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22 May 2023

The Inflation Reduction Act

In recent years, there has been a growing recognition amongst governments that climate change represents one of the most significant challenges facing humanity. Activities such as the burning of fossil fuels have been some of the primary causes of the levels of greenhouse gases in the atmosphere, which is leading to global warming and the destabilisation of our planet’s climate system. As such, government policy has had to adapt by implementing measures that can mitigate the impacts of climate change, such as reducing carbon emissions, promoting renewable energy, and investing in green infrastructure. In recent months, the US Government has taken centre stage in actively seeking to adapt its economy and implement legislation that is set to move the country in a greener direction. Signed by President Joe Biden in the summer of 2022, the Inflation Reduction Act (IRA) was designed to accelerate investment in a clean energy landscape, targeting the reduction of US greenhouse gas emissions by 40% compared with 2005 levels, which would put the USA on a pathway to net zero by 2050. The new legislation is set to be the largest investment in combating climate change in US history, containing an astonishing US$500bn in new spending and tax breaks. Not only does the plan aim to significantly improve the green energy infrastructure in the US, but it also aims to reduce healthcare costs, increase tax revenues and act as a catalyst for growth within domestic markets, with an overall goal of improving US economic competitiveness, innovation, and industrial productivity on the global playing field.
 
One of the focuses of the new legislation is a blanket investment into renewable energy development and production which, as of last year, accounted for approximately 12% of the country’s total energy mix. As of recent years, the war in Ukraine and rising political tension with China has left US consumers and businesses vulnerable to energy price fluctuations and supply disruptions, all of which have added inflationary pressure for the US economy. As a result, the US is looking to reduce its dependency on energy and energy infrastructure imports, shoring up manufacturing capabilities and kickstarting research and development (R&D) across a variety of markets including transportation, agriculture, clean energy production, and carbon capture technologies. The change will be made possible through a variety of tax credits and loans with which the government is aiming to incentivise both consumers and businesses to increase long-term investments within the economy. An example of this is the provision of an additional US$12bn in loans available to businesses in the energy sector for the purpose of upgrading, repurposing, or replacing energy infrastructure across the country. A further US$30bn of fiscal spending will also be given in tax credits for investment in wind, solar, geothermal, hydrogen energy, biofuels, and technology that captures carbon from fossil fuel power plants. Not only will this likely reduce the long-term use of carbon-intense energy supplies, but it will likely increase the country’s economic independence and build new talent pools within developing sectors.
 
With large-scale support packages and incentives available for firms actively seeking to focus their efforts on greener developments, companies such as Shell have started to increase their R&D spend within the US to capitalise on the opportunities and funding available. Last year alone, the oil major spent US$4.3bn on low-carbon energy solutions while, at the end of 2022, it identified three main interests across different energy markets. These include: the potential margins for producing sustainable aviation fuel (SAF) in the US which, following the IRA, increased significantly; carbon capture and storage (CCS), which has become more financially viable for smaller emitters; oil and gas companies’ methane emissions targets, which could become easier to meet, with extra funding for research and development projects. Using the example of carbon capture and storage, the IRA could be a game changer for some smaller emitters. The Act raises the government subsidy for capturing carbon dioxide from US$50 to US$85 per tonne sequestered and lowers the threshold amount of CO2 that a project must capture each year to qualify for the tax credits. Therefore, not only are companies like Shell benefitting from subsidies and tax credits to further develop their business, but the US Government will also benefit from companies with strong market positioning, R&D capabilities, financial resources and in-depth industry knowledge as these are best equipped to make cost-efficient strong growth compared with smaller and less developed businesses.
 
With such a large fiscal spending plan, industry leaders outside the US have expressed concerns that they could lose out to the subsidy scheme as US consumers are incentivised to buy from US manufacturers, while US manufacturers are incentivised to do business with other US manufacturers. UK automotive companies have already acknowledged that the act could change future investment decisions as UK and EU companies could be incentivised to move business over the Atlantic and make use of the various subsidies and benefits available, if the UK and EU don’t do enough to provide benefits and support to their own manufacturers.
 
It isn’t just businesses that are reaping the benefits of funding. US consumers are also able to unlock various rewards from the fiscal spending package with around US$43bn in tax credits set to be given out to consumers across the US to lower vehicle emissions and low-efficiency appliances. As part of the IRA, Joe Biden’s Government is making electric vehicles (EVs), energy-efficient appliances, rooftop solar panels, geothermal heating, and home batteries more affordable for consumers, with a potential household saving of roughly US$500 a year when fully implemented. As an example, from the start of 2023, qualifying electric vehicles could be eligible for up to US$7,500 worth of tax credits while other new and used EV owners could receive up to US$4,000 in tax credits as an incentive to switch from full petrol or diesel engines. Furthermore, homeowners could receive a tax credit of up to 30% of the total cost, capped at US$1,200 per year, for home improvements involving energy efficient heat pumps, biomass stoves and boilers, offering beneficial cost savings for new and more efficient appliances. Not only would the long-term effect be a likely shift away from more energy intense products, reducing overall energy consumption, but it would also provide long-term inflationary benefits as more efficient appliances use less energy, costing the consumer less.
 
But, as with most things, the tax benefits available come with strings attached. The products purchased relating to the benefits from the Act must be manufactured or developed in some form within the US. For example, to unlock the full EV consumer credit, a scaling percentage of critical minerals in the battery must have been recycled in North America or extracted or processed in a country that has a free-trade agreement with the United States. The battery must have also been manufactured or assembled in North America. As one of the wider objectives of the IRA is to reduce dependency on international economies, it may be obvious why the government would include various criteria to unlock the benefits available to promote strong domestic economic growth as well as greater development toward a stronger, more diverse science, technology, engineering, and maths talent pipelines of future employees.
 
It will be interesting to see how the long-term development of the Act will drive growth within sustainable energy markets and alter the competitiveness of international markets, especially given the incentives provided for US companies.

This article was taken from the March 2023 issue of Market Insight. To subscribe to our investment publications, please visit www.redmayne.co.uk/publications.

Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned. The value of investments and any income derived from them may go down as well as up and you could get back less than you invested.
The Inflation Reduction Act

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