Inflation Reduction Act – consideration of US investment incentives and construction of renewables infrastructure

April 2023  |  SPECIAL REPORT: INFRASTRUCTURE & PROJECT FINANCE

Financier Worldwide Magazine

April 2023 Issue

The Earth needs to cool. This is known and generally agreed, at least by the more than 190 countries adopting the Paris Agreement which was agreed in December 2015. Yet it is legislation signed across the Atlantic in Washington DC in August 2022, bearing the less-than-catchy name of the Inflation Reduction Act (IRA), that has caused a recent boom in renewable energy investment, as parties rush to access the $369bn worth of tax breaks and subsidies for energy investment and production.

That boom has caused tension between the US and the European Union (EU), as well as with other countries. While such tension continues, more than $100bn in new investment in the US has been announced since the IRA was signed as part of an effort to meet the global need to cut emissions. Deadlines in the IRA have hastened the clamour for the subsidies provided and so it is important to know about the scope of these as well as legal points and priorities in renewables construction. With the IRA arising from the need to cut global emissions by 2030, wider considerations extend to how the IRA may frame investment in renewables infrastructure elsewhere in the world.

Old as new – subsides for renewables investment under the IRA

Whether the IRA reflects front-loaded smart policy or economic nationalism is a subject of some debate; what is clear is that the US tax system has long included incentives for renewables infrastructure, with investment tax credits (ITCs), as well as credits for production and generation (PTCs). Prior to the IRA, these credits were, however, more limited and in the process of being phased down. It is relevant to note that under this new regime, the clean PTC is reinstated for solar projects, whereas it was previously only available from 1992 to 2005.

Under the IRA, the existing tax incentives for renewables projects are extended through to 2024, by which time these incentives are then transitioned into technology-neutral and emission-based clean ITCs and PTCs, which would apply to net-zero energy producing facilities placed into service after 2024. The new PTC is worth $0.003/kWh, with an increased rate of $0.015/kWh if the wage and apprenticeship requirements are met.

As for the new ITCs, this new tax credit has a base rate of 6 percent of the qualified investment, with an increase to 30 percent if the wage and apprenticeship requirements are met. To comply with the wage and apprentice requirement, the investor must ensure that all labourers are appropriately paid during the construction of the project throughout the credit period and that the necessary labour hours are undertaken by certified apprentices. The new tax incentives will be in effect until 2032 or when annual US electricity gas emissions are equal to or less than 25 percent of such emissions in 2022.

Points to consider in building renewables infrastructure

There are some key legal issues to consider for stakeholders when developing renewable energy infrastructure projects, including those outlined below.

Planning consent. Planning consent will usually be required from the local planning government authority for the development of any renewables infrastructure. The process is rarely straightforward, and a project can sometimes be hindered by concerns in the local community during this stage. In those circumstances, stakeholders should consider the need to engage both legally and politically to obtain the necessary planning permission.

Warranties and representations. Given the ever-evolving technologies involved in renewable energy projects, ensure warranties and representations set out in construction or supply contracts adequately reflect the circumstances and can compensate the relevant parties if the asset does not meet a certain performance level.

State incentives and benefits. Consider the eligibility and associated entitlement of the renewables project in a landscape where policies are in flux. For example, under the IRA, while various incentives are available to domestic manufacturers, the same incentives are not extended to components sourced from foreign entities of ‘concern’. Understanding and navigating the ever-changing regulatory and political landscape will be of crucial importance.

Grid connection. Most renewable projects will require connection to the grid for the purposes of exporting electricity during generation or after storage. Consideration should be given to legal requirements in grid connection agreements, such as import and export rules, connection capacity requirements and the location on the network.

Renewed focus on arbitration in renewables projects

The rapid development of the renewables sector in a changing regulatory environment has the potential for disputes, particularly as renewable energy projects carry technology risk, involve significant upfront capital and typically only provide for investment gains over a longer period of time, often through state subsidies.

Further, due to the same complexities, renewables projects will tend to involve numerous parties from the same country and abroad, as well as state actors. For example, under the IRA, many non-US companies have expressed an interest in constructing facilities and moving investments to the US to benefit from state incentives in the IRA, as well as individual state-specific incentives. Among the many deals to be announced, Ford Motors has partnered with Chinese battery company CATL to build a $3.5bn electric vehicle battery plant in Michigan. Japanese and Korean companies Honda and LG have similarly partnered together in Ohio for a $4.4bn battery plant facility.

In these circumstances it is expected that there will be a renewed focus on arbitration, given international arbitration has historically been the favoured dispute resolution process for large and complex projects. For renewables projects, which are usually highly technical, arbitration will allow parties to select arbitrators who have the relevant expertise. The confidential nature of proceedings will likely be seen as beneficial, as it protects the details of new advanced technologies from being the subject of court filings. In circumstances where renewables projects also operate on long-life cycles, and therefore involve long-term relationships on one or more projects, arbitration could be seen as a less antagonistic and faster form of dispute resolution. Unlike court judgments, arbitration awards can be more easily enforced in most countries around the world wherever the debtor’s assets are located.

Another area to observe is the extent to which international investment arbitration may be deployed as renewables projects expand. These types of disputes usually arise where the foreign investor makes a claim against a host state due to a change or withdrawal of renewables subsidies or incentives. In the European sphere, there are significant changes affecting the Energy Charter Treaty that has framed such disputes, with the EU currently in the process of a coordinated exit from the Treaty after being unable to agree climate neutral environmental and other public interest changes. In the US, the United States–Mexico–Canada Agreement retains limited provisions for investors to bring some such claims, although far fewer than under the predecessor North American Free Trade Agreement.

Will the IRA promote investment in renewable infrastructure around the world?

The IRA has sparked a degree of backlash in Europe as many companies have commenced or announced an intention to expand their investments in the US to take advantage of benefits under the IRA, potentially at the expense of European investments.

Perhaps in response, on 1 February 2023, the European Commission published its Green Deal Industrial Plan, which builds on the existing efforts of EU states to enhance Europe’s net-zero industry, as set out under previous plans like the 2022 REPowerEU plan. The latest plan includes a proposal for the easing of state aid rules temporarily to “speed up investment and financing for clean tech production in Europe” to enable faster access to funding. Other proposals include a potential Net-Zero Industry Act, which is intended to provide a simplified regulatory framework for the production of net-zero products, as well as a Critical Raw Materials Act, which is intended to protect the EU’s access to critical materials and minerals.

The IRA has therefore already proven to be a significant driving force to accelerate change in the energy sphere inside and outside the US, prompting much needed investment in the diversification of energy infrastructure and technologies. While there have been criticisms of the process, any rapidly growing sector will require changes to maintain competitiveness. We could therefore be seeing the latest stream of expanding international trade, rather than a zero-sum clean energy arms race.

 

Adam McWilliams is a partner and Catherine Lai is an associate at Quinn Emanuel Urquhart & Sullivan UK LLP. Mr McWilliams can be contacted on +44 (0)20 7653 2052 or by email: adammcwilliams@quinnemanuel.com. Ms Lai can be contacted on +44 (0)20 7653 2049 or by email: catherinelai@quinnemanuel.com.

© Financier Worldwide

BY

Adam McWilliams and Catherine Lai

Quinn Emanuel Urquhart & Sullivan UK LLP

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