“For a while, people doubted whether any of that was going to happen,” President Joe Biden remarked in August at the signing of the Inflation Reduction Act, a statement that best sums up the bill’s journey through the legislative process.
Upon its signing, however, it became the most significant piece of climate action by Congress, allocating $385 billion towards energy and climate spending, which could reduce US emissions by 40 percent below 2005 levels by 2030.
Together with the $1.2 trillion Bipartisan Infrastructure Law, also known as the Infrastructure Investment and Jobs Act, it caps off a year that saw doubts as to whether these two critical bills would pass or if the US would remain stuck on fossil fuels, in the slow lane of developed countries on transport and underserved in broadband.
Government spending surely won’t be the only solution to fixing the nation’s infrastructure, especially considering the original ambitions of both bills. When Biden first unveiled his infrastructure framework in March 2021, it was a $2 trillion investment bill. And when the Build Back Better plan was initially presented as a $2.2 trillion spending bill, it was later slimmed down to the $737 billion IRA. Such gaps in financing leave significant holes for the private sector to fill, but how much do the bills allow for the private sector to do so?
While there was $65 billion in the IIJA for what the White House described as “power infrastructure”, it was the IRA that renewable energy investors were really pinning their hopes on, so the surprise agreement reached in August between West Virginia Senator Joe Manchin and New York Senator Chuck Schumer was a boon to the industry.
“The IIJA was not specifically targeted at the renewable and energy transition sectors, but the IRA’s impact on them has been dramatic,” says Doug Kimmelman, senior partner at fund manager Energy Capital Partners. “The IRA has driven many uneconomic projects across renewables, storage, carbon capture, hydrogen, renewable fuels and energy efficiency to become economic. [It’s] a real positive shock to the system across these sectors.”
Mike Joyce, a partner at Vinson & Elkins specialising in energy transition projects, is equally effusive: “Pretty much all I’ve done for the last month is calls on the IRA – it’s a very impactful piece of legislation. This is one of the few times, as someone who’s worked in this industry for 20 years, that the government really understood where the pinch points were – putting aside abandoning the transmission credit, which was a terrible mistake.”
That is not the only nuance Joyce has to add: “The IRA is too new to see deals move because of it. However, we have started restructuring deals in its wake; we’re now thinking of taking advantage of the production tax credit versus the investment tax credit for solar transactions, for example.”
Those tax credits were the critical components of the bill that investors were holding out for. The tax credits for wind and solar have been in force since the mid-2000s, but have been the subject of constant uncertainty since, regularly renewed for short periods of time and subject to the short-termism that is anathema to an infrastructure investor.
However, the IRA renewed the credits for another 10 years and stipulated that they will only be phased out once greenhouse gas emissions from the electric generation industry are reduced by at least 75 percent of the annual 2022 emission rate. “One of the challenges with tax credits historically has been the uncertainty on what will be extended or not extended and for how long,” says Keith Derman, partner and co-head of infrastructure at Ares Management. “The IRA’s extension of these tax credits to 10 years is very meaningful. There are other changes to some of the tax rules – for example, solar now can utilise the production tax credits, which is, generally speaking, more valuable to the owner [than investment tax credits].”
If the ITC and PTC extensions were a firmer continuation of what existed before, the IRA also introduced for the first time ITCs for standalone battery storage projects, crediting up to 30 percent of investment costs. Storage was previously only eligible for credits when co-located with solar power projects.
As a result, Joyce believes standalone storage will be the biggest winner of the bill: “Standalone storage finally has a rational credit regime. We’re now starting to see a lot of those projects move forward with fewer questions.”
Indeed, the tax credit provisions relating to storage are nothing short of revolutionary, ECP’s Kimmelman explains. ECP, he says, is the largest owner of storage in the US, having owned, operated and developed about 5GW.
“[Before this bill], storage had no tax credit. Projects were getting done, but only in places of really high electricity costs, like California,” he says. “Now, other places will be able to justify building storage because of this new tax benefit, so it is accelerating investment activity, no doubt. These new tax credits for storage now make it much more economic to add battery storage to solar projects that can turn them from perhaps six-hour providers of electricity to 10 hours per day.”
Ethan Levine, head of real assets and sustainability at Commonfund, highlights the versatility and wider-ranging impacts of the tax credit extensions and introductions: “The continuation of the PTCs and the ITCs, and the flexibility of going between the two, and the certainty that wind and solar developers will have them for the foreseeable future, is going to make both these established industries and nascent industries like CCS and hydrogen cost competitive.”
All of this being said, some will argue that having benefited from such subsidies for years now, the extensions of the PTCs and ITCs for wind and solar merely keep an industry hooked on such schemes. Many investors in the European renewables market, where subsidies have been rolled back over the past several years, say the market is now better off as a result.
Derman is aware of critiques but disagrees that it’s time to let go just yet.
“There is a school of thought that wind and solar are already the cheapest forms of power generation, and they’ve already won the battle against fossil fuels, so giving out tax benefits to monetise the sector through tax equity is in some ways a barrier to entry and that it is possible that the industry, in the long run, might be better off without them.
“I understand their view but do not share that position because this subsidy gives renewables further economic benefit over other competing forms of generation. A bigger advantage and better economics means more projects, more green electrons and more rapid decarbonisation.”
Joyce, on the other hand, downplays the impact the tax credits will have on solar and wind at all. “The true impact of the IRA is likely more to be on the hydrogen and carbon sequestration side of things in terms of getting some projects off the ground that really wouldn’t have happened without legislation. The solar and wind stuff was happening anyway and would have continued to happen.”
Transfixed on transferability
Perhaps one of the most consequential measures in the bill is the transferability of these tax credits in the tax equity market, which has long been a critical component in the financing of US renewable energy projects. Indeed, the renewable energy tax equity market – valued by Norton Rose Fulbright to be between $17 billion and $18 billion in 2020 – has historically been dominated by JPMorgan and Bank of America, but has recently seen the introduction of ESG-hungry corporates, too. The market was expected to hit $20 billion in 2021 before supply-chain difficulties began impacting projects attempting to reach financial close.
The model, though, has been criticised for over-complicating transactions and limiting the number of players in the market. In the IRA, Congress has appeared to sidestep the tax equity industry by allowing the tax credits to be sold for cash.
More than over-complicating, Derman believes the model has “been one of the big constraints in renewables growth”.
“Now that big financial institutions will take interest in these projects in exchange for the tax benefits, this creates an opportunity for more institutions to come in, smaller ones or maybe ones that have less predictable earnings,” he explains.
Kimmelman is similarly pleased with the transferability provisions, but with a dose of scepticism: “With regards to the new transferability of tax credits for renewable and storage projects, it will be interesting to see if a streamlined market develops where the credits can be readily transferred and sold with hopefully a very small discount to their face value. There certainly will be plenty of sellers and the question will be how deep of a buyer’s market will develop.
“Let’s see how this plays out with renewable tax credits and storage tax credits. Let’s see if a very streamlined marketplace develops where one can readily sell this. We know there’s going to be a lot of sellers. Are there going to be buyers? And is it going to be done with a very low discount?”
It could also be a boon to those on the debt side, with Will Marder, head of project finance at Wilmington Trust, believing the new measure to be a “game changer”.
“The ability for project owners to sell tax credits now is something people have wanted for decades,” says Marder. “We’ve always had these convoluted and complicated structures where developers effectively had to bring in equity partners to monetise those tax credits, so now the ability to sell credits is a huge game changer.
“It creates an opportunity for project owners to raise more debt and a more flexible source of capital. Certainly, for some of the smaller developers, there may be a continuing need for tax equity to monetise the depreciation benefits, which can be significant.”
Much of the IRA rests on keeping things safe. As noted, one of the best qualities of the wind and solar tax credit extensions are based on the certainty they provide, as well as additional tax credits to nuclear in a bid to reliably keep the lights on.
However, one of the more significant bets in the bill is the $13 billion reserved in tax credits for hydrogen development. More specifically, this forms a 10-year tax credit from 2023 and pays up to $3/kg, depending on the amount of CO2 reduced by each project. It represents a major move towards clean hydrogen development, in addition to the $8 billion from the Department of Energy through the IIJA to create four regional hydrogen hubs, for which a funding opportunity announcement is expected this month.
This major programme from the IIJA and the acceleration of attention more generally meant interest was already piqued among institutional investors before passage of the IRA, according to Tim Chandler, an energy partner at law firm Sidley.
“We’re working on projects and none of them have counted on IRA credits,” he says. “[The credits are] widening the margin of safety, so if something goes wrong, they won’t tip over instantly.
“When developers go out to build projects, they have to have the stars aligned for them to put a project that’s economical. They have to have good offtake, good availability of electricity, good sourcing of natural gas. They have to have all of those things come together and if they don’t, the project isn’t viable. There are other projects that weren’t viable before these but they were close, and with these extra tax credits it’s less expensive and the spreadsheet turns from red to black.”
One project that closed before the IRA’s passage was the Advanced Clean Energy Storage site, a first-of-its-kind hydrogen production and storage facility funded by Haddington Ventures, GIC, Manulife, AIMCo and OTPP, and which received a $504.4 million loan guarantee in June from the DOE – the department’s first loan guarantee for a new clean energy technology project from the department’s Loan Programs Office since 2014.
Chandler was part of the Sidley team that advised the investor group in that deal and sees replicability for the future: “Every one of these projects you will see is going to go for those kinds of loans. It’s almost the exact same story for every single one of those projects. You get the loans, the credits, here’s our economic model. It makes sense because of these things.”
Chandler’s optimism is only outdone by that of S&P Global Ratings, which in an analysis of the IRA, described the production tax credit for hydrogen as “perhaps the most significant provision of the act”, accelerating its economic competitiveness by a decade. Depending on its progress, it could complement or even compete with batteries as the primary clean energy storage vehicle, writes S&P.
Back to basics
For all the excitement of new hydrogen and storage measures, the US renewables market has long been hampered by a sub-standard grid transmission system to deliver the clean power generated. With more than 70 percent of US transmission lines 25 years old or more, and not built for the wave of renewable power, it was time for an upgrade. The IIJA, at least in principle, delivered, allocating large pots of funding for grid improvements and resiliency.
This culminated at the end of August, with one of the largest announcements to date from the IIJA in the form of a request for information on the $10.5 billion Grid Resilience and Innovation Partnership Program. This comprises Grid Resilience Grants ($2.5 billion), which are designed to proof against extreme weather events; Smart Grid Grants ($3 billion), which will focus on increasing capacity of the transmission system; and the Grid Innovation Program ($5 billion), promoting partnership between the public and wider electricity sector to find innovative approaches to transmission, storage and distribution infrastructure. That’s plenty of appetite from the public sector and the RFI details that the DOE is “looking for proposals that will leverage private sector and non-federal public capital to advance deployment goals”.
“The transmission-related provisions of the IIJA and IRA provide additional tailwinds to an environment already calling out for new investments,” says Maxwell Multer, counsel at law firm Bryan Cave Leighton Paisner, who was also general attorney at the Federal Energy Regulatory Commission from 2016 to 2020. “How strong those tailwinds are remains to be seen but the possibilities are there. FERC and DOE appear to be making transmission a priority, which is good news for investors.”
Where the DOE’s partnership with the private sector might come particularly to the fore is the Transmission Facilitation Program, a $2.5 billion scheme announced in May that will see the DOE provide loans, participate in PPPs and engage in capacity contracts with eligible projects where DOE would serve as an anchor customer, contracting for up to 50 percent of the maximum capacity of the transmission line for up to 40 years.
“Given the regulatory hurdles and interconnection processes, it can be difficult to enter into the kind of commitments needed to put things forward,” says Multer. “The size of [the TFP] could be a limitation on the usefulness of this programme; $2.5 billion could go quite quickly when we’re talking about the development of high voltage transmission infrastructure.”
Multer’s TFP concern, alongside the fact there were few provisions for transmission improvements in the IRA, has some feeling worried.
“You can build as much electric generation in the states as you want,” says Joyce. “If you can’t move it freely, then what have you really accomplished in terms of grid stability and pricing stability?
“That’s where I think people are going to look back in a couple of years and have some frustration with this legislation. We did a really great job of helping build out the generation side. But frankly, if you don’t do at least as much with or more with transmission, you’re actually just creating a constraint and worsening the market because you now have more generation dumping into a constrained environment. It’s going to be interesting.”
Crucially, though, federal dollars will only be part of the solution, with sources pointing to transmission and interconnection bottlenecks needing to be solved at the state and local level. One of the more recent private investors in this space was InfraRed Capital Partners, which in August bought, via its UK-listed vehicle HICL, a 45 percent stake in Cross Texas Transmission, a regulated electric transmission utility in Texas, and an indirect stake in Nevada Transmission Line, a 231-mile 500kV electric transmission line in Nevada.
“In both Texas and Nevada, there are constructive regulatory environments that support new investments in order to supply reliable low-cost energy,” says Edward Hunt, head of core income funds at InfraRed.
That may be true, but, as Multer suggests, it also points to a chicken and egg situation for the growth of renewables; can the buildout happen sufficiently through support from the IRA while the IIJA upgrades the grid? With the building blocks legislatively laid, the next few years will be pivotal.