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Leonard Hyman & William Tilles

Leonard Hyman & William Tilles

Leonard S. Hyman is an economist and financial analyst specializing in the energy sector. He headed utility equity research at a major brokerage house and…

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The Inflation Reduction Act Is A Game-Changer For Decarbonization

  • The Inflation Reduction Act (IRA) includes more than $170 billion of tax credits for the electric industry, designed to encourage the shift from carbon-intensive fuels.
  • An analysis carried out in 2020 suggested that decarbonizing the industry was not that much more expensive than business as usual, this new bill will make it a no-brainer.
  • While utilities will see massive benefits from the bill, we will have to wait and see if the savings will ultimately be passed on to the consumer or not.

The Inflation Reduction Act (IRA) is the Biden administration’s legislative triumph of August 2022. But despite its name, it will plow more than $170 billion of tax credits and possibly $40 billion more in loans to electricity users, producers, distributors, and manufacturers of electrical equipment over the next ten years. This is mainly to encourage the shift from the use of carbon fuels. The act relies on handing out tax credits that even the most determined climate deniers would find hard to turn down, as opposed to the Obama administration’s policy of disciplinary actions that the industry so successfully stalled in the courts. “It’s a win-win situation,” say some never particularly environmentally friendly executives, “for consumers and companies.” Well, it definitely is a win for the electric companies. Electricity consumers might also get lucky. Who knows?

The act’s big awards going directly to electric companies are a renewable energy production tax credit ($51billion), a nuclear production tax credit ($30 billion), a clean electricity investment tax credit ($51 billion), and a clean electricity production credit ($11 billion).  

Let’s put these benefits in perspective. Several years ago we took a look at the price of electricity over the long term, comparing full industry decarbonization with a business as usual scenario. We based the analysis on two ideas. First, the new industry would be largely a fixed-cost business without fuel expenses, so we did not need a complicated model. Second, it was not legitimate to compare the cost of new renewables with old fossil-fueled stations as if the latter were a long-term alternative. Most plants were old and would have to be replaced, and replacement costs would be almost identical to the cost of renewables. Anyway, we did the analysis for a SURFA conference in 2020 and concluded that over twenty years power prices in a fully decarbonized industry would only rise 3% a year in real terms, and 2% with a business as usual approach. In other words, not much difference. Improve the energy storage component a bit, and the numbers would be close to the same.

Since that paper, we estimate that construction costs have risen 30%, fuel costs 60%, and cost of capital 10%. So we did some back-of-the-envelope calculations. Now we would estimate that going to clean electricity would raise prices by 4% a year in real terms and staying dirty would keep the annual price hike to 3%. But the various benefits in the IRA, stretched over 10 years, work out to about 3% per year off the nation’s electric bill, assuming that consumers get the benefit (more on that later.) Thus, if we are right, the act definitely tilts the economics toward no-carbon-emission fuels. 

Finally, will customers see lower bills due to the act? Start with this point. With electric sales growing at around 1% per year, and annual expenses rising 3% or more, electric companies will be asking for rate hikes for a long time to come. These tax benefits will simply delay the rate hikes by providing the utilities with an additional source of income. Some regulators may force the utility companies to return the tax benefits to customers in the form of rate reductions. But if they do then utilities will simply ask for bigger rate hikes to replace the lost tax savings.  This resembles a game of Whack-a-Mole, that’s all.  

In short, we view the Inflation Reduction Act as a really big deal for the environment. It is also a big deal for utilities which we predict will move quickly to collect the considerable benefits provided. In a way, the government has simply offered the energy industry considerable incentives to do what they could have and probably should have done years ago along with some likely modest benefits for consumers. 

By Leonard S. Hyman and William I. Tilles

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