Inflation and Public Perception in a Just Transition
August 19th, 2022 | Peter Mennie
The Inflation Reduction Act of 2022 (“IRA”) was passed in the United States in August of 2022 and despite its name, is in fact a dramatic benefit for climate change and clean energy project investment. We believe that the large tax credit programs and grants for clean energy investing in the IRA will provide a significant tailwind for the companies we invest in for our mandates that are focused on the energy transition. There is an important alignment between the enhanced investment opportunities created by the IRA, and the various components of the act that are designed to deliver the reduction of US carbon emissions by about 40% by 2030 from 2005 levels.
National Versus International Impacts
The IRA is a domestic program designed to spur USA economic activity and jobs in clean energy investing and carbon reduction. As a result, there were some early concerns expressed in the media by other countries that the IRA was essentially protectionist, by focusing on the USA domestic industries. In reality, we believe countries need to start at home to have a positive impact on climate change while augmenting industrial activity and building a green economy skill set. Other countries are doing the same, but the IRA is so impactful that it will likely spur competition among countries as they seek to make themselves as attractive a place to invest as the USA and introduce their own version of an IRA. This could increase available government incentives in many countries, which will increase investment activity in emissions and carbon reduction which is good for the global energy transition and the climate as well as providing additional investment opportunities for our portfolios.
Our mandates look globally for companies that are helping drive the energy transition towards a more sustainable future. Most of the companies we invest in operate internationally or rely on global supply chains. The US IRA comes at the same time as supportive initiatives in other countries, such as China’s 14th Five-Year Plan and market reforms, and the REPowerEU plan which are driving a dramatically increased forecast of renewable capacity expansion by the International Energy Agency (the “IEA”) as published in May 2022. The IEA sees renewables growing by almost 2400 GW over 2022-2027, which is equal to the entire installed power capacity of China today and is 30% higher than the forecast in the 2021 IEA report. The Russian invasion of Ukraine in February 2022 also had an impact on increasing renewables growth as energy security came into focus. A significant portion of this expansion of renewable power capacity will come from the public companies that we invest in, directly translating to the potential for revenue growth and strong investment returns if we identify the companies best positioned to take advantage of the supportive environment. Already we have seen increasing growth projections, supported by the IRA, in solar panel and tracker manufacturing as well as hydrogen.
Long-Term Investment Benefits
In a global context, the IRA is unique as it provides long-term policy visibility as it is in place for ten years. This is particularly beneficial for USA wind and solar projects which are seeing extended tax credits until 2032. Permitting reform is also part of the IRA which should assist in all areas of renewable energy development. This longer-term policy clarity allows for project investment decisions to be made that lower risks, reduce costs and enhance returns in companies that we are considering for investment. The IRA contains a hydrogen production tax credit of up to $3/Kg, which will drive investment growth in this area that we think is a key opportunity as our mandates look at hydrogen in the local context, providing opportunities for local sourcing and use. Hydrogen is still very early stage and the IRA production tax credit is helpful, but we remain diligent and selective on which companies and projects meet our investment criteria.
Investors, including us, typically prefer certainty. The duration of the IRA is attractive as it allows for planning and implementation of projects across potentially different Administrations. Permitting facilitation as well as clarity on domestic content should speed project development. The IRA is the most extensive investment in climate in US history and investments are just being planned to capitalize on $269 Billion of tax credits and subsidies towards renewable energy, clean fuels, carbon capture and storage, hydrogen hubs and electric vehicles that results in massive greenhouse gas reduction and investment in low or no carbon energy. The largest near term beneficiary is the power sector with provisions for rapid development of wind and solar in the next decade. We see opportunities in utility scale wind and solar as well as for solar in residential and commercial & industrial applications. The IRA, with clarity on the domestic content requirements, should make these projects economically attractive in many more jurisdictions in the USA which allows us to expand the companies and jurisdictions in which we invest.
Notable Features of the IRA
As clarity comes regarding the utilization and applicability of the tax credits, the companies initially expect that they can keep most of the benefits for themselves, rather than sharing with consumers. This is addressed in the IRA in the form of social adders which are passed on to consumers, focused on lower income populations and solar energy. In addition, the IRA will help consumers with direct utility bill rebates in 2023. This provides us confidence in incorporating the supportive features of the IRA in our investment analysis and investment thesis on companies. We typically build in a margin of safety in our assumptions when we set our expectations for companies, but these additional features of the IRA reduce the risk that regulators will recapture any of the investment upside potential in the future. Other questions include qualification for items like production tax credits, which have a domestic content requirement. We don’t yet know the details on domestic production, whether it has to be fully or partially produced in the USA or simply assembled. Despite this, there are already discussions underway regarding increasing USA polysilicon crystalline capacity and battery manufacturing, among other opportunities that we are following closely.
The IRA is unique with its “all carrot, no sticks” approach that provides numerous subsidies to kickstart investment and there are no items like cap and trade or carbon taxes in the legislation to jeopardize or reduce investment. This supports growth and jobs and doesn’t penalize anyone. Our assessment of the act is that it has many features that can contribute to improving the sustainability of the US economy, while providing attractive investment opportunities in specific companies and projects. The implementation of these projects may not actually reduce near term inflation, but we believe it will certainly improve the reputation of the USA on the world stage and increase the size and speed of investment in carbon and emissions reduction businesses across the USA and, with competing incentives, in other countries around the world. A win-win for society and for our investment efforts for our clients.
RIA Disclaimer
The views and opinions expressed in this article are solely those of the authors and do not necessarily reflect the view or position of the Responsible Investment Association (RIA). The RIA does not endorse, recommend, or guarantee any of the claims made by the authors. This article is intended as general information and not investment advice. We recommend consulting with a qualified advisor or investment professional prior to making any investment or investment-related decision.
Author
Jennifer Stevenson
Vice President & Portfolio Manager
Dynamic Funds
