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Wind at their backs: What the IRA means for clean energy industries

Multiple authors
2023-09-30
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The views expressed are those of the authors at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only. 

The US Inflation Reduction Act (IRA) is a historic piece of legislation that should lower the cost of the energy transition, spur innovation, and transform the US clean power and clean infrastructure industries. The law assures US$387 billion for solutions (Figure 1), with subsidies potentially amounting to far more over time, given resulting demand generation. And while the IRA primarily supports climate mitigation initiatives — reducing greenhouse gas (GHG) emissions to forestall the worst effects of climate change — it also incentivizes spending on climate adaptation and resilience.

Who stands to benefit most from the law’s deflationary objectives? In our view, industries like clean-power technology and electric utilities, which enable the economy to transition to renewable energy and reduce reliance on fossil fuels, are the most directly and positively affected. Developers and manufacturers along the solar and wind value chain could also see a boost, as could emerging technologies like green hydrogen and energy storage. Last, but not least, the law is a positive for US consumers, who should benefit from lower electric bills and less fluctuation in costs over time.

Figure 1
wind-at-their-backs-what-the-ira-means-for-clean-energy-industries-fig1

Significant boost for clean power technology

The IRA should drive demand and support clean power economics, with particularly meaningful tailwinds for subsectors that will benefit from new or revived tax credits, especially those refundable in cash.

For large-scale solar, a 30% transferable investment tax credit:

  • Enables the same return at a US$7/MWh lower price, making solar power 25% cheaper to produce1
  • Potentially increases savings to more than US$12/MWh (making solar 40% cheaper), via two 10% adders for domestic production

For small-scale solar, a 30% investment tax credit:

  • Shrinks the payback period for purchased home solar by five years, on average
  • Benefits lease customers in most states, who could see 20% savings on day one

For wind, a US$26/MWh production tax credit:

  • Cuts the power price needed for new projects by half or more, holding returns constant
  • Revives wind as highly competitive with solar
  • Benefits turbine original equipment manufacturers (OEMs)

For energy storage, a new 30% investment tax credit:

  • Pulls forward the cost-improvement curve by three to five years at a minimum
  • Could render home batteries (as opposed to generators) mainstream by 2025
  • Decouples credits from solar production, accruing benefits across the value chain: from battery manufacturing to developers

For green hydrogen, a US$3 per kilogram production tax credit:

  • Represents a 10-year cash subsidy for low-emissions producers
  • Could push industrial projects below the cost of traditional “grey” hydrogen
  • Nudges large-scale projects (over US$100 million) into investable territory

For domestic renewables manufacturers receiving refundable tax credits:

  • Increases the value of subsidies for solar panels to 200% of the typical gross-profit-per-watt
  • Increases the value of subsidies for solar trackers to 100% of the typical gross-profit-per-watt
  • Extends benefits to other manufacturers of wind products and batteries

For nuclear, new production credits:

  • Will enable some existing power plants to remain viable

For new technologies, the IRA provides a boost for:

  • Renewable and clean fuels
  • Modular (small-scale) nuclear
  • Carbon capture
  • Electric vehicle (EV) charging infrastructure

Additional tailwind for US electric utilities

The IRA further supports fundamentals in this sector, which was already benefiting from a decades-long trend of decarbonization, electrification, and a supportive regulatory environment. Potential acceleration from the IRA may increase projected regulatory asset base growth by 1% per year, from 6% – 7% to 7% – 8%. With expected 6% – 8% compound annual earnings-per-share growth, plus a 3% – 4% dividend yield, we see the potential for 10% per annum total returns for the sector through the end of the decade2.  Additionally, states that have not traditionally concentrated on renewable energy should eventually implement clean-energy transition plans as this process becomes more economical for ratepayers. Asset sales in the unregulated renewable space could also increase and command higher valuations given greater residual asset values. Overall, for utilities, the IRA:

  • Accelerates the energy transition. Tax credits included in the law will make supplying renewable-generated power more competitive than supplying fossil fuel power. This should level the playing field for regulated utilities with nonregulated renewables developers. As a result, utilities will be able to include more renewable investment in their regulatory rate base.
  • Lowers costs and spurs investment. By making clean power even cheaper to produce, the IRA acts as a deflationary force, lowering the price tag on the energy transition. The law provides “bill headroom” for utilities: As lower costs relieve pressures on consumers, utilities can potentially increase capital expenditures in other parts of their value chain, including grids and networks — thereby boosting regulated rate-base growth.
  • Provides cash tailwind for eligible utilities. The law allows for the transfer of tax credits, which can be used to offset the Alternative Minimum Tax (AMT). Eligible utilities will be able to exchange abundant credits for cash, enhancing both their balance sheet and investment capabilities.

Modest uplift for the renewables value chain

We expect the IRA to provide a boost for the rest of the solar and wind value chain, including developers, non-US suppliers, and lenders. In our view, while mainstream renewables now have a decade-long runway of stability and visibility of costs, the incremental growth trajectory is likely to be more modest than what current media headlines suggest. As Figure 2 shows, the IRA should have a positive net impact on solar demand. Absent the IRA, renewables demand would still have been strong from state and corporate mandates, but it would have been lumpier, due to the previously expiring credits. The IRA represents an evolutionary, not revolutionary, solar demand driver for two main reasons:

  • Material pricing headroom already existed. Solar is currently cheaper to produce than natural gas. Because existing tax credits were set to materially decline by 2026, new solar contracts would merely have needed to reprice higher (and remain below the cost of conventional power) to buoy growth. Extending and expanding credits should have a measured effect. 
  • State- and corporate-level mandates were already in place. These key demand drivers have long supported US solar adoption. We anticipate a net 10% – 20% structural uplift to demand versus prior expectations for 2023 – 2032, with higher incremental changes possible for wind.
Figure 2
wind-at-their-backs-what-the-ira-means-for-clean-energy-industries-fig2

Lowers costs for US consumers

Before the law’s passage, the average US household electric bill was projected to increase by 2% – 2.5% per year over time, to support costs associated with the low-carbon energy transition and electrification of the economy3.  Passage of the IRA potentially enables utilities to reduce the annual projected bill increase by up to 0.5% — 1%. (Note that the 2% – 2.5% range is before accounting for potential fluctuations in electric bills caused by fuel-cost pass-throughs.) Given the recent price spike in energy commodities like natural gas and coal amid Russia’s war in Ukraine — spurring spikes in electric bills — the IRA’s deflationary nature could prove even more valuable to consumers in the near to medium term.

For a broader take on the economic implications of this landmark legislation, please see 'Inflation Reduction Act: A big deal for the US economy

Final note: Watch for permitting reform

As a side note, we will be watching the US Congressional agenda for an upcoming bill, sponsored by West Virginia Senator Joe Manchin, which may include:

  • Two-year limit on federal environmental reviews for major projects
  • One-year maximum review for smaller projects
  • Allowance of permitting applications on a single form, to a single agency for review
  • Statute of limitations on court challenges to infrastructure projects

Easier permitting would facilitate the expansion of natural gas pipelines (or hydrogen pipelines, eventually) and electric transmission lines. We view permitting reform as imperative to achieving the goals of the IRA.

1Projections based on Wellington Management research. | 2Projections based on Wellington Management research. | 3Projections based on Wellington Management research.

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