What does the Inflation Reduction Act mean for renewable energy?
The Inflation Reduction Act, which was signed into law on August 16, 2022, is arguably one of the most significant pieces of U.S. legislation to date aimed at supporting a more rapid transition to renewable energy. Estimates suggest that U.S. greenhouse gas emissions may be reduced by 40% of 2005 levels by 2030 compared with an anticipated 26% without the new bill. The net immediate impact on U.S. utilities and renewable energy is encouraging, in our view, as is the potential for its significance to grow over time. We look at the provisions that may have the greatest bearing on the sector.
In the first six months of 2022, 24% of U.S. utility-scale electricity generation came from renewable sources.
The Inflation Reduction Act (the Act) is supportive of the utilities sector in three principal aspects:
- Further supports strong fundamentals—It provides support to a sector that was already benefiting from strong fundamentals through strong regulated growth, a favorable regulatory environment, and stable balance sheets.
- Lowers transition costs—The Act creates headroom for utilities to potentially accelerate capital expenditures and rate-base growth.
- Averts key challenges—The potentially restraining effects of a corporate minimum tax have been averted.
Highlighting the net positives
Several of the Act’s provisions are expected to boost established renewable energy operations, as well as potentially encourage adoption among companies and states whose efforts have lagged. Four key aspects of the Act stand out.
1 Investment and production tax credits
Investment and production tax credits form the cornerstone of the incentives that drive renewable energy project initiation in any given period. Investment tax credits help to initiate investment by allowing a percentage of investment costs to be deducted from taxes owed. Production tax credits reward utilities financially for producing energy from renewable sources. Both are critical to encouraging new projects and supporting the financial viability of ongoing operations. Several tax credits that were set to expire or wind down have been renewed and, in some cases, expanded through the Act, with positive anticipated results for the sector:
- Starting in 2022, wind production tax credits are extended for at least 10 years at 100% ($15/megawatts per hour (MWhr) initially and inflation indexed at a current level of $26/MWhr) with no step down. Previously, wind production tax credits were capped at 60%.
- Solar investment tax credits will remain 30% of capital expenditure for a minimum of 10 years.
- Offshore wind investment and production tax credits are extended.
- Battery investment tax credits and hydrogen production tax credits are new additions.
These provisions are anticipated to accelerate the inclusion of renewable energy within the country’s mix of energy sources. Already in the first six months of 2022, 24% of U.S. utility-scale electricity generation has come from renewable sources, according to the U.S. Energy Information Administration. And it projects that by 2050, 51% of all electricity generated will be from renewable sources.
U.S. electricity generation from selected fuels, AEO 2022 reference case (billion KWh)
Source: Annual Energy Outlook 2022 (AEO 2022) reference case, U.S. Energy Information Administration (EIA), 3/3/22. The AEO 2022 reference case represents the EIA’s assessment of how U.S. and world energy markets would operate through 2050. Key assumptions in the reference case provide a baseline for exploring long-term trends based on current laws and regulations as of November 2021. Solar includes both utility-scale and end-use photovoltaic electricity generation.
2 Nuclear moves to firmer footing
Nuclear production tax credits warrant separate mention as one outcome of the Act is to turn nuclear generation into a long-term base load alternative for the country—a significant development. All existing nuclear plants will remain operating through the life of the Act, which enables plants to make the capital expenditure investments needed to keep them operational beyond their originally assumed 25 to a 40-year lifespan. The following provisions support nuclear energy:
- Production tax credits are approved for 10 years, exceeding original proposals in the Build Back Better plan.
- All plants licensed with the U.S. Nuclear Regulatory Commission will continue to operate.
- Production tax credits provide up to a $15/MWhr credit (assuming domestic content) and a $40–$44/MWhr floor price.
- Tax credits apply to regulated and unregulated nuclear generation.
- Unregulated nuclear operators gain significant benefits in that tax credits reduce uncertainty around plants’ operating profitability.
- In the case of regulated nuclear generation, the benefits of tax credits will be passed through to customers; however, this remains a net positive for regulated plants as tax credits can reduce bill pressure while keeping a clean and reliable source of energy in operation.
3 Corporate minimum tax
Earlier indications were for a corporate minimum tax (or alternative minimum tax) to be introduced on terms that would’ve negatively affected utilities’ cash flows. Utilities currently pay little to no cash taxes due to accelerated depreciation. Although the Act introduces a company corporate minimum tax, it carves out production tax credits and accelerated depreciation so that in effect the utility sector continues to pay little to no cash taxes. This represents a risk averted for the sector.
The Act allows tax credits to be transferred, which is fairly significant for the sector as it allows unused investment and production tax credits to be monetized. This reduces the need for tax equity, which is a form of project financing that uses a combination of project-generated cash flows and federal tax benefits to fund new projects. Tax equity often requires developers to form partnership agreements with investors to be able to benefit from the tax credits available, but that may be unattainable if developers are structured as corporations, which many are. Foregoing the need for tax equity may greatly simplify the financing process for new projects.
Permitting changes still to come
Permitting is a federal approval process for energy projects that both renewable and oil and gas energy projects undergo to establish their environmental impact. It can be a long and expensive process, often involving multiple government agencies.
An easier permitting process is central to facilitating natural or hydrogen gas pipelines, and electric transmission expansion lines in the future; however, a review of the permitting process hasn’t been included in the Act. Rather, a separate permitting bill is expected to be sponsored in the future with the aim to gain congressional approval before the end of 2022. Anticipated provisions include a two-year limit on federal environmental reviews for major projects and a one-year maximum review for smaller projects. It’s also expected to call for a single designated lead agency to review permitting using a single document, which will streamline an onerous process. There would possibly also be a statute of limitations placed on court challenges to energy infrastructure projects, and federal agencies would have a maximum of 180 days to respond to federal court action vacating a permit. A permitting bill with these stipulations would significantly ease infrastructure expansion, and we believe it’s an imperative piece of legislation to pass in order to achieve all the goals of the Act.
A meaningful step forward
The $369 billion that the Act earmarks for renewable energy development and climate change prevention represents unprecedented support from the U.S. federal government. States that have traditionally not concentrated on renewable energy may ultimately begin to implement clean energy transition plans due to more economical outcomes for ratepayers.
Noteworthy is that the Act creates an incentive for multiple sources of clean energy, essentially following a source-agnostic approach. We see this as a broad-based net positive for the sector that could lead to the significance of this Act growing over time.
This material is for informational purposes only and is not intended to be, nor shall it be interpreted or construed as, a recommendation or providing advice, impartial or otherwise. John Hancock Investment Management and its representatives and affiliates may receive compensation derived from the sale of and/or from any investment made in its products and services.
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