Several years ago, the Philadelphia Water Department realized that it needed additional heat to operate its wastewater processing facility. To address that need, the city designed a facility that generates electricity and heat using methane gas derived from wastewater sludge. The city originally planned to finance the facility by issuing tax-exempt bonds. It also expected to own and operate the facility, because generating biogas, electricity, and heat would be tightly integrated with the operations of the wastewater treatment facility.

As with most local governments during the past few years, however, the city’s financial condition meant that it wasn’t able to fund the project directly. Philadelphia officials thought they might have to shelve the $35 million project, even though it had already been designed.

As the city reviewed the options available under the 2009 Recovery Act (ARRA), officials discovered that they could continue to develop the project under the unique structure of public-private ownership, operation, and financing.

By using the Section 1603 Grant in Lieu of Tax Credits, the city found it had greater flexibility in structuring the project. First, virtually any for-profit entity could claim the grant, regardless of whether that entity has a current tax liability. This expanded the pool of potential investors in the project, and also simplified the ownership structure, because tax ownership rules dictate many power facility ownership structures.

Second, under previous investment tax credit rules, leasing a system to a tax-exempt entity such as a city would invalidate the tax credit. The 1603 Grant, however, allows leases to tax-exempt entities; this means that Philadelphia would be able to lease and operate the facility and coordinate the project’s operations with the wastewater treatment plant’s operations.

Philadelphia officials hoped that partnering with a private owner and developer would lower the cost of the heat and power the system would generate. In the fall of 2010, the Philadelphia Water Department issued a request for proposals (RFP) to finance, install, maintain, and own a new 5.6 MW cogeneration plant that would be located on the wastewater treatment facility site. The cogeneration project would be powered by biogas derived from the waste sludge at the city’s wastewater treatment plant. 

This project is expected to qualify for a 30% grant because it meets the definition of a Landfill Gas Facility. Although most projects that are placed into service over the next two years would also be eligible to receive accelerated depreciation benefits, by structuring the project as a lease to a tax-exempt entity, the project will instead be subject to straight-line depreciation over a period of at least 12 years. While this lessens some of the possible financial benefits, in recent years, it has been increasingly difficult to identify tax investors who value these sorts of depreciation benefits. This means that the consequent reduced value is actually relatively small.

When completed, this project will provide most of the electricity and heat needed to operate the wastewater treatment facility and is expected to do so for less than what the city currently spends. It will also provide a predictable fixed cost of heat and power over the term of the lease, which is expected to be over a decade.

In the RFP, the city expressed its preference for entering into a lease agreement that would allow the city to lease the project from a system owner and to operate it, thereby providing the city with the operational control it requires. This was done because the power and heat needs of the wastewater treatment facility vary over the course of each day and throughout the year.

Although Philadelphia is still negotiating with a renewable energy services company, it has already identified financing partners. In addition, because the facility will be part of a utility that deals with waste, the project owner will be able to access tax exempt financing if it wishes to do so. 

The cogeneration facility is expected to create heat and power from a renewable source of energy that is also considered a greenhouse gas (methane emissions from wastewater treatment facilities are typically “flared,” or burned, to avoid the release of greenhouse gases into the atmosphere). Each year, this operation is expected to reduce emissions by 28 billion tons of CO₂, 50,000 tons of NO_x, and 180,000 tons of SO_x.

The financial benefits will also be substantial. In addition to saving the city an estimated $4 million in energy expense (offsetting 45 million kWh each year), the project, which would have been impossible without the 1603 Grant program, is expected to create 250 direct and indirect jobs in Philadelphia County, where 11.5% of the labor force is currently unemployed.

For reference, a glossary of finance terms begins on page 4 of the Clean Energy Finance Guide, available in its entirety on the Financial Products page of the Solution Center.

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Content for this Blog post courtesy of Darin Lowder, Ballard Spahr