PUBLISHED DATE: 2023-07-17 04:04:47

How the Inflation Reduction Act Impacts Utilities

Publicis Sapient Energy & Commodities

Christopher Dann • Sartaz Ahmed • Tripp Fried

Executive summary:

The Inflation Reduction Act has numerous, high-impact provisions that have tilted renewable project economics to significantly favor regulated utilities
To incentivize further growth in renewable power capacity, the act provides new pathways to monetize valuable tax subsidies previously inaccessible to utilities and, ultimately, their customers
This altered competitive landscape positions regulated utilities to undercut independent power producers and create new value for utility shareholders and ratepayers alike

More than simply curbing inflation, the Inflation Reduction Act (IRA) is poised to significantly impact the environment and the way Americans power their lives. The act pledges $369 billion to support the development of clean energy resources, with the goal of reducing power sector carbon emissions by 75 percent by 2032. In reality, however, the IRA’s provisions make these tax credits uncapped and perpetual, which likely pushes the value to developers well over $1 trillion before meaningful efforts to phase out financial incentives.

So, how does the IRA impact utility operators? In simple terms, utilities no longer have to watch from the sidelines. As the organizations that operate and maintain the bulk power system, regulated utilities have had a front-row seat to previous legislation over the last 20-plus years aimed at competitive project development through independent power producers (IPPs) and their financing partners. The IRA has overhauled federal tax codes so that investor-owned utilities are among the companies that will benefit the most through newly unlocked development cost advantages.

How will the IRA change the competitive power landscape?

The IRA is the most impactful piece of environmental legislation in over a century. It accelerates the growth of the renewables market and creates entry points for organizations both big and small to participate in—and take advantage of—the transition to clean energy.

Traditionally, regulated utilities in the United States have been limited by arcane accounting standards that curtailed their ability to take full advantage of the production and investment tax credit systems available to “competitive” developers, commonly referred to as IPPs. Consequently, they were not the lowest-cost builder or owner of solar and wind projects. Instead, "non-regulated" IPPs were provided an economic advantage that perfected the use of tax credit policy over the last several decades, allowing them to offer the lowest power prices in the market. One way that they did this was by leveraging tax equity investors as financing partners, creating a competitive advantage that eliminated the economic rationale for a regulated utility organization to even try building renewable projects. This ultimately left utilities and end consumers reliant on the operational and financial stewardship of IPPs and their partners.

The IRA completely changes these competitive dynamics. In a bid to deliver more energy on a larger scale from sources like wind and solar, the act levels the playing field in the renewables market between regulated utilities and IPPs through a combination of new pathways to tax credits.

How can utilities organizations create value through tax credits?

The available tax credits are diverse, far-reaching and uncapped—though they have some qualifying provisions like prevailing wage requirements. The IRA also includes stackable bonuses as sweeteners to the “base” value of investment and production tax credits. These sweeteners, combined with a new ability to sell credits on the open market as they are produced, create an entirely new mechanism for utilities to compete with IPPs.

The IRA also incentivizes the planning of renewable energy projects in “energy communities,” or communities whose livelihoods have been entwined with fossil fuels (e.g., mining or oil and gas towns). By building renewables in these special locations, utilities can access credit bonuses while creating new job opportunities that counteract the economic damage these communities may suffer as the market navigates this latest wave of investment aimed at sustainability.

Furthermore, these communities’ economies have historically relied on coal or natural gas power facilities. Since utility companies owned and operated these assets, those same companies can access their own transmission network during interconnection more easily than IPPs, thereby reducing costs and simplifying transitions. These incentives should empower regulated utilities organizations to enter the renewables market with confidence, even as IPPs face an increasingly challenging project development landscape.

How will Inflation Reduction Act tax credits benefit ratepayers?

Electricity customers also stand to benefit from IRA incentives due to the nature of their relationship with the local utility. It is the obligation of the utility to provide safe, reliable and affordable power to their customers; to achieve those three obligations, the organizations charge ratepayers what is deemed to be a reasonable return on their investment. As such, power production tax credits and investment tax credits technically belong to the ratepayer as a direct offset to what the utility spends to operate a renewable facility, creating a huge advantage for utilities to offer much lower power prices than the nearest competition.

The IRA accomplishes this by introducing a credit transfer policy that permits the sale of tax credits to any interested third party. This allows utilities to monetize and pass proceeds directly to customers through lower-cost power.

New opportunities need new strategies

The IRA’s restructured tax credit system and acceleration of clean energy development will impact energy markets, labor markets and supply chains. Utilities organizations should be proactive in reviewing their strategy to take advantage of the new playing field. Furthermore, the IRA will exacerbate volatile real-time energy markets, as the intermittent nature of wind and solar resources can lead to violent price swings. Organizations should prepare for volatility by building adaptable and resilient strategies, such as investing in battery storage, bolstering their trading and risk management capabilities and developing customer offerings that incentivize more constructive energy consumption behavior.

The IRA will bring sweeping changes to energy markets, and utilities organizations should prepare to make the most of these changes. As the IRA accelerates the transition to clean energy, utilities have an opportunity to unlock new value by tapping into renewable markets and claiming tax credits.

Learn how the Inflation Reduction Act’s incentives can generate new value and untap growth opportunities for your utility.

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