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FORWARD THINKING | – 4 Min

How will the US Inflation Reduction Act boost climate action?

In this article:

    After a tense few months during which President Joe Biden’s climate plans appeared to be dead in the water, a surprising about-turn from Senator Joe Manchin has paved the way for the Inflation Reduction Act of 2022. Berenice Lasfargues and Thibaud Clisson examine what this could mean for climate action from the world’s second-largest greenhouse gas emitter.  

    What has been dubbed as the most important piece of climate legislation in US history is now set for House of Representatives’ approval (seen as formality) before the Act – which also contains significant provisions for healthcare and tax reform – is signed into law.

    While not as ambitious as President Biden’s original multitrillion-dollar Build Back Better plan, the bill has the potential to be transformative. BNP Paribas Asset Management has long held the view that a significant US climate bill would be voted through this year to enable greater investment in deflationary renewable energy technologies [1].

    The package includes USD 369 billion in incentives to 

    • Help boost clean energy supplies
    • Decarbonise agriculture and industry  
    • Increase investment in new green technologies  
    • Increase investment in energy efficiency
    • Help lower-income communities adapt to climate change. 

    We’ve summarised the key elements and their implications for, for example, clean energy and electric vehicle deployment here.

    What will the bill mean for CO2?

    Initial analysis suggests that the measures would reduce net greenhouse gas (GHG) emissions by 31%-44% on 2005 levels by 2030. This is a significant improvement on the 24%-35% reduction forecast under current policy, but it is still some way off the US’ Nationally Determined Contribution (NDC) target of a 50%-52% reduction.

    There may be a lag until the package results in a measurable reduction in CO2 (as well as inflation) due to the lead times for new wind power projects, for example, and the time taken for new electric vehicles to filter into the market and for all registered vehicles to transform. The renewables industry is also experiencing supply chain issues that could affect delivery.

    However, the American Clean Power Association expects the plans to ‘supercharge’ investment in US clean energy. While the bill is more carrot than stick, the difference between it and prior tax credit incentives for clean energy is that there is now a longer line of carrots extending over a 10-year horizon, offering far greater certainty for investors.

    In the nearer term, the US Energy Information Association (EIA) expects US energy developers to add 29 gigawatts (GW) of new capacity in H2 2022, 50% of which will be solar generated.

    A compromise on energy projects

    To ensure passage of the bill, a compromise was reached on the expansion of fossil fuel (oil and gas) development on federal lands. Agreements were also made on the speeding-up of permit processes for oil and gas pipelines, with energy projects such as the controversial Mountain Valley natural gas pipeline in Appalachia being prioritised.

    While this may increase emissions from the oil and gas sector, it’s worth noting that under the bill, oil companies will have to pay higher rates. The minimum price for bids at auction would rise from USD 2 per acre currently to USD 10. Onshore royalty rates would increase to 16.67% from 12.5%, which should act to dampen emissions growth.

    There are other trade-offs – for example, new renewable projects on federal lands will only be greenlighted when drilling rights are being auctioned.

    Offshore, the bill requires that lease sales in the Gulf of Mexico and offshore Alaska be held in the next two years.

    However, it also contains positive news for offshore wind: restrictions will be lifted on developers targeting sites off the coast of Florida, Georgia and the Carolinas as well as the US territories of Puerto Rico, Guam, the Northern Mariana Island, the US Virgin Islands and American Samoa.

    Any remaining hurdles?

    The bill has to pass through the House of Representatives, though many view this as a formality.

    While there are now greater incentives for clean energy, the Supreme Court ruling against the Environmental Protection Agency in June, which stated the EPA is not allowed to regulate CO2 emissions from the US power grid without Congressional authorisation, will potentially limit the government’s powers to set more stringent regulation in the future.

    The ruling will not reverse the current trajectory, but it could still impact the speed of the US energy transition by influencing state lawmakers’ appetite to create specific renewables-friendly laws.

    However, it is worth noting that the ruling is does not impact pre-existing plans by certain utilities to transition away from coal due to already heavy investment in renewables and battery storage. New solar and wind capacity in the US has a lower cost of energy than gas or coal.

    The passing of the bill could have a positive effect on global climate action, by restoring the US as a credible international partner on fighting climate change as the world gears up for COP27 later this year.

    From an investor perspective, the US news, alongside Australia recently passing a bill to reduce the country’s emissions by 43% on 2005 levels by 2030 and India’s cabinet approving the country’s updated NDC, could result in significant further opportunities for clean energy investment not just in the US, but further afield.

    [1] We explore the relationship between inflation and different energy sources in ‘Greenflation’ – Navigating the climate policy, oil price and inflation nexus

    Disclaimer

    Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

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