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Analysis: Impact investors cheer Biden’s Inflation Reduction Act

Published: 23 August 2022

The Inflation Reduction Act is unlikely to reduce inflation but it has been hailed as the most significant piece of climate change legislation passed into law by the US Congress

US President Joe Biden signs the Inflation Reduction Act of 2022 into law during a ceremony at the White House in Washington, DC, on 16 August 2022 | MANDEL NGAN / AFP

In brief

  • The new Inflation Reduction Act is highly unlikely to have any impact on inflation. However it does give back leadership on climate change to the US, something that was much needed
  • The US Impacting Investing Alliance hailed it as “the most significant piece of climate change legislation passed into law by the U.S. Congress to date”
  • There are real impacts in the crucial area of power generation, and it will likely lead to a surge in green funds
  • Other impacts are smaller, and some areas have been largely left out. There is also a real risk a Republican victory in November’s congressional elections would see the Act repealed

The first thing to say about the Inflation Reduction Act (IRA) is that it is completely misnamed. This continues a worrying trend towards Orwellian language in US politics, building on last year’s Infrastructure Bill which only partially addressed infrastructure. One commentator quipped the next bill will be an “Act for Eternal Happiness”.

Previous government spending is what triggered inflation – it was already at 7.9% when Russia invaded Ukraine. Spending more money now doesn’t seem to be the best way out of this crisis, many would argue.

Indeed, analysis by the University of Pennsylvania suggests the Act would actually increase inflation until 2024, and decrease it thereafter. But “these point estimates are statistically indistinguishable from zero, thereby indicating low confidence that the legislation will have any impact on inflation”.

Even that may be optimistic. A large part of the inflation reduction argument is based on reduced energy consumption by households, as tax incentives of up to $7500 lead them to switch to electric cars. Unfortunately, as reported by several media outlets, electric car manufacturers including Ford, General Motors and Tesla, have recently announced price hikes.

US is back fighting climate change

Still, as Gregga Baxter, general manager at Gulf International Bank New York points out, while it won’t reduce inflation what the Act can do is “to change the perception of the United States as a laggard when it comes to tackling climate change”.

This was much needed after the recent Supreme Court ruling limiting the EPA’s climate change fight. “This is good news”, says Andrew Pitts-Tucker, managing director at Apex ESG ratings tells Impact Investor. “The US is back on track and can once more offer global leadership on fighting climate change.”

Indeed, the US Impacting Investing Alliance hailed it as “the most significant piece of climate change legislation passed into law by the U.S. Congress to date”. The Alliance was “particularly encouraged to see inclusion of a $27 billion “green bank” facility to help finance clean energy projects, within the $370 billion dedicated to climate programs”.

Sarah Gordon, CEO, Impact Investing Institute, says: “Our view is that private capital can and must work together with public policy and public capital to achieve a just transition to net zero. This bill provides concrete steps towards this happening at much greater scale than has been achievable so far.”

‘Game changing’

$370bn is certainly a big number and, in their detailed analysis, the Rhodium Group (RHG) estimates a reduction in US emissions of between 32 and 42% by 2030. “The package of new grant and loan programs, tax credits and emissions fees touches nearly every corner of the US economy and will make meaningful progress toward decarbonizing the US energy system,” the analysis says.

Their analysis shows the biggest contribution comes from the power sector. Under current policy there was already a reduction in emissions forecast in RHG’s central case – from 1551mmt (net million metric tonnes) of CO2, to 980mmt by 2030 (see chart below). But now, post the IRA, their central case is that this will fall to 485mmt. A truly massive reduction.

US greenhouse gas emissions by sector | Rhodium Group

This has big implications for investors. For Pitts-Tucker, “this bill is all about encouraging the flow of money towards areas that are important for energy transition.”

And it is certainly doing that. In their analysis, Deidre Cooper and Graeme Baker at investment manager Ninety One say the act is “game changing”, citing a total of $260bn being allocated to energy transition – with wind, solar and storage investment tax credits (ITCs) of some $128bn – compared to “only” $80bn in the Bipartisan Infrastructure Law.

Cooper and Baker argue: “Solar projects can now access more lucrative production tax credits, and wind projects with batteries can access the storage investment tax credit. Neither were previously possible.” They now “believe every coal fired power plant in the country could be economically replaced with renewable energy.”

The inclusion of energy storage for the first time is certainly significant. Tim Bachmann, portfolio manager of the DWS Invest ESG Climate Tech fund says: “Everybody was surprised that the ITCs are now also applicable to standalone storage operators (downstream), as well as a manufacturing production credit for the cells/packs/electrodes/minerals (upstream).”

A major factor holding back renewables has been the question of provision of sufficient ‘baseload ’ power.

Bachmann continues: “For peak-savings, frequency balancing, and energy arbitrage the grid operators will need to deploy huge battery storage facilities next to renewable energy plants.”

All in all, Pitts-Tucker says that the tax breaks will “put renewables once more at the top the agenda for new commitments. I can see this kicking off quite a surge in new capital going towards renewables and in managers rolling out specialist funds”.

Some negatives

So what’s not to like? Looking at the RHG analysis, not enough is being done to reduce the emissions from two big offenders: industry and transport. The central case in the RHG figures shows industry emissions falling from 1529 to 1449mmt in 2030 (compared to 1512 under current policy). And for transport there was already a reduction predicted from 1750mmt to 1543, now it will be only slightly less 1523 (again, see chart above).

These gains are marginal. In other words, the IRA is going a long way to solving the power sector problem, but the challenges faced by the industry and transport sectors are largely unchanged. All this means is that the order of offending will be different. The emissions from transport and industry will be roughly three times those from power by 2030.

And some sectors are hardly touched at all. RHG cites three areas where more is needed: carbon removal, agriculture, and buildings.

On this last point RHG notes the bill “modifies the current tax credit for the adoption of energy efficiency appliances, but the effect is largely to incentivize the installation of more efficient gas appliances, locking in long-lived fossil-consuming assets rather than driving needed progress in electrification”.

But perhaps the biggest negative is the very real risk for investors that the bill will be repealed should the Republicans win the November Congressional elections.

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