bulk of the spending in the Inflation Reduction Act is done through tax credits. Existing tax credits for wind and solar were expanded and lengthened and new tax credits were created for a wide variety of clean energy technologies from hydrogen to heat pumps.
But a reduction in your taxes — which is what a tax credit is — only helps you if you're making enough income to pay more taxes than the reduction. If you're a small or medium-sized firm, especially a startup, you might not even be revenue-positive yet, much less have a large enough tax burden to take advantage of a big tax credit.
It has long been possible for firms that can't take advantage of the tax credits themselves to sell those credits, but it has been, to simplify it substantially, an expensive pain in the arse. So lots and lots of firms can't or won't do it, which means lots and lots of the value of clean energy tax credits has been left on the table, unused.
However! IRA made some changes in the tax credit system that will make it much easier to sell tax credits to a much wider range of buyers and, IRA’s architects hope, create a robust market for tax equity investment that takes advantage of the full value of the tax credits.
To discuss the many-billion-dollar consequences of this seemingly wonky change, I'm talking to Alfred Johnson, CEO of Crux Climate. Crux has set out to make a platform for buying and selling tax credits that is easy to use, even for smaller firms. We're going to cover the basics of how tax credits work and how they've been changed, the new market for tax credits that is emerging, and the potential scale of new investment that could result from this shift.
All right then, with no further ado, Alfred Johnson of Crux, welcome to Volts. Thank you so much for coming.
Alfred Johnson
Hey, David. It's good to be here.
David Roberts
Alfred, this is one of those topics where it's kind of been in the corner of my eye for a while, and I've been thinking, "You know, this is like an accounting change. Is there really enough here to do a full episode on?" And then I started reading and researching about it, and now I'm in the much more familiar place of thinking, "How on earth are we going to get through all this in a mere hour?" So, this problem — where there are lots of businesses who can't really make use of the tax credit because their tax burden is not big enough — is an old problem.
Alfred Johnson
Yes.
David Roberts
And so some of the tax credits in the IRA were made what they called "direct pay," which is one way of solving this problem; which is you don't need to deduct the credit from your taxes, you just submit the tax credit to the feds and they give you the money.
Alfred Johnson
That's right.
David Roberts
Very simple. A very simple, straightforward transaction. So before we get into the sort of Rube Goldberg machine we're trying to build now to make a market for these tax credits, can we just discuss, why don't they just make all the tax credits direct pay? It just seems like so simple. You're saving enormous administrative costs, enormous soft costs. It's just much more transparent how much money the feds will spend. It just seems so much simpler than what we're doing. Do you have an explanation for why they don't just do this for all the tax credits?
Alfred Johnson
Yeah. So, David, as an avid listener of Volts, I know that your listeners are probably as much a fan of the political and legislative history that you do as I am, and I think that that's relevant here. So, as you say, we've been using tax credits to incentivize energy policy for a very long time, for more than 100 years for oil and gas, for decades for renewables, and they have been expanded and extended many times.
David Roberts
Yeah. Really, the backbone of US clean energy policy. I mean, really, the workhorse. The bulk of it.
Alfred Johnson
Totally. And when you look at the Inflation Reduction Act, which is the largest piece of climate legislation passed by any government ever, the bulk of it comes in the form of tax credits. There was a concept in the earlier history of this law, which, as you know, started in a prior form that at the time was called Build Back Better. It wound its way through the House and Senate and ultimately seemed to die before being resurrected in the form of the Inflation Reduction Act. Prior versions of the law had a substantial majority or all of the tax credits redeemable to the government for the face value of the credit.
At the end of the process, the Congress, the Senate, really decided to introduce this concept of transferability for most of the categories of credits. And there are now twelve credits that are transferable for cash, that are the solar credits, wind credits, battery storage, bioenergy, and then alternatively, some of these categories that can be either direct pay or transferable. And those are 45X, which are advanced manufacturing credits, the hydrogen credits, which are covered under 45V, and the carbon capture credits, which are under 45Q.
David Roberts
Right. So, I don't want to get bogged down in it. But can you just explain what was the politics there? People who say, "I don't want this credit to be direct pay," why? What is the objection?
Alfred Johnson
So, David, earlier in my career, I was at the Treasury Department working on, among other things, the Recovery Act in the 2009 through 2011 period. And in that period, the government had a program that was initiated via that law called the 1603 grants program — many of your listeners will be familiar with it — and that was effectively direct pay. The credits could be taken to the government and redeemed for cash. The thing that ends up happening with direct pay is the Treasury Department, the IRS then needs to be the arbiter of whether or not the credit is earned.
And then, substantially, the government also needs to pay you in a timely manner for the credit that you have submitted to them via your tax return. And sometimes that takes a while. So, one of the advantages of transferability is it introduces this element of private sector review, analysis, underwriting of the credit. So, a buyer of the credit, who is buying it from a clean energy developer, will look at the underlying attributes, understand the risk that is associated with it, and then make a purchase decision on the basis of that.
David Roberts
So, there's administrative work to be done to assess these before you buy them. And the IRS didn't want to take that on. Is that part of it?
Alfred Johnson
Yeah, I think Congress looked at what would be feasible in the context of a multi-hundred billion dollar program.
David Roberts
Yeah, this is a lot of tax credits we're talking about.
Alfred Johnson
Yeah, it decided to create a mechanism where private sector buyers are incentivized to participate in the market. So that's thing one. Thing two is the cash transfer dynamics of transferability versus direct pay tend to be favorable. So with direct pay, you submit the credit on your tax return and are paid by the government. When the government processes the return, that can be a very long time from when the credit is earned. In the case of transferability, you can sell that credit in the market and get paid in cash for it much sooner. And so we're seeing, even in these categories that are alternatively direct pay and transferability, like 45X advanced manufacturing credits, we are seeing those sellers come to the transfer market and seek to sell them because of these favorable cash dynamics.
David Roberts
Just speed, basically getting the money in your pocket faster. So you're saving the IRS from a substantial administrative burden, having to assess all these tax credits. And again, we're talking about now with the IRA, just lots more, just lots and lots and lots more. And B, the whole thing is supposed to be faster and I would expect kind of more fluid and more liquid.
Alfred Johnson
That's right. And David, there's actually another aspect to it that's interesting. Because this show tends to get into the politics of these things as well as the policy, one of the other dynamics of creating a transfer market is you create a lot more participants in that market. And when there are more participants in a market, there tends to be more support for the continuity of that market. And one of the things that is interesting about the IRA is that the IRA is heavy on carrots as opposed to sticks, and it brings many more people into the fold in a way that I think will ultimately be constructive.
David Roberts
Yeah, so by creating this market, you're also creating a new set of constituents, basically for further, for at least preserving the tax credits.
Alfred Johnson
Yeah. That believe in the market, have participated in it, are benefiting from it, are, in the case of buyers, driving investment into clean energy and achieving a savings on their taxes as a result of that. And that makes them a supporter of the program alongside the other more natural supporters of the program, like the developers who get the credits in the first instance.
David Roberts
Right, right, just make the whole thing more difficult to uproot. Okay, so this is why we're not just handing out the money. So explain to us then, pretend — this may be difficult for you, Alfred, but pretend you're speaking to someone who's grossly ignorant about financial matters and stocks and bonds and whatever the hell, Dow Jones, whatever the hell, pretend you're talking to somebody who doesn't know anything about this stuff. What is the change exactly? What, how is it that you could sell your tax credits before this? And then what did IRA do such that you can sell them more easily now. What is the change in question?
Alfred Johnson
Yeah. So principally, it was not technically legal to sell your tax credits in the past. Now, this was a problem because renewables developers, kind of, no matter who you are, earn a lot more credits than they have tax liability to pay. And if you have more credit, then you have liability, then there's an excess. Imagine you get a flight voucher from Delta Airlines for $3,000 and your plane ticket is for $1,000. And so you've got $2,000 of excess voucher, but you've got no more travel to do that year.
David Roberts
So if you have more tax credit than you have liability, they're not just going to pay you the difference then, because that's one of the things I wondered, if I have a $3,000 voucher from the government and I only have $1,000 of taxes. They wouldn't just pay me the extra $2,000 then. That's not how that works?
Alfred Johnson
No. You could use that voucher in a subsequent year, so you could use the tax credit to offset future tax liability. But then the value of that tax credit is unredeemed in the years between when you earn it and when you're able to fully use it. And therefore the value to the developer deteriorates over time.
David Roberts
Right. So, you say it was illegal to sell, but there was selling happening. So, how was that happening before?
Alfred Johnson
Yeah. So it wasn't technically legal to directly transact them. It was legal to form partnerships where the partnership would distribute the tax benefits associated with a project. So a partnership, a company would be formed. That company would have investors. The investors would be paid back on their investment in different ways. There was a category of investor called traditional tax equity investors who would typically invest into these partnerships and therefore these projects, in part to access the tax benefits that were associated with those projects. But they had to be equity owners of the project in order to receive those benefits.
And that market, the traditional tax equity market, has grown to something like a $20 billion annual market, where the largest providers of that form of investment are the largest banks in the United States.
David Roberts
It's kind of wild to me that it grew as big as it did, because what you basically have to do is you own the project and you have more tax credit than you have liabilities. So, you do this sort of Rube Goldberg series of things where you partner with a big bank. The big bank becomes the co-owner of the project, right? Because only the owner of the project can redeem the credit. So, the bank becomes co-owner of the project, splits the credit with the developer, and then gives the project back to the developer. It's just like an amazing accounting — it's just like a massive amount of accounting. Basically, you're like selling half your project, getting tax credits, getting the half of your project back. It's an elaborate financial dance you had to do to do this.
Alfred Johnson
And we shouldn't understate the impact and the benefit of the structure. Right. That structure has enabled tens of billions of dollars to flow into renewables development over this period, but it has been inherently constrained. There are only so many companies that have the internal capabilities to be able to do that kind of investment. They tend to be pretty expensive to structure. So, it doesn't usually make sense for projects that are below a certain size, $50 million or so of credit being about the floor that you can justify the investment of time, resources, and legal expense to do it.
And so it tended to be a structure that was only available to the largest projects on an annual basis with the money coming from the largest financial institutions.
David Roberts
Right. So, before we talk about transferability and how that changes matters, I'm just curious. Does anyone have an estimate of how much of the tax credit value, sort of faceplate value, was just left unused because of this structure? Like the cumulative amount of potential tax credit that was just left unexploited?
Alfred Johnson
I've not seen that specific estimate. The reality of the structure, the traditional tax equity structure, is it led to the formation of the market as it has been previously constituted, where the largest developers or the acquirers of large numbers of projects that have access to the traditional tax equity market are the ones that are owning the projects when those projects are placed into service. And that has led to a development dynamic where smaller developers have tended to sell their projects upstream to larger developers in order to get access to tax equity. Because tax equity has been so fundamental to the financing of these projects.
And the IRA did some material things: The IRA created tax credits for new categories that did not previously have tax credits. It expanded their use, so it made them more generous for projects and the developers that were creating these things, and it made them transferable for the first time. So, you no longer have to put in place this kind of traditional tax equity structure in order to monetize the tax benefits. Any developer who has the tax credits that are eligible for transfer can sell those credits into an open market to a third party for cash.
David Roberts
Right. And so the change now is that the party you're selling to does not have to become a co-owner of the project.
Alfred Johnson
That's correct.
David Roberts
That's the main thing. You can just sell them to a third party. And I just want to clarify this, too, because I think one of the things that kind of raises people's eyebrows about this, especially if they don't understand the details, is it sounds vaguely like another secondary market, you know, like for offsets or something like that, which just, like, opens the door to a bunch of shenanigans. So one thing to clarify is that you can only sell the tax credit once.
Alfred Johnson
That's right.
David Roberts
It does not become like a kind of currency that gets traded and traded and traded again and again. You just sell the thing once to one third party.
Alfred Johnson
That's right. So, Congress was very intentional in the construction of this. They specified in the statute what was eligible for transferability, what the dynamics of those projects and those credits needed to be, how transfers would work, including, as you mentioned, the prohibition on a second transfer of the credit so that there wouldn't be financial prospecting in the market. And then the Treasury Department, through guidance, has further specified how the market would work. And when you compare it to, for example, the voluntary carbon market, where an absence of standards has been inhibiting to the market growth, this market has government established standards at the center of it, and I think that will accrue to its benefit.
David Roberts
Right, right. And so, just before moving on from this question, though, I just want to emphasize, even if we don't have a specific number, that the inability of lots of developers to make use of the tax credits has yielded a situation where billions and billions of dollars, I'm guessing hundreds of billions over the course of decades of potential investment in renewable energy, has not happened because of this. So, there's just a lot of value left on the table. So, I'm trying to sort of convey why this is a big deal. This is going to allow, theoretically, for the full value of all those tax credits to be exploited to go to investing in renewable energy.
So it's a big deal now. So now we have this change. A bunch of the tax credits are transferable, which just means you can just sell them to someone. You don't have to have a giant accounting department and do a bunch of Rube Goldberg ownership deals. You just sell them like a product. So what does Crux do, and how did you come to this?
Alfred Johnson
Well, David, it starts with a walk that I took with my dog.
David Roberts
All good —
Alfred Johnson
August of 2022.
David Roberts
begin with dog walks.
Alfred Johnson
I was like a good Volts listener, listening to the two-part podcast that you did with Jesse Jenkins on what was in the Inflation Reduction Act. As you know, the introduction of transferability was an 11th-hour change to the law. It was not part of earlier drafts of the law. And in that podcast that you did with Jesse, you guys talked about how powerful this new mechanism of transferability is and the fact that it changes the project finance of a whole range of projects that are going to be really fundamental to the energy transition. I had not fully wrapped my head around that until that podcast.
I had a background at the Treasury Department, I'd been there early in my career, as I mentioned. I had done structured finance at Blackrock. I had built and sold a marketplace software company. And then I had most recently been back at the Treasury Department working for Janet Yellen as her deputy chief of staff, but had left that summer, was planning to start another business. I took that walk. I heard that point. And it sparked this prolonged moment of curiosity over the course of the third and fourth quarter of 2022, where I just could not get enough of tax equity, tax credits, the Inflation Reduction Act.
David Roberts
That's a weird fetish, Alfred.
Alfred Johnson
That's weird. And you're the reason I started it.
David Roberts
I apologize for that.
Alfred Johnson
Oh, thank you. One of the things that was super clear to me, the deeper I went in it, is if we're actually going to do this, if we are actually going to transition the way that energy is produced and consumed in the country, then we need to make sure that the subsidy that the government is channeling to the people that are developing these critical projects is channeled efficiently. And in the absence of an efficient market for the transferable credits, that subsidy is attenuated. And so we started to get our heads around what it would look like to create a vibrant, deep, liquid, efficient, standardized market in the transferable credits, and started down that road in earnest in early 2023.
We launched the company, we went out and fundraised our seed round. We didn't even have a name for it at the time. We were just so motivated by this problem statement. Ended up raising $4.5 million from Lowercarbon, QED, Overture, a handful of investors, and then went out to the market, got a lot of positive reviews on it and excitement around it. So raised a seed extension that was about another $4.5 million. So raised $9 million over the course of 2023. And then in that period, David, the market really started to form.
So, the Treasury put out guidance in June of '23. People started doing deals around August of last year. And then the market started to really move. And in that period, we started to see a lot of activity on the Crux platform. Billions of dollars of credits were listed.
David Roberts
You were up and running in June when the IRS put this out. So, you were ready for this thing when it got underway.
Alfred Johnson
Yes.
David Roberts
And so, what you're doing is just basically, I mean, I imagine people can sort of imagine what's involved. You just want this market to work. So, you're coming up with a platform where people can list their tax credits for sale and where buyers can come and review tax credits. It's just these are all soft costs. Right? Administrative stuff that you're trying to make easier.
Alfred Johnson
That's right. I think one interesting dynamic in this market is because traditional tax equity is so complex. We talk about transferable tax credits like they're simple, but they're not simple. Right. They still have hundreds of underlying documents, tons of stakeholders around the table, compliance obligations on the buy side. And so our platform is one part what you talked about. So you're a seller of credits. That means you're a renewables developer, you're an advanced manufacturer, you're capturing carbon, you get these credits that are associated with those activities. You can post the credits in an anonymous way on Crux.
So you say, "I've got $50 million of solar ITCs that will be placed in service in June of 2024." Put a picture associated with it. You give some attributes about yourself as a developer. The buyers that are in the Crux platform can search on the basis of technology, timing, fiscal year end, all these characteristics that will define the attractiveness of credits in the market. They can then express interest in credits within Crux. So they say, "David, your $50 million of credits looks great. The price that I would be willing to pay for that is this. I would like to close on that date."
And the seller is then able to review expressions of interest that they get through the platform. When there's alignment on the sort of outlines of what a deal could look like, then the parties agree to upload NDAs and are unmasked to each other. So, buyers and sellers are able to see the counterparty. And then, Crux is also the transaction management and workflow software that helps those parties to transact. So, we've got a structured data room where the seller can upload documents. We're increasingly launching features where buyers and sellers and their advisors can interact through the platform to limit the hundreds of emails that need to go back and forth.
We have launched pre-registration tracking, so you're able to track the number that is associated with the credit. The purchaser, the buyer, is able to store the credits that they have purchased in a single location. So, it becomes sort of the source of truth as well as the transaction management platform that people are using. And then, critically, David, it can also be used by intermediaries. So, tax advisors, syndicators, banks that may be making markets, meaning bringing together buyers and sellers in transferable tax credits, can use Crux as their transaction management software in their brand and can also access supply and demand.
David Roberts
You're licensing it to other people to use, basically?
Alfred Johnson
Yeah, one thing we find is that intermediaries in this market, like banks, are just going to be fundamental to the formation of the new larger market. Banks are connecting their clients that are renewables developers with their clients that may have tax capacity, but they need tools to be able to scale that kind of syndication. And basically, nobody has a fully balanced market, meaning anybody who might be trying to match buyers and sellers will tend to have more of one side than the other. And that's another thing that if you're an advisor or an intermediary using Crux, you can use it for, which is to find balance to your market, find the other side of a trade in places where you may have a seller but not a buyer, or vice versa.
David Roberts
All right, so this is all in the name of making this market smooth and liquid. So the IRS came out in June of 2023 with basically the rules of the road for how these things work, which more or less kind of fired the starting gun for this market. So recently, you put out a 2023 market review, which looks at the ensuing six months of 2023 and assesses what happened, how big is the market, who's coming in, what's happening? So what did you find?
Alfred Johnson
Yeah, so we found that this market started to develop much more rapidly than anybody thought that it would. So, going back to that podcast that you and Jesse did, there was an open question as to how much of the credits that were generated in the market would be sold via transferability and how many would be monetized via tax equity. And what we have found is that transferability is a really powerful mechanism, and it's a market that, at least in the early innings, buyers are very interested in participating in.
David Roberts
If I read this correctly, even some of the big players that were well established in the previous tax equity market are opting for this, even though they have the setup for the previous way of doing things, are opting for this instead.
Alfred Johnson
Yeah, so actually, the starting gun on this market was a transaction that actually happened in August of 2023 between Invenergy and Bank of America. Invenergy sold Bank of America $580 million worth of transferable tax credits in a direct transfer. And the reason that was so notable to the market is both of those participants, the buyer and the seller, had been historical large participants in the traditional tax equity market, deciding that a transferable transaction made more economic sense in the context of that deal. And after that, we just saw a ton of market activity. So, the early estimates on the market suggested that there would be $3 or $4 billion of transferable tax credits sold in 2023.
We specifically tracked, via our market report, more than $3.5 billion of specific transactions. So, that was publicly announced transactions, transactions that we found or were reported to us via a survey that we did. And then, transaction data from Crux, where we were able to show that with those $3.5 billion of transactions. We estimated that the market for 2023 credits was something more like $7 to $9 billion of total transactions, on top of what we estimate to be a $23 billion traditional tax equity market. But meaningfully, that $7 to $9 billion, David, came all between August and now; it was all in the back half of the year.
David Roberts
It's pretty obvious from trends thus far that this market is going to grow as large and larger than the traditional tax equity market.
Alfred Johnson
Yes, we think it'll be roughly the same size as the traditional tax equity market in 2024. And I should say — and this gets very energy project finance nerdy pretty quickly — but traditional tax equity and transferability are not mutually exclusive. You can do traditional tax equity and then the tax equity partnership can sell some or all of the credits.
David Roberts
I have several of these mega-wonk questions, but let's get through the basics first. So, the market is taking off faster than people thought. Who is buying and selling? Were you interested? Was it surprising at all to find out who's participating?
Alfred Johnson
Yeah, so it was. We found that on the sell side, it was a much more distributed set of companies than had previously had access to the traditional tech.
David Roberts
In terms of size, you mean like —
Alfred Johnson
In terms of size, but also tech types. So, you know, the IRA extends tax credits to categories that had not previously had access to tax equity, or credits at all. And we found that in the early market, the majority of transactions that we tracked were below $50 million in size, suggesting that transferability is leveling the playing field. And we found quite a lot of activity in segments that had just received tax credits for the first time via the Inflation Reduction Act. Things like advanced manufacturing tax credits that can now be sold directly.
David Roberts
Interesting. This might be kind of a dumb question, but if I have a dollar's worth of tax credit, how much can I sell it for? Like, presumably not a dollar. How much of a haircut am I taking when I sell one of these things?
Alfred Johnson
Yeah. So when a buyer is going through the process of diligencing a credit, understanding the underlying dynamics, exposing themselves to some amount of risk, it is manageable risk, we believe, but some amount of risk nonetheless. There's a cost to those activities. And to your point, they're not going to do that to offset a dollar of taxes that they would otherwise pay. So the market trades on a discount to a dollar, and we're seeing pricing at the top end of the market — so that would be the $100 million plus transactions — we saw in our market report that those are pricing between $0.94 and $0.96 — I've even heard of a 97 cent transaction.
David Roberts
Like the bulk of a dollar, you're not taking a huge haircut here.
Alfred Johnson
That's right. Now, pricing is highly correlated to size, so the smaller the transaction is, once you get into the sub $10 million transaction sizes, we're seeing pricing, on average, we saw 2023 pricing at around $0.89. But David, that's pretty healthy. And just to put that in context for a second, we see state transferable tax credits generally trade between $0.85 and $0.95. The low-income housing tax credit market — which is the most prominent transferable federal tax credit — the trailing three-month average on that market right now, and that's a 37-year-old program, is $0.89. So we saw that even for the smallest credits in the first six months of the market, we got to pricing that is comparable to other transferable credits.
David Roberts
Interesting.
Alfred Johnson
In much more established spaces, and I think that suggests that this is going to be a powerful mechanism for the large players, people like Invenergy, but also small players that are now able to keep their tax credit and sell it directly.
David Roberts
Is anyone lumping a bunch of small projects together to try to get a higher rate in this market? Sort of like emulating a larger project by clustering a bunch of small ones together?
Alfred Johnson
Yes, and there are a lot of development companies that have had that strategy for a long time. Basically, as long as traditional tax equity has existed, larger developers have been buying projects before they are placed into service and then financing them jointly. And that has been a mechanism by which they have gotten tax equity to finance smaller projects. It will also be a mechanism by which they sell the credits at a higher value by portfolioing them. But we're not finding that it is strictly necessary in the same way it was in the traditional tax equity market.
David Roberts
Right, right. It might not be worth the trouble just to go from $0.89 to $0.94 or whatever. One of the things I'm most interested in, most fascinated to find is presumably, I mean, these are not all selling for the same prices. Right. People are sort of bidding on these based on size and risk and technology kind, and so there's a range of prices that are getting paid. I'm very curious how different technologies are performing on this market. Are buyers preferring particular technologies like wind credits or solar credits because they're well established, or hydrogen credits because they're friggin' huge?
What are you finding about what flavors of tax credits are pulling the highest prices?
Alfred Johnson
Yeah, so once the credit type is established, and by that, I mean the treasury or whomever is relevant, has put out the necessary guidance for the market to understand what the credit is and how viability works in that particular segment. Once that happens, we are seeing convergence to the broader market. So, for example, for advanced manufacturing tax credits, which are production tax credits associated with the units of components or widgets that are being produced, that's a production tax credit. So, it is correspondent to a volume or an amount that is produced. It looks like other production tax credits in substance, like wind production tax credits that are associated with units of energy produced.
And what we saw in 45X, which is advanced manufacturing credits, is before guidance was established on that category of credits, they were trading at a deeper discount to other production tax credits. Once guidance was established on the credit, we started to see convergence to other similar tax credits that had similar attributes — other production tax credits. I think thematically in the market, as the market gets more comfortable, as guidance comes out on new technology categories, you're going to see convergence to market norms. I would observe for you, David, that the largest credits across category get better pricing than smaller credits.
So large 45X credits get better pricing than small 45X credits.
David Roberts
So size matters more than technology probably.
Alfred Johnson
That's right. There is more of a clear correlation to the credit value and that also has to do with the buyer's perception of the ability of the seller to stand behind any indemnity that they may be providing them. So, a seller is typically saying, "This credit that I have sold you is good, and if it isn't good, you can rely on me to make sure that you are whole." If that is coming from a public company with a strong balance sheet, then the buyer is likely to assign more value to it. If it's coming from a smaller developer with less track record, then the buyer is less likely to assign that level of value to it.
So, you definitely see that kind of dynamic. And I touched on this in my answer, but didn't specify it, so I will. Investment tax credits and production tax credits tend to trade differently in the market. Production tax credits are the premium product in the market, in part because it is observable, right. You produce x amount of energy, you get y amount of tax credit, and there isn't a lot of room for interpretation. With investment tax credits, those are derivative of the value of the project, typically the fair market value of the project as determined by an appraiser.
And in that sense, there is some amount of determination of what the value of the project was, and that can be challenged by the IRS later. Typically, what you are seeing is indemnity from seller to buyer that the credit is good and what they said that it was, and that the buyer can rely on it. Often, in 95% of cases, you're also seeing tax insurance that is typically procured by the seller to the benefit of the buyer. But still, we see production tax credits on average. In our 2023 sample, they were trading at around $0.94. Investment tax credits in our 2023 sample were trading at about $0.92 on average. So, you see the market make a little bit of a distinction.
David Roberts
Not a huge spread, but a little bit of a spread. And have we found anything in 2024 thus far that that is surprising, or the lines are going up and to the right? Is there anything new or interesting happening in 2024?
Alfred Johnson
Yeah, we're actually about to put out an update. By the time the podcast comes out, we may have already released it on what we saw in the first quarter of 2024. So, happy to give a little preview here. What we saw was the market remains very strong, so we're seeing quite a lot of activity still on unsold 2023 credits. The way that that works is if a project is placed into service in 2023, the credit can still be sold in 2024, and there's still a lot of demand for that. On Crux, 80% of 2023 credits have received at least one expression of interest, and many have received more than one.
David Roberts
Is that just a backlog because the market was late getting underway, or is there something else going on there?
Alfred Johnson
Yeah, I think there's a little bit of that. I think there's the fact that buyers have complete visibility into what their 2023 tax payments are going to be by the time you're in 2024. So there's more of an ability to map the tax credits that you're purchasing directly to known tax liability before the filing. And also, if you think about the cash dynamics on this, the buyer is paying for the credit closer to when they would otherwise pay the government. And therefore, the return on that, if you're thinking about it on a time-adjusted basis, is better to the buyer.
So, I think it is all of those dynamics, and the result of that is a remaining tight market on 2023 credits, where pricing is at where we observed it at the end of 2023. And we have seen pricing ease a little bit on 2024 credits.
David Roberts
And so, the market remains robust, still growing. I mean, it sounds like everybody's initial projections were low, about the size of this market. Based on what you've seen in 2023 and the first quarter of 2024, presumably, you've revised your projections of market size. What do we, how big do we think this market is going to get in the coming years? Is there a single number to throw around or an idea that we could get of how big it's going to get?
Alfred Johnson
Yeah. So the best estimates on that are the models of what uptake will be on these different credits. Once you're looking four, five, six years in the future, it's a question of how much advanced manufacturing will be done in the United States, and that defines what the number of credits that are associated to that will be. The best private estimates on that from investment banks like Credit Suisse and Goldman Sachs have the market getting to somewhere in the neighborhood of $80 to $100 billion of tax attributes to be monetized on an annual basis. You need to make some assumption, then, of how much of that market will be traditional tax equity and how much of it will be sold via direct transfer, where our assumption is the majority will be direct transfer, especially once you take account of the fact that tax equity can be invested and the partnership can be the seller of the credits.
This market gets quite large, quite quickly, in terms of transaction volumes.
David Roberts
And just out of curiosity, has the IRS issued guidance in June of last year, has it done what it has to do, or are there other important questions for the IRS to settle outstanding?
Alfred Johnson
So, the statute, the Inflation Reduction Act, gave the IRS just an extraordinary amount of homework. They had to put out guidance on many of the different credit categories, transferability, direct pay, and, you know, there's been a lot of complexity to that, some of which you have covered on this show through things like the hydrogen guidance. So, there's been a lot to do there. They have been making great progress on that. From my perspective, the guidance that they put out in June of '23 on the transfer market was observably beneficial to the market in the sense that you saw quite a lot of activity happen on the back of that guidance.
So, it gave the market the confidence that was needed to begin to transact meaningfully. That guidance came in the form of a notice of proposed rulemaking where the final rulemaking is expected to come out very soon. I would expect that will come out at some time in April, and that will further stabilize the way in which the transferable credits are treated as a matter of IRS guidance.
David Roberts
And you expect that to be roughly in line with the initial proposal. No big changes on the horizon?
Alfred Johnson
Yes, I think, if anything, they will likely draw additional nuance into the final guidance. Of course, whenever you receive comments, as you do on a notice of proposed rulemaking, it gives the opportunity to make the guidance clearer. We anticipate that it will accrue to the benefit of the market. It certainly gives more stability to the market, and there are a handful of areas where people are waiting on clarity in order to have the confidence to transact. And there are a number of other areas where it's possible that the IRS and Treasury take a more permissive approach to the interpretation of the statute that further benefits the market. But we'll see.
David Roberts
Okay, so we don't have a ton of time left, but I have a series of, sort of like, super nerdy questions, so, everybody, let's do it. Brace yourself. Buckle up your wonk pants.
Alfred Johnson
I'm ready.
David Roberts
So, first of all, one of the things that still recommends the traditional tax equity route, which is finding a co-owner of your project and then exploiting the tax credits that way, is that you get what's called a "step up," which is instead of the value of your project being assessed based on projections, it's based on the fair market value, which tends to be higher. Which is a long way of saying, you get a little bit more money for your tax credits through the traditional tax equity route than you do through transferability.
Is there any way of sort of getting that step up value into the transferability market?
Alfred Johnson
Yeah, so fundamentally what is happening, David, is as a project gets closer to being placed into service and earning revenue, the value of that project goes up in the determination of the market. And so, when you're earlier in the lifecycle of the project, you tend to rely on just the hard costs and directly related soft costs of the project. And as you get closer to when the project is placed into service, there is an argument to be made; there's observable market data that your project is worth more.
David Roberts
Right. And somewhat less risk too, right, as things proceed.
Alfred Johnson
Yes. Because you might be quite close to turning the project on and generating revenue on it. And so, developers in the tax equity model have relied upon a third-party appraisal to value the project, which is then placed into a partnership at the fair market value at the time when the transfer to the partnership is made. And again, the value of that is that the basis of the project is stepped up. The investment tax credit associated with it is higher. You're right that you can't directly do that on your own as a developer, absent some kind of determination of the value being higher.
One of the ways we are seeing developers manage that is to continue to do traditional tax equity. So, a traditional tax equity partnership is formed, the basis is stepped up on the basis of fair market value, and then the credits are sold by the partnership. Another strategy that we are increasingly seeing people begin to employ is a third-party investment of some size is made into the project using the then determined value of the project before the credits are sold in a way that further substantiates a fair market value that may be higher than the cost basis. And in that sense, a step up is achieved without passing it into a tax equity partnership.
You're seeing various tools like that. That for developers, for whom that step- up is very important, can use them to make sure that they are transferring the credits on the basis of the fair market value of the project.
David Roberts
So, still getting that step-up, there are some ways to still get it.
Alfred Johnson
There are ways that the market has adjusted to make sure that developers are taking responsible, fair market value step-ups of the project basis.
David Roberts
Right. What about what's called "recapture," which is if I'm, say, a small developer, I propose a project, I get underway. To begin with, I sell my tax credits and then whatever my cousin embezzles my company falls apart. I don't build the project, but I've already sold the tax credits. There are provisions in law whereby the IRS can come in and claw back the value of that tax credit from me. So if I then am selling my tax credit to a third party, and then I fall apart, the IRS is gonna come claw back my value from the third party.
Which means the third party is taking on some risk. Is that why they're getting $0.94 rather than a dollar? Is that the risk that the third parties are taking? And how do the third parties think about and deal with that risk?
Alfred Johnson
Yeah. So the only thing I would adjust in your example there is that people are transacting once credits are earned. So in the example, the credit purchase happens in advance of your cousin doing shady stuff around the project. The recapture case would be you earn the credit, so you get the project off the ground, and then the project runs into trouble after the credit is sold. And that could be financial trouble of the developer. It could also be a hailstorm that takes the project out of service for a period that is long enough or forever.
And then the IRS has the right to recapture the tax credit that was claimed by the buyer. What you are almost always seeing, what you're always seeing in an investment tax credit transaction, is that seller is indemnifying buyer of that risk. And as I mentioned earlier, that indemnity goes further with a better capitalized seller than a less capitalized seller. And then in 95% of cases we found, in the market survey that we did, there is also some form of tax insurance that is, again, typically bought by the seller to the benefit of the buyer. That makes sure that if there is an incidence of recapture, the insurance policy pays out.
But you know, David, these are not new concepts. We have been dealing with recapture since these credits have been monetized via traditional tax equity structures. The tax insurance that is used in transferability is largely the same as the tax insurance policies that are used in tax equity. So, this is a space where the market has some amount of understanding of how to manage risk.
David Roberts
Got it. Who gets the RECs? If I'm building a project and I get renewable energy credits for it, those are a currency effectively. Those are valuable. Do those go with the tax credits or do the developer keep them? How do they play into all this?
Alfred Johnson
They can go with the tax credits. I think the world that we are emerging into is one where the buyer is able to put their shopping cart together. And that shopping cart might include transferable tax credits. It might include renewable energy credentials that help them meet their net zero targets. It might include carbon offsets, if you're talking about a carbon capture project and the associated credits. And I think what we're going to see is buyers and sellers be able to more easily atomize the pieces of the project, the attributes of the project, and transact them. And the benefit of that is if there are efficient markets that exist for these different attributes of the project, then money is flowing more efficiently into the hands of the renewable energy developers or others that are earning the credits.
And the benefit of that is that they can turn around capital and build more things that we need for the energy transition.
David Roberts
So, long story short, RECs are just kind of a separate product that you can buy or sell as you choose.
Alfred Johnson
Yeah, they may be sold with the credits; they may not.
David Roberts
Right, right. Okay. And now this idea of "chaining," this is the technical term, chaining direct pay and transferability. What the heck does that mean?
Alfred Johnson
All right, so now everybody has to have their energy wonk pants all the way tight. Okay, so chaining, what is meant by that is credits that are eligible for direct pay or entities that are eligible for direct pay, which are generally tax-exempt entities. So nonprofits, Indian tribes, cities and states, churches, schools.
David Roberts
Pause there, in case anybody forgot this about the IRA. But direct pay was, as we mentioned before, massively restricted from what it was in Build Back Better. Almost all the tax credits were direct pay. And now, direct pay has been changed to transferability for most tax credits. But nonprofit entities specifically can still get direct pay. And that's nonprofits, churches, colleges, I think some colleges.
Alfred Johnson
That's right. And that was a big problem in the prior construction of the way in which we use tax credits to incentivize energy policy is you fundamentally needed to be a taxpayer in order to get the benefit of the credit.
David Roberts
Right. And if you're a nonprofit, if you're a non taxpayer, entities sort of by definition, you could not make any use of tax credits.
Alfred Johnson
Yeah. So there was not the same incentive for churches to put solar panels on their roof as there were for commercial building owners.
David Roberts
Right. So now there is. Now they're all direct pay.
Alfred Johnson
Yes. So the IRA creates a really cool change that church can now submit to the IRS for the credit value and receive it. The concept of chaining is the idea that the church or the school district or whomever would be able to sell their direct pay tax credit that could be taken on the return of the buyer and then redeemed from the IRS. And the reason why nonprofits and cities and states have argued that they be allowed to do that is in part because of the cash dynamics that we talked about at the beginning of the podcast, where they may want to pull forward the receipt of the cash associated with the tax credit ahead of when they would be paid it by the IRS.
David Roberts
Yeah, I was going to ask, like, why would they accept less value when they could get full value? Maybe just the money value, the value of time they could accept.
Alfred Johnson
Yeah, this is all just time value of money, cash management kind of considerations. What the nonprofits are arguing is if it is better for a company that has a credit that is, alternatively, direct pay or transferability, if it's a better economic decision for that company to be able to sell it via transferability, they're able to do that. But we don't have that tool available to us. So, give us the mechanism to sell our credit to a buyer who can then take the direct pay credit and get it redeemed by the government and give us that cash management tool that we don't otherwise have via direct pay.
David Roberts
And this is something that the IRS is pondering?
Alfred Johnson
Yeah. So, the IRS put out their updated final version of guidance associated with direct pay in March, and in that, they said that they were further considering chaining as an area where they invited more comment. So, it's very likely the industry will put in a lot of comments on this, as will nonprofits and cities and states and other consortiums, to make the argument for why chaining is to their benefit. And I think the deadline for comments on that is the end of the year, but I could be mistaken.
David Roberts
Interesting. So, we'll find out about that in the final ruling, how that comes out. That's all my nerdy questions. Unless you think there are other particular individual details or nuances of these markets that are too nerdy details that are worth surfacing.
Alfred Johnson
Yeah, I mean, I think one really interesting detail of the market is the fact that transferable credits are this massive catalyst to renewable energy, advanced manufacturing in the United States. It's going to drive a ton of subsidy and much-needed dollars into projects that are going to make the country more energy efficient and make sure that more manufacturing is happening here in the US. These credits are also a change to the way that projects are capitalized. It changes other aspects of the capitalization of the project in a way that is sometimes quite meaningful.
And one of the things that really excites us about this problem space for Crux and one of the reasons why we raised another $18 million recently from Andreessen Horowitz is we think that this change is going to drive a lot of other changes in the capitalization of projects to the benefit of the developers. And there needs to be more efficient mechanisms to drive that capital into these projects across the capital stack. And the transferable credits provide a tool to do that through things like loans that may be made against the future sale of the tax credits or repaid with the sale of the tax credits. Things like that will make the project finance of these developments more efficient.
And we're really excited about the rate of change that I think we will see in the market around how capital forms around these projects.
David Roberts
That's just because all small and medium-sized projects now can exploit the tax credits. It's sort of like, it's not a question anymore about the details of specific projects. Like if you're eligible for a tax credit, you can exploit that value of that tax credit. You're certain of it at this point.
Alfred Johnson
Yeah, it's a benefit that accrues to the seller of the credit, whether they're a renewable energy project developer or a manufacturer of associated components in the United States. And in that sense, it represents a receivable of cash that that developer will earn when the credits are earned and sold. And so in that sense, it becomes something that can be financed in a way that was more complicated to do before. And I use that as an example of the way in which a change to one part of the way in which these projects are capitalized changes the development of capital or the formation of capital around other parts of the project as well.
I think if we're able to build a transparent, liquid, standardized, efficient market in these transferable credits, we are going to be able to drive capital into other parts of the capital stack and to different projects more efficiently than ever was possible before. And I think that's really exciting.
David Roberts
Yeah. Yeah. I mean, this is, I tried to emphasize this at the beginning, but it's worth emphasizing again. Like all that credit value that was going unexploited before is now going to be going toward investing in projects. And it was, you know, many, many billions of dollars that were going unexploited before. So just this little sort of wonky change in tax law is going to have the effect of increasing basically investment in these clean projects by tens, hundreds of billions of dollars. Who knows, over years. That's the kind of take-home message here, which is quite exciting.
Alfred Johnson
Yes. This is a multi-hundred billion dollar change in the way that projects are financed that is also going to create a lot of other downstream, positive dynamics to people that are building renewable energy, infrastructure, manufacturing in the United States.
David Roberts
Quickly, what is Crux doing that sets it apart from other companies in this space? Presumably, I mean, is there going to be consolidation eventually around a single sort of set of tools, a single platform, or is there room here for multiple platforms? How's the space you're in going to shake out?
Alfred Johnson
Yeah. So, our view is that the market has some amount of natural fragmentation. Right. I referenced the Bank of America Invenergy deal earlier on this phone call. That was a direct deal that happened between those two counterparties. There are other brokers that make markets in the credits of various kinds. In that sense, there will always be some amount of deals that are directly brokered or happen between two counterparties. Our view is that for the largest market to form, intermediaries that are participating in it need to be in that market. And so, we have built Crux with a focus on software that enables intermediaries to participate in our market in a way that makes sense for them.
We already have more than 15 intermediaries that are live on the platform and using it to manage transactions and source supply and demand. So, that is one way we brought the intermediaries into our market. We've also really focused on software. So, we've built an eight-person software team very rapidly. We just raised another $18 million to grow even more rapidly on product design and engineering, in part because these transactions are not simple. And the more efficient and standardized we can make the process, the better and more efficient the market becomes. So, we're investing quite a lot there and have a lot of capital to do it.
And over time, I think we're going to see quite a lot of benefits accrue around whomever is able to convene the largest network. And frankly, we're already seeing that. So, in late 2023, and still now, we're seeing more and more competitive bidding dynamics on individual credits. So, in our 2023 sample, for credits that received a single bid, 40% received multiple bids. And in cases where the credit received multiple bids, we saw a material increase in the value of the credit that was ultimately sold to the developer. In that sense, what you're observing there is real-time network effects that are associated with being in the largest market if you're a seller.
As that kind of thing happens, we anticipate and have already seen more sellers come to the market.
David Roberts
Yeah, and it's kind of fascinating. You know, like one of the things markets are really good at is price discovery. And you're really seeing that from a sort of like, you know, academic econ point of view. It's a pretty fascinating, contained experiment in real-time price discovery. You know, like how much are these things worth? We're really finding out, right.
Alfred Johnson
That's exactly right.
David Roberts
In real time, it's pretty interesting.
Alfred Johnson
And in the first quarter, just the first quarter of this past year, we've seen one and a half billion dollars' worth of bids on the Crux platform. And what that means is, as a bid is placed, the seller gets a real-time indication of what at least one party thinks the credit is worth. And when they're receiving multiple bids, as we see in a lot of cases, then you're really seeing the market start to clear at a given price. And one of the reasons we have released as much data as we have to the market in the form of these market updates is we think the more data the market has, the better it converges on an efficient market.
David Roberts
Right, right, right. So, what else needs to be done then? You've got the IRS's guidance mostly done. You've got your platform and your software set up. What else needs to be done to get this market ready for, like, full scale?
Alfred Johnson
We have to build. We have to build in all the senses. We have to develop these projects really quickly because it's an existential moment for us to do it. We need to make sure that those credits can be sold in the market that is liquid and deep, and that's going to involve bringing many more buyers to the market than have previously been a part of it. We need to build software that makes these transactions efficient and standardized, and we need to start to build the other structures around this market, like other financial products, more efficient onboarding of insurance, things like that, that make the market as liquid as possible and drive as much capital as possible into the people that are doing the hard work of putting steel in the ground and making sure that we are transitioning the energy sector as quickly as we need to.
David Roberts
So, what this has effectively done is allow these third parties to buy these tax credits without becoming co-owners of the project. So, it opens up buying to a vast array of third-party players, mostly big corporations. And the quantity, the sheer quantity of tax credit value in IRA is mind-blowing. I'm sure you're familiar with the CBO had its estimate of $3.5 billion. But people have come along since and said there's going to be a trillion plus value cumulatively in IRA. And I'm just sort of wondering, like this sounds almost ridiculous to ask, but because there's so much value in these tax credits, as corporates buy these tax credits, is some substantial amount of the corporate tax burden going to be wiped out by this?
Like, what percent of corporate taxes are now going to be soaked up by these tax credits? It's not so crazy huge that it's going to like wipe out the US corporate tax burden. Is it like, do we have a sense of the relative quantities there?
Alfred Johnson
So, first of all, you're correct that corporates will make up the majority of the buying side of this market and plausibly the large majority of it. But individuals and S corporations can participate, assuming that they have a certain kind of tax liability, really passive tax liability. So, we have already seen, we've done deals with a family office that has enough passive tax liability to warrant participation. But that's a nuance underlining what is a good fundamental question. If you get to $80 to $100 billion per year of tax credits that need to be monetized, the corporate tax liability of the United States varies by the economy, performance of the economy, but when we get to roughly that scale, the CBO estimates that corporates will pay somewhere between $500 and $600 billion a year.
So, depending on how big the market gets, depending on what the characteristics are of the economy at that time, 10% to 20% of corporate tax liability that would need to be allocated to the credits in order to clear the market, absent any other changes that the government may make. For example, allowing individuals to participate in the market more broadly than they are currently expected to be allowed to participate.
David Roberts
Right. But that's just. I mean, 10% to 20% of the US corporate tax burden. I'm just trying to convey the scale of what's going on here. Like, that's a lot of money floating around in these credits and it's, you know, and this change to transferability is going to mean that the actual amount spent is a lot closer to sort of the faceplate, you know, what's on the tin than it would have otherwise been.
Alfred Johnson
Yeah, I mean, David, I think it's, the history is interesting here. Right. You know, we — the IRA was passed in 2022 after a series of pretty significant pieces of legislation were passed in the COVID era. Right. So there was quite a lot that went through Congress in 2020-2021-2022 we saw the administration and Congress invest quite heavily in what is basically industrial policy through the infrastructure law, the CHIPS Act, and this piece of legislation. And I think because the IRA came together at the end so quickly, people did not fully understand how big of an investment it is.
This is just enormous. Right. No matter what estimate you're using. And it's a really big bet. It's a really big bet that by advancing this amount of subsidy into renewable energy, advanced manufacturing, carbon capture, that we're going to build a ton here in the United States and we're going to be able to change the shape of the line.
David Roberts
Yeah.
Alfred Johnson
And we're going to be able to bend back towards where might be sustainable for the planet, or at least better for the planet. And this is the way that we're doing it. Tax credits are two thirds of that law.
David Roberts
Yeah, and I really love it. It just pleases my nerd heart that, like, this sort of wonky technical change in tax law is alone going to be responsible for, like, tens of billions of dollars of additional investment. Really, if you ever just doubt the heroic nature of the wonks working away in the basements of Washington, DC, this is a good one on their resume.
Alfred Johnson
Yes, but we have to make it efficient. Right. It has to work and that's what we're trying to do.
David Roberts
Awesome. Well, Alfred, thanks so much for walking us through this. This is, you know, this right in my sweet spot, this sort of wonky but a big deal is right where I love. So thanks for your work. Thanks for listening to Volts and, you know, creating a business in response. I love, you love to hear it.
Alfred Johnson
David, it's an honest thrill to be here. I mean, you are, you are a material, you're like a forefather of Crux. So having this conversation with you is a real honor.
David Roberts
Thank you for listening to the Volts podcast. It is ad-free, powered entirely by listeners like you. If you value conversations like this, please consider becoming a paid Volts subscriber at volts.wtf. Yes, that's volts.wtf. So that I can continue doing this work. Thank you so much and I'll see you next time.
Why "transferable" tax credits are such a big deal