Inflation Reduction Act and Energy Transition

Event Speakers

	Nomi Ahmad | CEO, GE Energy Financial Services
	Katie Jackson | EVP - Acquisition & Divestment and New Business Development, Shell

The US Inflation Reduction Act (IRA), has climate, trade, security and foreign policy implications for the rest of the world. Through a mix of grants, loans and tax credits, the act aims to advance US emission reductions, strengthen domestic manufacturing capacity – thus reducing dependency on China, and catalyse investments into R&D and the commercialization of clean technologies. It also includes trade-distortive subsidies, including local-content requirements which support the on-shoring of key energy transition manufacturing components.

Russell Reynolds Associates recently hosted the sixth instalment of the Energy Matters, People & Money Networking Series which focused on the transatlantic implications of the IRA and the group came together to discuss what it means for Europe, global energy and the future of international relations.

Which Sectors Does the IRA Cover?

Signed into law on August 16th 2022, the IRA is one of the most significant climate legislations in US history. It calls for investments to the tune of $437bn between 2022 and 2031 – of which $369bn is committed to energy and climate change. It covers almost every sector within energy transition (see Figure 1).

Figure 1 | Estimated IRA Energy Transition Spending (2022-2031)

^{Source: EIA, EPA, Joint Committee on Taxation, BloombergNEF. Note: Chart only captures tax credits and incentives and not grant programs or loans.}

Mobilizing Private Capital

The reliability of tax offsetting has begun addressing private capital concerns around the cycle of uncertainty associated with clean energy investment opportunities. The IRA extends both the existing production tax credit (PTC) and investment tax credit (ITC) through the end of 2024. ITC qualification value range for utility scale projects will be between 6-50%, up to 70% for projects under 5 MW, compared to current 26%. PTC qualification value range will be circa. $5-30/MWh, compared to the current $26/MWh PTC. These major changes are a consequence of the US Treasury effectively backing the payment of the tax credits, thus stabilising risk.

Corporates are the biggest IRA recipient, with more than $200 billion worth of tax credits. With lower costs and an increased number of projects available, many are scaling up investments with more flexible return profiles and higher tolerances for experimenting with new energy projects at scale. Shell for example, expects an 18% IRR from its upstream portfolio blend versus lower anticipated returns from new energy investments.

Advancing European Green Hydrogen Ambitions

New US hydrogen economics could potentially make the EU an eventual importer of subsidised hydrogen. The group highlighted NextEra, the US utility provider, who plans to export green hydrogen to Europe alongside the need for an overarching set of regulation and clear standards from the IRS and US Treasury to support hydrogen transportation and export opportunities.

Supply Chain Relocation

European producers are disadvantaged by US manufacturing incentives as they must compete in a distorted market with subsidised US-based producers.The IRA dedicates $60 billion to on-shoring clean energy manufacturing and provides PTCs for domestic manufacturing of some solar and wind energy components. Since the IRA, several European companies have announced the construction of new or expanded manufacturing plants in the US including European companies such as Volkswagen, BMW, Enel, battery group Freyr.

A Wake-up Call? The EU’s Green Plan

The European Commission has proposed a Green Deal Industrial Plan in response to the IRA, with increased levels of state aid to help Europe compete as a manufacturing hub. It also includes a temporary relaxation of state rules around renewable technologies, including green hydrogen and biofuel storage in order to allow member states to support their own net-zero technology industries. The group were largely disappointed with the European legislation and complexity was seen as the biggest barrier to success. Europe needs to act fast to evolve regulation as the US and China continue to localise their supply chains, producing subsidised products for global markets.

Emerging Markets

The group discussed emerging markets becoming increasingly attractive, given their ability to deliver green power at a lower price point. Therefore, as the pace of development for export infrastructure (hydrogen pipelines, interconnectors) increases, emerging regions could become more attractive than the USA, even with the IRA subsidy on offer.

Leadership Questions

1. With the US talent market overheating and salaries increasing by 25% a year, what can be done to alleviate this and retain key talent in Europe? 
2. As new markets are explored, and the challenges become sector agnostic, how can boards and investors get more comfortable with leaders who look radically different?
3. With the rapid rise of Article 9 funds and climate investors globally, when will compensation be tied to environmental impact versus financial returns?

Authors

Chris Nicholson; a Partner in the firm’s Global Industrial & Natural Resource Practice, covering the Energy markets.

Abigail Skerrett; a member of the firm’s Global Industrial & Natural Resource Practice and co-lead of the Global Energy Transition Practice.

Shola Brown; a member of the firm’s Global Industrial & Natural Resource Practice.

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