The Inflation Reduction Act of 2022: ESG Implications

After months of negotiations, the US Senate and House of Representatives passed the Inflation Reduction Act of 2022 (IRA2022). Both votes were along party lines. The bill has been signed into law by President Biden. From an environmental, social and governance (ESG) perspective, the legislation is designed to address climate change while also providing incentives for the fossil fuel industry. More than $380 billion is to be invested in energy and climate reform; this is short of the $555 billion that Democrats had originally proposed, but still represents the largest federal clean energy investment in US history.

Why IRA2022 Matters

The impact of IRA2022 on the US’ reliance on fossil fuels should not be understated. The legislation, through significant investment in renewable energy sources, indicates that renewables can, over time, replace fossil fuels as the most cost-effective energy source. Importantly, the expected significant 40% reduction in carbon emissions by 2030 is in accordance with the US re-entering the Paris Agreement upon President Biden’s first day in office.

For corporations, ignoring the need to invest in a long-term net zero1 transition plan will arguably hurt business performance given the large investment in the transition from the federal government. Coincidently, the regulation arrives just as the SEC is finalizing rules to mandate climate-related financial disclosures from publicly listed companies. IRA2022 underscores that US lawmakers are willing to act in order to meet pledges and catch up to their counterparts in Europe, which is far ahead in its ESG regulatory efforts. One of many examples of such policy intervention in Europe is the announcement by the EU to end sales of combustion engine vehicles by 2035.

Major Elements of the Law

IRA2022 was borne out of the broader Build Back Better (BBB) agenda that President Biden proposed in 2021. According to the Congressional Budget Office, IRA2022 includes $790 billion of offsets to fund roughly $485 billion of new spending and tax breaks. Overall, the legislation is primarily funded by higher taxes for large corporations (through a 15% corporate alternative minimum tax for companies with at least $1 billion in profit) and lower Medicare prescription drug costs. In addition, a 1% excise tax on stock buybacks was added at the eleventh hour as a replacement for the carried interest tax loophole.

Included in the $485 billion of new spending is $386 billion targeted towards energy and climate policies, as shown in Figure 1.

Figure 1: Inflation Reduction Act of 2022 — Energy and Climate Investments

Source: Committee for a Responsible Federal Budget, July 28, 2022.
See: What’s In the Inflation Reduction Act? | Committee for a Responsible Federal Budget (crfb.org).

Based on a summary drafted by Senate Democrats, the legislation will put the US on a path to a 40% emissions reduction by 2030. IRA2022 targets support in five key areas:

• Encouraging renewable energy demand and lowering energy costs To encourage renewable energy usage and help alleviate the high price of gasoline, IRA2022 provides consumers with incentives to buy energy efficient appliances and home improvements, electric vehicles (EVs), and solar rooftop panels. Specific to EVs, lower and middle income consumers can claim $4,000 in tax credits to purchase used clean vehicles and up to $7,500 for new EVs.
  
  
• Reduction of greenhouse gas (GHG) emissions through a methane emissions charge IRA2022 includes both carrots and sticks for the oil and gas sector. Specifically, up to $1.55 billion in incentives are set to help reduce methane emissions, while the regulation also introduces a methane emissions charge — the first direct federal fee on GHG emissions.

The incentives include $850 million for methane mitigation and monitoring (primarily through the Environmental Protection Agency, or EPA) and $700 million for mitigation from conventional wells. The emissions charge will apply to methane emissions from facilities that are subject to annual GHG reporting to the EPA’s Greenhouse Gas Emissions Reporting Program (GHGRP) including:

1. Offshore petroleum and natural gas production
2. Onshore petroleum and natural gas production
3. Onshore natural gas processing
4. Onshore natural gas transmission compression
5. Underground natural gas storage
6. Liquefied natural gas storage
7. Liquefied natural gas import and export equipment
8. Onshore petroleum and natural gas gathering and boosting
9. Onshore natural gas transmission pipeline

The Congressional Budget Office estimates that gross revenue from the methane charge will range from $667 million to $1.87 billion between 2026 and 2031.

• Boosting American energy security and manufacturing activity The legislation includes over $60 billion to support manufacturing in the US across the supply chains of clean energy and transportation technologies. This includes tax credits to ramp up production of solar panels, wind turbines, batteries and critical minerals processing in the US. Importantly, the regulation includes production tax credits for polysilicon, which is the base input for most
  solar panels.
  
  
• Decarbonizing the US economy IRA2022 includes a number of measures designed to reduce emissions from electricity production, transportation, industrial manufacturing, buildings and agriculture. Among the provisions:
  — Tax credits, grants and loans of $30 billion to states and utilities to accelerate the
  transition to clean electricity
  — Grants and tax credits to reduce emissions from industrial manufacturing processes
  including $6 billion towards a program to lower emissions from the largest emitters (e.g.
  chemical, steel and cement plants)
  — A significant investment ($3 billion) for the US Postal Service to purchase EVs
  — A $27 billion clean tech accelerator to support reducing emissions, especially in
  disadvantaged communities
  
  
• Investing in communities and environmental justice Consistent with the theme of supporting disadvantaged communities, IRA2022 targets over $60 billion in investments to drive environmental justice priorities. A number of grants (e.g. Environmental and Climate Justice Block Grants, Neighborhood Access and Equity Grants, Grants to Reduce Air Pollution at Ports) are designed to invest in community-led projects that address environmental concerns, safety and affordable transportation access.
  
  
• Investing in farmers, forestland owners and resilient rural communities IRA2022 will make investments to support rural communities in their transitions to a clean energy future. The investments include more than $20 billion to support climate-aware agriculture practices as well as grants and tax credits to support the production of biofuels and to conserve and restore coastal habitats.

Finally, the regulation has a wide range of investment implications.

• Demand for commodities As a result of significant investments in renewables, there will be a massive need for commodities such as silicon (solar panels) and lithium (EV batteries) that form the raw materials for renewable energy.
  
  
• Stock buybacks Over the past few years, record profits and low interest rates have
  fueled corporations to return cash to shareholders in the form of stock buybacks. While the
  regulation’s 1% tax on stock buybacks is expected to raise billions for the federal government, it is unlikely to dull the appeal of share repurchases by large corporations.
  
  
• Corporate taxes The legislation will impose a minimum 15% tax for corporations with at
  least $1 billion in net income. Under the proposal, a company like Amazon.com Inc. (which
  reported a record $35 billion in profit in 2021) will pay over $5 billion in taxes (vs. the $2.1 billion it has previously paid). This provision is primarily aimed at large companies that pay little to no income taxes.
  
  
• Demand for EVs and energy-efficient appliances The law’s tax rebates for EVs and smart
  appliances may spur additional demand for vehicles from companies such as Tesla Inc.,
  General Motors Co. and Samsung Electronics Co. Ltd. The addition of rebates for used cars
  may also spur demand from lower income households that cannot afford the high costs of
  new EVs. However, these companies, already challenged by supply chain constraints, may not be able to ramp up production in the short term to keep up with increased demand.
  
  
• Oil and gas sector IRA2022’s requirement that the Interior Department holds lease sales for oil and gas exploration in the Gulf of Mexico and Alaska directly benefits the oil and gas sector during a period of high gas prices for Americans. This ensures a smoother energy transition rather than an abrupt shift away from fossil fuels, and should benefit Big Oil companies such as ExxonMobil Corp. and Chevron Corp. as they seek new sources of oil.
  
  
• Production and Energy Investment Tax Credits The law provides more certainty for
  investors to put capital into clean energy facilities by extending production tax credits (IRC
  Section 45) and energy investment tax credits (IRC Section 48) for solar, hydropower, storage technology and other projects that start construction before 2025.

While not matching the ambitious agenda of BBB, the Inflation Reduction Act achieves many of the goals that President Biden sought in BBB including the largest fiscal package ever enacted for climate change mitigation. Importantly, from an ESG standpoint, it puts the United States on a path to reduce 2005 emission levels nearly 40% by 2030. The legislation also has significant investment implications, including the effects of an excise tax on stock buybacks and a minimum corporate income tax, along with the implications of an increased demand for commodities that serve as the raw materials for renewables.