Energy policy is gathering momentum around the world. A series of major policy initiatives in the US are prompting European leaders to consider their own regulatory initiatives, with both regions looking to loosen China’s current grip on many key components of the renewable energy ecosystem. Here we break down the key implications of recent policy developments and investigate how this is impacting opportunities across different markets.
What is the Inflation Reduction Act?
The US Inflation Reduction Act (IRA) is the largest clean energy package in US history. Signed into law in August 2022, the bill includes more than USD 350 billion of climate-related spending – alongside other measures to lower healthcare costs and improve taxpayer compliance. The IRA is the third in a series of US policy initiatives that aim to overhaul the energy landscape, alongside the 2022 CHIPS1 and Science Act (which aims to strengthen clean energy research and domestic semiconductor production) and the 2021 Infrastructure Investment and Jobs Act (which is more focused on the infrastructure required for a shifting energy mix).
The clean energy sector will receive the largest amount of IRA-related spending, but substantial funds are allocated across a range of different themes.
IRA spending breakdown by sector
USD billions
Source: Inflation Reduction Act of 2022: Provisions Related to Climate Change (R47262), J.P. Morgan Asset Management. Chart reflects analysis of new appropriations and the extension, modification or creation of tax credits relating to climate change in the Inflation Reduction Act. *CCS is carbon capture and storage. Data as of March 2023.
How will the IRA really work?
Almost three quarters of the IRA’s climate investments will be delivered via tax incentives. For example, households can claim tax credits of up to USD 1,200 per year to recoup the cost of home improvements that increase energy efficiency, or up to USD 7,500 in tax credits against the purchase of qualifying new electric vehicles.
Selected examples of tax credits in the IRA
Source: Inflation Reduction Act of 2022, J.P. Morgan Asset Management. Specific criteria apply for each tax credit. For illustrative purposes only. Data as of March 2023.
For corporates, examples include credits that can be offset against new investments into solar and wind power, or incentives that aim to increase the affordability of sustainable fuels, such as clean hydrogen and sustainable aviation fuels. Rather than the US government going “all in” on one technology, incentives are available across multiple industries. Many of the tax credits are structured to provide a lower “base credit”, and then a “bonus rate” that is five times higher if targets are met in areas such as fair wages and apprenticeship schemes. Another feature that makes the tax credits especially attractive is that many of them are “transferable”, which allows businesses whose tax credits exceed their tax liabilities to sell those tax credits onto another taxpayer. This frees up capital for further investment more quickly than if a business had to wait to accrue tax liabilities in future years.
Will the IRA achieve its intended impact?
The IRA significantly increases the likelihood that the US will achieve its climate targets of a 50%-52% reduction in greenhouse gas (GHG) emissions by 2030, relative to 2005 levels. Estimates from the Rhodium Group indicate that the IRA could reduce GHG emissions in the US by an additional 440 million-660 million metric tons in 2030 beyond what’s projected without the bill. This increase would be equivalent to closing as much as 50% of the gap between the current US emissions trajectory and the 2030 target. Much of this reduction is thanks to a significant increase in the share of clean electricity.
Projected clean energy share in the US by 2030
% total generation
Source: BloombergNEF, National Renewable Energy Laboratory, Rhodium Group, J.P. Morgan Asset Management. The emissions scenarios reflect uncertainty around future fossil fuel prices, clean technology costs, and economic growth, detailed in the Rhodium Group's Taking Stock 2022 report. For example, the low scenario assumes low clean energy technology prices, higher oil and gas prices, while the high scenario assumes higher clean technology prices, lower oil and gas prices, and a higher economic growth rate. Data as of March 2023.
With a wide range of ‘climate tech’ innovations not yet available in a mass-market setting, policy support can make new technologies commercially viable while they are still building critical scale and create new investment opportunities.
How is the IRA encouraging policy change in other parts of the world?
The generous incentives provided by the IRA have led to concern from policymakers in other regions that companies may be tempted away from domestic markets, with the European Union (EU) feeling particular pressure to respond. In short, this tension is centred around a fundamental difference in approach: is it better to make bad climate behaviour more expensive, or to make good behaviour cheaper?
Historically, the EU’s preferred approach to climate policy has been centred around regulatory “sticks”, such as carbon pricing mechanisms. With the US now providing plenty of regulatory “carrots”, such as tax credits, a change of heart is underway in Brussels. In February 2023, the European Commission announced a new “Green Deal Industrial Plan” (EU GDIP), which is based on four key themes:
Simplifying the regulatory environment
Accelerating access to funding
Developing skills in strategic industries
Strengthening supply chains
Rather than allocating new resources, funding will be drawn from existing pots of money, such as the post-Covid Recovery Fund and the REPowerEU plan that aimed to rapidly reduce dependence on Russian fossil fuels following the Ukraine war. The total funding available amounts to just over 1% of GDP according to European Commission data (as at March 2023), which is not too far from the roughly 1.5% of GDP that the US is allocating via the IRA.
The primary implementation tool will be a relaxation in state aid rules, allowing national governments to provide more direct assistance to green manufacturing industries. Historically, this type of direct support was often seen as counter to the EU’s desire to maintain solidarity within the bloc. Given the current lead time on many renewables projects, one particularly interesting development is the new commitment to fast-track permissions for solar and wind projects within the Net-Zero Industry Act, an element of the GDIP. The main challenge to date, however, is that actionable policy details remain light, with concrete action unlikely until summer 2023 at the very earliest.
Permitting process duration for wind and solar projects
Source: Fachagentur Windenergie an Land, McKinsey & Company, Wind Europe, J.P. Morgan Asset Management. Data as of October 2022.
How are new climate policies impacting investment opportunities?
Whichever side of the Atlantic investors are focused, we see this latest wave of climate spending making an impact across a range of different sectors and asset classes. In order to gauge the impact on portfolios, we asked a group of our investors for their views.
Tanya Barnes, portfolio manager, Private Capital Group
Climate solutions that promote onshoring of manufacturing – especially in the energy, battery and automotive sectors – or provide related enabling technologies will likely be immediate beneficiaries from the IRA and EU GDIP. The IRA also earmarks over USD 135 billion in funding for sectors that demand the greatest share of global GHG emissions, namely transportation, industrials & manufacturing, food & agriculture, and real estate. We believe this funding will stimulate investments in sustainable fuel and vehicles, resource-efficient manufacturing, climate-smart agriculture, and building electrification.
On the supply side, the extension of tax credits for community solar projects is particularly interesting. We are awaiting additional detail on the tax credit allocation process and eligibility from the Treasury. Market participants expected guidance in February, but the release from Treasury was not detailed enough to enable investment decisions. We expect project delays in 2023 as a result of the lack of clarity. If clearer guidance is issued soon and the impact of the IRA is fully realised, we believe that community solar capacity could more than double, with over 11.5 gigawatts installed by 2027.
We expect the EU GDIP to similarly drive investments in both energy supply infrastructure and demand-side technologies, particularly those enabling home and vehicle electrification, and decarbonisation of heavy industry.
Francesco Conte and Sara Bellenda, portfolio managers, International Equity Group
The IRA will lead to opportunities across a broad range of climate change solutions. We’re focused on three key areas.
First, the IRA aims to accelerate the transition to clean energy while also re-shoring renewable technologies. This directly benefits clean energy providers, and we have investments in companies providing solutions such as heat pumps and batteries.
Second, producers of electrification equipment will benefit not only directly via subsidies, but also indirectly from the additional need for electrification infrastructure given the push towards renewables and energy efficiency.
The third focus is new technology. According to data published by the International Energy Agency in October 2022, producing green hydrogen using renewable energy costs between USD 3 and USD 8 per kilogramme (kg), compared to only USD 0.5 – USD 1.7 per kg when using natural gas. Through the IRA, clean hydrogen plants can receive a tax credit of up to USD 3 per kg, encouraging more investment which can hopefully reduce future costs. Our investments in new technologies are currently modest but could become more meaningful if subsidies for areas such as carbon capture and hydrogen materialise.
Ed Fitzpatrick, portfolio manager, Global Fixed Income, Currencies and Commodities Group
Since the Biden administration took office, there has been an effort within the US Treasury to develop a sustainable financing programme. With the passage of the IRA, the US Treasury will be able to specifically link green projects to funding needs and issue green bonds if it chooses.
While there has been no indication of intent to issue green bonds so far, the US Treasury’s foray into this space would be a tremendous benefit to the development of the market, adding further diversification within the US dollar universe. Additionally, it would allow the green bond market to more closely resemble traditional high-quality diversified fixed income universes that are more familiar to the industry and investors.
Danielle Hines, portfolio manager, US Equity Group
We think that the investment opportunity lies not only in the companies that are directly exposed to the provisions in the IRA, but also the companies that are indirectly exposed through leverage to the broader value chain. For example, increased incentives for electric vehicles will not only benefit the vehicle manufacturers themselves – grid infrastructure will be required to handle increased load, semiconductors are necessary to enable the innovation, and renewable generation is required to service demand. The same indirect benefits will likely play out across other areas, such as hydrogen. We believe the IRA will help all the impacted sectors to become much more dynamic in the years to come.
We see particular potential within the utilities sector given how the IRA will drive longer duration of growth for companies in this space. In practical terms, the bill gives greater visibility on more than two decades of renewable tax credits. The IRA’s new opportunity set now also includes upgrades of existing renewable plants and collocating standalone energy storage projects on the current footprint of energy sites.
1 CHIPS stands for “Creating Helpful Incentives to Produce Semiconductors”.
Sustainable Investing Insights Webinar: Policy tailwinds for climate innovation
The momentum behind climate-focused policy across the globe is accelerating following the introduction of the US Inflation Reduction Act. In the first episode of our Sustainable Investing Insights series, Hugh Gimber is joined by Francesco Conte, co-manager of the Climate Change Solutions strategy, to discuss the latest global policy developments, the potential influence they could have on markets, and the opportunities being created for investors.
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