How might the Inflation Reduction Act impact the energy sector?

The Inflation Reduction Act (IRA) is an unprecedented downpayment on deficit reduction to combat inflation regarding the US economy. The IRA aims to invest a historic amount of money into domestic energy production and manufacturing to achieve the countries ambitious aim to reduce carbon emissions by roughly 40% by 2030.

Originally signed into law by US President Joe Biden back in August 2022, the bill sets out long-term investments for local, state and tribal governments, as well as American private sector tax credits. However, the biggest area of discussion is the US Government’s investment plans for Energy Security and Climate Change. The US Government will raise the gargantuan $739bn* by:

• Increasing minimum corporate tax rate by 15% ($313bn)
• Prescription drug pricing reforms ($288bn)
• IRS tax enforcement ($124bn)
• Closing carried interest loopholes ($14bn)

$369bn will be invested into US Energy Security infrastructure and Climate Change initiatives, while $64bn will be used towards a three-year extension for the Affordable Care Act, resulting in an estimated total deficit reduction of $300bn. The IRA will focus a large part of its resources towards cleaner energy supply, cleaner manufacturing practices, air pollution & greenhouse gases, clean vehicles, transportation infrastructure and carbon removal.

*Stated figures are subject to change by the Congressional Budget Committee and the Joint Committee on Taxation.

Mixed emotions from ally nations

Renewable energy, sustainable technologies and climate change solutions are quickly becoming key focuses for both countries and industries alike. However, the IRA has received a less than positive reception from officials around the world.

Canadian Minister for Natural Resources Jonathan Wilkinson in an interview with the Financial times, expressed his concerns that the IRA could potentially cause a ‘carbon subsidy war’ and the impact of significant subsidies have ‘created an unlevel playing field for Europeans and Canada’.

Similarly, in his closing arguments during the EU’s official response to the IRA, Mikuláš Bek (Czech Minister for European Affairs) stated: ‘We will need to be ready to react, if necessary, once the IRA is in place at the beginning of next year [2023], while putting a strong emphasis on avoiding a trade war with the US at this particularly delicate geo-strategic moment.’

An optimistic outcome moving forward

While there has been a mixed reception to the IRA, there has been a lot of collaboration between the US and EU to ensure that their respective energy and innovation markets remain competitive, and the financial ‘playing field’ level.

In a recent discussion to CNBC, German Finance Minister Christian Lindner reiterated EU concerns but also expressed his optimism around a US/EU task force, working together to support business growth and healthy finances across both continents: ‘We should do everything we can to avoid a tit-for-tat scenario or even a trade war…. I really appreciate this EU/US task force to work on common ground, I would like to go even further. Probably, this is an opportunity to renew the idea of trans-Atlantic free trade.’

What does this mean for the energy market?

It’s difficult to speculate on how the markets will react to the IRA, it’s safe to presume that renewable energy is going to be an era-defining industry in the coming years. If the US and EU can agree to an amicable deal to provide long-term growth and development opportunities for preferred trade partners, then this space will become a very broad and competitive market.

If a deal can’t be agreed upon, the IRA could result in the US taking the lead in combatting climate change. The US may be able to influence or direct finances for science and innovation to countries or territories of their choosing. Additionally, countries such as smaller members of the G20 who haven’t committed to sizable targets could be brought onboard with potential American investment.

Poor or vulnerable countries could struggle with the costs of transitioning from non-renewable energy to green energy. The US would need to lead financing efforts to ensure these countries receive adequate funding to competently manage green energy adoption.