Legislative Carrot Feeds US Climate Transition

Despite causing short-term supply issues, the IRA is set to have far-reaching implications for net zero transition strategies, domestically and globally. 

It’s been just over six months since US President Joe Biden signed the Inflation Reduction Act (IRA) into law, pledging US$369 billion to accelerate the upscaling and deployment of renewable energy and clean technologies across the US. 

“It’s an unparalleled and historic piece of climate legislation that’s likely to be a significant catalyst for driving investment into the country’s [net zero] transition for years to come,” says Nikita Singhal, Co-Head of Sustainable Investment and ESG at Lazard Asset Management. 

The 730-page bill is rife with long-term grants, loans and tax advantages designed to incentivise change, rather than punishing carbon-intensive industries, driving the domestic development of industries like electric vehicles (EVs) and solar. It’s expected to cut US emissions by over 40% from 2005 levels by 2030, growing GDP by nearly 1% by the end of the decade and creating nine million jobs 

“The full impact of the IRA won’t be realised overnight – it’s going to take two, three or even four years before the economic benefits are fully felt by these industries,” notes Anthony Catachanas, CEO of private asset investment and advisory business Victory Hill Capital Group. “But we’re already seeing that project valuations are becoming more competitive, more interesting, and are certainly taking into consideration the benefits that the IRA will bring,” he adds.  

The IRA underlines the sharp 180° turn in US climate policy since the Trump administration and it has huge significance beyond US borders, given the country’s historic role in contributing to global warming. 

Despite the uncertainty caused by the anti-ESG movement and emerging short-term pressures on much-needed resources, the ripple effects of the IRA are undeniable, causing an international scrambling as other governments work to step up their efforts in the race to net zero.  

Crucially, it signals a mood change in US markets for both companies and investors.  

“There’s excitement out there amongst companies that are looking for innovative climate solutions, now that they know they have governmental and industry support and more capital is behind them as they develop these solutions,” Kristina Wyatt, Senior Vice President of Global Regulatory Climate Disclosure at climate reporting technology company Persefoni, tells ESG Investor. 

A green wave  

The IRA has set a number of new green investment opportunities into motion, with around US$28 billion in new manufacturing investments already announced by October 2022.  

One of the “biggest areas of opportunity” lies in solar energy, according to Lazard AM’s Singhal. The IRA is providing a 30% solar investment tax credit until 2025, with projects that can certify that all steel, iron and other manufactured product components were produced in the US qualifying for an additional 10% tax credit.  

Goldman Sachs Research has predicted an 18% compound annual growth rate in US solar installations through to 2026.  

South Korea-headquartered Hanwha Q Cells announced earlier this month that it will be investing more than US$2.5 billion in developing its US solar supply chain, opening a second plant in Georgia, raising its total annual solar panel production capacity to 8.4 gigawatts (GW) by 2024. US-based FirstSolar is investing US$1.2 billion to build a new solar panel manufacturing plant and expand its three existing plants in Ohio.  

For domestic EV production, the IRA has extended US$7,500 consumer tax credits for purchasing new EVs and US$4,000 for used EVs. 

Following the finalisation of the act, Michigan-headquartered vehicle manufacturer Ford began the construction of its US$5.6 billion EV assembly plant in Tennessee. Further, BMW announced its plans to invest US$1.7 billion in EV production in South Carolina, with the aim of producing six fully electric vehicle models in the US by 2030. General Motors is investing US$760 million at its Toledo Propulsion Systems to expand manufacturing for EV models.  

“We estimate cumulative IRA spending in support of light vehicle EVs could be at least tens if not hundreds of billions of dollars over the life of [the IRA],” Goldman Sachs Research noted. 

IRA incentives are not limited to solar and EVs. US$2.6 billion has been committed to the conservation and restoration of coastal habitats, US$5 billion to supporting and upscaling fire-resilient forests, forest conservation projects and urban tree planting, and US$20 billion to the development of climate-smart agricultural practices.  

“With the IRA underpinning the transition, renewable power generation and associated technologies are going to be a very appealing proposition for investors over the next few years and will likely begin attracting huge investment,” says Catachanas. 

The right materials  

However, the sudden spike in demand for the necessary manufacturing materials has had short-term ramifications. 

Most notably, the supply of critical minerals like copper, lithium, nickel and cobalt is under pressure, with global demand expected to grow by 400-600% over the next several decades. A limited number of countries currently export the necessary materials, many of which present social and governance risks. The Democratic Republic of Congo produces around 70% of global cobalt supplies, and around two-thirds of lithium-ion factories are based in China 

“In the short term, we expect there are going to be increasing supply and demand mismatches, which is going to impact the prices of these materials,” says Singhal. 

To encourage the upscaling of domestic supplies, only EVs with their final assembly taking place in the US are eligible for the aforementioned IRA tax credits. Further, from 2023, at least 40% of the raw minerals used in EV batteries must be sourced from North America, climbing to 80% from 2026. One hundred percent of EV batteries must be manufactured and assembled in North America by 2028. 

Companies have been responding. Honda and LG Energy Solution have announced a joint US$4.4 billion venture to produce lithium-ion batteries in the US, and Michigan-based energy storage company Our Next Energy is planning a US$1.6 billion cell manufacturing facility, which will begin production in 2024.   

Governments are also taking note. “Policymakers in Bejing will be paying close attention,” warns Hugh Gimber, Global Market Strategist at JP Morgan Asset Management, noting that the US IRA is a blatant challenge to China’s dominance in the renewable supply chain. “China is unlikely to be willing to give up its position as the global leader in renewable technology any time soon.” 

Smoke and mirrors 

But could the sustainable investment the IRA seeks to incentivise come under threat from the ESG backlash spearheaded by certain Republican states and federal politicians?  

“The anti-ESG movement features a lot of smoke and mirrors, attempting to divert attention from what’s actually happening in the real economy, which is a recognition by investors that climate risk is a financial risk and that there is a need for sustainable solutions and full transparency from companies as they transition,” says Persefoni’s Wyatt.  

The movement has already had a negative effect on some US-based investors.  

Most notably, US asset manager Vanguard withdrew from the Net Zero Asset Managers initiative (NZAM), following political pressure related to its acquisition of shares in US utilities. Other asset managers like BlackRock have also been challenged by Republican-run states on their climate policies. 

“With the Democrats retaining control of the Senate, a lot of the provisions in the IRA are likely protected in the medium term,” says Lazard AM’s Singhal.  

“These incentives are quickly being rolled-out and will be hard to roll-back once they’ve been implemented – so it’s likely they are here to stay. This provides corporates and investors with the certainty they need to be investing capex to ensure they are mitigating climate risks and taking advantage of IRA tailwinds.” 

You can catch more flies with honey  

The climate transition is a world first, and only time will tell whether it is more effective for governments to wield the stick or dangle the carrot on the path to net zero. 

While the US is taking the latter approach through the IRA, the EU has to date emphasised the former, recently reaching consensus on its three-pronged carbon pricing strategy, which will essentially force carbon-intensive industries to transition to low-carbon products and processes to avoid paying for their emissions. 

“The IRA’s impact should ultimately be much larger as other nations seek to ensure they do not lose out as a result of less generous policies relative to the US,” predicts JP Morgan AM’s Gimber. 

The US’ ‘protectionist’ act has certainly ruffled European feathers, with some political leaders concerned that the design of the financial incentives in the package is potentially in violation of World Trade Organization (WTO) rules and will ultimately draw business away from the EU. 

It’s a valid concern. Swedish battery developer Northvolt is considering pausing a German factory expansion to instead take advantage of the opportunities in the US. These concerns have also been echoed by other countries, including South Korea, the UK and, unsurprisingly, China 

“Europe has also made climate policy decisions that are having an impact in the US, such as its carbon pricing model,” points out Emily Pierce, Vice President of Global Regulatory Climate Disclosure at Persefoni.  

“This is just a consequence of different jurisdictions approaching the same existential challenge with different policy tools and the same objective,” she says. 

Spanish Prime Minister Pedro Sanchez has said Europe should learn from the US when it comes to supporting green industries, by reforming its state aid, reducing bureaucracy and encouraging companies to relocate to the EU instead.  

Subsequently, European Commission President Ursula von der Leyen unveiled the Green Deal Industrial Plan at Davos this month, which includes the Net Zero Industry Act. It aims to increase funding for domestic clean energy technologies across the 27 member states.  

“Regions such as Europe that have previously focused on the ‘stick’ over the ‘carrot’ on climate policy are rapidly deciding that this strategy is no longer enough,” says Gimber. “The EU’s Green Deal Industrial Plan is the latest response in a game of policy tennis that is only just getting started. European policymakers will be determined to ensure that their industry leaders don’t gravitate towards more attractive policy measures in overseas jurisdictions.” 

Lazard AM’s Singhal agrees, adding that she won’t be surprised if other major players in the space, including China, India and Brazil, start to “think up similar policies”.  

Nonetheless, while the IRA is a huge, landscape-shifting step forward, more action will need to be taken if the US is to fulfil its net zero commitments 

“It’s going to take a number of these types of initiatives going forward if the US is going to actually achieve its goals,” says Catachanas.  

“But we are undoubtedly going to be riding the wave of the IRA for a while before the next round of commitments and legislation.” 

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