Renewables are the cheapest power source presenting an even lower cost than the most competitive fossil fuel options. Developed and developing economies are accelerating their adoption of renewables in the face of rising global energy prices. According to IRENA, the adoption of renewables in 2020 will save emerging countries up to $156 billion over their lifespan.
Countries continue to commit significant resources and pass legislation to support the adoption of renewables and drive energy costs down further. The United States recently passed the Inflation Reduction Act which dedicates over $370 billion to renewable energy and emission reduction. The Rhodium Group predicts the Act will reduce greenhouse gas emissions from 24-35 percent to 31-44 percent by 2030.
The Act improves upon many existing policies that offer tax credits to incentivize renewable adoption and investment. These credits offset a portion of the associated costs to deploy renewables and enable companies to sell energy into the market at even lower prices. These policies will exert downward pressure on energy prices and accelerate the faster adoption of renewables.
Policies Driving Renewable Adoption
The United States was on pace for a 24-35 percent reduction in greenhouse gas emissions. This was partly driven by existing policies that provided tax credits to incentivize companies to invest in renewables. These policies created the base for the Inflation Reduction Act and received significant upgrades to improve renewable adoption.
Production Tax Credits
The Energy Policy Act of 1992 was introduced to promote the development of certain renewable energy sources. The Act implemented production tax credits which created incentives for energy companies to invest in renewables. These credits are a major driving force behind the adoption of wind and solar over the past three decades.
Production tax credits provide a kilowatt hour (kWh) credit for electricity generated by specific renewable energy sources. The credits could be claimed over a ten-year window and acted as a vehicle to offset renewable investment startup costs. The production tax credits expired on December 31, 2021, which prevents any renewable energy project commenced during the new year from claiming them.
Production tax credits have been extended 12 times and expanded multiple times to include additional resources like closed-loop biomass and geothermal technologies since they were enacted in 1992. The Congressional Research Service estimated that production tax credits created $5.1 billion in tax expenditures in 2019. It is also projected to generate $19.3 billion in tax expenditures between 2019 and 2023.
Investment Tax Credits
The Energy Tax Act of 1978 introduced a temporary 10% tax credit for business energy property and equipment using energy resources other than oil or natural gas. There were investment tax credits specifically for solar and wind energy properties that were refundable. This concept continued to grow as a means to encourage adopting a broader range of energy technology and resources.
The Consolidated Appropriations Act of 2016 extended investment tax credits to 2019. These investment tax credits apply to certain renewable energy properties like solar and wind developments, geothermal heat pumps, and fuel cells. They create a dollar-for-dollar credit for expenses invested in renewable energy properties.
These energy credits provide specific rates for qualified renewable technology and a start-of-construction deadline. The rates varied between 10-30% and were determined as a percentage of the taxpayer’s basis in the eligible property. The credit rates for solar and wind were specifically increased up to 30% in 2019.
A carbon credit represents one metric tonne of carbon dioxide equivalent that can be traded, sold, or retired. In the United States, states develop their own policies to establish carbon credit programs. These programs reward companies that invest in renewables and carbon removal projects which can effectively reduce the cost of energy.
California’s cap-and-trade program is the fourth largest in the world and includes over 450 businesses that are responsible for almost 85% of the state’s total greenhouse gas emissions. The cap-and-trade program generates a significant source of revenue from the auctioning of carbon credits which are reinvested into local projects that improve air quality. The California Climate Investments 2020 Annual Report highlighted the auctions have generated $12.5 billion in revenue since the program began and reduced greenhouse emissions by the equivalent of removing 10 million vehicles off the road for a year.
Carbon credits serve as an incentive for companies to invest in renewable energy to obtain allowances that may be sold to generate revenue or avoid additional taxes for excess emissions. They increase the cost of emission-intensive industries like gas and fossil fuels and make renewables more competitive in price. In combination with production and investment tax credits, carbon credits make renewable energy the most attractive energy source.
How the Inflation Reduction Act Improves These Policies
The United States pledged to reduce greenhouse gas emissions by 50-52% from 2005 levels by 2030. The Inflation Reduce Act raised projections from 24-35% to almost 44% emission reduction by 2030. The Act achieved this by improving production and investment tax incentives and expanding its carbon credit program.
Production and Investment Credits
The Inflation Reduction Act extended the construction period for qualified facilities under the production and investment tax credit clauses. It also increased the credit per kilowatt hour from $0.017593 to $0.03 further offsetting renewable investment costs and reducing energy prices. Finally, the Act expanded the facilities that qualify for investment credits to include standalone energy storage, qualified biogas property, fuel cells using electromechanical processes, dynamic glass, and microgrid controllers.
The production tax credits encourage businesses to create more efficient facilities that provide fair wages during construction. The facilities must have a maximum net output under 1 megawatt, construct a facility 60 days prior to published guidance on prevailing wage and apprenticeship requirements, or satisfies the prevailing wage and apprenticeship requirements to qualify for a potential 500% increase in credits. The facility can earn a further 10% credit increase by using certified steel and iron produced in the United States.
These credits are one of the core factors driving the increased projection of emission reduction by 2030. The credits incentivize investment in renewable facilities from businesses and investors They will also continue to drive down the cost of renewable energy to reduce the impact of the global energy crisis.
Tax Credit Direct Payments and Transfers
The Inflation Reduction Act introduces two new components for businesses to leverage investment and production tax credits. The first way enables businesses to take direct payments for tax credits instead of claiming them. The second way allows businesses to transfer tax credits to another taxpayer.
The Act establishes guidelines for specific entities to elect to claim their tax credits in the form of a direct payment. It also allows businesses to transfer credits in return for cash payments from the transferee. These new policies create an additional way for businesses and investors to potentially profit from investments in renewable facilities.
Transfers represent a similar mechanism in the cap-and-trade carbon credit markets. Companies can further monetize their renewable investments by selling credits that may finance additional renewable activities. The credits themselves may serve as a form of collateral that can incentivize green financing for projects.
Carbon Capture Expansion
The Inflation Reduction Act expands carbon capture programs and provides enough incentives to make them attractive to the heaviest polluting industries. The Act raises the tax credits allocated for carbon capture, transportation, and storage while reducing the threshold for companies to participate. The improved accessibility and credits build the foundation for a thriving carbon capture market in lieu of a federal carbon tax program.
The Act raised the $50 per tonne of carbon captured and storage tax credit to $85 per tonne. It also increased the credit value of direct air capture to $180 per tonne. These tax credits also fall under the direct payments and transferability sections of the Inflation Reduction Act.
The Clean Air Task Force estimated that the average cost of carbon capture, transportation, and storage for heavily polluting industries was between $65-$100 per tonne. Direct air capture, the most expensive type of carbon capture, had a future range between $100-$200 per tonne. The significant rise of carbon capture tax credits in the Act makes carbon capture more feasible for the industries producing the most greenhouse gas pollution.
Reducing the Cost of Renewables
The Inflation Reduction Act improves upon existing policies that drove renewable adoption while adding additional policies to expand the scope and drive more value for businesses. The improvements in the production and investment tax credits make renewable facilities more attractive and effectively lower the cost of energy. It also creates an entirely new market for businesses to receive direct cash payments or sell tax credits to other companies.
The improvement of carbon capture policies may be one of the most significant portions of the Inflation Reduction Act. The carbon tax credits cover the majority of costs for the heaviest polluting industries like gas and coal plants to invest in carbon capture programs. Altogether, these policies serve as strong incentives for companies to accelerate their adoption of renewables by lowering the cost of investment through tax credits and effectively reducing the price of electricity for consumers in the future.