IRA: A Driver of Increased M&A Activity?

Shearman & Sterling Partner Emily Leitch outlines the potentially catalytic impact of the Inflation Reduction Act on the US green technology sector.

The US Inflation Reduction Act of 2022 (IRA), signed into law on 16 August, could spur additional ESG-focused mergers and acquisitions of green companies. Though the IRA falls short of the massive Build Back Better tax bill originally envisioned by Democrats, it nevertheless contains significant funding and tax provisions geared toward energy security and climate change investments that are intended to put the US in line with meaningful emissions reductions targets of a 40% drop below 2005 levels by 2030. Some of these provisions are likely to increase the supply of and demand for companies who directly benefit from the IRA.

What are the relevant aspects of the IRA?

The IRA contains provisions that create incentives for investments in green companies, including: (1) production tax credits to accelerate US manufacturing of clean energy infrastructure, such as companies that produce solar panels, wind turbines, batteries, and those that process minerals critical to the greening of the American economy; (2) investment tax credits aimed at clean technology manufacturing facilities, including facilities for electric vehicles, wind turbines, and solar panels; and (3) grants to retool existing auto manufacturing toward clean vehicles. Ultimately, these provisions aim to invest in decarbonising all sectors of the economy, increasing US energy security, and lowering energy costs.

The tax incentives, loans, and grants that comprise the line items within the IRA are geared toward making green energy competitive. In this vein, green tax incentives for existing emitters are the biggest line item from the IRA, both for conventional green energy sources like wind and solar as well as for other green energy alternatives like nuclear energy, hydrogen power, and traditional fossil fuels accompanied by carbon capture, utilisation, and storage. These tax credits are expected not only to change corporate behaviour, but also to make green companies more appealing as acquisition targets, and to private equity and venture capital.

Similarly, the IRA directly empowers the government to invest in green technology initiatives. The IRA expands the Department of Energy’s existing loan and investment programmes such that, as measured by the Congressional Budget Office’s fair value estimates, merely US$11.7 billion of appropriations to support these loans has the potential to support up to US$312.6 billion of new energy investments. Foremost among these programs is the Energy Infrastructure Reinvestment Program, which could catalyse up to US$245.8 billion in investment in projects to replace retired energy infrastructure or enable operating infrastructure toward reducing greenhouse gas emissions and other forms of pollution. As some commentators have noted, investment on this scale could spur the creation of hundreds of new companies within the green energy space. Some of those companies are likely to be enticing targets for companies seeking to enhance their clean energy capabilities, take advantage of the benefits of the IRA or avoid the penalties in the IRA, or simply to pursue greater promotion of ESG initiatives supported by investors or management.

How could these provisions increase M&A transactions?

The aspects of the IRA outlined above are likely to create demand-side incentives for mergers and acquisitions. The IRA directly rewards existing energy companies for changing their corporate behaviour through its generous tax credit provisions. These provisions represent novel and financially rewarding opportunities for companies to cut their current emissions, which is likely to give rise to changes in those entities’ manufacturing or operating models. Because of this, companies seeking synergistic acquisition opportunities are likely to be more receptive to acquiring businesses that would facilitate their own strategies toward achieving the changes in corporate behavior that would generate rewards under the IRA.

More specifically, the IRA is likely to directly benefit several industries. For example, the IRA will protect and promote the solar industry, which has been struggling to overcome the recent hurdles in supply chain logistics. Other industries that will be boosted from the IRA are domestic lithium and battery businesses. The current production market for lithium is severely limited in the US. However, the IRA’s major incentives for electric vehicle production and consumption will reward companies that are able to smooth existing obstacles in the supply chains for the component parts of electric vehicle batteries – particularly because the IRA includes domestic sourcing requirements.

The IRA also will enhance the existing 45Q tax credit, which allots direct air capture facilities US$50 per ton of carbon removed from the atmosphere. This will expand the number of qualifying facilities and make carbon capture and sequestration companies more competitive. Such entities could be synergistic targets for traditional fossil fuel companies seeking to green their emissions portfolios, placate activist investors, or promote ESG governance principles for directors and officers hoping to transition into the green economy.

The companies that are at the forefront of developing lower-carbon or zero-carbon technologies will be in greater demand because acquiring such entities will likely make a business more competitive and lower its cost curve in relation to its peers. Because of this increased competitiveness, such companies will present more enticing investment opportunities for private equity firms both in a traditional dollars and cents framework for analysing investments and from a lens of social responsibility or ESG.

Ultimately, the IRA contains significant incentives for renewable energy, including for alternative sources and technologies like clean hydrogen, carbon capture and sequestration, and electric transmission. These incentives are likely to drive corporate strategies for capital expenditures and may even spur increased activity in mergers and acquisitions as companies hoping to leverage the IRA’s green economy provisions seek synergy or profit opportunities. The IRA is not simply a climate bill – it also seeks to make the US green technology sector self-sufficient, and incentivizes companies to develop facilities and personnel in the US. Consequently, American companies that can develop the tools, expertise, and connections to take advantage of the IRA will be attractive investment targets for longer-existing companies hoping to make ESG-focused transactions and changes to their businesses.

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