High inflation in the U.S. could make things difficult for the clean energy sector, but the passage of the Inflation Reduction Act could more than make up for those impacts, experts say.
In the U.S., consumer prices in July were up 8.5% compared to the previous year, albeit slightly lower than June’s 9.1% year-over-year increase. Late last week, the House of Representatives passed the Inflation Reduction Act, which authorizes $369 billion in funding for climate change-related and clean energy initiatives. The legislation includes a wide range of incentives and tax credits for clean energy, electric vehicles, nuclear power, and clean hydrogen, among other things, and is projected to decrease U.S. carbon emissions by 40% by the end of the decade.
Clean energy projects that began to get underway as inflation ramped up face two countervailing forces, according to Harry Godfrey, managing director at Advanced Energy Economy: on the one hand, as natural gas gets more expensive, interest in solar and wind, for instance, is likely to increase. But at the same time, the primary way to combat inflation is to raise interest rates, in an attempt to “cool” the economy, which means that the cost of capital for clean energy projects will also rise.
“So while there is, I think, a greater appetite to build these projects because they are deflationary, there is also [the fact that] the cost of the capital I need to raise to then build a multi-million dollar – let alone a multi-billion dollar – project has gone up. So those are the two forces at work there,” he said.
Two countervailing factors
It’s difficult to ascertain the impact that inflation has had on the solar sector, particularly because it’s been an especially weird time for the industry, according to Dan Whitten, vice president of public affairs at the Solar Energy Industries Association. In March, the U.S. Department of Commerce announced an anti-dumping circumvention investigation of solar cells from Cambodia, Malaysia, Thailand and Vietnam, in response to a petition from California solar panel assembler Auxin Solar. A few months later, President Joe Biden implemented a two-year exemption on tariffs for solar panels imported from these countries, which the industry expects will continue in parallel to the investigation.
“There are a lot of outside forces beyond pure economic analysis that have influenced the price of solar over the last year, tied to supply chain, tied to trade policy – and so it’s really hard to evaluate the impacts inflation is having in solar based on those other forces,” he said.
At the same time, renewables do not lend themselves to price volatility, Whitten added – “and so therefore, we don’t think it’s as bad as it has been for other energy sources.”
Clean energy projects tend to be inherently anti-inflationary – if not deflationary – in nature, Godfrey agreed. Conventional resources like coal, oil and natural gas are coupled to the global commodities market, and therefore subject to significant price volatility – but renewable projects, which don’t involve a fuel factor risk, can be viewed as a kind of “shock absorber” in the economy.
“The greater your share of that, the less you’re going to see your energy prices rise as those commodity prices rise,” he noted.
But future renewable projects face a different dynamic, according to Morten Lund, partner with Stoel Rives. Take a solar project for instance – a developer would essentially need to spend nearly 100% of the lifetime cost of the project in building it, he noted. Which means that an inflationary cost of construction, including the cost of financing, will be baked into the power purchase agreement price for a new solar project – essentially locking it in for 20 years.
“So then in five years, when oil prices come back down, those solar PPAs will still be high,” he said.
The two countervailing factors impacting clean energy development could affect projects at the margins, according to AEE’s Godfrey. That being said, wind and solar projects aren’t only built because they are the least cost resources – they are also driven by emissions reduction goals, as well as a need to diversify energy sources.
“So it’s important to note the cost of capital, and how that can impact these projects, but it’s not the sole determinant of project viability,” he said.
‘A mild headwind’
High inflation has also had implications for storage projects, industry advocates agreed, and the sector is facing several sources of increased cost due to inflationary pressures and supply chain constraints, like materials, labor, and the cost of capital to get things financed, said Jin Noh, policy director with the California Energy Storage Alliance.
“My view is that [inflation] is like a mild headwind” against the backdrop of a larger transition from the conventional, fossil fuel fleet to new energy sources, said Alex Morris, CESA’s executive director.
The impacts of inflation on the ground include some projects getting downsized or delayed, or force majeure invocations, he added.
In California, this has led to responsiveness both from the industry as well as the utility or load-serving entity side to keep project deals intact – efforts that signal the industry’s commitment to absorbing a portion of the risk, as well as the power providers’ commitment to moving deals forward and serving load with clean resources, Morris said.
“It hasn’t been perfect, and each load-serving entity negotiates these things and approaches these things differently, so it’s hard to draw a single, standard conclusion – but generally, we are still seeing progress,” he added.
The Inflation Reduction Act
The Inflation Reduction Act, however, could change many of these dynamics.
Take, for instance, the cost of capital. AEE’s first-cut analysis suggests that the provisions in the IRA are going to more than offset the increased, underlying cost of capital driven by inflation, according to Godfrey. The IRA would restore to full value and extend the Investment Tax Credit and Production Tax Credit for clean energy projects, as well as institute a credit for standalone storage. It also includes a variety of adders, like meeting domestic content requirements, and when stacked together, “for the ITC, you can get like a 50% tax break on it for a big project – that’s huge,” he said.
Another meaningful aspect of the legislation is that it will continue many of the tax credits into the 2030s, providing developers with more certainty and a clearer line of sight, said Godfrey.
“I think what’s in the IRA more than counterweights the inflation of this moment,” he added.
In California and the West, there is already a fundamental drive toward more renewables and storage, and the IRA essentially reflects a continued commitment and reduced cost to achieving that, said CESA’s Morris. In addition, the legislation could also lead to changes in how storage is configured and shows up on the grid.
“We’ve seen a lot of storage paired with renewables – we know that that can make a lot of sense, but it’s also linked to the investment tax credit for solar. And now, we may see different configurations of storage, including more independently connected standalone storage not necessarily colocated with solar,” he said.
