Introduction to Energy Storage: Section 48 Investment Tax Credit

April 15, 2024

What is energy storage?

Energy storage is one of the fastest-growing parts of the energy sector. The Energy Information Administration (EIA) forecasts that the capacity of utility-scale energy storage will double in 2024 to 30 GW, from 15 GW at the end of 2023, and exceed 40 GW by the end of 2025. Energy storage projects help support grid reliability, especially as a larger share of electricity is supplied by renewable resources like wind and solar. During periods of intermittency — for instance, when Texas solar generation dipped during the recent solar eclipse — energy storage resources can step in to ensure that total grid output is unaffected.

Historically, energy storage projects qualified for tax credits only if they were co-located with another qualified energy generating project (often a solar project), but recent changes to the tax code allow energy storage projects to qualify for tax incentives on a standalone basis. These projects differ in important ways from other power generating facilities: they can be quick to deploy, particularly in urban areas where electricity demand is growing fastest, and have extremely low environmental and land use impacts. Guidance from the IRS in 2023 clarified that a wide variety of energy storage projects can qualify for tax credits.

Tax credit transferability can be a particularly attractive monetization strategy for energy storage project developers and sponsors. These projects often have differing offtake agreements compared with wind or solar power projects, which can reduce appetite among tax equity investors. However, the ability to sell tax credits in a simpler transfer agreement can offer a means to monetize tax credits without a tax credit buyer making a longer term investment in a project.

Common types of energy storage

Battery energy storage systems (BESS): large batteries are some of the most prevalent energy storage technologies. In recent years, lithium-ion (Li-ion) batteries have emerged as the dominant technology for utility-scale energy storage. Proposed guidance from the IRS makes clear that all rechargeable electrochemical batteries that receive, store, and discharge electricity meet the definition of energy storage for purposes of claiming tax credits.

Thermal batteries: thermal batteries are the second category included in the proposed guidance. IRS defines these technologies as energy storage property which is connected to a building heating or cooling system and removes heat from (or adds heat to) a storage medium for subsequent use, and provides energy for heating or cooling a commercial or residential building. In practice these systems can include ice storage systems that use electricity to freeze ice which can later be used to run a cooling system, or a heating system that heats bricks in a furnace to later provide heat to a building.

Fuel cells: hydrogen fuel cells comprise a third category of energy storage system. In a hydrogen fuel cell, hydrogen and oxygen molecules are combined to produce heat and water. The IRS permits hydrogen storage (whether as a compressed or liquefied gas or chemical storage in ammonia or methanol) to be considered energy storage as long as the hydrogen “is solely used for the production of energy and not for the production of end products, such as fertilizer.”

How do energy storage projects generate tax credits?

All varieties of energy storage projects defined above are eligible to generate Investment Tax Credits under Section 48 of the internal revenue code. The base value of the tax credit is worth 6% of the project’s qualifying energy costs, or 30% for projects meeting prevailing wage and apprenticeship requirements (PWA). Other bonus adders are available for energy storage projects as well, which can boost the value of the ITC to 50% of the project’s cost.

Energy storage projects, like other ITC-eligible projects, generate tax credits when they are placed in service. The IRS has defined PIS as the earlier of “the taxable year in which the property is placed in a condition or state of readiness and availability for a specifically assigned function,” or the tax year when the period for depreciation begins. Importantly, the PIS date for the energy storage facility does not need to coincide with the discharge of electricity, which may not occur at or around the PIS date.

How does energy storage differ from other ITC-eligible projects?

Different cash flow considerations: output from energy storage is less predictable than from wind or solar energy. That is because a battery, by its nature, will usually be called upon as a backup resource to provide power when other sources are not available. This form of backup power is critically important, especially as the US derives an ever-larger share of total energy from renewable sources whose output doesn’t necessarily align with electricity demand. In practice, this means that battery projects will have unique considerations in offtake agreements — perhaps receiving compensation for capacity, ancillary services, congestion relief, or other energy services.

In traditional tax equity partnership deals, the less predictable nature of these cash flows can present a challenge, particularly for partially-contracted or merchant energy storage projects. However, tax credit transfers typically occur (or are funded) after a project is placed in service. As such, project financing has already been arranged and the details of a project’s cash flow are not as relevant to funding the transfer. Tax credit buyers are not taking a stake in a project or its cash flows, and so they are relatively well-insulated from merchant/wholesale power market exposure.

Buyers will still work to understand the project’s financial position in order to manage the risks that are relevant to tax credit transactions, such as the risk of recapture. Buyers often will choose to mitigate these risks by accepting an indemnity from the tax credit seller or requiring the seller to obtain insurance to cover risks (or both).

Lower land use requirements: energy storage projects are typically concentrated blocks of batteries or other storage devices, which can require a fraction of the land use of other renewable resources for a comparable nameplate generating capacity. A 50 MW solar project might require around 400 acres of land, while a 50 MW battery would typically require only a few acres. This large differential in land use helps developers locate battery installations closer to urban areas, where electricity demand growth is growing rapidly. The National Renewable Energy Laboratory (NREL) notes in a white paper that locating BESS near urban areas has several advantages. The systems have no emissions impact, which alleviates the impact emissions on communities. Additionally, “BESS systems can be co-located near load with fewer siting challenges than conventional generation. Placing storage near load can reduce transmission and distribution losses and relieve congestion, helping defer transmission and distribution upgrades.”

For corporate taxpayers with sustainability objectives oriented towards biodiversity/ecology, or towards driving investment in the communities in which they operate, battery projects can offer distinct advantages.  

Supports resiliency as the share of energy from renewable sources increases: energy provided by renewable sources is projected to increase from 25% of total electricity supply in 2023 to 54% by 2032, according to the EIA’s most recent Annual Energy Outlook. Rising dependence on wind and solar generation places an important premium on technologies like energy storage to support grid reliability when output from those resources declines due to natural weather patterns or other factors. For instance, during the recent solar eclipse, Texas solar output declined steeply between noon and 2 PM, before returning to normal. Energy storage resources, as well as generation from conventional fossil fuel plants, were able to step in and ensure that total electricity supply was not affected by the change in solar generation. These events are not common, but energy storage enhances resource availability and diversification, ensuring that overall electric system reliability remains robust.

Electric generation from renewable sources, through 2032 (EIA 2023 Annual Energy Outlook)

Energy storage projects can qualify for a range of bonus adders which increase the value of their credits

Domestic content (10%): the IRA creates additional bonus tax credits for projects which can demonstrate that they have used domestically produced materials in their construction. The IRS sets separate standards for different components. For instance, at least 40% of a project’s manufactured components must be made in the U.S. while 100% of the steel/iron used in the project development must have been produced domestically. Energy storage projects generally consist of a larger share of manufactured components, and some have consequently been able to demonstrate that they meet the domestic content requirements.

IRS Summary of BESS Components for DC Bonus Adder

Energy communities (10%): projects located in qualifying energy communities are eligible for an additional 10% bonus adder. Each year, the IRS publishes a list of census tracts which it determines meet the criteria of an energy community. A wide range of communities historically qualify, including many urban areas where battery storage projects are often located.

It is relatively common for project developers seeking to sell their tax credits and bonus adders to obtain an insurance policy covering their eligibility for the base ITC as well as for the PWA, DC, and EC (if applicable) bonus adders.

Over $250 million of tax credits associated with hundreds of MW of energy storage capacity are currently listed on Crux. These projects are part of a fast growing segment of the energy complex and constitute critical investments in grid resiliency and electric resource diversity. Get in touch with us today to learn more about how Crux can help companies to buy or sell tax credits for energy storage projects.

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