Inflation Reduction Act (IRA) of 2022
On 17 August, US President Joe Biden signed the IRA into law, marking a major turning point in US climate policy. The Bill will fund the US clean energy sector with at least $369bn, providing a strong boost to renewable energy, and electric vehicles specifically.
The Joint Committee on Taxation estimates the tax credits dedicated to decarbonising power at $195bn through wind, solar, storage and nuclear technologies. The 12-year visibility for wind, solar and storage will trigger a strong wave of investment in the sector, likely resulting in 2-4 times higher capacity additions compared to prior assumptions. This will be complemented by incentivising domestic manufacturing ($37bn for wind, solar and batteries), benefitting both US manufacturers and project developers, helping to lower contracted electricity prices.
The Electric Vehicle Tax Credit extends the maximum $7,500 credit to 2032 while removing the cap of 200,000 units that was in place. Although the credit conditions are stricter, requiring North American assembly of batteries or free-trade country provenance for battery materials (which will force manufacturers to rethink their operations), it is expected to help the US in closing part of the gap to Europe or China who have experienced an electric vehicle penetration rate 3-4 times higher than in the US. Also, a new credit will help lower-income households access the electric vehicle second-hand market, and commercial vehicles should also see a boost in adoption with the new maximum credit of $40,000 (for trucks over 14,000lbs).
In addition to the domestic manufacturing incentives in the Electric Vehicle Tax Credit, the Bill will also support the battery supply chain in the US through several tax incentives, including a $35/kWh production credit for battery cells and a $10/kWh credit for battery modules. These credits would represent a 20-30%* reduction in domestic battery production costs from the global average $132/kWh in 2021**. Battery as a means of energy storage stands out as a clear beneficiary as standalone energy storage will be eligible for investment tax credit of 30% whereas previously, only batteries charged by solar panels were eligible for the credit, which greatly limited battery’s market potential.
Green hydrogen will also see a significant boost in the US through the new maximum $3/kg tax credit. This is expected to make green hydrogen fully price competitive with grey hydrogen (currently the standard method of producing hydrogen, from methane), with its after-tax costs likely approaching zero by the end of the decade as production costs will continue to decline through volume leverage efficiencies.
In addition, the Bill also includes more generous tax credits for carbon capture and storage and tightens regulations around methane emissions.
Note: Other parts of the IRA (non-clean energy) also present major changes for US legislation, including the new 15% minimal corporate tax rate and the 1% buyback excise tax, the Prescription Drug Pricing Reform and Affordable Care Act Extension.
https://www.democrats.senate.gov/inflation-reduction-act-of-2022.
Source: Forecasts contained herein are for illustrative purposes only and does not constitute advice or a recommendation. 1. Joint Tax Committee estimate, 2. Bloomberg NEF, US Climate Bill Changes the Game for Two Key Sectors, 8 August 2022, 3. https://repeatproject.org/docs/REPEAT_IRA_Prelminary_Report_2022-08-12.pdf
Investment cluster outlook
Clean power generation
The promising prospects for clean power generation have been further helped by geopolitical events in Europe and new legislation in the US. The Russian war in Ukraine and the use of gas supply as a political weapon have created a new sense of urgency in the need to implement the decarbonisation of European energy systems. While in the short term there will be a resurgence of traditional existing sources (coal; nuclear), the European Union has taken a strong stance towards using renewables’ deployment as a key replacement for Russian gas. The existing REPowerEU plan has seen its target expanded and given shorter timelines and is now mainly dedicated to counteracting the disruptions caused by Russia. It focuses on diversifying supplies, saving energy and accelerating clean energy developments.
These European and American (see above for more on the Inflation Reduction Act) programmes should unleash several trillion dollars in cumulative investments in renewable development over the coming decade. This growth in the sector will be further supported by the continued decline in costs due to higher efficiencies and technological developments.
Energy conversion and storage
We continue to maintain meaningful investments in the power conversion segment as we consider the power semiconductor companies to be the essential enablers of the energy transition and electrification trends. Substantial growth drivers for them include the further build-out of solar and wind including its integration into the grid, electric vehicles and all the applications in the energy efficiency segments. During the past few months, we have seen an acceleration in the transition from conventional silicon power semiconductors to next-generation compound semiconductor materials such as silicon carbide and gallium nitride, which offer significantly higher energy efficiency, reducing losses in power conversion. The main growth driver is a faster than previously expected adaption of silicon carbide-based power semiconductors in electric vehicle powertrains, enabling longer driving ranges. First movers among the makers of electric vehicles applying the highly-efficient silicon carbide technology are Tesla, Hyundai and Lucid as well as the Chinese firms BYD, NIO and XPeng. The leading producers of premium-priced silicon carbide chips such as ON Semiconductor and STMicroelectronics now target reaching $1bn-related sales each in 2023, earlier than previously planned, providing structural resilience against the macroeconomic environment.
The storage sector will be supported by the continued trend of the electrification of transport and by the above-mentioned support for battery development in the US through the IRA. The growth in solar and wind generation will also further drive demand for battery energy storage systems. Energy storage is a key part of the energy system as it not only helps balance the variability in renewable power generation but also enables the consumption of self-generated renewable power by consumers and reduces the need to feed excess electricity back into the grid. While the demand for such grid-scale and distributed energy storage (residential and commercial) are increasing, they make up a smaller part of the total battery market today, where those for electric vehicles dominate. The burgeoning demand for electric vehicle batteries has limited production capacity for the grid-scale and distributed storage users. During the past few months, we have seen battery manufacturers expanding capacity in order to meet soaring demand, with automakers increasingly seeking partnerships in order to secure supply in a tight market environment.
Energy transmission and distribution
The power grid and electric equipment segment remains another important building block for the energy transition and we expect the sector to continue to see substantial growth supported by the needed build-out of the grid to enable the integration of renewables and increasing electrification. The hydrogen sector, a solution for decarbonising hard to electrify sectors, is expected to see a massive surge in investment as it is supported by the recent European and American regulations. REPowerEU now plans for 20 million tons of green hydrogen by 2030 while the IRA’s new production tax credit will make green hydrogen cost competitive with grey hydrogen (the current method of producing hydrogen from natural gas).
Energy efficiency
The ‘energy efficiency’ cluster is the largest in number of stocks as it covers many end-markets. Energy efficiency is often the cheapest, safest and cleanest way to reduce energy use and emissions. It is therefore a topic that is supported by both the regulatory framework and the pure economic attractiveness of the solutions it represents.
Energy efficiency is often the cheapest, safest and cleanest way to reduce energy use and emissions. It is therefore a topic that is supported by both the regulatory framework and the pure economic attractiveness of the solutions it represents.
With big data, the needs for energy efficiency are structural (keeping size and temperature in data centres at levels that allow competitive scale-up) as well as environmental (the use of data will continue to rise quickly and we need to foster technologies that minimise its impact). Buildings are the largest users of energy, mostly through temperature control, and energy-efficient heating and cooling solutions are an essential part of a decarbonised future.
Energy efficient industrial processes are key to lowering the manufacturing footprint from the design phase to logistics. Finally, higher energy efficiency in transportation (the second largest energy-using sector and the fastest growing) can be achieved through electrification, either direct or through the use of hydrogen.
* Polar Capital estimates.
** BNEF. It should not be assumed that recommendations made in future will be profitable or will equal performance of the securities in this document. A list of all recommendations made within the immediately preceding 12 months is available upon request. Past performance is not a reliable indicator of future returns. The money invested in a fund can increase and decrease in value and past performance is not a reliable indicator that you will get back the full amount invested. All opinions and estimates constitute the best judgment of Polar Capital as of the date hereof, but are subject to change without notice, and do not necessarily represent the views of Polar Capital and may not be achieved.
