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Sizing up Biden’s plan to decarbonize America

US Macro Strategist Juhi Dhawan examines the Biden administration’s commitment to a lower-carbon economy, including proposed infrastructure spending, tax incentives, and regulations, as well as the implications for industries and the broad economy.

The views expressed are those of the author 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.

Seven of the warmest years on record have occurred since 2014, and 2020 was the second-warmest year on record (Figure 1). As the earth heats up, the physical effects, from droughts and wildfires to hurricanes and floods, are a growing threat to human life and economic stability. More than 110 countries have responded by pledging carbon neutrality by 2050, but progress has been slow. In September, the United Nations reported that despite current pledges, emissions are on pace to increase 16% by 2030, compared to 2010 levels. Scientists, meanwhile, believe emissions must be cut 45% within that time frame to limit the rise in the global average temperature to a target of 1.5 degrees Celsius.

This gaping divide has made climate change a top priority for President Biden. Since taking office, his administration has reentered the Paris Agreement, affirmed the US commitment to the 2050 net-zero goal, and called for a carbon-free power sector by 2035. Key personnel decisions have also been made, including the appointment of John Kerry as climate czar and Gina McCarthy as a national advisor. Now the debate turns to policy levers that can be used to achieve the administration’s ambitious goals, including the climate-related infrastructure spending proposals and regulatory changes that I focus on in this note.

FIGURE 1

History of global surface temperature since 1880

Increased investment in sustainable and eco-friendly infrastructure

Policymakers are gradually hammering out the details of climate-related infrastructure plans that could support and accelerate decarbonization (the plans are part of a revival in US infrastructure spending that I wrote about in a recent note). Within the $550 billion bipartisan infrastructure package making its way through Congress, there are a number of climate-related proposals, including:

  • $15 billion for electric vehicle (EV) production, procurement, and infrastructure
  • $73 billion for power grid improvements, including clean-energy technology
  • $50 billion for water storage and resiliency (e.g., mitigating drought and floods)
  • $39 billion for public transit (to reduce cars on the road and their environmental impact)

There are also many climate-related initiatives included in the broader 10-year budget package that the Democrats hope to push through on their own via the reconciliation process. While the full size and scope of the package is still to be determined, here are some of the key proposals:

  • Tax credits for zero-emission electric power generation and grid improvements
  • Grants to electric utilities to meet clean-energy targets through 2030
  • Funding for rural electric cooperatives to accelerate decarbonization efforts
  • A new EV tax credit ($7,500 per vehicle) with no manufacturer cap
  • Fees on methane emissions associated with oil and gas production/transmission
  • Funding for removing carbon via soil conservation and reforestation

Importantly, I think the increase in government spending could boost private-sector investment in climate-related infrastructure (private infrastructure investment has been relatively flat in the US for over a decade). In many areas, the government will be doing some of the foundational work (e.g., EV charging stations), but given the scale of the challenge, the private sector will have a large part to play.

A key role for regulation

We’ve already seen the Biden administration flex its regulatory muscle on the climate front, including revoking the permit for the Keystone XL pipeline and freezing new oil and gas leases on public lands. Most recently, it proposed that car makers increase their fuel efficiency by 8% per annum between 2024 and 2026, effectively raising fleetwide efficiency by about 12 mpg by 2026, relative to 2021 — a meaningful step up. Biden is also aiming for EVs to represent 50% of all new auto sales by 2030.

What’s next on the regulatory front? I think we could see a reduction in the number of fossil fuel subsidies, higher efficiency standards for buildings and appliances, and new emissions standards to ensure electrification of light- and heavy-duty vehicles. In addition, increased climate disclosures could act as a catalyst for companies to rethink their carbon footprint and to address concentration risk related to physical facilities in areas vulnerable to the impact of global warming. For financial institutions, climate-related stress tests could be on tap, as well.

It is also worth noting that Biden will likely make climate change part of his international agenda. This could include commitments in trade agreements and leadership on the global policy stage. One possible area of leadership is making good on the commitment to help poorer nations fund the cost of transitioning to a lower-carbon economy.

The implications of a more rapid clean-energy transition

Considering the full scale of Biden’s infrastructure proposals, including the climate-related initiatives, and bearing in mind that the final dollar amounts will likely be lower, I think the spending could provide a lift in economic growth of 50 bps – 75 bps over the next few years, led by investment spending and putting some upward pressure on interest rates. And as I wrote previously, these investments, if designed well, should also raise US productivity over time.

In terms of the impact of the climate-related proposals specifically, they will hasten the clean-energy transition, which, as Figure 2 shows, is at an inflection point that has been decades in the making. This will fundamentally affect multiple industries, including agriculture, utilities, building materials, and manufacturing, among others. Besides power generation, transportation could be facing the most significant transformation, as the largest source of US greenhouse gas emissions. And for the defense industry, the geopolitical instability fostered by climate-related disruptions is likely to be a long-term tailwind — a topic my colleague Thomas Mucha has written about here. In addition, demand for a wide range of commodities will rise, to support new technologies that will be needed to drive the clean-energy transition (Figure 3).

FIGURE 2

Reaching an inflection point on US energy production sources

FIGURE 3

Decarbonization will require increased commodity consumption

Of course, the goal of decarbonizing the economy must be weighed against issues of reliability and affordability. For example, the transition risk in energy usage brought on by the move from fossil fuels to renewables needs to be managed judiciously (we’ve seen early growing pains in Texas and Europe recently). More broadly, policymakers must consider not only the physical risks of an increasingly unstable climate and what they mean for the economy, but also the risks that will arise as economic agents start to alter their behavior — if, for example, consumers shift to electric vehicles but governments have not done enough to support a nationwide charging infrastructure.

The high cost of transitioning to a low-carbon economy will entail risks as well. Paying the bill will likely require somewhat higher personal and corporate tax rates, and with such large dollar funding being put to work, there is the risk of poor investment decisions. As with the other infrastructure plans, the climate-related spending will add to the persistent increase in fiscal spending, which poses the risk of higher inflation. Added climate regulation also raises the cost of doing business, which is ultimately passed on to consumers.

Even as regulation is pushing toward reduced fossil fuel use, we could see the unintended consequence of a spike in oil prices driven by infrastructure development. What’s more, years of underinvestment in fossil fuels, as well as many minerals and metals, have raised the risk of destabilization in energy prices. Finally, a carbon price, which exists in other parts of the world, may be under consideration. While many states in the US have tried to create a carbon-credit trading system, the price of carbon remains quite low relative to other countries. Finding the right balance during these transition years will be important in sustaining a healthy expansion.

Conclusion

The Biden administration is renewing America’s commitment to a lower-carbon economy. A mix of tax incentives, tougher regulations, and some penalties aimed at fossil fuels will likely make this a decade of acceleration in the country’s decarbonization process. Balancing reliability and affordability concerns is critical in ensuring a sustainable economic expansion. Power generation, transportation, building materials, agriculture, and finance will be impacted by the upcoming changes. The macro effects should include higher investment spending, higher nominal growth, and, eventually, somewhat higher interest rates.

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