POWER March 2012 - 28

Rethinking Security
Requirements for Generation
Developers
By Margaret H. Claybour
A
universal reality for U.S. power generation developers is
the challenge of obtaining funding in today's tight credit
markets. Financing exigencies make the level of security
a developer must post of critical importance to its ability to
achieve the return thresholds necessary for project development.
The amount of security postings transmission owners require for
interconnection agreements can be a major impediment for projects.
These requirements, accordingly, have been debated and
continue to evolve.
Wholesale Tax Advantages
Current Federal Energy Regulatory Commission (FERC) policies obligate
generation project developers to make payments to transmission
owners for the construction of interconnection facilities.
From the tax perspective, these payments constitute the " income
tax component of contribution " (ITCC) and represent potentially
taxable income to the transmission owner. FERC policy also imposes
liability on the developer for any ITCC taxes the transmission
owner will pay. The good news is that the Internal Revenue
Service (IRS) has promulgated rules that provide the transmission
owner a comprehensive " safe harbor " for transfers under an
interconnection agreement, effectively ensuring that the transmission
owner should never have to pay any ITCC taxes.
The safe harbor rules are designed to confirm that the primary
purpose of the interconnection facilities is to enable the
generator to deliver its generation to wholesale markets and not
primarily to enable the transmission owner to make retail sales
of power to the generator. It is, however, theoretically possible
in extreme cases (for example, if the generator consistently operates
at capacity factors below 20%) that a generator will fail to
comply with the safe harbor rules and subject the transmission
owner to contingent ITCC tax liability.
FERC's policy successfully protects the transmission owner
from any possible exposure relating to ITCC. The transmission
owner may require either that the developer make an upfront
payment for the amount of possible tax " gross up " or post security
in that amount. Transmission owners in almost every
instance require developers to post security to cover any potential
future ITCC liability. In the unlikely event a developer
contravenes the safe harbor rules and the transmission owner
is obligated to pay the tax, the transmission owner can enforce
its rights in the security.
Real Cost of Security Posting
While the policy protects the transmission owner, the question
remains whether this policy is cost effective and best advances
energy policy, particularly the objective to encourage the development
of more efficient, more environmentally benign power
plants. The IRS safe harbor notices provide the generator explicit
and easy-to-comply-with rules to avoid a taxable event for trans28
actions
under interconnection agreements. Not surprisingly, we
are aware of no contribution under an interconnection agreement
that has caused a transmission owner to incur an income tax liability.
The facts are that the risk of any ITCC exposure, while admittedly
greater than zero, is negligible; the corresponding cost
to the developer of maintaining the security for the theoretically
maximum amount of tax exposure exacts real costs and necessarily
impedes project development.
In essence, the amount of ITCC security required is the taxable
amount of the developer's contribution multiplied by the transmission
owner's effective tax rate. If major interconnection facilities
are needed-the costs of which can be in the eight-figure
range or higher-at a 35% tax rate, the ITCC security requirement
often exceeds seven figures.
Regulators, legislators, and consumer advocates tend to view a
security posting requirement as a " win/win, " because it protects
the utility and yet imposes no cost on the party posting security.
That myopic view, however, ignores financial reality: Security
posting is a zero sum game. Posting of security represents a real
cost to the developer, depriving it of capital necessary to develop
the project. The question that needs to be addressed is whether
it is good policy to require a developer to set aside substantial
sums every year, over the term of an agreement, to protect the
transmission owner from a risk that most likely will never arise.
Not to be overlooked are the administrative costs of the security
that are imposed on the transmission owner to calculate, track,
and maintain the ITCC security.
The right equation must be to compare benefits versus costs
(both to the developer and to the transmission owner). Given the
limited risk to transmission owner and real cost to developer, the
ITCC security requirement warrants reconsideration.
Rational Security Policy Is Possible
The good news is that at least one major California utility, based
on experience and a better understanding of the costs of administering
the ITCC security in compliance with FERC's rules, has
decided that the cost of an ITCC requirement exceeds its benefits.
The transmission owner obtained authorization from FERC
to waive the ITCC security requirement and retained the option
to reinstate the requirement at a later point, if necessary. This is
a " win/win " approach that others should follow.
Why stop there? Regulators and parties supposedly benefitting
by the security posting should constantly assess security
requirements and challenge whether the benefits warrant the
costs being imposed. It may be that the optimal result for all
constituencies in the energy arena is to reduce arbitrarily imposed
security amounts and allow scarce capital to be redirected
to more productive purposes. ■
-Margaret H. Claybour (margaretclaybour@dwt.com) is an associate
in the Davis Wright Tremaine LLP Energy Practice Group.
www.powermag.com
POWER | March 2012
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POWER March 2012

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