The Climate Bill Creates Tremendous Investment Opportunity
By Roger Mortimer, Portfolio Manager
The Inflation Reduction Act, signed into law by President Joseph R. Biden, is transformational in its impact. Intended to provide relief to Americans from rising costs, it also represents the most comprehensive advancement in US climate policy in decades and creates substantial new investment opportunity.
At a time when uncertainty about economic growth is rising, the Act (referred to here as the 'Climate Bill') provides a range of economic incentives that will change the way energy is generated and consumed in America. If fully implemented, it will position the United States to achieve a 40% reduction in its greenhouse gas emissions by 2030 relative to 2005 levels. Research from Wood Mackenzie projects that the $369 billion in incentives will trigger some $1.2 trillion in private investments by 2035.1 Carmichael Roberts, investment committee co-head at Breakthrough Energy Ventures (founded by Bill Gates), suggest that as many as 1,000 companies will be created as a result of the bill.2
Government policies to influence behavior are typically either 'carrot' or 'stick' in their approaches. ‘Carrots’ are incentives, tax breaks, stimulus spending etc., and ‘sticks’ are taxes, limits, quotas and laws regulating behavior.
Europe's "Fit for 55" plan targets a 55% reduction in greenhouse gas emissions by 2030, and utilizes an emissions trading system at its core. Emissions allowance markets let companies purchase the right to emit, and compare the cost of that allowance to the cost of changing their business practices to avoid the emission. This is a largely ‘stick’ based approach – the limits and penalties mean the cost of the old way of doing business – the avoided cost – rises over time, making it less profitable and a less interesting place to invest new capital.
By contrast, the US Climate Bill is primarily incentive-focused. It provides tax credits and incentives that reduce the cost and stimulate domestic investment in renewable power generation, the development of energy storage that is required to handle the intermittency of renewables, the electrification of transport, the adoption of green hydrogen use and of processes that relate to carbon capture and storage. Most of the incentives are structured to be in place for a decade, providing a big runway for adoption and scaling of clean energy technologies and processes. The bill includes $60 billion to support development of domestic manufacturing.
An area where there is substantial new incentive to deploy technology is in the use of hydrogen. An industrial gas, hydrogen is a widely used building block in the chemical, refining, plastics and fertilizer sectors. More than 95% of the 10 million tonnes of hydrogen produced annually in the US today is ‘grey’, meaning that it is produced with fossil fuels (typically natural gas)3. The production of grey hydrogen produces ten times as much CO2 as it does hydrogen by weight4, making it a critical high-emitting sector to resolve.
Hydrogen can also be produced by charging water with electricity in a process called electrolysis. If the electrolytic process uses renewable electric inputs, then the resulting hydrogen production creates no harmful emissions (with water vapor the only output) and is referred to as ‘green hydrogen’. The idea is not new, but both the perception of need and the economics of production are increasingly aligned with accelerating deployment of green hydrogen.
Energy policy experts believe that green hydrogen will be both blended with natural gas in existing power generation infrastructure, reducing the associated emissions, and utilized in dedicated zero-emission processes, for which new infrastructure will be built.
Green hydrogen production cost is a function of both the cost of the electrolyser and the cost of the power to run it. If excess renewable electricity is used, the marginal power cost is extremely low.
According to S&P Global Platts, grey hydrogen costs between $1.71-2.18/kg to produce in the US5. This is the cheapest in the world as the US has very low-cost natural gas. The unsubsidized cost of green hydrogen production is estimated to range from $3.73-$6.50/kg with some regional variations.6
The Climate Bill provides substantial incentive for green hydrogen development in the form of both investment and production tax credits. The $3/kg production tax credit (PTC) is large enough that renewable based hydrogen should be immediately competitive in some US regions with fossil-based ‘grey hydrogen’ production. In fact, it is likely that the resulting low-cost green hydrogen production in the US will be the cheapest in the world. Falling technology costs with scale manufacturing should drive further cost savings and make green hydrogen product profitable for developers, driving a virtuous cycle of adoption. The 10 million tonne annual market in the US implies a $30 billion addressable market for green hydrogen, and the substantial PTC will help attract investment and project finance capital to the space.
The KraneShares Global Carbon Transformation ETF (Ticker: KGHG) portfolio includes exposure to companies that are significant beneficiaries of the Climate Bill, including those with specific hydrogen expertise. US corporate holdings New Fortress Energy and Plug Power are well positioned to capitalize on the green hydrogen opportunity. The two companies have entered into an agreement to build an industrial scale green hydrogen plant in Texas. Initially sized at 120 MW, it will be scalable to 500 MW. New Fortress is an energy infrastructure company focused on LNG, and this project is its first major commitment in green hydrogen. Plug is a specialized hydrogen technology company with integrated expertise across electrolysis, fuel cells and storage. We believe that the landmark Climate Bill will provide for the rapid development of green hydrogen infrastructure in the United States.
KGHG seeks to invest in companies that are emerging as decarbonization leaders and believes that a valuation arbitrage is available for capture as incumbent industry players increasingly migrate capital investment plans towards greener growth areas within their industries. KGHG portfolio manager Roger Mortimer notes that “large incumbent energy and industrial players have many of the qualities required to succeed in the energy transition, including large existing operations and customer bases; the relevant project management skills; and adjacencies to emerging areas. A targeted strategy of investing in these companies, where management is committed to the energy transition, offers, in our opinion, the potential not only for significant environmental impact but also for superior growth and revaluation among the leading participants.”
For KGHG standard performance, top 10 holdings, risks, and other fund information, please click here.
- Data from Barron’s as of 6/30/2022.
- Data from CNBC as of 6/30/2022.
- Data from Shearman & Sterling as of 6/30/2022.
- Data from Recharge News as of 6/30/2022.