The Inflation Reduction Act and U.S. energy transition

Dominique Barker: Welcome to The Sustainability Agenda, a podcast series focusing on the evolving complexities of the sustainability landscape with a view on addressing current issues in a concise format to help you navigate and take action. I’m your host, Dominique Barker. Please join me as we explore today’s most pressing matters with special guests that will give you some new perspective and help you make sense of what really matters.

James Wright: Think about the bill as a kind of big bag of carrots of all shapes and sizes. So what I mean by that is, compared with previous attempts that Congress has made to pass sort of sweeping federal level climate legislation, I think they’ve taken a bit of a pragmatic approach here, this time to frame this around incentives like carrots rather than penalties, sticks.

Dominique Barker: Today we welcome James Wright, Managing Director and Head of US Project Finance and Infrastructure for CIBC Corporate Banking, and Frank Palladino, Managing Director of Renewables for CIBC Global Investment Banking. Both are heavily involved in helping to oversee our US renewables and energy transition businesses. On today’s episode, we’re going to be discussing the Inflation Reduction Act, its impact on the US energy transition and of course what it means for our clients. My own expectations is that this is a major opportunity. This act was announced back in August, but we’re going to hear from the experts from James and Frank and hear what they have to say. James, Frank, thank you for joining today’s episode of The Sustainability Agenda.

James Wright: Thanks, Dominique. Great to be here.

Frank Palladino: Yeah, same here. Thanks for having us.

Dominique Barker: So to both of you, let’s begin by introducing CIBC’s growing US renewables team. Where are we focusing in the US and why? If you could just start us off by level setting, that would be great.

James Wright: Sure. Happy to kick off. So just the first thing I’d say is we’re really positioning our platform here to be a one stop shop for our clients in this space, thinking end to end right across the capital stack. What we’ve seen is a lot of banks in the space have one or two particular piece of the puzzle that they like to focus their efforts on where what’s increasingly important to our clients, as we see it, is really being able to offer them solutions that start long before shovels go in the ground right the way through to what after a product eventually being built. So that kind of whole lifecycle, as you think about it, we’ve been very successful with that in the US market here, particularly our renewables balance sheet is probably one of the largest in the space. We’ve got about 60% of our overall project finance and infrastructure deal flow now comes from renewables and energy transition. And I’d also quickly add that our client base is really broad here, right? From developers to asset managers, private equity, IPPs, utilities and oil and gas majors. So right across, right across the piece.

Dominique Barker: Frank, anything to add?

Frank Palladino: Yeah, I would echo what James just said there. Definitely a diverse group of clients. And really when I think about the investment banking side, it really is a client focused strategy where we’ve looked to grow the business. So really working on transactions anywhere from multibillion dollar platform investments for a group like Blackstone to a smaller regional commercial or community solar investments, for example, for Axium and their acquisition of BlueWave, we’ve also raised capital for some more unique and interesting transactions like a long duration storage company or raise capital to support a client in their New York based offshore auction. And just as far as to give an idea of scale, a couple of years ago, the business here, we had two senior professionals and maybe a team of five in total that were focused in US market renewables and now it’s five senior professionals and about 15 people. And with that have looked to increase the deal flow in US market focus from 3 to 4 transactions annually to ten plus going forward.

Dominique Barker: Yeah. And I can attest I started in March 2020 in this group and the group has grown tremendously, including adding both of you and I’ve been involved in some of your work and you know, it’s a really impressive team. So thanks for that because I think it will surprise people how large the business has become in the US. Let’s get into the meat of the podcast today. What I think a lot of people want to learn more about, and that’s the Inflation Reduction Act, which has the unfortunate acronym of IRA, that’s the US bill that was signed into law this past August. It allocates approximately $370 billion. That’s billion with a B towards climate and energy investment. James, in simple terms, provide an overview of the IRA and what makes it so meaningful for the energy transition.

James Wright: Yeah, simple terms for a 700 page-

Dominique Barker: Right? Sorry. (laughs)

James Wright: So the way I think I’d see this up is to think about the bill as a kind of big bag of carrots of all shapes and sizes. So what I mean by that is, compared with previous attempts that Congress has made to pass sort of sweeping federal level climate legislation, I think they’ve taken a bit of a pragmatic approach here, this time to frame this around incentives like carrots rather than penalties, sticks. So all the incentives provide renewables and other energy transition technologies with economic kickers to enable them to be the cheapest form of energy generation in the country, right? So putting aside things like carbon taxes and some other kind of complicated politics around those approaches, this is very simple. It’s layering in additional tax incentives that on a purely economic basis, technologies like wind and solar will continue to be the most competitive form of energy versus fossil fuel alternatives. That’s the first thing. It’s also very broad because it covers a wide range of additional technologies with standalone batteries now having tax credits support, hydrogen having support, plus an expanded 45 queue for carbon capture. The other thing I’d note is that this really provides investor confidence, I think. This is a package that extends these credits ten or more years into the future. Whereas as we’ve all seen previously, the industry has been on kind of tenterhooks as Congress has kicked them down the road every couple of years, which has been challenging. The final quick sort of high level observation I’d make is to think about this legislation is also giving a really good bunch of structural tools to make these tax credits more accessible and utilizable more. So a few key ones being a limited form of what’s called direct pay for Hydrogen and US, which provides other routes to monetize these credits for developers of those projects. There’s a sort of weedy concept of transferability in there which could, in theory, reopen up the universe of corporates who can invest in these tax credits, i.e. adding more liquidity to the space. There’s a PTC election now available, the production tax credits for solar, for example, which we may touch on shortly. And there’s also some really kind of increased flexibility to both carry back those credits into previous tax years and also carry them forwards, which again, just give us more flex on how they can be utilized, so a lot of kind of structural tools there as well.

Dominique Barker: Great. So a carrot salad. I like that. I like that bag of carrots. Frank, before the passage of the IRA, what were some of the storylines surrounding the US energy transition in renewables technology? And I happen to know that you’re an expert in tax equity. I would love if you could talk a little bit, bring in the concept of tax equity and what might change related to this bill.

Frank Palladino: Sure, sure. Happy to. So without a doubt, we’ve got huge ambitions on the clean energy, energy transition side. And as we’ve chatted about the IRS’s and the government has used tax credits as a major incentive to facilitate the buildout. And where we got to is that it seems the tax equity market was a major constraint in the market. We were at a point where the supply of tax equity really was at or not meeting the demand for it and the projects that were being built out. So I had, I think the market initiative myself had some questions about how we would really kind of accelerate the shift to clean energy in the US with the current tax equity market in the current regime that we had, you know, when you think about wind and solar, that took a bulk of the supply of the market, just onshore wind and solar, then you layer on solar plus storage, you layer on our offshore wind ambitions, you layer on a carbon capture credit and then think about biofuels and others. I just didn’t see how we would be able to meet that demand with the tax equity that we had in the market. And so I think what this bill does with things like James talked about with direct pay for certain technologies, with carry backs, with transfer provisions, I think, you know, hopefully that that will open up a good portion of the market and also add help to facilitate some new corporates and others to enter the tax equity market and can continue to facilitate the build out here.

Dominique Barker: Great. Yeah. It was always surprising to me how few corporates were actually involved in tax equity. And so it sounds like going forward we could see, as James mentioned, a lot more liquidity coming in, which will be very positive, I think for energy transition. So James, going forward, why don’t you touch on some of the technologies or asset classes that you think will benefit the most from the IRA and become more commonplace as part of the US energy transition?

James Wright: Yeah, sure. So I think in relative terms kind of versus where they were six months or a year ago, probably the two biggest winners would be hydrogen and carbon capture. I mean, hydrogen now has a tax credit for the first time, which could be really meaningful for the economics of things like green hydrogen plays in particular, and for carbon capture, the value of the existing credit is substantially increased. It’s, you know, $85 a ton of sequester projects, for example, which again could be really meaningful for some of those projects which up until recently had kind of borderline sponsor economics. So that’s kind of maybe the sort of relative winners. In sort of absolute terms that we really need to focus on the broader package, right? I mean, battery storage, again, it now gets a standalone credit for the first time where previously it only got support if they were paired with solar PV systems. I’d also highlight solar. There’s the ability to elect the production tax credit now instead of just the investment tax credit, which structurally may well actually provide again, a lot of liquidity and market capacity for financing those projects. There’s a lot more folks out there with PTC capacity than ITC capacity. It’s also great for the wind market again on an absolute basis because as I mentioned before, with this longer lens on the PTC being available far into the future, the industry has a lot less of that pressure we’ve had in the past on qualifying projects for these incentives and also less of that construction cliff within a certain tax year. So it’s going to ease some of those pressures we’ve seen on that side. Those are the key ones.

Dominique Barker: Great. Well, we’d like this podcast to be balanced, and so why don’t we talk a little bit of the challenges? James I know we could probably do an entire podcast on the challenges, but maybe just briefly mention some of the challenges that we’ve identified with this IRA or Inflation Reduction Act.

James Wright: Yeah, I think you said it right. We could spend a lot of time on this. At a very high level, I think obviously the Treasury guidance has to come out to kind of put some of the meat on the bones around some of these provisions, particularly around the guidance around economic kickers for putting projects in disadvantaged energy communities, prevailing wage requirements around how these credits are going to be structured going forward as well. So some of that kind of weedy stuff has to be formalized by the Treasury. There’s going to be a significant time if we think about the EV side actually, which we haven’t touched on, there’s obviously support for EV on automotives, but there’s quite a bit buried in there around supply chain requirements and actually a lot more domestic content being needed to qualify for those credits. And again, as we know from what’s happened in the past couple of years with the supply chain pressures globally, we understand why that’s in there. And obviously, it makes a lot of sense on many levels, but that’s going to take time to come, right? I mean, factories don’t just pop up overnight. Education with non-traditional investors is important, right? Again, to your point, Dominique, liquidity is super interesting here as we think about some of the transferability provisions. But how those tax credits work and how their structures are going to be put together is going to take some time and a bit of education there with sort of non-traditional buyers.

Dominique Barker: And Frank, what would you add in terms of constraints or question marks?

James Wright: Yeah, I mean, I understand you want to keep this balance, but I’m still overall pretty bullish. I could talk about all the positive-

Dominique Barker: Absolutely.

James Wright: For hours here. There are definitely some other constraints. You know, James touched on supply chain and having confidence that your equipment’s going to get there. It’s going to be on time, on budget, that it’s sourced in a sustainable and humane way. You know, inflation obviously, is an overhang on what we’re seeing and just understanding the cost of your projects and also the cost of capital on the back end will be critical. Interconnection queues will need to see some reform and see that open up a bit to accommodate all the projects that we’re going to see built out. Transmission, would’ve been nice to see something in the bill around transmission, hopeful that that is coming. I’ll also just note that, you know, while these are some near-term headwinds, I really do think that the tailwinds far outweigh them at this point.

Dominique Barker: Yeah, I mean, I absolutely agree with you, Frank. And this Inflation Reduction Act is absolutely a massive, massive tailwind and opportunity. And it’s something we’ve been speaking about is this concept of inevitable policy response. So this Inflation Reduction Act is exactly that to address the challenge of climate change. So James, maybe just to close off, what is CIBC doing to continue to serve clients in this rapidly changing environment?

James Wright: Yeah. So look, as we’ve been talking about this, an unprecedented period of capital investment happening right now. And I think we’re entering this kind of early innings, if you like, for the energy transition on this side. So with that in mind, I think there are two themes that we’re thinking about very much in terms of how we service our clients, the first one before leadership, right? There’s just so much happening in this space, the stuff we’ve all been talking about the last few minutes, and it’s happening at relatively quick speed as well. And that’s so incumbent on banks like CIBC, I think, to really help distil that for our clients and provide investable ideas, really thinking about those new technologies out there, how to finance them. There’s a lot of complex politics and regulatory considerations around them we just have to kind of help guide our clients on. So thought leadership would be one. Secondly and kind of building on that first point, innovation, right? So again, given the speed of change we’re seeing in the energy transition economy, we need to constantly innovate the products and services that we’re providing to our clients. It’s fair to say the financing structures that this market has mobilized for decades for midstream or even renewables more recently are probably not going to be entirely fit for purpose when we think about carbon capture projects or hydrogen projects, especially with some of these quite bespoke tax structures we’ve just been talking about on this call. Third and final, very quick, will be just serving more clients, right? I mean, there are these technologies are now bringing new clients into this economy that weren’t even in existence a couple of years ago. So I think we’re going to see more clients who are sort of ready for prime time with a broad suite of capital markets products that a bank like CIBC brings to the table.

Dominique Barker: Great. And speaking of thought, leadership, I know you’re involved in speaking at conferences this fall and we’ll be hosting our own renewables conference. So that’s part of that thought leadership. Contact your CIBC representative if you’re interested in knowing more. Thank you, James and Frank, for joining us today on the show, and thank you to our listeners for tuning in.

James Wright: Thanks, Dominique.

Frank Palladino: Thank you.

Dominique Barker: Please join us next time as we tackle some of sustainability’s biggest questions, providing different perspectives to help you move forward. I’m your host, Dominique Barker, and this is The Sustainability Agenda.

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