Inflation Reduction Act, Part 1: What’s the Big Deal?

Given its title, when the US Government’s Inflation Reduction Act (IRA) was first touted you could be forgiven for thinking it wouldn’t have much to do with energy or climate policy. But since it was passed into law last year its magnitude in encouraging the shift to clean energy has become increasingly apparent. It has been described as a “game changer”, a “big deal” and the “largest investment ever directed to combatting climate change”. And it is expected to have global clean energy investment implications.

The Act commits around US$394 billion (A$589 billion) towards the energy transition while encouraging investments in US manufacturing capacity, procurement of critical supplies locally or from free-trade partners and jump-starting research, development and commercialisation of technologies like carbon capture and storage and clean hydrogen.

The legislation has raised concerns in Europe, amongst some Asian countries, and even here in Australia because of its potential to draw in investments and skills. In this article we look at some of key areas in the IRA. In a separate article [here] we also consider the responses to the IRA and some of the resulting implications.

What’s in the IRA?

The IRA, along with the Bipartisan Infrastructure Law, aim to help reduce US greenhouse gas emissions by 40 per cent on 2005 levels by 2030 as shown in figure 1, with contribution by sector under those mechanisms shown in figure 2.

Figure 1: Net Economy-wide carbon emission reductions by 2030 (MMT CO₂)

Source: US Energy Department

Figure 2: Share of emission reductions by sector (MMT CO₂)

Source: US Energy Department

The inflation reduction touted in its title is expected to come in part from lowering end user energy bills as a result of shifting the US economy to cleaner generation sources that can also help insulate the US economy from oil and gas price volatility.

The Bill  Act boosts and extends the support for renewables and introduces a number of new credits to support early-stage technologies like green hydrogen, as well as storage and carbon capture and storage. The Act also contains overt industrial policy measures to promote the development of local clean technology supply chains.

US$394 billion is directed to energy and climate funding with the bulk delivered in the form of tax incentives. The remainder is being provided through grants and loans (see figure 3).

Figure 3: Energy and climate change funding in the IRA (US$billion)

Source: McKinsey analysis of appropriation figures.

Batteries with renewables will see the largest share of funding, with other clean electricity sources, carbon capture and transport (which includes electric vehicle (EV) incentives) major beneficiaries (figure 4).

Figure 4: US Government Funding by Focus Area

Source: McKinsey analysis of appropriation figures.

A major proportion of the tax credits are directed at the corporate sector which enjoys an estimated US$216 billion of credits. Many of the tax incentives in the IRA are direct pay, meaning that an entity can claim the full amount even if its tax liability is less than the credit.

Around $43 billion of the tax credits are aimed at consumers and lowering emissions by making EVs, energy-efficient appliances, rooftop solar panels, geothermal heating, and home batteries more affordable.

Clean Energy Technologies

A major part of the IRA is the implementation of several tax provisions and significant grant and loan programs to support deployment of commercially-available and innovative clean energy technologies, including:

• Current Production Tax Credit (PTC) and Investment Tax Credits (ITCs) have been modified and extended through 2023 and 2024 and after that they will shift to become technology-neutral, emissions-based credits known as the Clean Electricity PTC and Clean Electricity ITC.
• A new US$27 billion Greenhouse Gas Reduction Fund. The US Environmental Protection Agency will award competitive grants to mobilise financing and leverage private capital for clean energy and climate projects.
• The Department of Energy Loan Programs Office receives US$40 billion in loan authority backed by US$3.6 billion in credit subsidies for loan guarantees for innovative clean energy technologies, including renewable energy systems, carbon capture, nuclear energy, and critical minerals processing, manufacturing, and recycling.

Made in America

The IRA has been designed to encourage developments in the US and incentivises investments in domestic manufacturing capacity. It is also intended to encourage procurement of critical supplies domestically, or from free-trade partners, and jump-start R&D and commercialisation of technologies, such as carbon capture and storage and clean hydrogen.

Specifically, the IRA package includes more than US$60 billion to support “on-shore clean energy manufacturing in the US”. For example, clean energy tax credits are increased if the amount of American steel used in wind projects meets the domestic content threshold, and bonus credits apply to employers who adhere to prevailing wages and apprenticeships.

It follows a strategic review of supply chains undertaken for the White House. The report Building Resilient Supply Chains, Revitalizing American Manufacturing, and Fostering Broad-based Growth assessed supply chain vulnerabilities. Amongst the four key products considered were large scale batteries, like those for EVs, as well as critical minerals and materials.

According to Wood Mackenzie around 70 per cent of all photovoltaic modules and 80 per cent of lithium-ion cell manufacturing occurs in China, while it also produces nearly 70 per cent of all powertrains and 65 per cent of castings for wind generation. In contrast US manufacturers met 2 per cent of global demand for PV modules, 7 per cent of demand for battery cells and met no demand for powertrains and castings in 2021. Wood Mackenzie estimated the IRA could cut the cost of solar, wind and storage equipment by between 20-60 per cent and lift annual investment in US renewables by US$50 billion to around US$114 billion in 2031 compared to 2022. It also expects the IRA to boost total spending on renewables by $300bn by 2035 and extend the life of nuclear plants.

At the same time the Boston Consulting Group (BCG) predicts it will lead to a substantial lowering of the levelised cost of energy for clean energy technologies as a result of the tax credits being offered (as shown in figure 5).

Figure 5: IRA Credits and Levelized Cost of Energy

Think tank Energy Innovation estimates the IRA’s clean energy tax credits could add up to 1,053GW of new solar and wind capacity by 2030.

The scale of the changes proposed and the strong emphasis on “Made in America” has led to concerns being raised not just in Australia but elsewhere (most notably the EU), which is discussed further in this separate [LINK] article. Some key areas that benefit from the Act include:

Transport

Transport is the major source of greenhouse gas emissions in the US accounting for 27 per cent in 2020, according to the White House’s Guidebook on the IRA, so encouraging the take-up of EVs along with increasing production in the US is a key part of the policy.

Under the Clean Vehicle Credit arrangements, those buying a qualifying EV can get a tax credit of up to US$7500 for new vehicles and US$4000 for used vehicles from this year.

To qualify for the maximum $7500 credit, the vehicle must meet certain standards:

• 40 per cent of critical components used in the batteries must be extracted in the US (or countries that have a free trade agreement with the US, such as Australia), rising to 80 per cent by 2026;
• 50 per cent of the batteries must be assembled in the US or free trade partners, increasing to 100 per cent by 2028.  
• The car should undergo final assembly in North America.

The Future Battery Industries Co-operative Research Centre has pointed to the potential for Australia to take advantage of the IRA via our raw minerals and leverage the funds to help develop a batteries industry. And Federal Industry Minister Ed Husic has talked up development of a domestic battery industry by taking advantage of our lithium and other critical materials and our Free Trade Agreement with the US which he believes gives us the chance to "straight away... be able to contribute”.

The US also only accounts for around 10 per cent of global EV production, compared to 25 per cent from the EU and the IRA aims to help accelerate the US involvement in EV production.

Restrictions on which vehicles qualify as clean begin in 2024 and include removing vehicles that use materials from “entities of concern” (including Chinese companies) in the battery, and for any of the mineral sourcing or processing starting in 2025.

There is also US$500 million to incentivise the sale and use of higher blends of ethanol and biodiesel, by extending existing tax incentives for a range of alternative fuels, including biodiesel, renewable diesel, and second-generation biodiesel, through to the end of next year and it introduces a new Clean Fuel Production credit from 2025.

Hydrogen

To build on earlier initiatives such as the Bipartisan Infrastructure Law, which included US$9.5billion for clean hydrogen initiatives, the Inflation Reduction Act includes a new hydrogen production tax credit, which is expected to encourage domestic production of clean hydrogen. The base production tax credit is US$0.60/KG (which will be adjusted for inflation) multiplied by the applicable percentage which ranges from 20-100 per cent depending on the lifecycle greenhouse gas emissions. There is also a bonus credit of five times the base credit if a facility meets prevailing wage and registered apprenticeship requirements. The credit is available for facilities in service before 2033 for their first 10 years in service.

Transmission

The Inflation Reduction Act invests nearly US$3 billion in the U.S. transmission system to help overcome financial and permitting challenges that would hinder the buildout of new high-capacity lines.

Home Improvements

The IRA provides nearly US$9 billion for home energy rebate programs to electrify appliances, to introduce solar and battery storage and retrofit properties to make them more energy efficient.

New tax credits and deductions in the Inflation Reduction Act are aimed at reducing the cost of energy-efficient home upgrades, including heat pumps and other appliances, as well as more energy efficient windows and doors. It will offset the cost of adding residential clean energy sources such as solar panels and battery storage and make the building of energy-efficient homes cheaper.

Qualifying home improvements are eligible for a tax credit of up to 30 per cent of the total cost, capped at US$1200 annually. For heat pumps, the credit is capped at US$2000 per year. Full details of the scale of support and eligibility can be found here.

Carbon Capture, Utilisation and Storage

The tax credit for different types of carbon capture, utilisation and storage (CCUS) has been increased. The credit for carbon captured from industrial sources and power generation and re-used has increased from US$35 to US$60 a tonne. The credit for carbon captured from those sources and stored increased from US$50 to US$85 a tonne.  The credit for direct air capture (DAC) of carbon and storage has increased significantly (from US$50 to US$180 a tonne). As with other parts of the IRA there is a base credit which increases if wage and registered apprenticeship requirements are met.

The tax credit change complements funding in the Bipartisan Infrastructure law for CCUS and DAC which included US$2.5 billion for a Carbon Capture Demonstration Projects Program, US$937 million for Carbon Capture Large-Scale Pilot Programs, and US$3.5 billion for Regional Clean Direct Air Capture Hubs.

The US currently has 23 million tonnes per annum of carbon capture capacity in operation, with a further 112 Mtpa planned and Wood Mackenzie analysts expect at least another 55 Mtpa of capacity to emerge as a result of the more generous incentives.

Reactions

The IRA is the largest ever direct investment into the energy transition, and its quantum has created waves globally. In a follow up article in this edition of Energy Insider we dive deeper into these reactions, a consider the impact of the IRA on global supply chains, as well as what it might mean for other nations seeking to follow in the footsteps of the US.