Inflation Reduction Act: Key Energy Provisions

Practical Law Legal Update w-036-5087 (Approx. 12 pages)

Inflation Reduction Act: Key Energy Provisions

by Practical Law Finance

Extension and Modification of Energy Tax Credits

The IRA makes several key changes to the federal income tax credits available to low carbon (clean) energy projects, including expanding the projects that qualify for certain credits. It also gives developers more flexibility in managing these credits to better suit their needs. For example, project owners can transfer or otherwise sell their credits. These changes are expected to have significant effects on the financing of clean energy projects.

Production Tax Credit (PTC)

The PTC is a ten-year, federal income tax credit for each kilowatt hour (kWh) of electricity generated by qualifying renewable energy projects (26 U.S.C. § 45). The PTC is adjusted annually for inflation from a statutory rate of 1.5 cents per kWh. Some projects (for example, marine and hydrokinetic energy projects) qualify for half of the PTC amount. Before the enactment of the IRA, the PTC was equal to 2.5 cents or 1.3 cents per kWh depending on the energy technology or resource used and was available for qualifying facilities that began construction before January 1, 2022.

The IRA:

Extends and makes available the PTC for wind facilities, closed- and open-loop biomass facilities, landfill gas facilities, trash facilities, and qualifying hydropower, marine, and hydrokinetic facilities that begin construction before January 1, 2025 (see Amount of PTC and ITC and Bonus Credits). This extension is retroactive to January 1, 2022. After 2025, the PTC is technology-neutral (see New Emissions Based PTC and ITC). For more information on these resources or technologies, see Practice Note, Renewable Energy: Overview (US): Types of Renewable Energy.
Revives the PTC for solar facilities, which had expired in 2005.
Extends the option to claim the investment tax credit (ITC) in lieu of the PTC.

Investment Tax Credit (ITC)

The ITC is a federal income tax credit for certain types of renewable energy projects including solar, geothermal, and fuel cell energy (26 U.S.C.§ 48). Before the IRA, owners of qualifying energy projects could claim a tax credit up to 30% of their project's capital costs, subject to a phase down. Qualifying projects could claim:

26% of the ITC if they start construction before January 1, 2023.
22% of the ITC if they start construction before January 1, 2024.
10% of the ITC if they start construction on or after January 1, 2024.

The IRA:

Extends and makes available the ITC for solar facilities that begin construction before January 1, 2025 (see Amount of PTC and ITC and Bonus Credits). Thereafter, the ITC is technology-neutral (see New Emissions Based PTC and ITC).
Expands the technologies that are eligible for the ITC to include standalone energy storage technology. The requirement that energy storage systems be co-located (or installed at an ITC-qualified facility) had limited the development of these projects (see Practice Note, Renewable Energy Project Development Issues: Siting Considerations for Co-Located Energy Storage).
Extends the option for a taxpayer to claim the ITC in lieu of the PTC for certain qualified facilities, without a phase-down, to align with the extensions to the PTC and ITC.

Amount of PTC and ITC and Bonus Credits

The amount of the PTC and ITC available for eligible projects may be higher if certain conditions are met. Depending on the structure of the project, the combination of the higher ITC and PTC amounts and the available bonus credits can result in significant benefits for a project developer.

PTC

The IRA sets the PTC at 0.3 cents per kWh (0.5 cents per kWh in 2021, or 0.3 cents for half-credit technologies, after being adjusted for inflation). Projects can qualify for a higher PTC up to 2.5 cents or 1.3 cents per kWh in 2021 if they meet any of the following conditions:

They pay prevailing wages during the construction phase and the first 10 years of operation and meet registered apprenticeship requirements.
They generate a maximum one megawatt (MW) of electricity.
They begin construction within 60 days after the IRS publishes guidance on the wage and registered apprenticeship requirements.

Qualifying hydropower and marine and hydrokinetic renewable energy projects that are entitled to receive 50% of the PTC would be entitled to the full PTC if they meet the conditions above.

A "bonus credit" amount of 10% of the PTC is available for projects that:

Meet domestic content requirements. This provision requires project owners to certify that certain steel, iron, and manufactured products used in the project are domestically produced.
Are located in an energy community. An energy community is defined as:
- a brownfield site;
- an area which has or had significant employment related to oil, gas, or coal activities and has an unemployment rate at or above the national average; or
- a census tract or any adjoining tract in which a coal mine closed after December 31, 1999, or in which a coal-fired electric power plant was retired after December 31, 2009.

ITC

The IRA sets the ITC at a base rate of 6% for solar, fuel cells, waste energy recovery, combined heat and power, and small wind property, and 2% for microturbine property. The ITC may be increased to 30% and 10%, respectively, if the project meets any of the following conditions:

It pays prevailing wages during the construction phase and during the first five years of operation and meet registered apprenticeship requirements.
It generates a maximum net output of less than one MW of electrical or thermal energy.
It begins construction within 60 days after the IRS publishes guidance on the wage and registered apprenticeship requirements

A bonus credit amount equal to 2 percentage points, or 10 percentage points for projects that meet wage and workforce requirements is available for projects:

That meet domestic content requirements. This requires project owners to certify that certain steel, iron, and manufactured products used in the facility were domestically produced.
Located in an energy community.

New PTC for Qualifying Clean Hydrogen Projects

The IRA creates under Section 45V of the Code an inflation adjusted PTC (with the option to elect the ITC in lieu of the PTC) for clean hydrogen produced in the US at a clean hydrogen production facility for 10 years starting on the date the facility is placed in service.

Clean hydrogen is defined as hydrogen which is produced through a process that results in a lifecycle GHG emissions rate of not greater than 4 kilograms (kg) of carbon dioxide equivalent (CO2e) per kg of hydrogen. It can be produced from different sources, including renewable electricity (green hydrogen) and natural gas (blue hydrogen).

The amount of the credit is equal to $0.60 per kg times the applicable percentage specified in the IRA. The credit amount a project can claim depends on the lifecycle GHG emissions rate achieved in producing clean hydrogen. For example, the applicable percentage is:

100% for hydrogen achieving a lifecycle GHG emissions rate of less than 0.45 kg of CO2e per kg.
33.4% for hydrogen achieving a lifecycle GHG emission rate of less than 1.5 kg of CO2e per kg (but not less than 0.45 kilograms).

This credit is available for projects that begin construction before January 1, 2033. Facilities existing before January 1, 2023 would qualify for this credit based on the date that modifications to their facility required to produce clean hydrogen are placed into service. This credit is not available for projects that claimed credits for carbon capture under Section 45Q of the Code.

Similar to the existing PTCs, the IRA provides that clean hydrogen projects can qualify for up five times the base credit amount ($3.00 per kg) if the clean hydrogen is produced at a facility that meets prevailing wage and registered apprenticeship requirements (see Amount of PTC and ITC and Bonus Credits).

New PTC for Qualifying Zero-Emission Nuclear Power Projects

The IRA creates a new tax credit (Section 45U of the Code) for qualifying zero-emission nuclear power produced and sold after December 31, 2023. Qualified nuclear power facilities are taxpayer-owned facilities that use nuclear power to generate electricity that did not receive an advanced nuclear PTC allocation under Section 45J of the Code, and are placed in service before enactment of the IRA. The credit expires on December 31, 2032.

The PTC is equal to 0.3 cents per kWh, but would be reduced when the price of electricity increases. Credits would be reduced by a "reduction amount," which is 80% of the excess of gross receipts from electricity produced by the facility and sold over the product of 2.5 cents times the amount of electricity sold during the taxable year. The PTC for these projects phase down as annual average prices exceed 2.5 cents per kWh and expires on December 31, 2032.

Similar to the other credits set out in the IRA, a project can qualify for a higher credit amount (five times the base amount per kWh (up to 1.5 cents per kWh) if they meet certain prevailing wage and registered apprenticeship requirements (see Amount of PTC and ITC and Bonus Credits).

New Emissions Based PTC and ITC

The IRA adds two new sections to the Code (Sections 45Y and 48E) that make the ITC and the PTC available to projects that do not emit GHG starting on January 1, 2025. These provisions aim to incentivize innovation and the deployment of more low emission technologies. These credits phase out the earlier of December 31, 2032 or when the Secretary of the Treasury determines that the annual GHG emissions are equal to or less than 25% of the emissions produced in 2022.

This credit is not available for projects that have already claimed other energy-related ITCs or PTCs.

Technology-Neutral PTC

This new PTC is available for projects that produce electricity with a GHG rate not greater than zero. The base PTC amount is equal to 0.3 cents per kWh. Similar to the technology-based PTC, the credit amount may be increased to 1.5 cents per kWh for facilities that meet any of the following conditions:

Pay prevailing wages and meet registered apprenticeship requirements.
Generate a maximum of less than one MW of electricity.
Begin construction within 60 days after the IRS publishes guidance on the wage and registered apprenticeship requirements.

A 10% bonus credit is also available for these projects (see Amount of PTC and ITC and Bonus Credits).

Technology-Neutral ITC

This new ITC is available for qualifying zero-emissions electricity generation facilities, energy storage technology, and interconnection property for clean electricity projects smaller than 5 MW. The base ITC amount is 6%. Similar to the technology-based ITC, the base credit amount can increase to 30% for facilities that meet any of the following conditions:

Pay prevailing wages and meet registered apprenticeship requirements.
Generate a maximum net output of less than one MW of electricity.
Begin construction within 60 days after the IRS publishing guidance on the wage and registered apprenticeship requirements.

A 10% bonus credit is also available for these projects (see Amount of PTC and ITC and Bonus Credits).

Carbon Oxide Sequestration Credit Extension and Modification

Under current law, industrial carbon capture or direct air capture (DAC) facilities that begin construction before January 1, 2026 can qualify for a tax credit for carbon oxide sequestration under Section 45Q of the Code. This tax credit can be claimed for carbon oxide captured during the 12-year period following a qualifying facility's being placed in service. The IRA extends the start of construction deadline for these projects to before January 1, 2033.

Before the IRA, the per metric ton inflation adjusted tax credit for geologically sequestered carbon oxide was set to increase to $50 per ton by 2026 ($35 per ton for carbon oxide that is reused, for example, for enhanced oil recovery).

Under the IRA:

The base credit amount is $17 per metric ton for carbon oxide that is captured and geologically sequestered and $12 per metric ton for carbon oxide that is reused. A project may qualify for increased credit amounts of $85 per ton and $60 per ton, respectively, if they pay prevailing wages during the construction phase and during the first 12 years of operation and meet registered apprenticeship requirements.
The credit amount for carbon oxide captured using DAC and reused is $26 per metric ton, but can be increased to $130 per metric ton if the project pays prevailing wages during the construction phase and during the first 12 years of operation and meet registered apprenticeship requirements.
The credit amount for carbon oxide captured using DAC and geologically sequestered is increased to a base rate of $36 per metric ton, with a credit of $180 per metric ton for projects that meet prevailing wage and apprenticeship requirements.

These changes substantially increase the financial incentives to deploy carbon capture and sequestration (CSS) projects.

Clean Energy Development Provisions

Energy Supply Chain Support

The IRA includes provisions to incentivize the development of clean energy, strengthen the US energy supply chain, and reduce reliance on foreign components.

Advanced Energy Manufacturing Tax Credit

The IRA extends the qualified advanced energy manufacturing tax credit (Section 48C of the Code), up to 30% tax credit for investments in projects that reequip, expand, or establish certain energy manufacturing facilities. It also expands the types of projects that qualify for this credit to include the production or recycling of renewable energy property, energy storage systems and components, grid modernization equipment and components, and property designed to remove, use, or sequester carbon oxide emissions, among other technologies.

Advanced Manufacturing Production Tax Credit

The IRA includes a new advanced manufacturing production tax credit (Section 45X of the Code) for the domestic production and sale of qualifying solar and wind components. The solar components that qualify for this credit include thin film photovoltaic cells or crystalline photovoltaic cells, photovoltaic wafers, solar grade polysilicon, polymeric backsheets, and solar modules. For wind energy projects, the components include blades, nacelles, towers, fixed platform offshore wind foundations, floating platforms, and offshore wind foundations.

The amount of this credit depends on the eligible component. This credit begins to phase out for components sold after December 31, 2029, and expires for components sold after December 31, 2032.

Expansion of Offshore Wind Leasing in the Southeast

The IRA withdraws the 10-year moratorium on offshore wind leasing in the Southeast established during the Trump administration. The IRA also expands the definition of the Outer Continental Shelf (OCS) to include land that is within the US exclusive economic zone and adjacent to any US territory (including Puerto Rico, Guam, American Samoa, the U.S. Virgin Islands), and allows the Department of the Interior (DOI) to conduct wind lease sales in these areas if the leases meet specified criteria.

Department of Energy Loan Program Office Funding

Section 1703 Funding

The IRA appropriates $3 billion for the Secretary of Energy to provide loans to eligible projects under Section 1703 of the Energy Policy Act of 2005, including renewable energy systems, advancing fossil energy technology, hydrogen fuel cell technology, advanced nuclear energy facilities, CSS projects, efficient electric generation and end-use energy technologies, producing fuel efficient vehicles, pollution control equipment, and refineries.

The Secretary of Energy is also authorized to make commitments to guarantee loans to support these projects up to a total principal amount of $40 billion.

Energy Infrastructure Reinvestment Financing

This is a new $5 billion program created under the IRA to provide loan guarantees for projects that either:

Retool, repower, repurpose, or replace energy infrastructure that has ceased operations.
Enable operating energy infrastructure to avoid, reduce, utilize, or sequester air pollutants or anthropogenic emissions of GHG.

This program is appropriated through September 30, 2026.

Transmission Facility Financing

The IRA also provides funding for transmission development. It appropriates:

$2 billion to provide loans to construct or modify electric transmission facilities.
$760 million for grants to siting authorities' covered transmission projects that, among other things:
- study and analyze the effect of certain transmission projects;
- examine up to three alternate corridors where the covered transmission project could be sited; and
- host and facilitate negotiations among the siting authority, the covered transmission project applicant and those opposed to the covered transmission project.

The IRA does not address the biggest challenge to transmission construction: streamlining the permitting and siting of these projects across state, county, and city lines. There many projects waiting to connect to the electric grid but cannot do so because of limited transmission capacity. Upcoming environmental permitting legislation is intended to address this issue.

Oil and Gas Provisions

The IRA includes several provisions relating to oil and gas development, including changes to the fees oil and gas companies are required to pay to exploit oil and gas resources on federal land.

Increases Onshore Oil and Gas Royalty Rates and Other Fees

The IRA amends the Mineral Leasing Act (30 U. S. C. §226) to, among other things:

Increase:
- the minimum royalty rate for onshore oil and gas leases from 12.5% to 16.67%;
- the national oil and gas minimum acceptable bid from $2 per acre to $10 per acre. The time period for making these payments is also increased from two years to 10 years; and
- the rental rate from $1.50 per acre to $3 per acre. This increase is for two years after the lease begins. The rate then increases to $5 per acre for six years and at least $15 per acre for each year thereafter.
The royalties payable on these leases apply to all methane produced, consumed, or lost. This includes all gas that is consumed or lost by venting, flaring or negligent releases through equipment in upstream operations. This provision does not apply to gas that is vented or flared in emergency situations or used for the benefit of the lease or unit area.
Amend the conditions for lease reinstatement to require a minimum future royalty rate of 20%, up from 16.67%.
Authorizes the Secretary of the Interior to require a $5 per acre fee, which can be adjusted for inflation every four years, for individuals who submit an expression of interest in leasing land for oil and gas exploration or development.
Allows the Secretary of Interior to facilitate competitive bidding processes for land that has not had an accepted bid or that has an expired lease.

Increases Offshore Oil and Gas Royalty Rates

The IRA amends the Outer Continental Shelf Lands Act (OCSLA) (43 U. S. C. §1337) to increase the royalty rate for offshore oil and gas lease bidding from 12.5% to no less than 16.67% but not more than 18.75% during the first 10 years after the IRA's enactment. After this period, the rate can be no less than 16.67%.

The royalties payable under these leases apply to all methane produced, consumed, or lost. This includes all gas that is consumed or lost by venting, flaring or negligent releases through equipment in upstream operations. This provision does not apply to gas that is vented or flared in emergency situations or used for a lease or unit area's benefit.

Leasing on the Outer Continental Shelf

The IRA allows the DOI to grant leases, easements, and rights-of-way in land areas previously withdrawn from leasing disposition fees. The IRA also extends the definition of OCS to include land within the exclusive economic zone of the US and adjacent to US territory.

Methane Fee

The IRA imposes a "waste emissions charge" for an owner/operator of a facility that emits more than 25,000 metric tons of CO2e annually. The fee is intended to force oil and gas companies to plug leaks and stop venting methane during oil and gas operations. The fee must be paid on quantities of methane emissions from a covered facility that exceed certain threshold specified in the IRA and is equal to:

$900 per ton for excess 2024 emissions.
$1,200 per ton for excess 2025 emissions.
$1,500 per ton for excess 2026 emissions and each year thereafter.

The fee applies to oil and gas operations including:

Offshore and onshore oil and gas production.
Onshore natural gas processing.
Onshore natural gas transmission compression.
Underground storage.
Liquefied natural gas (LNG) storage.
LNG import and export equipment.
Onshore natural gas transmission pipelines.

This fee has been criticized by environmentalists and other groups for exempting around 60% of industry emissions (including smaller companies that emit significant GHG) and companies that comply with the Environmental Protection Agency's upcoming methane rule. This rule is scheduled to be finalized later this year (see Legal Update, EPA Proposes Rule to Regulate and Reduce Methane Emissions from the Oil & Gas Sector).

Oil & Gas Leasing

The IRA requires the DOI to reinstate Lease Sale 257 in the OCS in the Gulf of Mexico no later than 30 days after the IRA's enactment. This sale was nullified in January 2022 when the US District Court for the District of Columbia found that the DOI's analysis of the environmental impact of the decision to proceed with the sale was "arbitrary and capricious" and deficient under National Environmental Policy Act because it did not consider foreign GHG emissions when evaluating the effects of the sale. See Friends of the Earth, et al. v. Haaland, (D.D.C. Jan. 27, 2022). This sale offered up about 80 million acres, although less than two million acres were ultimately leased by energy companies.

The IRA also requires the DOI to conduct the following offshore lease sales that it had previously canceled:

Lease Sale 258 in Alaska Region's Cook Inlet by December 31, 2022.
Lease Sale 259 in the Gulf of Mexico by March 31, 2023.
Lease Sale 261 by September 30, 2023.

The IRA requires that the restored and new lease sales be held despite the fact that the Five-Year Leasing Plan mandated by the Outer Continental Shelf Lands Act expired in June 2022.

For more information on the Friends of the Earth decision, these lease sales, and the Five-Year Leasing program, see Practice Notes, Biden Administration Energy and Climate Change Policies and Regulations: 2022 Tracker : Oil and Gas Leasing on Federal and Tribal Lands and US Oil & Gas Industry: Overview and Legal Update, Interior Department Seeks Comment on Five-Year Offshore Oil and Gas Leasing Program.

Renewable Energy Leasing Tied to Oil & Gas Leasing

The IRA establishes a 10-year window in which any leasing of renewable resources on federal lands and waters is directly linked to oil and gas leasing. Under the IRA, the DOI cannot issue a right-of-way for wind and solar energy development on federal land during this period unless:

In the case of any new onshore wind and solar rights, it held an onshore oil and gas lease sale within 120 days before issuing these rights-of-way and the acreage offered to lease for oil and gas development in the last year is at least two million acres or 50% of the acreage for which expressions of interest have been made, whichever is smaller.
In the case of offshore renewable energy development, it held an offshore oil and gas lease sale in the last year and at least 60 million acres have been offered for offshore oil and gas development in the last year.

Practical Implications

The IRA represents the largest investment in clean technology and emissions reduction in US history, but its oil & gas provisions have been criticized by some environmental groups. Brett Hartl, the government affairs director at the Center for Biological Diversity, has labelled it "a climate suicide pact." However, many environmental groups are welcoming the new bill because, according to a study conducted by Energy Innovation, for "every ton of emissions increases generated by IRA oil and gas provisions, at least 24 tons of emissions are avoided by the other provisions." The study also concluded that the IRA "could cut greenhouse gas (GHG) emissions 37-41 percent below 2005 levels."

Supporters of the IRA view its oil & gas provisions as a worthwhile and necessary compromise or trade-off to get any climate or energy-related legislation passed. The BBBA had been stalled for months, and without the oil and gas provisions agreed with Senator Joe Manchin, the IRA would never have passed. Moreover, although the IRA's provisions requiring the federal government to hold large lease sales may seem to undermine President Biden's climate goals, it encourages emissions reductions in every sector of the US economy from transportation and construction to energy production and agriculture. A focus on GHG emission reduction versus a ban on oil and gas development is seen by many as a more economically and politically viable path to meeting President Biden's objectives than suspending oil and gas development.

Some oil and gas industry groups have also criticized the IRA, arguing that "the considerable tax increases and new government spending in the IRA amount to the wrong policies at the wrong time."

It is worth noting that the IRA does not address permitting of energy projects. However, as part of the agreement with Senator Manchin, Congressional Democrats agreed to consider a permitting bill that allows for more natural gas development. This agreement may have significant implications for several permitting rules being considered by federal agencies including:

The Updated Policy Statement on Certification of New Interstate Natural Gas Facilities (178 FERC ¶ 61,107 (2022)) (see Legal Update, FERC Issues Updated Policy Statement on Certification of Interstate Natural Gas Pipeline Applications).
FERC's interim guidance on GHG emissions, Consideration of Greenhouse Gas Emissions in Natural Gas Infrastructure Project Reviews (178 FERC ¶ 61,108 (2022)) (see Legal Update, FERC Issues an Interim Policy Statement on Greenhouse Gas Emissions from Natural Gas Pipelines).

Inflation Reduction Act: Key Energy Provisions | Practical Law