Transitioning from coal to green energy technology: implications for Section 1031 of the tax code

Some time back I posted a proposal arguing that Section 1031 of the tax code should be altered to provide oil and gas companies a "one-way swinging door" from fossil to green. In a nutshell, the current tax code allows these companies to sell fossil development assets and defer recognizing the gain on the sale if they then reinvest in a "like-kind" asset. Like-kind, of course, means fossil. The code does not allow O&G companies to use this powerful tool to shift their focus away from fossil and into green technologies.

Since the Obama administration has made the migration to sustainable energy a priority, the proposed modification to Section 1031 not only makes solid intuitive sense, it also sounds like a good idea to literally everyone we've talked to (a list that includes tax professionals, investors, lawyers, senior corporate leaders, oil and gas industry executives, journalists, academics and Congressional staffers).

As we continue seeking to draw more interested parties into this discussion, we thought it might make sense to have a similar look at another industry implicated by this strategy, coal. I charged Lauren McNitt (School of Journalism and Mass Communication, University of Colorado) and Wenting Zhang (Daniels College of Business, University of Denver), who are interning with Accruit for the summer, with taking a look at the coal industry, which is necessarily implicated in any meaningful attempt to green our economy. While there's no evidence that coal companies currently have an appetite for this kind of reinvestment (perhaps because they've never thought of it), it nonetheless makes sense to begin aligning the tax code with our long-term goals today. As the authors suggest, our shift away from coal is a matter of when, not if. - Sam Smith

Overview

The U.S. coal mining industry reaps $25 billion in annual revenue and is second in the world in terms of production. The top ten coal companies, such as Peabody Energy, Rio Tinto and Arch Coal control about 65 percent of the industry. The main customer of the mining companies is the electric utilities industry, which includes 2,200 plants and has a combined revenue of $80 billion. In 2008, coal accounted for 48.5 percent of electricity generated in the U.S.. The fate of the U.S. coal mining industry relies on the electric utilities industry's continued use of coal.

Coal: State of the Industry

Coal power plants, which account for a third of U.S. greenhouse emissions, are facing a series of dilemmas as climate disruption and renewable energy increasingly occupy the attention of lawmakers. Earlier this year, President Obama signed an economic stimulus package focused on "greening" the U.S. economy. The New York Times noted the following provisions in the bill:

• A large sum for energy efficiency, including $5 billion for low-income weatherization programs; over $6 billion in grants for state and local governments; and several billion to modernize federal buildings, with a particular emphasis on energy efficiency;
• $11 billion for "smart grid" investments;
• $3.4 billion for carbon capture and sequestration demonstration projects (sometimes referred to as "clean coal");
• $2 billion for research into batteries for electric cars;
• $500 million to help workers train for "green jobs";
• a three-year extension of the "production tax credit" for wind energy (as well as a tax credit extension for biomass, geothermal, landfill gas and some hydropower projects); and
• the option, available to many developers, of turning their tax credits into direct cash, with the government underwriting 30 percent of a project's cost.

The emphasis on greening our economy continued with the introduction of a climate bill currently under debate in the Senate, S. 1464: American Clean Energy Leadership Act. The bill's sponsors hope it will create clean energy jobs, lead to U.S. energy independence, promote clean energy technology, reduce global warming and assist the transition to a clean energy economy. The House already passed its version of the bill (H.R. 2454: American Clean Energy and Security Act).

What legislators are ignoring

The goal of these bills is to facilitate the transition to a clean energy economy, yet the legislation is missing a key provision that would encourage companies in the fossil fuel mining and utilities industries to begin a crossover to the renewable energy sector: a revision of the tax code to allow companies to employ 1031 Like-Kind The transfer of the relinquished property to the Qualified Intermediary, and the receipt of the replacement property from the Qualified Intermediary is considered an exchange. To be compliant with IRC Section 1031, the transaction must be properly structured, rather than being a sale to one party followed by a purchase from another party. Exchange s (LKEs) when transitioning from fossil to renewable energy assets.

The bills instead address the negative effects of the fossil fuel industry on the environment (in particular coal fired power plants) by proposing cap-and-trade policies. If passed, cap-and-trade will require carbon-emitting companies to buy permits that allow them to emit a specific amount of carbon. Companies looking to decrease the number of permits they buy may potentially invest in controversial carbon capture technology instead of investing in proven renewable energy technologies.

CCS technology is not a long-term solution

This presents a problem since, as reported in the Washington Post, carbon capture and sequestration (CCS) technology is not yet feasible on a large scale. Storage on a large scale is difficult because holding carbon under ground is only possible in the relatively few areas where the earth is not porous. Most coal plants are not located above appropriate geological formations, and transport of carbon dioxide is expensive. Carbon transport and storage also presents legal ramifications. If large amounts of carbon were to escape, the effects could be harmful or lethal to those in the vicinity. We saw an example of what can happen in such a scenario in the 1986 Lake Nios disaster, where the lake released a concentrated bubble of carbon dioxide and killed approximately 1,700 people.

Additionally, the equipment that captures and stores carbon consumes large amounts of energy, requiring the generation of yet additional carbon. Keith Johnson of the Wall Street Journal reports:

A new book by Harvard University's Belfer Center estimates that clean coal plants use 30% more energy than traditional plants - that is, clean coal plants require more coal to produce the same amount of energy as dirty coal plants.

The Economist further explains the expenses associated with CCS:

The problem with CCS is the cost. The chemical steps in the capture consume energy, as do the compression and transport of the carbon dioxide. That will use up a quarter or more of the output of a power station fitted with CCS, according to most estimates. So plants with CCS will need to be at least a third bigger than normal ones to generate the same net amount of power, and will also consume at least a third more fuel. In addition, there is the extra expense of building the capture plant and the injection pipelines. If the storage site is far from the power plant, yet more energy will be needed to move the carbon dioxide.

Now consider the expense of the initial construction of a CCS coal plant. The FutureGen project is a joint project between the public and private sector to build the first coal-powered, near zero-emissions power plant. The estimated cost of development for the 275 megawatt plant is $1.5 billion. A somewhat smaller 150 megawatt wind farm costs about $225 million, meaning wind farms are approximately $1 billion less expensive to build (at least on that scale).

Even if safe, energy-efficient, inexpensive carbon capture and sequestration technology is developed, coal reserves are not unlimited. The government estimates that the U.S. has enough coal in the ground to last 240 years. However, this estimate is misleading. As recently noted in the Wall Street Journal, last year's U.S. Geological Survey found that only 6% of the coal in the nation's largest and most productive coalfield can be mined profitably. California Institute of Technology professor David Rutledge estimates that coal reserves will last only 120 years, or less than two human life spans.

The tipping point

Considering the money available for companies who choose to "go green," the expense of adhering to the increased regulations on the coal industry, and the fact that the profitable coal reserves will eventually run out, it makes sense for policymakers and energy industry executives to begin exploring how they might transition to renewable energy. At present, coal companies aren't clamoring for a way out of the coal business, but it seems evident that time is running out on our coal-fired infrastructure. The question isn't whether or not there's a tipping point, it's how quickly we'll reach it. All signs suggest that moment will arrive sooner rather than later.

If Congress wants to encourage companies involved in our electricity generation cycle to get serious about green technologies, a revision of the tax code allowing wind, hydroelectric, solar and other renewable technologies to be considered "like-kind" with traditional fossil technologies might potentially show fossil companies a path to long-term viability.