Assessing the Inflation Reduction Act’s Impact on Energy Prices and Grid Resilience

Following a last-minute agreement between Senators Chuck Schumer (D., N.Y.) and Joe Manchin (D., W. Va.) in August, the Senate passed the Inflation Reduction Act of 2022 (IRA). The legislation thus cleared its only major hurdle before landing on President Biden’s desk. The IRA will affect many economic sectors, but the bill’s effects on energy policy deserve special attention. In its 755 pages, the IRA appropriates $369 billion to support conservation, energy efficiency, and clean energy.

The Inflation Reduction Act is immense in its size and scope. It extends and introduces a wide variety of tax credits which will alter the market dynamics of batteries, geothermal facilities, wind turbines, solar panels, electric vehicles, biofuels, clean hydrogen, nuclear power, and more. These new incentives have the potential to drastically change the energy landscape in the United States for years to come. The scale of the impact depends on the extent to which these subsidized technologies will still be successful in the absence of these credits.

The presence of inflation adds further uncertainty to the mix, as these subsidies will likely increase demand for scarce goods and encourage the Federal Reserve to continue to raise rates. These higher rates will, all things equal, reduce the availability of capital for new innovative ventures. In the short-run, it is unlikely that the IRA will help relieve Americans from rising energy prices, and in the longer term, we may look back on the Inflation Reduction Act as a missed opportunity to make critical regulatory reforms that would ensure Americans have access to reliable, affordable, and clean energy.

Changes to tax credits for renewables and nuclear

The IRA extends existing tax credits for geothermal, solar, and wind power production. To address Senator Manchin’s concerns about the fiscal impact of the bill, the basic rate of these extended production tax credits was reduced to 0.3 cents per kilowatt hour produced. However, certain qualifying facilities can receive 1.5 cents per kilowatt hour. To qualify, the project must have a maximum net output of less than one megawatt, construction must have begun prior to 60 days after the Secretary of Energy publishes guidance, and all workers, including contractors, must be paid a prevailing wage.

The extension of the tax credit will give businesses that invest in geothermal, solar, and wind a rebate on their investment. For example, if a qualifying business had 20 kilowatts worth of solar generation and 165 hours of peak sunlight hours per month, they would generate approximately 3300 kilowatt hours of power per month. The business would now qualify for 1.5 cents per kilowatt hour, or $49.50 a month, or $594 per year in federal tax credits. The business will also save money on their electricity bill by reducing their consumption during these peak sunlight hours. These tax credits can be claimed for 10 years. Additionally the IRA expanded a Residential Clean Energy credit which allows households to receive a federal tax credit equal to 30 percent of all expenditures related to household solar and battery storage installation before December 31, 2032.

However, these subsidies come at a cost. Tax credits for non-dispatchable sources, like wind and solar — which cannot ramp up production to meet short-term excess demand — can have the unintended effect of making the grid less resilient to shocks. By distorting the demand for wind and solar, these credits can lead to overbuilding of non-dispatchable sources in the short-run.

Warren Buffett once found himself in hot water for saying the silent part out loud:

I will do anything that is basically covered by the law to reduce Berkshire’s tax rate … on wind energy, we get a tax credit if we build a lot of wind farms. That’s the only reason to build them. They don’t make sense without the tax credit.

With earlier tax credits, this overbuilding led to dispatchable power sources, particularly coal plants, going offline as subsidies for wind and solar drove their revenues below breakeven. These plants going offline has led to grid instability and the threat of rolling blackouts in California, Texas, New England, and throughout the Midwest.

The lower tax-credit rate and one megawatt restriction may help mitigate the unintended consequences of the tax credit. Instead of subsidizing someone like Warren Buffett for building a massive wind farm that he does not believe should exist, the incentives may motivate ordinary American households and small businesses to invest in geothermal and renewables and encourage investment in those industries domestically.

The Inflation Reduction Act attempts to mitigate these unintended effects further by offering tax credits to dispatchable energy producers as well.

First, it funds a zero-emission nuclear power production credit with a basic rate of 0.3 cents per kilowatt hour produced. Qualifying facilities which pay a prevailing wage, however, will receive 1.5 cents per kilowatt hour produced — just like geothermal, solar, and wind power producers. This change is progress toward an even playing field among clean energy sources and will help the country’s existing nuclear power plants to compete and stay online. The credits start on December 31, 2023, and are slated to run until December 31, 2032.

The zero-emission nuclear power production credit only applies to existing nuclear facilities. However, new advanced nuclear reactors can benefit from the Clean Electricity Production Tax Credit and an extension of the previously authorized Advanced Nuclear Tax Credit.

The Clean Electricity Production federal tax credit will allow for these qualifying plants to receive 1.5 cents per kilowatt-hour for the first 10 years of operation. If new clean energy plants choose to locate on the site of a former coal plant they will receive 1.65 cents per kilowatt-hour. Likewise, small modular and advanced nuclear reactors that would go into service in 2025 or after are now eligible for an investment tax credit for up to 30 percent of the building cost, or 40 percent if they locate where a former coal plant was. Qualifying facilities will need to decide which tax incentives are most beneficial for their venture, as they are mutually exclusive.

While a more even playing field will be a boon to American nuclear power, to see a true renaissance Congress needs to enact broader regulatory reform. Regulatory reforms and funding changes for the Nuclear Regulatory Commission could accelerate investment in new nuclear power plants. When it comes to reliable, affordable, and low-carbon energy in the future, the clearest path forward is to reform America’s nuclear regulations. In this respect, the IRA leaves a lot to be desired.

It is too soon to tell if the bill will deliver on its promises

The raw scale and diversity of programs enacted and funded through the IRA should give analysts pause as they try to project the consequences into the future. Particularly now, when lower-income Americans’ budgets are already devastated by inflation, it is unclear what the aggregate effects will be.

The bill attempts to balance new spending with increased taxes and allocates the funding over the course of the next ten years. However, it also included rebates for electric vehicles, appliances, and home renovations which will likely result in increased demand for scarce goods, driving prices up. Despite its name, the short term effects of the bill are unlikely to reduce inflation. If interest rates continue to rise, which seems likely, the IRA may be viewed as a missed opportunity to truly combat inflation and a compromise on critical regulatory reform that could expand access to clean, affordable energy to more American homes and businesses.