On August 16, 2022, President Biden signed the Inflation Reduction Act (“the Act”) into law. We believe the Act is a critical catalyst to accelerate the sustainable development of a sustainable green resources sector in the U.S. and should serve to amplify the investment opportunities in this emerging new asset class. The vast majority of this bill is focused on tax credits and infrastructure funding to address climate and energy security, enhancing the economic viability of the relatively nascent green power, manufacturing, transportation and agricultural industries. With approximately $400 billion earmarked for these initiatives over the next 10 years, the current federal government has clearly indicated its intention to provide meaningful support to a variety of industries with the aim of securing the U.S.’s energy independence and significantly reducing its emissions.
In our view, the most impactful part of the legislation is less so the dollar amount of spend directed toward these tax credits and more the certainty in their duration over the next 10 years through potentially changing and divided governments. The ramifications of the Act’s duration are substantive. Roughly half of the legislation is directed toward the extension of investment tax credits (“ITC”) and production tax credits (“PTC”) for the wind, solar and, now, electricity storage (batteries) industries, by paving a pathway of 30% tax credits (30 cents per dollar spent on developing a project can be deducted from federal taxes) or up to a 1.5 cents per kilowatt hour credit for green power production through 2032. Whereas historical tax extensions have been renewed every few years since their inception in 2006 (with the current ITC level at 26%, stepping down to 22% in 2023-2024 and 10% thereafter) the general uncertainty of extensions of the ITC/PTC at prevailing rate resulted in developers’ inability to plan longer term around investment and project returns.
The Act also addresses many other verticals of U.S. emissions. It is, however, important to note that the “fine print” around qualifying for additional tiers of benefits reveals a strong push toward using domestic content, as well as project development incentives in “energy communities,” areas in the country that previously had significant employment or shuttered projects in the extraction, processing, or transportation of coal, oil, or natural gas. In theory, a solar developer using domestic panels for a project at a closed coal mine could avoid paying taxes on 50% of the cost of their project.
While the Act has been long awaited and is a welcome piece of legislation across energy transition industries, it pays to note that there is still much room to grow if the U.S. wants to decarbonize and spur investments, in both renewables buildout as well as new technology development, to truly make a dent in the following years. The European Union, since announcing its Green Deal in 2019, has earmarked well over $1 trillion toward energy independence and decarbonization. Other major countries such as China and India, while short of announcing official spending targets, have already spent a decade–plus investing in (China) or are rapidly moving toward (India) decarbonization through widespread national, regional and local initiatives. In our view, the Act is a solid start at the federal level, but much more needs to be done in climate–related actions and investments at all levels of government (critically, including state and local communities) in conjunction with the private sector.
In our opinion, a major disconnect in the Act’s vision versus reality is the strong requirement to incorporate domestic content while providing minimal support for the mining, processing and refining of the critical minerals that are the fundamental building blocks of the green electrification of our economy. We believe this could be a major road block in attaining energy transition goals while also maintaining energy security and the wide cost advantages the U.S. presently holds.
A Spectrum of Stocks Benefit
We hold a number of names across our portfolios that should benefit from these policies. Whether eligible to benefit from hundreds of billions of dollars from the U.S. government, or just single figure billions, companies across a wide range of sectors in which we invest stand to gain–both in terms of funding and stability when it comes to planning.
We look below at two of the sectors we think to be most exciting and our holdings within them that we think are particularly promising.
Renewable Energy
As mentioned above,a significant portion of the Act is directed toward tax credits to support the growth of traditional renewable energy (wind and solar) as well as battery storage. Currently, the ITC for solar is 26%, while the PTC, usually used toward wind projects, expired at the end of last year. The Act allows for a step up to 30% ITC (and potential additional bonus adders, noted above) and PTC of 1.5 cents/kWh produced assuming certain domestic labor standards are met. Other incentives outside of tax credits include an advanced manufacturing production credit, which applies to the build out of the renewables supply chain.
We hold a number of names across our portfolios that benefit from these policies. Companies such as diversified solar inverter manufacturer Enphase Energy (5.63% of the VanEck Environmental Sustainability Fund (ESF) net assets, 2.48% of the VanEck Global Resources Fund (GRF) net assets)1 should benefit from the necessary and rapid buildout of solar projects into the decade, as well as homeowners’ move toward independent energy management. The company currently holds 35% market share of inverters in the U.S., with a strong bent toward technological innovation as it rolls out products focused on automation and energy optimization for applications inside the home. We think the solar inverter, considered the “brain” of energy flow from solar panels, grid, and appliances, can result in costs savings for both utilities and homeowners by reducing power wastage. Enphase is uniquely positioned to benefit from the long arc of adoption through residential, commercial, and utility solar, as well as increased wallet share from end consumers as it engages more with home energy control.
Spotlight on the Consumer: EVs
Another major policy that has received plenty of airtime has been subsidies for electric vehicle (EV) purchases. The Act offers up to a $7,500 income tax credit for new cars and up to $4,000 for used cars. It is available to individuals making less than $150,000 a year, with price caps of $55,000 on sedans and $80,000 on pick–ups or SUVs to spur mass–market adoption. In line with the focus on domestic manufacturing and supply chain security, this subsidy is only available on models with final assembly in North America, with a “glide path” upward on the percentage of critical minerals and batteries manufactured in North America.
We have witnessed an increasing number of battery manufacturers over the past two years break ground (or with intention to break ground) in North America and Europe, in order to address supply chain security in an industry in which 70%+ of critical minerals are found and/or are processed in Asia. This Act encourages an ongoing trend, and reflects the very strong view that the U.S., a major global player in the traditional automotive market, does not intend to lose its foothold in a multi–trillion–dollar EV market.
Given EV manufacturers’ increased interest in domestic content as well as attractive incentives for EV buyers, we believe that Freyr Battery (3.24% of ESF net assets, 0.92% of GRF net assets) is in a unique position to benefit from the inflection of growth we should see with the entry of the mass market EV at scale. The Norwegian–based battery manufacturing company sources 100% of its electricity through renewable energy. It is estimated to be one of the lowest cost battery manufacturers on a per kilowatt hour (kWh) basis in part due to cheap electricity, but also due to a novel manufacturing process licensed from 24m, a lithium ion battery cell manufacturing process designed by researchers out of MIT. Freyr has expanded its footprint significantly over the past few years and is currently constructing a “gigafactory” in Norway and, through partnerships, additional factories in the US, Finland, and Sweden. Freyr has been planning its U.S. facility through a joint venture with Koch Strategic Platforms since 2021, and is very close to determining the site location and beginning its customer qualification process.
Although the Act may not directly address domestic content (to us an important issue), the breadth and depth of what it does address is significant. We see this legislation as not only laying the ground work for the energy transition over the years to come, but also providing a very necessary “shot in the arm” for many companies. In our view, more important than the financial incentives of this act is its duration that should prove to be very beneficial in the long–term planning process of many companies. At VanEck, we believe that these historic investments provide a significant and unique opportunity to invest in industries and businesses that are positioned at the forefront of the energy transition and are expected to grow dramatically in the coming decades.
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Originally published by VanEck on 14 September 2022.
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