Tuesday, March 13, 2012

Selling off tax credits for renewables projects in Canada

An article on Sprott Power caught my attention this afternoon. They announced that they closed their second round of flow-through share offerings this past month. The flow-through share is an interesting financing mechanism in concept, though it is little used in the renewables industry in Canada, as it is limited to financing "development" work.

The concept of a flow-through share was adopted in the renewables business from the mining business in Canada. There, mining prospectors issue flow-through shares to sell-off tax credits for their prospecting to other companies. This provides them with a means to raise money for their exploration and mine development work. This is useful for these companies as these future tax credits would be parked for many years as an idle asset until the mine starts to be profitable. The flow-through share simply allows the prospector to hand over these tax credits to other companies who can use them right away.

To solve a similar problem in renewables, where potential tax credits are not useful earlier in a project's development, the Canadian government created a special tax class called the Canadian Renewable Conservation Expense. This program allows for "flow-through" shares for development expenses for renewable energy projects. Flow-through means that the project developer can create a special class of shares, "flow-through shares", and can allocate tax credits for project development expenses to these share holders, rather than having to bank these tax credits to offset future profits.

Although interesting, there are a few things that I believe keep this mechanism from being adopted more widely than by larger wind farm developers. First, the market for buyers of flow-through shares is small, as buying tax credits for renewable energy projects is exotic -- it is not well known and these shares look very different from common stock. Second, development costs for renewables projects are a much smaller percentage of a completed project's costs than they are in the mining space (a few percent, rather than in the teens). Third, these flow-through shares have to be established before the project begins. Due to the "distributed" nature of renewables projects (small and dispersed) and the immaturity of the industry, development work is largely undertaken by small companies or individuals, who do not have the scale to establish such a special class of share and to market them before a project begins. 

Thanks to a financial market in Canada that is somewhat versed in the concept of flow-through shares, Sprott  was able to oversubscribe its latest flow-through share offering (sold more shares than it initially anticipated). Thus, although flow-through shares for renewables project development are exotic, there is an appetite for them. This means that there is more capital available not only for developed and operating projects, but also for those in the early stages who are out there with nothing but a dream and a lot of hours of sweat equity invested. This program is yet another innovative way that Canada overcomes the conservatism of Canadians, if only the renewables business can continue to stay in business during this era of fiscal restraint and amnesia about climate change.