What the Inflation Reduction Act means for oil and gas

I think it’s fair to say that many in the oil-and-gas industry are not thrilled with the Inflation Reduction Act (IRA), which allocates $369 billion to energy and climate initiatives. Here, for example, is the verdict of the American Petroleum Institute: “It falls well short of addressing America’s long-term energy needs and further discourages needed investment in oil and gas.” A letter from 60 industry groups complained of higher taxes and fees and lack of permitting reform. ?And around the (virtual) water cooler, there is more than a little skepticism.?

Credit: mcb.cpa

The IRA is more than 700 pages long; I don’t imagine that there has been any legislation (or, indeed, book) of that length where I have agreed with every word. My take: while the IRA is clearly much more oriented toward renewables and other low-emissions technologies, it also has positive elements for the oil-and-gas industry. Here are a few provisions that stand out.

Drilling, ?leasing, and permitting: Rent and royalties will be more expensive, but there will also be new opportunities for leasing on federal lands and a number of canceled leases were restored. And while the IRA does not do much on permitting reform—something the industry has, correctly in my opinion, wanted for years—part of the legislative sausage-making was to agree to address ?the topic. That may happen later this year . We’ll see.

Methane: Methane is a potent greenhouse gas, coming mostly from livestock and natural gas production ; it accounts for about 10 percent of US emissions. The IRA imposes a charge of $900 per metric ton of methane in 2024, increasing to $1,500 after two years. This is not, of course, wildly popular among O&G professionals, although there is also $1.5 billion to help companies comply. ?But this is hardly the end of natural gas. For one thing, there is nothing new here; indeed, Colorado created effective methane regulations in 2014. For another, many companies are already taking action, by reducing flaring and improving detection. Oil and gas do need a social license to operate; coping with methane is part of that.

Carbon capture, use and storage (CCUS): The existing tax credit is raised to $85 a ton (up from $50) for the geological sequestration of CO2, and $60 for its capture and use (up from $35), for example in enhanced oil recovery. The legislation also lowers the amount of emissions needed to qualify, meaning the technology may become possible for smaller facilities. The credit for sucking carbon out of the air (“direct air capture” or DAC) rises to as much as $180 a ton. All told, the IRA could triple the amount of emissions that can be captured through CCUS, and help to make it more economically feasible in high-emissions sectors like cement, refining, and steel.

Hydrogen: The IRA includes a 10-year tax credit, known as 45V , to incentivize production of cleaner hydrogen. According to Resources for the Future , an environmental economics think tank, these credits could “make hydrogen production from natural gas with CCS price-competitive with current hydrogen production without CCS.” That’s not quite a game-changer, because hydrogen would still be expensive, but it’s big. In addition, the IRA also benefits green hydrogen—that is, produced from electricity generated from no-emissions sources, such as wind and solar—for the same reason, cutting its relative cost. In addition, the Infrastructure Investment and Jobs Act directed $8 billion to new hydrogen hubs. Put it together, and the ?effect is to give the industry a degree of stability for the next decade. No wonder the Fuel Cell and Hydrogen Energy Association is “thrilled.”

These last two items—CCUS and hydrogen—are not a big part of O&G portfolios at the moment. But they could be, because these companies have the expertise needed to deploy these technologies. Moreover, they could help the sector lower its emissions. So the IRA’s ?support for these areas, while not meant to benefit O&G producers, likely will.

O&G companies are already looking into?the conversion of methane in natural gas ?to hydrogen as well as the possibility of?blending hydrogen into natural gas ?to lower the carbon content. And Houston, my hometown, is the national leader in carbon capture, and is taking hydrogen very seriously.

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I believe the United States—indeed, the world—is undergoing a long-term energy transition away from fossil fuels. ?But the words “long term” and “transition” are important. The United States ?needs reliable, inexpensive baseload power to fuel our homes and businesses—and right now that comes, overwhelmingly, from fossil fuels (79 percent) .?

In effect, the IRA accepts this, and therefore places lots of bets on lots of technologies—albeit, with a preference for renewables. As I see it—and I understand that not everyone will agree—the?legislation represents an “all of the above” strategy. And “all of the above” is what we need to power the transition.

All views are mine and not those of McKinsey & Company or of the Greater Houston Partnership.??