The U.S. Inflation Reduction Act was signed into law on August 16, including major climate provisions intended to reduce demand for fossil fuels while encouraging consumer and commercial users to switch to renewable energy sources. S&P Global Ratings thinks that initiatives in the legislation could accelerate existing actions at the state and local government level and by corporations that already underpin long-term energy transition. By lowering the cost of clean energy technologies and incentivizing consumers to adopt low-carbon technologies, we believe the act could spur further decarbonization efforts.
The law targets a number of other key priorities, including domestic energy production and manufacturing, inflation reduction, lowering prescription drug costs, and deficit reduction. It is expected to invest $437 billion over 10 years, raise $737 billion in new revenue, and support over $300 billion in deficit reduction, according to estimates by the Joint Committee on Taxation and the Congressional Budget Office.
We believe the legislation may have mixed credit rating implications across sectors. It focuses on utilities, transportation, manufacturing, health care, and oil and gas as these sectors are some of the largest contributors to greenhouse gas emissions (GHG) in the U.S. (see chart 1). More broadly, the law also touches on a number of key stakeholder groups, including historically disadvantaged communities, workers, the elderly, farmers, and rural communities, among others.
While the legislation is far-reaching, its primary achievement is the investment in climate action and renewable energy. The U.S. is the second largest emitter of GHGs following China. Estimates by various groups suggest that the combined investments in the act will help the U.S. achieve roughly 40% emissions reduction by 2030 from a 2005 baseline and support 13% to 14% of additional emissions reductions over the business-as-usual case (see chart 2). While this trajectory falls short of the U.S.'s nationally determined contribution under the Paris Agreement of 50% to 52% reductions below 2005 levels by 2030, it demonstrates concrete action.
The largest share of spending is earmarked for energy security and climate change investment, with $370 billion allocated toward tax rebates and credits and grant and loan programs for the following:
- Lowering household energy costs;
- Growing domestic manufacturing for wind turbines, solar panels, and batteries;
- Developing renewable energy, storage, nuclear, and green hydrogen;
- Incentivizing farmers, ranchers, and forest landowners to adopt climate-smart conservation practices;
- Building new clean vehicle manufacturing facilities; and
- Extending the existing $7,500 consumer credit for qualifying electric vehicles, plug-in hybrids, and hydrogen fuel cell vehicles.
|Congressional Budget Office Score Of The Inflation Reduction Act|
|Energy and climate||366|
|Clean electricity tax credits||161|
|Air pollution, hazardous materials, transportation and infrastructure||40|
|Individual clean energy incentives||37|
|Clean manufacturing rax credits||37|
|Clean fuel and vehicle tax credits||36|
|Conservation, rural development, forestry||35|
|Building efficiency, electrification, transmission, industrial, DOE grants and loans||27|
|Other energy and climate spending||14|
The Act Balances Transition To Renewables While Mitigating Near-Term Impacts On Oil and Gas Producers
From a credit rating perspective, the legislation supports our view that over the long term, renewable energy will become a greater piece of the energy pie but that oil and gas will remain part of the energy lexicon. The provisions of the legislation specifically targeting oil and gas producers result from increased royalty rates for onshore leases as well as the establishment of fees on methane gas emissions. It's expected that onshore royalty rates for new acreage will increase to 16.67% from 12.5%. Notably, this is slightly lower than the newly established rate by the Bureau of Land Management of 18.75%. It will also increase lease rentals to $3 from $1.50 for new onshore acreage, ultimately increasing to $15 per acre after eight years while establishing a minimum bid for new onshore acreage at $10 per acre from $2.
The other major provision targets reducing methane gas emissions through fees. Operators who are emitting methane above the 0.2% Environmental Protection Act limit of total gas produced will face a fee starting at $900 per metric ton of methane, increasing to $1,500 per ton by 2026. For the U.S. oil and gas industry, these provisions will certainly increase producers overall costs, but only marginally. S&P Commodity Insights believes that the impact on overall production breakevens for U.S. producers will increase by less than $3 per barrel. However, smaller scale producers, who are not connected to pipelines for methane removal, who don't have the ability to utilize methane for their own energy use, and those who have not built sufficient methane monitoring systems, will be at a disadvantage.
The legislation opens up additional federal land for lease sales and expands tax credits for the use of carbon capture technology. However, most carbon capture technology is expensive and primarily reserved for larger producers who could take advantage of the tax credits. Over time, smaller producers might find it difficult to compete, which could create significant barriers to entry for new market participants.
New And Expanded Tax Credits For Utilities To Enhance Renewables Could Be Positive In The Long Run
The legislation could be a significant gamechanger for the merchant and contracted power sector, and specifically for clean energy technology. The long-term extension at full rates for wind and solar production tax credits (PTC) and investment tax credits (ITC) create tailwinds for onshore wind and utility-scale solar as well as for offshore wind and residential solar. In addition, the domino effect of three provisions in the law could benefit manufacturing of solar inverters and potentially shift meaningful production to the U.S. These are: extension of the solar ITC; standalone storage ITC; and domestic manufacturing credits for inverters. Perhaps key among all others is the green hydrogen tax credit that could make production of green hydrogen economically feasible a decade sooner than expected, potentially leading to a substantial new market for renewables. New federal production tax credits for existing nuclear power generation units and stand-alone storage are also significant for those sectors.
However, we think the law will generally be credit neutral for the investor-owned, public power, and electric cooperative utilities. While under the law investor owned utilities with more than $1 billion in adjusted financial statement income are subject to a new minimum 15% tax--which could pressure cash flow and credit ratings--depreciation and tax credits allowed under the internal revenue code can offset tax payments, limiting the impact on financial performance. In addition, the law allows for the expansion of tax credits by including nuclear, renewables, clean hydrogen, and batteries, which will increase the total tax credits available, providing additional options for utilities to lower the tax burden. However, the full value of the tax credit expansion is not expected until 2025, which may lead to minimal near-term benefits for the industry.
Furthermore, the legislation's provisions that facilitate the monetizing of tax credits by not-for-profit utilities for investments in wind and solar resources could support public power and electric cooperative utilities with the option to build renewables rather than relying on a partnership with generation developers that can monetize the tax credits. In the long run, we think that the combination of tax credit expansion and transferability may lead to the industry accelerating the pace of renewables to support the reduction in GHG emissions. However, a greater share of renewables driving generation capacity could underscore the need to concurrently develop and install firming battery capacity to offset intermittency. Utilities that fail to prioritize this aspect of their operations could face customer ramifications if rate increases are necessary, potentially pressuring financial positions.
The Law Is Likely Neutral For Transportation Providers, Particularly Compared To The Infrastructure Law
Compared to the far-reaching implications of the Infrastructure Investment and Jobs Act of 2022 (IIJA), the legislation has substantially less direct impact on transportation infrastructure providers. However, its focus on energy transition with renewable and alternative fuel tax credits, GHG emission reductions, and additional environmental reviews, could have a meaningful and likely longer-term effect on the credit ratings for airport, port, roadway, and transit operators stemming from operational and policy initiatives. In terms of direct dollars, the act provides grants via existing or newly created federal programs under formula or competitive funding mechanisms, generally with a federal participation rate of 75% to 100% of eligible costs, which could continue funding available in the IIJA to support the substantial capital needs in the sector. U.S. ports will benefit from $3 billion in grants to reduce air pollution and emissions by installation of zero-emission equipment and technology including $1 billion for the replacement of heavy-duty vehicles. In addition, public transit providers may tap into this funding and potentially the $27 billion included for the creation of national and state green banks to support zero-emission technologies or projects that reduce GHG emissions. State departments of transportation and metropolitan planning organizations may benefit from $3.2 billion allocated to improve walkability and transportation access for disadvantaged or underserved communities and $2 billion to incorporate low-carbon transportation materials into projects. Furthermore, airport sponsors are eligible to compete for nearly $300 million to finance projects that encourage the production, use or storage of sustainable aviation fuel.
Over the longer-term, the transition to electric and hybrid vehicles supported by the tax credit provisions in the legislation may accelerate the erosion of federal and state fuel tax revenue that is critical funding sources for highway and transit capital investment, particularly the federal Highway Trust Fund. This transition could also be a downside risk for gas tax bonds without some form of substitution pledge.
Extension Of Expanded Health Premium Subsidies Is A Net Positive To Providers And Individuals
The legislation extends expanded premium subsidies through 2025 to individuals purchasing health insurance on the health insurance exchanges. The expanded premium subsidies were initially implemented with passage of ARPA in March 2021 with planned expiration on Dec. 31, 2022. The extension prevents these individuals from losing access to expanded subsidies in 2023 and paying higher premiums resulting in continuing access to affordable health insurance to seek care for their health needs. This extension also aids providers by helping maintain an expanded pool of patients covered by insurance (who otherwise might have become uninsured) or by helping maintain a better-insured patient pool who may have otherwise purchased more limited health plans with lower premiums but higher deductibles. Both situations could contribute to near-term credit rating stability to providers by reducing exposure to bad debt expense that affects operating margins and cash flow. Also, when the public health emergency ends and certain Medicaid enrollees no longer qualify for Medicaid, these expanded subsidies may help those individuals access affordable health insurance off the health insurance exchanges. That said, these expanded subsidies are only approved for three years and long-term benefits for providers could be limited unless future legislation makes them permanent.
This report does not constitute a rating action.
|Credit Ratings Analysts:||David N Bodek, New York + 1 (212) 438 7969;|
|Suzie R Desai, Chicago + 1 (312) 233 7046;|
|Kurt E Forsgren, Boston + 1 (617) 530 8308;|
|Gabe Grosberg, New York + 1 (212) 438 6043;|
|Aneesh Prabhu, CFA, FRM, New York + 1 (212) 438 1285;|
|Tiffany Tribbitt, New York + 1 (212) 438 8218;|
|Paul Watters, CFA, London + 44 20 7176 3542;|
|Nora G Wittstruck, New York + (212) 438-8589;|
|Sustainable Finance Analysts:||Corinne B Bendersky, New York + 44 20 7176 0216;|
|Michael T Ferguson, CFA, CPA, New York + 1 (212) 438 7670;|
|Ashley Yen, Washington D.C. 202-280-8696;|
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