Building on Incentives: Harnessing Inflation Reduction Act Tax Credits for Decarbonization

Legislation intended to fight climate change and promote the domestic production of clean energy, the Inflation Reduction Act, invests almost $400 billion in tax incentives aimed at reducing carbon emissions and accelerating the country’s energy transition away from fossil fuels.

While companies associated with renewable energy will be significant beneficiaries of the act’s incentives, companies in the fossil fuel sector also benefit from several new and expanded incentives designed to encourage investment in decarbonization activities.

Recently during ESF North America, we gathered leaders, Thomas Baker , Managing Director & Partner, Boston Consulting Group, Deanne Barrow , Senior Associate, Norton Rose Fulbright, Rebecca Jones PMP , Senior Project Manager, Wood, David Smith, LL.M. Partner, Manatt, Phelps & Phillips and Nick Macilveen , Managing Director, Embarcatec to discuss how the refining and chemicals industries can navigate decarbonization incentive programs, the key take-aways of which are:

• Globally leading in decarbonization projects and technologies - the Inflation Reduction Act’s $370+ billion investment into decarbonization and clean energy solutions is estimated to catalyse trillions of dollars worth of project growth and production in the US between now and 2032.??
• Increased CCS credits - The IRA supersized the value of tax credits for carbon capture from $50 to $85 for every tonne of CO2 permanently stored and sequestered and from $30 to $60 per tonne used for enhanced oil recovery (EOR) or other industrial uses of CO2.??
• Tax equity investors have provided access to subsidies - Not every company eligible for these credits can use the credits because they might not have the taxable income creating stranded money, and the need for a tax equity investor.?
• For CCS and clean hydrogen production, you can now get cash through direct pay - the IRA strongly incentivized the carbon capture industry because it can sell tax credits as well as get paid directly by the IRS. There are strings attached, namely the upfront project costs and some limitations.?
• Stackable tax credits - there are multiple revenue streams on the table of stackable credits that can add up to huge benefits across most decarbonization projects, including investment credits and production credits.?
• There are huge opportunities to save money on fuel costs and decarbonize at the same time - for example, with the green hydrogen production tax credit of $3 per kilogram, after supply chain and permitting challenges subside, the cost of electrolyzers and renewable electricity will fall and the forecast is green hydrogen production cost of $3 per kilogram, creating a scenario whereby natural gas can be replaced with a ultra low cost fuel. The IRA will make clean hydrogen a long-term game-changer in the United States.?
• Renewables and decarbonization in general have bipartisan support – Anything is possible. The risk of ‘defunding’ the IRA by a future administration to remove the incentives is relatively low. For example, renewables tax credits, the Production Tax Credit (PTC) and Investment Tax Credit (ITC) were extended a few years ago in a Republican-controlled house of Senate and Presidency. The IRA economically benefits many areas of the country, including former energy communities that relied on fossil fuels for their economic vitality.??
• The EPA mandates for carbon capture and sequestration will have a significant impact on existing operations in the power sector - The proposed rule requires either 90% capture of carbon dioxide using CCS by 2035 and/or co-firing with low-GHG hydrogen at a ratio of 30% (by volume) beginning in 2032 and ramping up to co-firing with low-GHG hydrogen at a ratio of 96% (by volume) beginning in 2038. It was very notable last year when the IPCC and others announced that we cannot meet the Paris Agreement without carbon capture.?
• There is a risk that Tax Equity won’t be sufficient to monetize all tax credits needed for these types of projects - $85 was a number talked about in the industry which might bring it to some parity. The amount you can get out of the IRA differs if you're making productive, profitable use of the carbon somehow, either enhanced oil recovery or some other commercial use of it. Companies are grappling with transferability and whether to sell tax credits or do a traditional tax equity deal.??
• Supply chains, permitting, access to capital, and transmission interconnect are the main barriers to advancing projects and technologies incentivized by the IRA? - despite modest permitting reform, permitting is still taking too long. Whether it's green hydrogen, efuels, or renewables, there is a real recognition of the need for increased green electricity going forward. On a positive, the 10% bonus credit is driving domestic content.?
• The IRA has shifted the boundaries of the clean fuel market globally – when looking at how the IRA has impacted global markets, taking export costs of clean ammonia as an example, pre-IRA, the US was the least cost-effective market when compared to Canada, South East Asia, Australia, and the Middle East. Today, US producers are the most cost-competitive. The US now produces blue and green hydrogen $1+ cheaper than any other exporter. We’re seeing a copycat consensus globally. Governments looking to incentivize and promote their own domestic production of clean fuels, will likely need to subsidize their domestic production industries to compete with US producers.?
• Transferability, something new in the tax credit space - The IRA has enabled an enormous new market of selling and buying tax credits through ‘transferability’ to enable a developer of a carbon capture or a clean hydrogen project to sell their IRA credits to a company with tax appetite. Key takeaways of the process include 1) the cash proceeds from selling the credits are not taxable 2) the value of the credit to the buyer–that is, the difference between a discounted price paid for the credit and the full dollar of tax savings–is not considered taxable income to the credit buyer 3) you can sell your credit from one project to multiple buyers, but the credits can't be resold – the first-time buyer is the ultimate buyer 4) the buyer bears the financial responsibility for a recapture event? (excluding upstream ownership changes); the seller can indemnify the buyer and some insurance is available.?
• There are a lot more zeros in the grants - Regulations and incentives are increasingly driving the economics and business decisions. Building the capabilities within teams and companies to respond to these grants and understand the incentives is incredibly important to businesses going forward.?
• A gold mine of opportunities to decarbonize – we are eight months in and still trying to figure out the requirements and how to navigate the requirements. Structuring the deals takes work, but the incentives can enable project success and make new projects possible.

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Watch out for the full takeaway report release from our ESF North America 2023 - Energy & Sustainability Forum, San Francisco.

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