Abundant Natural Gas Heats up A Large Tax Incentives for Gas-Fueled Building Energy Equipment

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Recent U.S. large scale natural gas finds and major improvements in U.S. natural gas distribution infrastructure are giving U.S. property energy managers and facility managers the confidence to invest in highly energy efficient natural gas building equipment. Tax professionals knowledgeable about Section 179(D) of the Energy Policy Act (EPAct) and the 10% Combined Heat and Power (CHP) tax credit or cash grant can help their companies implementing natural gas equipment projects to achieve substantial energy cost reduction and receive large tax deductions.

The EPAct Tax Opportunity

Pursuant to Section 179(D) of the Energy Policy Act (EPAct) and it’s underlying ASHRAE (American Society of Heating Refrigeration and Air Conditioning) building energy code, commercial buildings are eligible for energy efficiency tax deductions of up to $1.80 per square foot.

If a building’s energy reducing investment doesn't qualify for the full $1.80 per square foot deduction, deductions are available for any of the three major sub-systems: lighting, HVAC and the building envelope. Each component can qualify for up to 60 cents per square foot EPAct tax deductions. The building envelope is anything on the perimeter of the building that touches the outside world including roof, walls, windows, doors the foundation and related insulation layers. Increased natural gas availability creates new potential for HVAC EPAct deductions, as several options for highly efficient natural gas heating systems are becoming increasingly popular.

The Combined Heat & Power Tax Credit

Pursuant to Internal Revenue Code Section 48, companies or individuals installing Combined Heat & Power HVAC systems (CHP) can take a 10% tax credit for the total equipment and installation cost. In addition, sections 1104 and 1603 of the American Recovery & Reinvestment Act of 2009 allow for the taxpayer to take the 10% tax credit as a cash grant, although grant eligibility is contingent on commencing construction of the CHP system before year end 2010. The requirements for “beginning construction” have not always been clear; however, the Department of Treasury recently released guidance that officially explains the requirements for taking a cash grant in lieu of a tax credit1.

The New Natural Gas Finds

The recent and unanticipated U.S. natural gas reserves boom can be summed up by the 200 trillion cubic feet Louisiana natural gas find called Haynesville Shale2. A find at this magnitude is equivalent to 18 years of current U.S. natural gas production. Another surprisingly huge strategically-located find is the Marcellus Shale Appalachian (“The Marcellus”) find3. The Marcellus is primarily located in Ohio, Pennsylvania, West Virginia and New York. Portions of this huge find touch Virginia, Maryland, Tennessee and Kentucky. Other huge new natural gas finds have also occurred in Texas and Arkansas. One industry produced study estimates that the U.S. has more than 2,200 trillion cubic feet of natural gas ready to be extracted which is enough to supply 100 years. Less than ten years ago the consensus was that natural gas production was facing a permanent decline. The graph below presents the recent major swing in US natural-gas reserves:

The Large Companies Sense Opportunity

The expected large impact of the recent natural gas finds can be evidenced by the recent involvement in the natural gas sector of major oil companies. In late June 2010, ExxonMobil completed its merger with XTO Energy. It is now expected that Exxon will be a player in the development of renewable resources, specifically natural gas, under the XTO name4. Royal Dutch Shell and Total SA also recently purchased natural gas assets, having purchased East Resources and a part of Chesapeake Energy respectively5. As oil drilling becomes more inaccessible, and the cost of gas development continues to plummet, natural gas is going to become essential to the oil and energy sectors of the United States.

Improved Natural Gas Distribution

The advantage of having huge new natural gas finds in multiple regions of the country is that it can more easily be distributed to major markets. For example, the Marcellus find is in a great location to supply the winter regions of New England and the large market areas requiring winter heating such as New Jersey, New York, Pennsylvania and Ohio.

On December 29th 2009 Spectra Energy announced the signing of agreements to supply natural gas into New Jersey and New York with Chesapeake Energy Corporation, Con Edison and Statoil Natural Gas. In its first stages this added system will connect to the existing Texas Eastern Transmission and Algonquin gas transmission pipeline systems. The project is expected to include a 16 mile pipeline extension connecting Staten Island to New York City and five miles of large diameter pipeline to New Jersey and New York.

Natural Gas HVAC Equipment Tax Deductions

The two major natural gas HVAC equipment categories that generate EPAct tax deductions are: 1. energy efficient heaters for non air conditioned, heated-only facilities, such as warehouses and industrial buildings, and; 2. hybrid gas/electric chillers for conditioned buildings6.

Direct Fired Natural Gas Heaters

Because lighting represents the majority of energy use in a non-conditioned space, whenever a property owner is considering a heater retrofit it should be completed before or currently as a lighting upgrade to highly energy efficient fluorescent, induction or LED lighting in order to maximize the EPAct tax deduction. The following chart illustrates the potential EPAct tax deductions, for warehouses and industrial buildings where a high efficiency natural gas heater is installed with an energy efficient lighting upgrade:

Hybrid Gas/Electric Chillers

A hybrid chiller conditions a building using natural gas or electricity as alternative fuel sources. It is programmed to use gas in the summer months when electricity is more expensive and electricity during the winter months when natural gas is more expensive. Because a hybrid chiller takes advantage of time-of-day energy pricing and seasonal gas and electricity pricing to drastically lower building energy cost, and EPAct tax deductions are driven solely by total building energy cost reduction, the installation of a hybrid chiller will typically qualify for large immediate EPAct HVAC tax deductions.

Combined Heat and Power Systems

Combined Heat and Power systems, sometimes known as cogeneration facilities, are able to generate electricity while also producing thermal energy, essentially providing usable heat from the waste heat given off during the electrical generation process. Because CHP systems capture that waste heat, facilities relying on CHP can eliminate redundancy in their systems, reducing overall energy use and lowering overall building emissions. CHP systems are preferred by the U.S. Department of Energy and the EPA because of their energy efficiency and greenhouse gas reductions7. Also, installation of a CHP system will help a company comply with the EPA’s July 2010 pollution emissions reduction proposal, which will affect 31 states and Washington D.C.. Typically natural gas is the fuel used in these highly energy efficient CHP systems8. In addition, CHP facilities are eligible for the 10% Federal tax credit or cash grant mentioned above.

Conclusion

Huge new natural gas finds and improved natural gas distribution is going to enable building owners in cold winter jurisdictions, particularly in the Northeast, to have assured supplies of natural gas. Informed property owners can use section 179(D) and 10% tax credits or cash grants to help reduce the cost of the required heating equipment.

1- Payments for Specified Property in Lieu of Tax Credits Guidance, Mar. 2010, <http://www.ustreas.gov /recovery/docs/guidance.pdf>.

2 - Casselman, Ben. "US Gas Goes From Bust to Boom." The Wall Street Journal. 30 Apr. 2009. Web. 4 Jan. 2010. <http://online.wsj.com/article/SB124104549891270585.html>.

3 - "Marcellus Shale Gas: New Research Results Surprise Geologists!" Geology.com - Earth Science News, Maps, Dictionary, Articles, Jobs. Web. 04 Jan. 2010. <http://geology.com/articles/marcellus-shale.shtml>.

4 - See “Exxon-Xto Energy Merger Completed," iStockAnalyst.com, 29 Jun. 2010, <http://istockanalyst.com/article/viewarticle/articleid/4259788>.

5 - See Tom Taulli, “Royal Dutch Shell Scoops Up East for $4.7 Billion,” dailyfinance.com, 28 May 2010 < http://www.dailyfinance.com/story/company-news/royal-dutch-shell-buys-east-resources/19495355/ >.

6 - See Charles Goulding, Jacob Goldman and Raymond Kumar, Large EPAct Energy Tax Deduction Opportunities for Commercial Heaters, Corp. Bus. Tax’n Monthly, Jan. 2010, at 11.

7 - See Charles Goulding, Emergency Economic Stabilization Act of 2008 Law, Explanation and Analysis, 2008, at 205.

8 - See EPA Proposal Cuts Pollution from Power Plants in 31 States and D.C., 06 Jul. 2010, < http://yosemite.epa.gov/opa/admpress.nsf/0/C045295CED 7DCF6885257758005B74BB>.

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