On August 16, 2022, President Biden signed into law the Inflation Reduction Act (“the Act”). We believe the law is a critical catalyst for accelerating the sustainable development of a sustainable green resource sector in the United States and should serve to amplify investment opportunities in this new emerging asset class. The vast majority of this bill is focused on tax credits and infrastructure funding to address climate and energy security, thereby improving the economic viability of the relatively nascent industries of green energy, manufacturing, transport and agriculture. With approximately $400 billion earmarked for these initiatives over the next 10 years, the current federal government has made clear its intention to provide meaningful support to various industries with the goal of securing America’s energy independence and reducing its emissions considerably.
In our view, the most impactful part of the legislation is less the dollar amount of spending on these tax credits and more the certainty of their duration over the next 10 years through potentially changing and divided governments. The ramifications of the duration of the Act are substantial. About half of the legislation is geared towards extending investment tax credits (“ITCs”) and production tax credits (“PTCs”) for the wind, solar and, now, electricity storage (batteries), opening up a path of 30% tax credits (30 cents per dollar spent on project development can be deducted from federal taxes) or up to 1.5 cents per kilowatt-hour credit for green power generation until 2032. While historic tax extensions have been renewed every few years since their inception in 2006 (with the current ITC level at 26%, rising to 22% in 2023-2024 and 10% thereafter), the general uncertainty of ITC/PTC extensions at the prevailing rate has resulted in the inability of developers to plan longer term around investment and returns of projects.
The law also addresses many other verticals of U.S. emissions. Importantly, however, the ‘fine print’ regarding eligibility for additional tiers of benefits reveals a strong push towards the use of domestic content, as well as incentives for project development in ‘energy communities’, areas of the country that previously had significant advantages. closed jobs or projects in the extraction, processing or transportation of coal, oil or natural gas. In theory, a solar developer using household panels for a project in a closed coal mine could avoid paying taxes on 50% of the cost of their project.
While the law is long overdue and a welcome piece of legislation in energetic transition industries, it’s worth noting that there’s still a long way to go if the United States is to decarbonize and drive investment, both in building renewables and developing new technologies, to really make a dent in the years to come. The European Union, since announcing its Green Deal in 2019, has spent more than $1 trillion on energy independence and decarbonization. Other major countries such as China and India, although they have not announced official spending targets, have already invested more than a decade in (China) or are rapidly moving towards (l India) decarbonization through widespread national, regional and local initiatives. In our view, the law is a good start at the federal level, but much more needs to be done in climate-related actions and investments at all levels of government (essentially, including state and local) in collaboration with the private sector.
In our view, a major disconnect between the Act’s vision and reality is the strong requirement to incorporate national content while providing minimal support for the extraction, processing and refining of critical minerals which are the building blocks green electrification of our economy. We believe this could be a major impediment to achieving energy transition goals while maintaining the energy security and broad cost advantages that the United States currently enjoys.
A spectrum of stock market benefits
We hold a number of names in our portfolios that stand to benefit from these policies. Whether eligible to benefit from hundreds of billions of dollars from the US government, or billions in the single digits, companies in a wide range of sectors in which we invest stand to gain, both in terms of financing and planning stability.
Below we take a look at two of the sectors we think are the most exciting and our holdings within them look particularly promising.
Renewable energy
As mentioned above, a significant portion of the law is dedicated to tax credits to support the growth of traditional renewables (wind and solar) as well as battery storage. Currently, the ITC for solar is 26%, while the PTC, typically used for wind projects, expired at the end of last year. The law allows an increase of up to 30% in the ITC (and possible additional surcharges, indicated above) and a PTC of 1.5 cents/kWh produced assuming that certain national labor standards are met. Other incentives aside from tax credits include an advanced manufacturing credit, which applies to building the renewable energy supply chain.
We hold a number of names in our portfolios that benefit from these policies. Companies such as diversified solar inverter manufacturer Enphase Energy (5.63% of VanEck Environmental Sustainability Fund (ESF) net assets, 2.48% of VanEck Global Resource Fund (GRF) net assets)1 should benefit from the necessary and rapid construction of solar projects during the decade, as well as the evolution of owners towards independent energy management. The company currently has a 35% U.S. inverter market share, with a strong bent on technological innovation as it rolls out products focused on automation and energy optimization for indoor applications of the House. We believe that the solar inverter, considered as the “brain” of the energy flow of solar panels, grid and appliances, can lead to cost savings for utilities and homeowners by reducing energy waste. Enphase is uniquely positioned to benefit from the long arc of residential, commercial and utility solar adoption, as well as increased end-consumer wallet share, as it becomes more committed to home energy control.
Consumer Spotlight: Electric Vehicles
Another major policy that received a lot of airtime was subsidies for electric vehicle (EV) purchases. The Act provides up to $7,500 in income tax credit for new cars and up to $4,000 for used cars. It’s available to people earning less than $150,000 a year, with price caps of $55,000 on sedans and $80,000 on pickups or SUVs to drive mass market adoption. In keeping with the focus on domestic manufacturing and supply chain security, this subsidy is only available on models with final assembly in North America, with an upward “glide path” on the percentage of critical minerals and batteries made in North America.
We have seen an increasing number of battery manufacturers over the past two years innovating (or intending to innovate) in North America and Europe, to ensure supply chain security in an industry in which more than 70% of the critical minerals are found. and/or are processed in Asia. This law encourages a continuing trend and reflects the very strong view that the United States, a major global player in the traditional automotive market, has no intention of losing its footing in a multi-trillion dollar electric vehicle market. .
Given the increased interest of EV manufacturers in domestic content as well as attractive incentives for EV buyers, we believe that Freyr Battery (3.24% of FSE net assets, 0.92% of net assets of the GRF) is in a unique position to benefit from the downturn in growth. we should see with the mass market entry of large-scale electric vehicles. The Norwegian battery manufacturing company derives 100% of its electricity from renewable energies. Estimated to be one of the cheapest battery manufacturers on a per kilowatt hour (kWh) basis, partly due to cheap electricity, but also due to a new manufacturing process licensed from 24m, a researcher-designed lithium-ion battery cell manufacturing process. out of MIT. Freyr has significantly expanded its footprint over the past few years and is currently building a “gigafactory” in Norway and, through partnerships, additional factories in the United States, Finland and Sweden. Freyr has been planning its US move in a joint venture with Koch Strategic Platforms since 2021, and is in the process of determining the site location and beginning its customer qualification process.
Although the Act does not directly address national content (an important issue for us), the breadth and depth of what it does address is significant. We consider that this legislation not only lays the foundations for the energy transition in the years to come, but also provides a much needed “boost” for many companies. In our opinion, more important than the financial incentives of this law is its duration, which should prove very beneficial in the long-term planning process of many companies. At VanEck, we believe these historic investments provide a significant and unique opportunity to invest in industries and companies that are positioned at the forefront of the energy transition and are expected to experience dramatic growth over the coming decades.
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Originally published by VanEck on September 14, 2022.
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