Inflation Reduction Act of 2022: Initial Takeaways from Enverus

The Inflation Reduction Act of 2022 would restore tax credits for solar and wind projects to their full rates and ensure they stay in effect at those levels for at least another decade, removing the ambiguity and unknowns that were bad for business. In addition, the act would introduce tax incentives for standalone storage and hydrogen projects as well as expanding and extending 45Q carbon capture credits. It also includes other measures that encourage energy efficiency, electric vehicle adoption, and investment in advanced manufacturing. If it passes Congress, it would provide a great boost to all things related to the energy transition.

So, what happened?

Ongoing efforts aimed at energy security and climate change since the Build Back Better plan failed have finally come to a head with the newly proposed legislation (this time supported by Sen. Joe Manchin, D-W.Va.) called the Inflation Reduction Act of 2022. Among other things, the legislation will invest nearly $370 billion in energy security and climate change programs over the next decade. This investment will aim to incentivize further renewable energy development, increase electric vehicle (EV) adoption, encourage energy efficiency, and even target emissions from oil and gas infrastructure and the agricultural sector.

To pay for the investment, the bill introduces tax and prescription drug reforms, which should result in a net $300 billion reduction in the deficit over the next 10 years. Most of the benefits of this plan come from tax breaks, meaning this proposal reduces the cost of renewable energy without burdening the cost of traditional energy. The bill has been submitted to the Senate and voting could be set to begin as early as next week. Thanks to the budget reconciliation process, the bill will be able to circumvent the Republican filibuster. It must then pass through the House before President Biden can sign it into law.

So, what does it say?

Within the 725-page legislative text, it is the Title 1, Subtitle D – Energy Security that is of interest to understand what is being proposed in terms of energy.

A few highlights (by no means an exhaustive list) of measures included in the act are:

The tax credit qualification for wind, solar and several other types of electricity producing facilities has been extended to those starting construction before Jan. 1, 2025 (previously Jan. 1, 2022).
Production Tax Credit (PTC), which is claimed by wind projects has been modified.

The base PTC amount has been decreased to $0.003/kWh (previously $0.015/kWh). However, this is counteracted by the measure that the base production tax credit amount is multiplied by five (back to $0.015/kWh) should the facility meet prevailing wage and apprenticeship requirements. It is worth noting that this base credit is always adjusted for inflation. The base PTC for projects starting construction in 2022 is $0.026/kWh when adjusted for inflation.
The phaseout clause which reduced wind project PTC over time has been removed (previously 40% reduction to the base PTC rate). The removal of the phaseout is not retroactive.
There are new PTC uplift bonuses applicable to the calculated base rate based on meeting domestic content or energy community requirements. These credits can be stacked (10% uplift each).

Investment Tax Credit (ITC), which is claimed by solar projects has been modified.

The base Investment Tax Credit (ITC) amount has been decreased to 6% (previously 30%). However, this is counteracted by the measure that the base ITC is multiplied by five (back to 30%) should the facility meet prevailing wage and apprenticeship requirements.
The solar ITC phaseout clause is removed (previously 26% going to 22%). The removal of the phaseout is not retroactive.
There are new ITC uplift bonuses added to the calculated base rate based on domestic content, energy community, and low-income community requirements. These credits can be stacked (10% uplift each).
Solar projects now have the option to claim the PTC in lieu of the ITC.
Energy storage projects now qualify for the ITC (previously not available for standalone storage). The ITC is available at the base 6% rate for any projects starting construction before Jan. 1, 2033. Afterwards, it starts phasing out (5.2% before Jan. 1, 2034 and 4.4% before Jan. 1, 2035).

In addition to the above amendments, solar and wind facilities (in fact, any electricity generating facility with greenhouse gas emission rate of 0) starting construction after Dec. 31, 2024, will be eligible for a new technology neutral PTC or ITC which will stay in effect until the latter of the below two options:

A gradual phase out begins when the applicable year occurs. The applicable year is the calendar year in which the annual greenhouse gas emissions from the production of electricity in the U.S. is less than or equal to 25% of the emissions in calendar year 2022. In the next three calendar years after the applicable year, the applicable credit to the plant is reduced to 100%, 75% and 50% of the base rate respectively. Thereafter, the incentive is no longer available.
The calendar year 2032.

Additionally, it is worth noting these additional measures introduced by the act:

Tax credit qualification for carbon oxide sequestration facilities has been extended to those starting construction before Jan. 1, 2033 (previously Jan. 1, 2026). The 45Q tax credit amount follows a similar structure to the PTC based on prevailing wage, apprenticeship and domestic content requirements.
A PTC has been put in place for hydrogen facilities with a similar structure to the PTC based on prevailing wage, apprenticeship and domestic content requirements. There is an option to opt for the ITC in lieu of the PTC.
A PTC has been put in place for nuclear facilities, which are in service before enactment, with a similar structure to the PTC based on prevailing wage and apprenticeship requirements.
Tax credit qualification for EV charging stations has been extended to those placed in service before 2033. Similar structure to the ITC based on prevailing wage and apprenticeship requirements.
A $7,500 tax credit for new EVs placed in service before 2033. There are reductions and limitations for applicability based on where the battery components are sourced, price of the EV, and taxpayer’s income.
Direct pay option is only afforded to few applicable entities and technologies. However, tax credits will now be saleable for cash to other companies not related to the seller. This removes the complex tax equity structures that were relied upon previously.
Renewable fuel and residential credits have been extended and expanded.
Increased royalty rate on offshore oil and gas leases from 12.5% to a minimum of 16.66% and maximum of 18.75%. The minimum bid was also increased from $2/ac to $10/ac.
Royalties will now be paid for gas flared on federal lands (previously only for gas sold).

So, what does it mean?

To summarize, it means nearly all things related to the energy transition got positive news. Existing tax credits were increased and extended. New tax credits were introduced for nascent or emerging technologies.

The above changes certainly impact the economics of solar, wind and storage projects significantly. All else equal, they increase the tax credit amounts afforded to upcoming solar and wind projects. Additionally, the implementation of an ITC for storage will certainly make the economics for standalone storage projects more attractive. The extension of the 45Q for carbon capture and the new PTC for hydrogen will have similar positive impacts on investments in these technologies.

Although the ability to sell tax credits for payment in cash is nice, it isn’t quite the direct pay alternative that the industry had been hoping for (although that also had shortcomings).

So, what does it not mean?

First off, there are still a few more steps before this gets signed into law.

Additionally, as good as these measures may look for these technologies, they don’t solve some of the immediate structural problems such as the all too apparent supply chain issues, ongoing anti-dumping/circumvention related concerns, location and security of rare earth minerals reserves and manufacturing, or the aging and frail power grid. Although the incentives for domestic manufacturing and mining of pretty much anything used for renewables will help, it is not an overnight solution. Additionally, labor shortages remain an issue and it is unclear that the incentives will make domestic manufacturing competitive with global supply.

It is ambitious, but it still isn’t a clear roadmap of how we meet climate goals in the U.S. (and certainly not abroad). It provides support for the technologies and investment necessary to add more renewable sources of energy and build a grid that can support the ever-increasing amount of intermittent electricity generation. However, it isn’t the silver bullet.

So, what is next?

At Enverus, we are always helping our clients not only understand but quantify the impact of these kinds of changes on the energy industry. Our suite of data and analytical tools served through our SaaS platform along with the insights that our team of analysts create from them are invaluable to staying ahead of the energy transition.

Disclamer

This piece was written to summarize the essence of the legislation as we understand it. As always, consult qualified law professionals before making any business decisions.

If you would like to read the full bill, you can find it here.

 

Interested in learning more about how this will impact the energy industry? Join our team for a live webinar Tuesday, Aug. 9. We’ll take a deep dive into these details and their impacts. Register below.

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