by Hamish Chamberlayne, CFA and Aaron Scully, CFA

For many years, the United States has been seen as a laggard, and sometimes even an obstacle, to the global pursuit of sustainability. With the United States currently the second largest emitter of greenhouse gases (GHGs), its contribution to a global reduction in CO2 emissions is essential. But could President Biden’s new Inflation Reduction Act put an end to this uncomfortable truth?

By name, the Inflation Reduction Act (IRA) may imply intentions to rein in inflationary pressures caused by pandemic-related fiscal and monetary policy hangovers, supply shortages and the Russian invasion of Ukraine. By nature, however, it is easy to identify a distinct sustainability-focused program tucked between the pages. We have long drawn parallels between a sustainable economy and achieving economic resilience, and we are pleased that the world’s most influential government sees the need for economic security and responding to the climate emergency as one and the same. .

Key areas of focus include reducing the costs of drugs, health care and energy, with the goal of “building an economy that works for working families.” Interestingly, the details of the law include US$400 billion in funding for green activities, incentives for US homeowners to invest in electrical upgrades and insulation, specific provisions for tax-free credits for electric vehicles (EVs) and regulatory clarity regarding the renewable energy sector.1 A White House statement called the Inflation Cut Act “the most aggressive action to address the climate crisis in American history”, aligning the United States with the Paris Agreement.

The behavior of the United States has an impact on the situation as a whole. It is the largest economy and the second largest emitter of GHGs behind China, accounting for nearly 13% of global emissions, and remains among the largest emitters per capita.2 With the urgency of climate change more pressing than ever, could the IRA catalyze a downward trend in US emissions and help steer global emissions in the right direction?

Renewable energy use is key to meeting climate goals, with some reports suggesting that global renewable energy growth must double to meet Paris Agreement goals.3Today, renewable energy is the cheapest form of energy in countries that represent two-thirds of the world’s population and 75% of global GDP.4 Despite this, renewable energy represents only 12% of total energy consumption and 20% of electricity production in the United States.5 The act is expected to advance clean energy in the United States through infrastructure funding and federal tax cuts intended to increase wind and solar power, clean hydrogen, and zero-emissions nuclear power generation.

Impressively, new onshore wind and solar construction is cheaper than operating depreciated coal and gas-fired power plants for 58% of the world’s population, which accounts for two-thirds of energy production.4 If the positive impact of clean energy were not enough, improved renewable energy capacity would also significantly reduce energy costs, thereby reducing inflation – a win for people’s pockets and for meeting climate goals.

Energy is the engine of GDP; it is the basis on which all productive economies rest. A barrel of oil alone contains six gigajoules of energy, enough to power the average American home for nearly two months.6 However, recent events underscore that traditional energy methods are simply no longer sustainable in the developed world. Divergent geopolitical regimes have disrupted globalized energy markets and the climate crisis is more serious than ever. Therefore, relocating and redefining strategically important industries will be fundamental to creating a sustainable, energy-independent economy.

With the next round of capital investment long overdue, we believe the IRA marks the beginning of the end for fossil fuels in the world’s largest economy. The current period of high inflation financially incentivizes companies to invest in productivity, substitution and efficiency. The old model of resource arbitrage and global supply chains should naturally give way to a new economic model based on clean, local energy and more efficient infrastructure. This should create jobs, improve economic security and promote growth. Above all, the IRA facilitates this change in the United States. As Biden made clear, “when [he] hear the climate, [he] think jobs.

It is clear to us that normalizing inflation via the IRA depends on creating a sustainable economy. We believe both angles of the ERI – climate and growth – provide fertile ground for active investors over the next decade.

Transportation, building, and manufacturing are the three largest GHG emitters after electricity/heating in the United States, presenting huge opportunities in the transition to clean energy – exhibit 1. In addition to areas the most obvious such as renewable energy generation, batteries and transportation electrification, technologies such as the Internet of Things, data centers, communications, factory automation, digitalization and software , and semiconductors should play a major role in the “green” reindustrialization of the United States.

Exhibit 1: US greenhouse gas emissions by industry

Source: Climate Watch Historical Country Greenhouse Gas Emissions Data, sectoral GHG emissions data from 1990 to 2019.

We believe semiconductors are particularly attractive given their use in increasingly diverse end markets as technology advances. Once considered narrowly focused on computing end markets, semiconductors are now used across many industries to enable the digitization of a wide range of products and applications. With this in mind, some might see semiconductors as closer to industry than technology. Either way, it’s clear that the line between technology and industry is blurring. We expect the next round of capital investment to follow a similar shape, with today’s technology becoming the new foundation for the green industrial revolution.

Batteries are needed to effectively increase the proportion of renewable energy and electrification in the economy. Currently, China dominates the battery industry and is responsible for almost 80% of all battery production in Specifically, the world depends on China for its cathode power, which is essential for lithium-ion batteries and accounts for around 50% of the total cost of battery cells.8 To encourage domestic EV production and minimize its dependence on China, the IRA is seeking to offer deep tax credits to the auto industry if its EV supply chain is carried out only in countries that have free trade agreements with the United States. In other words, an EV customer will not receive tax credits if the car in question contains materials from China, which does not have the necessary agreements in place.

Outside of China, Quebec in Canada has all the materials and intellectual pedigree needed to produce batteries. Home to many essential components of lithium-ion batteries – nickel, cobalt, lithium and graphite – and with a vibrant academic research sector and a strong regulatory framework, it is becoming the Silicon Valley for batteries. However, it currently accounts for only 10% of battery demand in the United States.9 We believe the IRA tax incentives inspire a compelling growth story associated with the clean development of battery technology, with Canada becoming the cornerstone of battery production in North America.

Crises often accelerate innovation, and we believe this is the case in the United States. The IRA addresses two problems with one solution by seeking to create a sustainable and more resilient economy. Not only is this the most ambitious climate legislation the United States has ever passed, but it is perfectly aligned with driving investment and growth in the American economy. This aligns with our long-term thesis, which we’ve talked about many times before, of energy independence, economic resilience, and supply chain relocation to create a sustainable global economy.

We believe that the United States is on the cusp of a period of tremendous value creation associated with a green industrial revolution, with dramatic technological changes in multiple sectors. Combined with the relative economic strength of the United States, this could present an excellent opportunity for investors.