- Aug 29, 2022 7:07 pm GMT
The Inflation Reduction Act (IRA) is the most significant climate legislation in United States history. Energy Innovation Policy and Technology LLC® modeling finds the IRA’s $370 billion in climate and clean energy investments could help cut U.S. greenhouse gas (GHG) emissions up to 43% below 2005 levels by 2030.
Combined with state action and forthcoming federal regulations, the IRA puts the U.S. within reach of its Paris Agreement commitment to cut emissions 50% to 52% by 2030. The IRA will strengthen the U.S. economy by creating 1.3 million new jobs, and avoid nearly 4,500 premature deaths annually by reducing air pollution, both in 2030.
In this series, Energy Innovation® analysts showcase the IRA’s benefits in the power, buildings, and transportation sectors. This article is one of two covering the power sector, detailing the IRA’s supercharged clean energy tax credits.
The IRA’s clean energy tax credits are a game changer. Stable, long-term policy will unlock clean energy for utilities and developers, accelerating renewable energy and battery storage deployment. Government funds will be spent more efficiently, and millions of Americans will enjoy cleaner air and cheaper electricity.
Resources for the Future projects the IRA will save average U.S. households up to $220 annually on electricity bills while protecting against volatile fossil fuel price swings. Together with its reinvestment financing program, Energy Innovation finds the IRA’s power sector provisions will drive about two thirds of its GHG emissions reductions, expanding 2030 wind and solar capacity by 2 to 2.5 times pre-IRA projections.
Easing energy bills with clean electricity
Clean energy tax credits—in use to varying degrees since the 1990s—have moved wind and solar power from nascent and expensive a decade ago to mainstream and low-cost today. Tax credits lower the upfront capital cost of clean power (investment) or incentivize renewable electricity output (production).
Clean energy tax credits are arguably the most impactful federal climate policies. Renewable energy costs have plummeted, making wind and solar the cheapest sources of electricity today, with solar and onshore wind costs falling more than 85% and 60% in the 2010s, respectively. Renewables now produce more electricity annually than coal, and wind and solar comprised 76% of new U.S. power generation capacity in 2021, creating thousands of jobs.
Accelerating renewable energy deployment fights inflation by reducing energy bills. The U.S. Department of Energy forecasts electricity prices will increase 6.1% this year, due mainly to high natural gas prices. Fossil fuels still provide 60% of annual U.S. electricity generation, mostly from natural gas, but fuel commodities are subject to global market forces. For example, Russia’s invasion of Ukraine is partly responsible for U.S. natural gas prices being two to three times higher than last year.
Because renewable “fuel” is free once projects are built, low-cost wind and solar put downward pressure on electricity bills and stabilize costs over time, curtailing inflation. Global oil price shocks will affect consumers at the pump tomorrow, but today’s operational wind and solar projects are fully insulated over their lifetimes from any changes to their component prices.
However, renewable uptake isn’t happening quickly enough to provide needed relief for the climate and consumers. Tax credits have historically relied on a piecemeal approach: technology-specific credits, varying incentive amounts, short timelines with last-minute extensions, and complex ownership structures needed to monetize value.
Scaling wind and solar generation from about 13% today to upwards of 60% by 2030 requires a cohesive federal strategy that gives renewables a greater edge over existing coal and new natural gas power plants. Rapid industry expansion will require sustained incentives, a strong domestic manufacturing base and workforce, and utility buy-in.
Not your father’s tax credits
Enter the IRA, which revamps the tax credit structure via four core design elements.
First, it provides business certainty by extending credits at their full value for at least ten years, giving investors, manufacturers, utilities, and developers enough time to plan and build new manufacturing facilities and projects into the 2030s. The credit value will only start to decline after we’ve slashed power sector emissions 75% from today’s levels. This breaks Congress’ tradition of letting credits periodically expire or renewing them at the last minute, which drove boom-bust cycles.
Second, the IRA expands the federal tax credits’ scope and flexibility, allowing any new zero-emissions technology to qualify for either investment or production credits. For example, solar projects can qualify for the production tax credit (PTC), which will become preferable as upfront capital costs fall further. Energy storage technologies are now also eligible for investment tax credits (ITC). A new PTC for existing nuclear power should keep most U.S. nuclear plants online, empowering new renewables to displace fossil fuels instead of zero-carbon electricity.
Third, the IRA supports workers and domestic manufacturing by tying clean energy credit value to human impacts. Project developers can only earn one-fifth of the credits’ original value unless they meet worker training and competitive wage conditions. They gain additional credit value by sourcing components from domestic manufacturers and siting facilities in fossil-dependent communities. Clean energy tax credits more than offset the minimal cost of these high-road labor policies.
Fourth, the IRA uses government funds more efficiently, benefitting a greater pool of project developers. Developers typically need to leverage the tax appetite of larger financial institutions to monetize tax credits—a complex process that siphons a third of the credits’ value at taxpayer and customer expense. The IRA makes tax credits “transferrable,” allowing developers to sell credits directly to anyone with tax liability, circumventing waste and making each federal dollar go much further. It also offers cash grants to tax-exempt entities like municipal utilities and rural electric cooperatives, further simplifying the process.
Renewables prospects should outweigh utility and investor penchants for fossil fuels
The IRA’s tax credit framework will chip away at utilities’ entrenched preference for building and operating fossil fuel power plants despite worsening economics.
Utilities are subject to a counterproductive tax law requiring them to spread the ITC over an asset’s life rather than claim the full value upfront. As a result, utilities often couldn’t bid below private solar developers free from this constraint.
As utilities only earn returns on infrastructure they own, they tend to prefer building and operating fossil assets over buying power from independently-produced renewables—decades of experience have given them a competitive advantage here. While this isn’t a problem where utilities aren’t allowed to own power plants, it helps explain why regions like the Southeast have seen little clean energy growth.
The IRA puts utilities on a more level playing field. They can now choose the PTC for solar, which pays out over ten years for utilities and developers alike. They can also sell credits to capture their value without engaging in tax equity deals. This will help utilities profit from developing renewables, which may begin preferring them over less capital-intensive fossil fuel plants.
The IRA also includes money for carbon capture and low-carbon hydrogen technologies. However, carbon capture demonstration projects remain fraught with challenges, and utilities risk losses if their investments don’t perform as expected. Hydrogen may eventually support power decarbonization, but it won’t meaningfully contribute until the grid surpasses 80% clean electricity. In both cases, utilities will face pressure from investors to reduce risk, from regulators to choose the lowest-cost resources, and from the public to adopt zero-carbon technologies.
Investment firm Morgan Stanley shows utilities can increase investor returns, provide cheap power for consumers, lower emissions, and earn higher ratings by transitioning old fossil capital into new, cheaper clean energy projects. Clean energy tax credits are key to this equation—reducing costs even further means utilities and customers both benefit from a faster transition.
Implementation will be essential
The IRA is a paradigm-shifting federal investment in clean power, but without binding emissions reduction targets, remaining structural barriers could delay the transition. Achieving our climate goals depends on additional action from federal agencies, state legislatures, utility regulators, and grid operators.
The U.S. must build roughly 100 gigawatts (GW) of wind and solar capacity annually through 2030 to hit its climate targets, but it developed just 28 GW in 2021. More than 920 GW have applied for grid interconnection, but most projects drop out when faced with insurmountable transmission upgrade costs that have many “free-rider” beneficiaries. Successful ones languish for years waiting for approval.
IRA incentives can help push through a greater share of these projects, but more importantly, they greatly increase the impact of any measures that ease these development bottlenecks. The Federal Energy Regulatory Commission and regional grid operators can refine outdated, unfair processes for connecting renewables to the power grid, helping break the dam on shovel-ready projects. They can also help spur new transmission line construction to open new wind- and solar-rich regions to development.
States should pass more ambitious clean energy targets to capitalize on federal support, ensuring utilities relinquish old biases to bring low-cost renewables online. Regulators should also re-examine utility resource plans in light of new energy economics, identifying coal facility retirement opportunities and forgoing risky new natural gas power plants for similarly performing clean energy portfolios. New IRA financing provisions can also help reduce the cost of paying down stranded assets, freeing up utility balance sheets for more renewable energy projects without raising rates.
The IRA’s clean energy tax credits can accelerate power decarbonization to give us a fighting chance at meeting our climate goals, while creating new manufacturing jobs and strengthening the economy. It sets the U.S. up for global competitiveness across the 21st century while working toward a stable climate. If utilities, developers, and regulators take full advantage of the opportunity, generations of Americans will benefit from cheaper electricity, cleaner air, and a growing economy.
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