The Inflation Reduction Act – a USD 369bn bill for the climate

The Inflation Reduction Act (IRA) was signed in law by President Biden on 16 August 2022 after House Democrats approved the biggest-ever federal investment against climate change with a 220 to 207 vote.

The package targets USD 369bn of spending on energy and climate change. To illustrate the monumental size, some are pointing out the spending will be four times more than Obama’s Recovery Act of 2009 for climate initiatives. The impact will be far-reaching – even pushing some technologies, in our view, past tipping points.

The legislation aims to cut emissions by at least 40% by 2030.

Some key points

Solar & wind: extension of ITC and PTC for a full ten years

The investment tax credits (ITC) and production tax credits (PTC) have been extended for ten years. This is important because it removes uncertainty for developers. In the past extensions were only one- or two-years creating uncertainty for projects that take 5 years or more to complete. The biggest beneficiary should be solar. The wind industry will also benefit from no more policy delay which has been a drag on development.

Clean energy tax credits – PTC/ITC – have been extended beyond wind, solar and now cover technologies such as geothermal, storage and carbon capture and storage (CCS). They also have scope to increase and even double thanks to adders – depending on specific criteria such as local content rules (US-made steel and iron for example), location rules (high unemployment areas), wage and apprentice rules.

For example, before the IRA bill, the solar ITC was 26% in 2022 falling to 10% in 2024. Solar’s post-IRA ITC now moves to 30% – retroactive from March 2022 – and stays at 30% for 10 years then falling to 22.5% in 2034. The 30% rate can now increase to 50% or even 60% if the project meets the new specific criteria.

Tax credits and loans promise to accelerate nation-wide deployment of renewable energies, already cost competitive with fossil fuels, making them even cheaper with scaling. Low-income communities and communities that historically depended on exploiting fossil fuels for livelihood (example coal mining towns) are now targeted for access.

Green hydrogen: USD 3/kg tax credit, a gamechanger

The IRA introduces a critical incentive for business: a USD 3/kg tax credit. This will make green hydrogen cheaper to produce than grey hydrogen, particularly where solar and wind energy costs are falling or where the difference between green and grey has widened with inflationary gas prices.

Today, in the US, the cheapest grey hydrogen is USD 1.71/kilo. The cheapest green hydrogen is USD 3.75/kilo. The new tax credit at USD 3 would bring the cost of green hydrogen down below USD 1.00/kilo.

Transport: extension of incentives for cars & trucks, new incentive for SAF

The EV industry is central to clean energy.

Advanced Technology Vehicle Manufacturing has some USD 2bn in loans earmarked and these loans can be significantly leveraged with no cap at all. So, for example USD 20bn and much more in auto loan guarantees could be used to guarantee (de-risk) investments in the EV supply chain. This should help drive battery costs down to USD 100 per kilowatt hour tipping point, at which point EV production costs are equal to ICE.

The IRA extends the USD 7,500 consumer income tax credit for the purchase of a new clean energy vehicles (EV and hydrogen Fuel Cell vehicle) and eliminates the per-manufacturer limit on these tax credits. It introduces a new credit of up to USD 4,000 for the purchase of a used EV. The legislation also caps the price of a new car at USD 55,000 and USD 80,000 for trucks and vans.

In order to be eligible, the manufacturers must produce their cars and batteries in North America. Introduction of a minimum USD 1.25/gallon credit for each gallon of Sustainable Aviation Fuel (SAF) sold as part of a qualified fuel mixture with a demonstrated lifecycle greenhouse gas (GHG) reduction of at least 50% vs conventional jet fuel. The tax credit increases by 1 cent for each percentage point by which the lifecycle GHG emissions reduction exceeds 50% up to USD 1.75/gallon.

Agriculture: new package

The IRA includes USD 40bn in agriculture provisions. The bill will provide funds for voluntary, conservation programs, biofuel infrastructure and debt relief for farmers throughout the US:

  • USD 20bn in funding to support expansion of the conservation practices and USD 500m to help provide greater access to biofuels,
  • USD 20bn for the USDA conservation programs.

Manufacturing: new incentives to re-shore clean energy manufacturing, de-risk supply chains

With a clear aim to localize clean energy manufacturing in the US, the IRA will boost manufacturing spending through ITC/PTC-type advanced manufacturing credits, loans, cash investments. USD 30bn will be earmarked for PTC to accelerate US clean energy manufacturing, and an additional USD 10bn of ITC to build clean technology manufacturing facilities, such as factories that make solar modules and other clean energy products.

As an example, each step of solar panel production has a tax credit associated with it.

Energy efficiency: new inclusive home energy efficiency improvements

Rebates of up to USD 4.5bn are earmarked for heat pumps, and other improvements to home equipment that will lower utility bills for US households, especially low-income ones. Heat pumps are eligible for USD 2,000 of tax credits and Zero Energy Homes can be granted USD 5,000/unit.

This raise a few questions

How important is the speed of implementation?

In order to secure the bill ahead of elections to come, we think the IRS will be fast to clarify the new rules and that this will be key. Guidance and permitting delays are often blamed for slow implementation.

Is this already included in share prices?

We don’t think so.

Looking very simply at the today versus just after Biden’s election of the iShares Global Clean Energy ETF (ICLN) shows we are still 13% below the 2021 December levels when hope the Build Back Better (BBB) program would be adopted. The rally since the Senate IRA bill approval has been strong but more cautious in light of the economic environment – inflationary pressure met by rising rates.

Arguably the new bill increases the value of clean energy which adds energy security and energy resilience at an uncertain time of war and increasing climate events.  Whereas in the US interest rates have risen since BBB was expected to pass, so have electricity prices. In the US average wholesale prices have also risen over 50%, with inflation in some states much higher than others. This upward trend is expected to continue according to the IEA. Interest rates have risen 130% from August y/y.

The inflationary power pressure is clearly higher in EU where wholesale electricity prices have risen by between +80% and +365% y/y from 06/21- 07/22.

A final point to note is the pass through of higher costs achieved in PPAs by developers.

Concrete responses

The IRA vote has been followed by some very material decisions to re-shore manufacturing. Two are Toyota and First Solar’s rapid responses below:

Toyota announced it would invest an additional USD 2.5bn in its Toyota Battery Manufacturing facility in North Carolina, which is expected to begin production in 2025. The company originally planned to invest USD 1.29bn and is now roughly tripling its investment to USD 3.8bn in the U.S. This increases the OEM’s total planned investment for battery production to USD 5.6bn as it expects to have combined capacity in the US and Japan of 40 GWh.

First Solar announced a plan to invest up to USD 1bn in new, 3.5 GWDC manufacturing facility in the US Southeast.

This signals a complete strategy reversal. Only one month before the IRA legislation, the company had decided to invest in India rather than in the US due to unclear solar policy.

The recent statement is directly tied to IRA with the company officially stating: “In passing the Inflation Reduction Act of 2022, Congress and the Biden-Harris Administration has entrusted our industry with the responsibility of enabling America’s clean energy future and we must meet the moment in a manner that is both timely and sustainable,” said Mark Widmar, First Solar’s CEO. “This investment is an important step towards achieving self-sufficiency in solar technology, which, in turn, supports America’s energy security ambitions, its deployment of solar at scale, and its ability to lead with innovation. We are proud of the fact that our manufacturing presence in the US is expected to directly and indirectly support over 18,000 jobs across the country by 2025, while our manufacturing investment will add an estimated USD 3.2bn in value to the US economy, reflecting the impact of solar manufacturing on our country. We are investing in America’s future.”