The Latest: On July 27 2022, it was announced that a deal had been reached between Senators Chuck Schumer and Joe Manchin on a budget reconciliation bill known as the Inflation Reduction Act of 2022. The Biden administration has been working toward such a deal since earlier in year when the President’s Build Back Better law failed to pass through the Senate. The Act contains USD370bn in climate and energy spending, including extensions of key renewable energy tax credits and consumer incentives for clean energy technologies. The proposed provisions would increase lease costs for upstream oil and gas companies and impose tighter regulations on methane emissions for the wider O&G industry. On the other hand, the Act would also reduce some uncertainty for offshore oil and gas operators reinstating canceled lease sales in the US offshore.
Implications: The bill includes extensions of the existing production tax credit (PTC) and investment tax credit (ITC) for renewable energy projects that begin construction before 2025 which would drive investment in the near-term. Each credit has been modified into a two-tiered incentive with a ‘base’ rate and an ‘increased’ rate. A project becomes eligible to receive the ‘increased’ rate when it meets prevailing wage and apprenticeship requirements established in the Inflation Reduction Act. For the PTC, projects will receive a base rate of USD0.003/kWh and an increased rate of USD0.015/kWh. Solar projects would also now be eligible to claim the PTC. For the ITC, projects will receive a base rate of 6% and an increased rate of 30%. In addition, energy storage projects would now qualify for the ITC which were previously not included as an eligible technology. Renewable energy tax credits have been a key driver in the sector’s rapid growth in the US market. If passed, the extensions included in the Act would provide added business certainty for renewables developers in the near-term and present a sharp upside risks to our non-hydro renewable forecast. The modifications would particularly benefit standalone energy storage projects, which currently are not eligible for renewable energy tax credits.
Extensions to existing tax credits are meant to serve as a bridge in the near-term until the newly designed credit scheme takes effect in 2025. The Act creates technology neutral versions of the PTC and ITC with similar incentive values for projects that begin construction after December 31, 2024. Any zero-emission electricity generation project will qualify for the technology neutral credits until 2032 or until US electricity sector emissions decrease 25% from 2022 levels. Further, the bill establishes both a PTC and ITC for clean hydrogen production facilities with a structure similar to the newly designed technology neutral credits. The new credit design also provides projects the opportunity to receive ‘bonus’ credit for design characteristics related to policy goals. Projects can receive a 10% addition by reaching certain thresholds of domestically produced materials in construction. An additional 10% is available to projects related in designated energy communities and 20% for projects located in low-income areas. The proposed tax credits included in the Inflation Reduction Act would drive long-term investment in the US renewables sector and we expect a positive shift in our forecast if the bill passes Congress. We highlight particular upside risks to the nascent green hydrogen industry which would be newly eligible for tax credits in the US market.
For the oil and gas industry, the Inflation Reduction Bill would increase costs for upstream producers active in onshore and offshore as well impose new charges for methane emissions. The bill would among others update certain provisions in the Mineral Leasing Act:
On top of provisions that would impact upstream operators, we highlight new methane emissions regulations that would amend the Clean Air Act and impact the wider petroleum and natural gas systems industry. The Inflation Reduction Act would impose a threshold of 25,000mt of CO2e/y for all “applicable facilities”, which include i.e. certain offshore/onshore production sites, natural gas processing plants, midstream infrastructure, storage and LNG facilities. The facilities that exceed this threshold would be charged for exceeding emissions: USD900/mt CO2e in 2024, USD1,200/mt CO2e in 2025 and USD1,500/mt CO2e in 2026, which would effectively become a new tax on oil and gas operators.
This provision would likely have a widespread impact across the US O&G basins. For example, according to the data from the Environment Protection Agency for 2020, 467 onshore oil and gas production facilities across the US submitted their emission reports, out of which 279 reported CH4 emissions exceeding the stated threshold of 25,000mt CO2e/y. For the largest basins, like Permian, Anadarko or Appalachia Eastern Overthurst Area, the share of facilities that exceeded the stated threshold would linger at respectively 61%, 73% or 82%. Tighter methane emissions regulations would likely accelerate the development and implementation of emissions capturing solutions in the long run however in the medium-term these provisions would raise operational costs for a number of O&G producing and transporting companies