Negatives Of The New Tax Bill On Duke Energy

The US tax regime has undergone a significant change last month with the passing of the Tax Cuts And Jobs Act. This new tax law is believed to be favorable for the US economic growth and corporates in general. However, it could have a varying impact, positive or negative, on the various sectors in the country. In this series of articles, we aim to discuss the impact of the new tax law on Duke Energy and its valuation. In our previous analysis, Positives Of The GOP Tax Bill On Duke Energy, we had talked about the positive effects that the tax reforms would have on the company. In this note, we plan to touch upon some of the other provisions of the new tax bill that could negatively impact Duke Energy.

See Our Complete Analysis For Duke Energy Here

With the increased use of clearer sources of energy, renewable sources of energy, such as wind and solar, have gained popularity. In order to support these environment-friendly energy sources, the US government has been providing investment tax credits (ITC) and production tax credits (PTC) to companies establishing wind and solar projects. However, due to the capital-intensive nature of these projects, renewable companies find it difficult to fund the entire project by themselves and end up trading their tax credits (received from the government) with multinational banks and investors in exchange for investment in their projects. These banks and investors utilize these tax credits to lower their heavy tax burdens, while the renewable companies reduce their total costs by roughly 30% through this barter. At present, roughly two-thirds of wind projects and three-fourths of solar projects in the US are operating on this tax-equity financing.

Duke Energy’s Wind And Solar Capacity

Source: Duke’s Investor Meeting Presentation, November 2017

But, with the new tax reforms, the future of these renewable companies and their key financing tool appears to be in danger. This is because the newly implemented tax law imposes a new tax, called the Base Erosion Anti-Abuse Tax (BEAT), on companies that can significantly reduce their tax liability by shifting their profits to cross-border affiliates. Under this provision, if a company’s tax liability as per US tax laws reduces to less than 10% of its taxable income post its cross-border payments, then the company would be subject to a BEAT tax. Now, while calculating the tax liability of a company, the tax credits, both ITC and PTC, earned from investment in wind and solar projects are taken into consideration. This would mean that multinational companies that finance these renewable projects have a high probability of being subject to the BEAT tax, making it less attractive for them to continue investing in such projects.

Fortunately, the Trump government paid heed to the plea of  several renewable players and tweaked the provision slightly, before implementing the final law. According to the final version of the bill, the multinational banks and investors will be able to utilize tax credit earned from renewable projects to offset 80% of their minimum tax liability. While this may reduce the severity of the situation, it may not be able to completely offset the risk of reduced investment in the renewable industry in the coming years.

Duke’s Anticipated Power Generation Mix 

We say this because the multinational investors, who previously enjoyed a full advantage of the tax credits, would now have to consider the implications of the new tax law before investing in these projects. The determination of the tax liability and eligibility for the BEAT tax is fairly complicated, and in some cases the investors may not know if they would be eligible to take advantage of their tax credit until the end of the year. This is likely to put off investors, reducing their interest in financing renewable projects.

Since Duke Energy is one of the largest utility companies in the US with a strong exposure to wind and solar projects, it is likely to be impacted by the new tax law. The new tax rule could not only impact the financing of Duke’s future projects but is expected to negatively weigh on the value of the existing wind and solar projects, where large investors have invested their money. While it is difficult to quantify the impact this would have on the company’s valuation, we figure that the value of its current, as well as future projects, will be dependent on the investor sentiment towards the BEAT tax. Hence, we plan to keep a close watch on the investor response to this new tax regime and how that could impact Duke’s valuation.

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