Clean Energy Tax Credits - What Are They?

The Inflation Reduction Act represents the single biggest climate investment in U.S. history, so how will these provisions influence consumers' pocketbooks and the clean energy market? Head of Global Thematic and Public Policy Research Michael Zezas and Global Head of Sustainability Research Stephen Byrd discuss.

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Michael Zezas Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Head of Global Thematic and Public Policy Research.

Stephen Byrd And I'm Stephen Byrd, Morgan Stanley's Global Head of Sustainability Research.

Michael Zezas And on this special episode of Thoughts on the Market, we'll focus on the Inflation Reduction Act's bold attempt to stem the tide of climate change. It's Tuesday, August 23rd at noon in New York.

Michael Zezas Regular listeners may have heard our previous episodes on the potential impact for the U.S. economy and on taxes from the Inflation Reduction Act. Today, we'll focus on another essential aspect of this new legislation, namely its sweeping support for clean energy, which represents the single biggest climate investment in U.S. history. So, Stephen, there's a ton of important issues to address here. Let's start with an immediate pain point that most of us deal with on a daily basis, the cost of energy. How does the Inflation Reduction Act aim to lower energy costs for Americans?

Stephen Byrd The simplest way to think about this is that in the past decade, wind and solar costs in the U.S. declined every year by double digits. What's exciting about the IRA is that there are really important investments that will increase the scale of manufacturing. So, the fundamental point in terms of the benefit of the IRA really is support for a variety of clean energy investments that's going to increase efficiency, reduce per unit costs. This is becoming really essentially a very big business. To put this in context, in the last 12 months utility bills in the U.S. and most of the U.S. have increased by sometimes well into the double digits. And yet clean energy costs remain quite low. Given some of the near-term COVID supply chain dynamics, costs aren't dropping as quickly as they normally would, but before long we're going to see those reductions continue. That should result in lower power costs for customers across the U.S. and that's the single biggest benefit from a sort of deflationary point of view that I can think of around the IRA.

Michael Zezas And the IRA also has a stated aim to increase American energy security. In what ways does it attempt to do that?

Stephen Byrd Yeah, Michael, it's really interesting. The IRA has some very broad areas of support for domestic manufacturing of all kinds, of not just clean energy but related technologies like energy storage. And we do think that's going to likely result in quite a bit of onshoring of manufacturing activity. That is good for American energy security, that brings our sources of energy production right back home, creates jobs, reduces dependency on other governments. So, for example, the subsidy for solar manufacturing is really very large. It can be as high as essentially $0.17 a watt, and to put that into context, the selling price at the wholesale level for many of these products is around $0.30 a watt. So that subsidy for domestic manufacturing should result in real investment decisions in real U.S. factories, and that will help to improve American energy security.

Michael Zezas Now, another aspect of this legislation is its attempt to substantially limit carbon emissions in the U.S. What are some of the measures that are aimed at doing this?

Stephen Byrd Decarbonization is a major area of focus, just as you said, for the IRA and this shows up in many ways. I'd say the most direct way would be providing a number of incentives to increase the growth of wind and solar. So, we'll see a great deal of growth there as a result. However, there are other elements that are really interesting. One example is support for nuclear. I think the drafters really wanted to ensure that we didn't lose any additional nuclear power plants. Those plants provide obviously zero carbon energy, but they also provide really important grid reliability services so that's helpful. There is also quite a bit of capital for carbon capture, which should reduce the emissions profile of other sectors as well. There's quite a bit of support for electric vehicles that will help with the pace of electrification. And that's kind of a nice double benefit in the sense that if more consumers choose electric vehicles and the grid becomes cleaner then we get a double benefit. So, we're really seeing very broad-based support for decarbonization in the IRA.

Michael Zezas Now, one of the methods here to incentivize decarbonization is through tax credits. What are some of these tax credits? How do they work?

Stephen Byrd We have a lot of tax credits in this IRA for what I think of as wholesale players, that is the big clean energy developers. There are tax credits for wind and solar that get extended well into the next decade. We have a new tax credit for energy storage. We have tax credits that have been enhanced for carbon capture and utilization, which is very exciting because that's at a level needed to incent quite a bit of investment in carbon capture. We have a new very large tax credit for green hydrogen. That's great, because today hydrogen is made in a process called ‘gray hydrogen’ that does have quite a high carbon profile. So, a variety of tax credits essentially at the wholesale level or at the developer level, but also that could benefit consumers as well, such as on electric vehicles and those are quite sizable as well.

Michael Zezas Now these tax credits and the other efforts in the Inflation Reduction Act aimed at carbon reduction, they represent a major pickup in spending on clean technologies. Can you give us some perspective on that? And is the industry ready to supply all the equipment and labor needed to make this a reality?

Stephen Byrd I think what we're seeing with many technologies here in clean energy is that the demand is starting to grow very rapidly. Now the industry is really pushing very hard to keep pace, essentially. The limit on growth for some of our companies is really down to people. That is, how many people can they hire and train. So, for some of those companies, that growth rate caps out at about 25% per year. You know, that's quite good and we'll see that continue for many years. I think we're going to see a lot of increased efforts on education. And you'll see also within the IRA a lot of language around prevailing wage and ensuring that employees get paid a fair wage. On top of that, though, there are some areas of shortage. So in energy storage, for example, demand is very high across the U.S., not just for electric vehicles, but also to help with grid reliability. A good example would be in Texas during the winter storm, parts of the Texas grid failed and quite a few people were without power during very cold conditions. That was very challenging. And as a result, a lot of customers, both individuals and corporations, want to have storage. There are limits, there is a shortage essentially globally in terms of energy storage, and that's going to take years to address. That said, the IRA does make important headway in terms of providing incentives and financial support to bring a lot of manufacturing back to the U.S. so we have better control of manufacturing. We'll be able to scale up more quickly and also avoid a lot of the logistics and supply chain issues that have plagued some of our companies that have dealt with very complex and challenging global supply chains.

Michael Zezas So, for investors, then, what's the takeaway? Is this perhaps a boon for the clean tech sector, or is it maybe too much, too soon?

Stephen Byrd I think this is a boon for not just the clean tech sector. I think ultimately this is going to translate into much more rapid adoption of clean energy, which fundamentally is very much a deflationary force. So what we're going to see is further innovation, further manufacturing in the U.S. That means more jobs in the U.S, that means a faster pace of innovation and a faster rate of cost reduction. So that does look to us to be a virtuous cycle that's going to benefit not just the decarbonization of the U.S. economy but benefit the consumer and provide jobs as well.

Michael Zezas Stephen, thanks for taking the time to talk.

Stephen Byrd Great speaking with you, Michael.

Michael Zezas As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people find the show.