The 700+ page Inflation Reduction Act (IRA) is the most significant and comprehensive climate legislation ever passed in the US, touching virtually every major greenhouse gas emissions driver in the economy.
After nine months of failure to move climate legislation forward following the COP26 UN climate conference in Glasgow, US Senators Chuck Schumer and Joe Manchin surprised everyone with this breakthrough legislation in late July. Beyond the obvious long-term benefit of a cleaner environment, the IRA creates tremendous incentives for the private sector, which should lead to opportunities for investors.
It’s important to state up front that while analysis of the Congressional Budget Office (CBO) scoring of the IRA points to a net deficit reduction over the next decade of $238 billion, private estimates vary widely. One Wall Street auto analyst estimates the value of just the clean vehicle purchase credit likely to be captured by GM and Tesla annually by mid-decade at two times the total outlay for the clean vehicle program over a decade. If the Wall Street analysis turns out to be accurate, the shift in this single provision alone would cut the deficit reduction in half. The name of the IRA is also somewhat misleading; economists from Moody’s and University of Pennsylvania’s Wharton School point to an initial inflationary impulse and any potential inflation reduction occurring many years in the future, though with a low level of confidence. While inflation and budget dynamics are debatable at this stage, it is clear the IRA will be a significant accelerant for decarbonization in the US with many associated benefits.
An analysis by the Princeton University Zero-carbon Energy Systems Research and Optimization (ZERO) Lab found that the IRA could cut annual emissions in 2030 by 1 billion tons relative to the existing policy pathway. This reduction in emissions would get the US two-thirds of the way to the nation’s net-zero pathway and stated 2030 target of a 50% reduction relative to 2005 emissions. The most significant drivers of decarbonization in the Princeton analysis are acceleration of clean electricity and clean vehicle deployment, together representing 65% of emissions reductions.
With decarbonization largely based on electrification throughout the economy, a shift toward a zero-carbon power sector is foundational. Clean power provisions in the IRA replace the past practice of short-term incentive structures for wind and solar power projects, creating over a decade of visibility for developers and system owners. Incentives take the form of up-front investment tax credits (ITCs), or production tax credits (PTCs) captured over time as power is produced, with increased flexibility to choose the type of credit most appropriate at the project level. Full capture of the new credits requires paying a prevailing wage to workers and meeting apprenticeship requirements. Beyond attractive ITC and PTC levels, there are a series of bonus credits that can further improve project economics.
In the transportation sector, the IRA transforms a limited 200,000- unit tax credit by manufacturer into an open-ended program centered on a point-of-sale purchase credit for consumers. While in theory this program should level the playing field, there are devils in the details. The full $7,500 credit is limited to consumers below certain income caps based on taxpayer status and will only be available on sedans below $55,000, and trucks and SUVs below $80,000. Additionally, only vehicles assembled in the US are eligible, and then, only if they meet tightening US-based battery production and material sourcing requirements. The legislation clearly favors large manufacturers with scale production in the US and the foresight to invest in battery technology and local manufacturing. Many large manufacturers and most newer entrants will likely be strategically disadvantaged under this new incentive regime.
Beyond the headline-grabbing clean energy and clean vehicle aspects of the IRA, there are dozens of other credit and financing provisions that will fundamentally alter the growth path in several areas from EV charging, green hydrogen production, building systems, and carbon capture. Local content provisions for the power sector and domestic manufacturing and material sourcing provisions for clean vehicles should drive significant development of US-based supply chains. The significantly expanded Department of Energy loan program and newly created GHG Reduction Fund should support emerging technologies.
Taking a step back, the big difference between the US approach with the IRA and approaches to development in other parts of the world can be described as carrot vs. stick. The IRA provides incentives for private capital deployment, which will likely lead to many multiples of spending across targeted areas. The Princeton ZERO Lab analysis points to an incremental $4.1 trillion in energy supply-related infrastructure spending alone, not counting residential investment or multipliers from supply chain development and new technology financing. Further, ZERO Lab estimates net energy-supply-related job growth of 1.7 million through 2030.
Activity across industries will be broad-based, with many utility, industrial, and material companies most likely able to capture benefits, though in certain areas there will be structural winners and losers. Beyond more obvious clean-tech-focused companies, there will be opportunities for legacy industrial and energy companies to transition, in some cases rapidly. There will also surely be plenty of greenwashing and glaring instances of misallocation of capital with a program this far reaching. As IRA funding works into various sectors and companies, our investment team will be watching closely for both opportunities and risks across public and private markets.