By
Nick Hedley
The Inflation
Reduction Act, which rose from the ashes in recent weeks, will accelerate the
transition to a more sustainable economy – and institutional investors should
position themselves accordingly, allocators, researchers and scientists say.
The bill includes
$369 billion in spending on climate and clean energy programs, alongside
measures to reduce healthcare costs for consumers and boost corporate income
tax collections. After being unexpectedly revived, it advanced through the
Senate and the House before being signed into law by President Joe Biden.
While it is a
watered-down version of the package initially proposed by Democrats, and
includes compromises allowing new gas pipelines and other fossil fuel
infrastructure, climatologist Michael E. Mann says it is “the most aggressive
climate investment ever taken by Congress – this is a big deal.”
Estimates by research
firm Rhodium Group show that the legislation will cut U.S. greenhouse gas
emissions by around 40% by 2030, compared to 2005 levels. That compares to a
24% to 35% reduction under current policy.
Clean energy will
rise from 40% of the electricity mix in 2021 to a 60-81% share in 2030, while
industrial emissions will “turn the corner” thanks partly to carbon capture
incentives, Rhodium Group says. And tax incentives will see electric vehicles
accounting for 19-57%
of all vehicle sales by the end of the
decade.
“It’s a critical
step forward in tackling the climate crisis, but not yet quite enough – we need
at least a 50% reduction by 2030 to be on a path to avoiding dangerous 3°F
planetary warming,” Mann, director of the Earth System Science Center at
Pennsylvania State University, tells Markets Group.
Risks and Opportunities
First, the act
raises the risk that coal, oil and gas companies will have to write down the
value of their assets, and that some of their projects will become completely “stranded”
as demand declines, says Vivian Claire Liew, an adviser to sovereign wealth
funds and the founding CEO of PhilanthropyWorks.
“The U.S.’s
grit in strategizing and realizing this Hail Mary act confirms the global
commitment to decarbonization, and also encourages or pressures other countries
to substantiate and elevate their climate commitments,” Liew tells Markets
Group.
In addition to
dimming the outlook for fossil fuel investments, some groups have warned that the
legislation could weigh on shareholder returns more broadly.
In a letter to
members of the Senate, a coalition of 253 state and local chambers of commerce
and trade associations argued that the act would do little to fight inflation,
but would discourage investment, undermine economic growth and harm investors.
In particular,
the coalition believes the plan to enforce a 1% excise tax on stock buybacks
“would only distort the efficient movement of capital to where it can be put to
best use and diminish the value of Americans’ retirement savings.”
Others, however,
are bullish, arguing that the legislation will provide new opportunities to
invest in clean energy, electric vehicles, commodities, and mitigation
technologies – without closing favorable tax dispensations for private equity
firms.
If the bill is
passed into law, it will significantly enhance policy certainty, partly by extending
the tax incentives for green energy projects by at least a decade. This will
encourage institutional investors to invest further into the clean energy
transition, says Ben Squires, chief investment officer at Australian
fund NGS Super, which has about A$13 billion (US$9.2 billion) under
management.
“Taking a leap of
faith is not something that institutional investors like to do, so having a
clear policy direction will certainly help,” Squires tells Markets Group.
NGS Super recently
sold its holdings of oil and gas companies as part of its plans to reduce investment
risk and achieve a carbon-neutral portfolio by 2030.
The Inflation
Reduction Act, as well as firmer decarbonization commitments by the European
Union, China and Australia’s new government, will “increase the momentum” of
the clean energy transition, bringing risks and opportunities for investors,
Squires says.
Jon
Winkelried,
CEO of private equity firm TPG Capital, says the bill will likely spark “substantial
investment in climate-related technologies and solutions,” thereby creating
attractive opportunities.
TPG’s investments
in the climate space include Summit Carbon Solutions, which is developing one
of North America’s largest carbon capture and storage systems. Under the new
legislation, tax credits for these types of projects will be increased from $50
a ton to $85 a ton of CO2 captured and stored.
TPG co-founder
Jim Coulter says the act is unlike previous attempts at climate
mitigation, which focused on adding taxes to greenhouse gas emitters. “This
bill is almost 100% incentives… And obviously, that serves us well.”
An analysis by
Princeton University’s Jesse Jenkins and other researchers shows the
legislation will drive nearly $3.5 trillion in cumulative capital investment in
new energy supply infrastructure in the U.S. over the next decade.
“If that
investment is going to happen, you probably have to at least double your
money,” Coulter says. “That’s a very substantial potential profit pool for
investments, and that should open the aperture of deals that will make sense
for us given our high hurdle.”
The
legislation will also drive technological advancements that will be exported
elsewhere, creating new investment opportunities outside of the U.S., Coulter
adds.
Like other
private equity firms, TPG and many of its portfolio companies will be partly shielded
by the tax hikes put forward in the legislation.
To cover the
costs of the clean energy program while also reducing the budget deficit, the act
requires a minimum corporate tax rate of 15% for companies that generate more
than $1 billion in annual profits.
However, a clause
that would have closed the “carried interest loophole” was ultimately removed
from the bill before it advanced through the Senate and House. In effect, this
means that the minimum corporate tax rate will not be applicable to businesses
owned by private equity firms.
Meanwhile, Maria
Vassalou, co-CIO for multi-asset solutions at Goldman Sachs Asset
Management, says clean energy investments will likely boost future economic
growth “and may present attractive investment opportunities.”
However, the
transition will significantly alter the commodity landscape and increase the
importance of a handful of countries rich in copper, nickel and lithium, she
says.
While this
reliance on “green” metal producers – mainly in emerging markets – will bring
risks, BlackRock thinks it provides opportunities for investors in
commodities.
“Going green
and electrifying the power base will be incredibly metals intensive,” says Olivia
Markham, natural resources portfolio manager at BlackRock Fundamental Equity.
Thanks to
improved capital discipline in the sector, commodities companies could continue
to outperform on a relative basis, she says.
Alongside
providers of the required commodities, BlackRock says “already green” companies
and carbon-intensive firms with credible decarbonization plans are set to drive
portfolio returns going forward.
A New Energy Landscape
Looms
One of the emerging
technologies that is expected to gain further momentum thanks to the act is
green hydrogen, which is touted as a clean replacement for gas in heavy
industrial processes, heating and transport.
The analysis
by Princeton’s Jenkins, as part of the Repeat Project, says investments in
hydrogen production will likely increase to $3 billion annually by 2030 –
triple the levels under current policy – and to more than $50 billion by 2035.
According to
Bloomberg New Energy Finance, the production tax credits will immediately make green
hydrogen cost competitive versus traditional hydrogen-manufacturing
technologies, which rely on fossil fuels.
However, the
biggest investment boom, according to Repeat Project’s analysis, will be in
domestic solar PV and wind. These technologies are set to attract some $321
billion in funding in 2030, versus $177 billion under current policy.
Traditional fossil
energy companies will benefit as well, albeit not nearly as much.
The legislation
sets aside 2 million acres of federal land and 60 million acres of offshore blocks
each year for oil and gas development – a clause that has been met with much
criticism from climate activists and scientists.
Many others, however,
say it is a worthwhile compromise.
An analysis by
Energy Innovation, a nonpartisan energy and climate policy research house,
shows that for every ton of expected emissions from the bill’s fossil fuel
provisions, 24 tons of emissions reductions will be delivered.
Samantha
Gross, director of the Energy Security and Climate Initiative at Brookings
Institution, notes that the bill fights demand for fossil fuels via its clean
energy incentives for households, and this is the best way to lower emissions.
“The fossil
fuel demand reductions that the bill would bring about vastly outweigh the
provisions encouraging fossil fuel production, and the industry may never drill
much of the land that might be leased,” Gross says.
Moreover, gas
producers will need to take extra steps to prevent methane leaks, since the
bill includes a provision to charge, for the first time, methane emissions from
along the oil and gas industry’s value chain.
Repeat Project
estimates that the act will lead to a 13% decline in the use of petroleum fuel and
an 8% decline in gas use by 2030, compared to 2021 levels. This implies reduced
valuations for booked oil and gas reserves, and incrementally reduces the
incentive to invest in new production facilities, Jenkins says.
Mike Sommers,
president and CEO of the American Petroleum Institute, says while the
organization is encouraged that the act will likely open the door to more
federal onshore and offshore lease sales, and will expand and extend tax
credits for carbon capture, “we remain opposed to policies that raise taxes and
discourage investment in U.S. oil and natural gas.”
Given the
different interests at play, investors warn that the transition could bring
volatility.
Sally Auld, CIO at Melbourne-based private wealth
manager JBWere, recently told Markets Group that “there’s serious
capital that wants to be put to work” in the shift to a more sustainable
economy.
“But the
transition won’t be smooth – we left it too late and we’re now suffering the
consequences of a lack of investment. Volatility in energy prices of late is
testament to this,” Auld says.
Will the Legislation
Tame Inflation and Boost Growth?
According to a
Penn Wharton Budget Model (PWBM) study, the act will very slightly increase
inflation until 2024, and marginally decrease it thereafter.
The
Congressional Budget Office described the legislation’s estimated impact on
inflation in 2022 and 2023 as “negligible,” and Wells Fargo says it largely
agrees with this assessment, adding that it will not change its outlook for
inflation or monetary policy over the next 18 months.
Lundy Wright,
partner and portfolio manager at Weiss Multi-Strategy Advisers, says the act
was misleadingly named, given that it will do little to tackle inflation,
particularly in the near term.
“Still, since
a longer-term clean energy plan has been glaringly lacking from recent
policies, this element of the bill is a positive step, even if its immediate
impact is very low,” Wright tells Markets Group.
It is also
positive that Medicare will now be able to negotiate the prices of a handful of
prescription drugs. “This low-hanging fruit has been lobbied against forever,
so finally breaking through on this issue is a win for consumers,” he says,
adding that it will not result in significant losses for pharmaceutical
companies.
“For the time
being, the takeaway from this bill is some small steps in the right direction
of fairness, some momentum for the Democrats to have passed a spending bill,
plenty of suspect political talking points, and a lot of long-term hopes,”
Wright says.
However, the bipartisan
Committee for a Responsible Federal Budget argues that the act will do more to
tackle inflation than some believe. The deficit reductions will be steeper than
PWBM and others expect, while measures to reduce healthcare, electricity and
transport costs for households and businesses “will likely help combat
persistent inflation.”
According to
Repeat Project, the legislation will lower annual U.S. energy expenditure by at
least 4% in 2030 – a saving of nearly $50 billion per year for households,
businesses and industry. That excludes savings from lower oil and gas prices as
demand for fossil fuels recedes.
Rhodium Group’s
analysis suggests energy cost savings of $112 per household by 2030.
Moody’s
Analytics, meanwhile, says the legislation “will nudge the economy and
inflation in the right direction.”
The Inflation Reduction Act will provide
financial help to millions of lower-income and elderly Americans with their
health insurance premiums and prescription drug costs, the research firm says.
“It is also the first meaningful effort by the
federal government to address climate change and its long-run corrosive
economic effects. Moreover, all of this is more than paid for and will thus
reduce the government’s future budget deficits, which seems sure to soon become
a more pressing economic problem.
“While modest legislation, there is plenty to
like in the Inflation Reduction Act,” Moody’s Analytics says.
Rhodium Group says while the legislation alone
will not get the U.S. to its 2030 target of cutting emissions in half, it will
lower the costs associated with additional action.
“All eyes will now be on the Environmental
Protection Agency, the Department of Energy and other federal agencies as well
as states to push the next wave of policies that build on the act and get U.S.
emissions down to 50-52% below 2005 levels in 2030.”
Congress could also assist, particularly by promoting
policies where there has been recent bipartisan agreement, including in
electric power transmission, CO2 pipelines, and building energy efficiency, the
group adds.