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Inflation Reduction Act: Faustian Bargain Could Jeopardize Offshore Wind, Renewable Energy On Federal Lands – Renewables



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ANALYSIS: Tradeoffs in the Inflation Reduction Act of 2022
between climate protections and fossil fuel interests could be dire
for offshore wind projects and for solar and wind projects on
federal lands. Congress seems to be driving with both feet pressed
firmly on the gas pedal and the brakes at the same time. The devil
is in the details.

Key Highlights of the Bill – Climate
& Energy Incentives

The bill on the whole is good for the environment and good for
the economy. This landmark legislation – the most
comprehensive U.S. initiative to mitigate climate change yet
– seems poised to pass Congress and be signed into law by
President Joseph R. Biden, Jr. later this month with relatively few
major changes. Beyond the climate and energy provisions are
significant measures to lower prescription drug prices and to close
the carried-interest “loophole” that has benefited
private equity, real estate, and hedge fund managers.

The bill extends existing renewable energy tax credits –
production tax credits (PTC) and investment tax credits (ITC)
– and contains other important climate and energy provisions.
Standalone energy storage (with normalization opt-out for large
projects), biogas property, microgrid controllers, dynamic glass,
and small interconnection facilities (though not transmission
lines) would become eligible for the ITC. Bonus tax credits are
available for certain projects located in brownfield and
coal-mining communities or for small wind and solar projects placed
in service in certain low-income communities. Bonus credits are
also available for some investments if additional goals are met for
domestic content and labor standards (prevailing wages and
apprenticeships to create skilled jobs and domestic manufacturing
capacity). The Internal Revenue Code Section 45Q tax credit for
carbon capture and sequestration (CCUS) would be extended, though
the bill lowers the minimum amount of carbon oxide that must be
captured to qualify. The bill provides up to a 1.5 cent/kWh PTC
until 2032 for existing zero-emission nuclear power facilities that
have not already claimed the PTC under Section 45J.

The bill would impose a 15% corporate alternative minimum tax on
companies with adjusted financial statement income over $1 billion.
The new corporate alternative minimum tax might lead to greater
participation in tax equity markets, if more large corporations
seeking tax shields become investors in partnerships that own
renewable energy projects. Other provisions of the law allow the
transfer of partnership interests to unrelated third parties to
make it easier to monetize energy tax credits. Broadening the depth
and liquidity of tax equity markets could reduce slightly the cost
of tax equity, helping project sponsors and lowering the cost of
capital for eligible projects.

In a departure from traditional incentive mechanisms, the bill
shows a policy migration away from tax credits based on different
types of renewable technology to credits based on emissions
avoidance or reductions. The bill would ultimately provide a
10-year PTC or an ITC (but not both) for electricity generation
facilities with a zero greenhouse gas emissions rate. This
technology-agnostic tax credit would also cover retrofitted plants
placed in service after 2024, so long as the existing facility had
not previously qualified for an energy credit. Emissions do not
include amounts sequestered through carbon capture technology.
Similarly, clean hydrogen incentives are tied to reductions in
lifecycle greenhouse gas emissions rates (measured in kilograms of
CO2e per kilogram of hydrogen) rather than overly-prescriptive
technology choices. Other provisions of the law would reward
reductions in methane emissions, including in relation to biogas
and agricultural waste-to-energy plants, and monitoring and control
of fugitive emissions tied to oil and gas production.

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Subsidies also flow to manufacturers of equipment for renewable
and clean energy manufacturing, including electric vehicles and
trucks. Buyers of new or used EVs or alternative fuel vehicles
would also receive refunds. Clean fuels, including biodiesel and
sustainable aviation fuel, also receive economic incentives. On
December 31, 2024, existing fuel credits would transition to the
Clean Fuel Production Credit.

But some unfortunate surprises are buried deep in the 725-page
bill now in front of Congress. These provisions would support
expanded investment in domestic oil and gas exploration and
production, especially on federal lands and in offshore federal
waters. Those provisions run counter to the Biden-Harris
Administration’s goal of reducing U.S. greenhouse gas emissions
by 50% by 2030. The pending Inflation Reduction Act remains
critical to that effort. If the bill is enacted as currently
written and the desired investments, incentives and innovations
come to pass, then meeting that climate goal will remain
conceivably within reach. Without the bill or similar legislation,
reaching that ambitious climate goal is likely impossible.

New Rules for Energy Leases on Federal Lands and in
Offshore Waters

A small, easily overlooked provision of the bill could have a
big impact, though not necessarily in the way its authors might
intend. Just over two pages long, Section 50265 jeopardizes the
development of billions of dollars of planned offshore wind
projects and renewable power projects on federal land. And it adds
to the complexity and uncertainty of obtaining federal
environmental permits even as both Democrats and Republicans
proclaim the need to streamline the entitlement process.

Under this provision, for the next decade after the new law
takes effect, no right of way could be granted for wind or solar
energy development on federal lands unless a quarterly lease sale
is held that results in issuance of an oil and gas lease, if any
acceptable bids have been received, within the 120 days prior to
the proposed wind or solar energy right of way being issued. Every
time a wind or solar right of way is to be issued by the Bureau of
Land Management (BLM), for each project that applies and has met
the permitting requirements under the National Environmental Policy
Act (NEPA) and other laws, a separate determination would be
required about the status of oil and gas leases sold under
BLM’s lease program. That determination would not depend on the
quality, value, compliance or merit of any energy project, just on
the calendar and the progress of wholly unrelated administrative
actions.

In addition, at least 2 million acres of federal lands (or, if
less, at least half the acreage for which expressions of interest
have been submitted from potential bidders) must have been offered
for oil and gas leases in the year before each proposed wind or
solar right of way is issued. In practice, assuming sufficient
expressions of interest are received by BLM, that means at least 20
million acres of federal lands must be offered in total for new oil
and gas leases over ten years on a quarterly basis. Any
interruption or suspension of oil and gas lease sales over the next
decade for any reasons (including, apparently, if necessary
environmental approvals cannot be obtained, if courts block the
sales, if sellers express interest but fail to bid, or if a future
administration suspends any oil and gas lease programs) would bring
development of all new solar and wind power projects on federal
lands to a screeching halt.

Offshore wind projects would face similar risks. Given the
earlier stage of development of the U.S. offshore wind industry,
the very large scale and complexity of offshore wind projects, and
the lengthy, multi-year permitting process they must undergo, the
dependence of their federal leases on the sale of unrelated leases
for offshore oil and gas drilling may be a more existential threat.
Under the proposed law, no lease for offshore wind development
could be issued by the Bureau of Ocean Energy Management (BOEM) in
federal waters any time in the next ten years unless, at the time
of each new lease of an offshore wind area, BOEM has within the
prior twelve months also offered to sell a new oil and gas lease
and, if any acceptable bids have been received for any offered
tract, issued a lease. In addition, no less than 60 million acres
of federal waters on the outer continental shelf must have been
offered for oil and gas leases in the prior year, or no new
offshore wind leases could be issued. In effect, over 600 million
acres of federal waters must be offered (though unsold areas could
be reoffered) for new oil and gas exploration and production.
Failure to maintain the required annual pace of offshore oil and
gas leases would block all subsequent offshore wind leases.

Misunderstood Circumstances, Unintended
Consequences

Mandatory new oil and gas leases might not materially expand
fossil fuel production. But tying them to new wind and solar leases
could slow down the permitting for renewable projects and throw up
roadblocks to new renewable energy investments. The issuance of all
federal energy leases and rights of way must comply with NEPA
review of environmental impacts and mitigants. Under the new bill,
only developers of new wind and solar projects would face an extra
requirement unrelated to their renewable projects, and completely
outside the developers’ control: that the issuing agency (BLM
or BOEM) also be offering and issuing new oil and gas leases
recently and on an ongoing basis. That regulatory uncertainty could
significantly chill investment in renewable projects on federal
land and, especially, offshore wind, undercutting the other
provisions of the bill meant to stimulate such investments.

To put these numbers in perspective, the public lands required
to be opened to new oil and gas drilling leases would total 20
million acres over a decade, an area bigger that the land area of
the State of Maine. The new ocean areas to be opened to offshore
drilling would equal 60 million acres (an area nearly as large as
the State of Wyoming), each year for ten years.

BLM oversees about 245 million acres of federal public lands
(including lands that are managed for outdoor recreation,
development of oil, gas, coal, and renewable energy resources,
grazing and timber production, cultural heritage and sacred sites,
and supporting wildlife habitat and ecosystem functions). In
response to President Biden’s Executive Order 14008 (January
27, 2021), the Department of the Interior (DOI) issued a report
in November 2021
reviewing federal oil and gas leasing and
permitting practices. According to the report, which was critical
of existing BLM leasing practices including low royalty rates and
poorly managed or unproductive leases, DOI calculated that federal
onshore oil and gas production accounts for approximately 7% of
domestically produced oil and 8% of domestically produced natural
gas.

BLM currently manages 37,496 Federal oil and gas leases covering
26.6 million acres with nearly 96,100 wells. The proposed new law
seeks to increase that acreage under lease by 75% over ten years.
Of the more than 26 million onshore acres currently under lease to
oil and gas companies, nearly 13.9 million (or 53%) of those acres
are non-producing, according to the DOI report. The oil and gas
industry has a substantial number of unused permits to drill
onshore. As of September 30, 2021, the oil and gas industry held
more than 9,600 approved permits that are available to drill. In
fiscal year (FY) 2021, BLM approved more than 5,000 drilling
permits, and more than 4,400 are still being processed. DOI then
analyzed 646 parcels on roughly 733,000 acres that had been
previously nominated for leasing by energy companies. Of those, DOI
reduced the expected area to be offered under final sale notices by
80% to approximately 173 parcels on roughly 144,000 acres, working
together with local and tribal communities.

DOI also examined offshore leasing areas, noting that the Outer
Continental Shelf accounts for 16% of all oil production and just
3% of natural gas production in the United States, mostly in the
Gulf of Mexico. Due to market conditions and industry drilling
strategy, the offshore acreage under lease by BOEM has declined by
more than two-thirds over the last 10 years. Offshore drilling is
expensive, challenging and, given low oil and gas prices over most
of the last decade until recently, less competitive than many
onshore resources. Of the more than 12 million offshore acres under
lease today, about 45% is either producing oil and gas or is
subject to approved exploration or development plans, which are
preliminary steps leading to production. The remaining 55% of the
leased acreage is non-producing, “indicating a sufficient
inventory of leased acreage to sustain development for years to
come,” according to DOI.

In fact, the most recent BOEM lease sales have drawn little
interest, with only a small fraction of the tracts offered for
lease attracting bids. In BOEM’s most recent sale (No. 257 in
November 2021) only 1.7 million acres received bids out of nearly
81 million acres offered. Only 33 companies participated in the
sale. The prior sale (No. 256 in November 2020) attracted bids from
17 companies for just over half a million acres out of almost 80
million acres offered. This is not a new trend. For instance, Sale
No. 247 (March 2017) offered almost 50 million acres for offshore
oil and gas drilling. Less than 1 million acres attracted bids from
24 companies. In each of these sales, the average number of bids
per block being offered was…about one. Almost all blocks have
just a single bidder. Everyone wins, but very little is actually
sold. And many leased tracts are never developed or prove too
speculative.

Requiring that an additional 60 million acres a year –
five times the total area of all existing federal offshore oil and
gas leases – be offered for new offshore oil and gas leases
as a precondition to new offshore wind leases being issued, and
that onshore lease areas be similarly expanded as a condition to
new solar and wind energy projects on federal lands, assumes that
there is sufficient industry interest to develop those oil and gas
leases, that doing so would materially increase the domestic supply
of oil and gas at a competitive price, that the nation’s energy
security would be enhanced by mandatory expansion of oil and gas
lease areas, and that the BLM and BOEM have the resources,
personnel and policies in place to significantly increase and
administer the federal oil and gas leasing program and associated
environmental reviews. None of these assumptions are likely
correct. Even if they were, there is no logic to holding up
offshore wind development or onshore wind and solar projects to
find out.

Other provisions of the bill might make new oil and gas drilling
leases less attractive, regardless of market conditions. The bill
would increase royalty rates for onshore and offshore federal oil
and gas leases to be more commensurate with the royalty rates
changed by many states for drilling leases on state public lands.
More stringent regulation of carbon oxide, nitrogen oxide (NOx) and
methane gas emissions, potential requirements for CCUS (encouraged
in the bill generally, with lower standards and more generous
credits), and demand erosion for hydrocarbons may make new federal
leases even less attractive over the coming decade.

Reinstatement of 2021 Offshore Oil & Gas Lease
Sale

And that’s not the only Easter egg in the bill for fossil
fuel development in federal waters. What else happened to the most
recent lease sale by BOEM? Sale No. 257 was originally held in
January 2021, rushed to market in the waning days of the Trump
Administration. President Biden’s Executive Order 14008, in
addition to directing the DOI review, temporarily paused offshore
oil and gas leases. A federal district court in Louisiana enjoined
the suspension and the sale went through in November 2021, only to
be set aside again by the United States District Court for the
District of Columbia in January 2022 (Friends of the Earth, et
al. v. Debra A. Haaland, et al.
). The D.C. federal court ruled
that BOEM had not complied with statutory requirements for
environmental review of the lease areas before issuing the
leases.

A few paragraphs in Section 50264 of the Inflation Reduction Act
would reinstate Sale No. 257 and also direct BOEM to proceed with
other specified oil and gas lease sales, notwithstanding the
court’s determination that BOEM failed to comply with NEPA with
respect to the relevant lease areas. President Biden would be
unable to suspend the issuance of those new offshore oil and gas
leases.

Want Fries With That?

Congress has often embraced compromises that contain subsidies
and incentives for both renewable energy and fossil fuels. The
Energy Policy Act of 2005, enacted under President George W. Bush,
extended the Production Tax Credit and Investment Tax Credit for
wind and solar power, respectively, added tax credits for oil, gas
and coal, mandated blending subsidies for biofuels and ethanol, and
expanded access to federal lands and offshore waters (and lowered
royalty rates) for oil and gas wells and other energy activities,
although stronger greenhouse gas reduction measures were defeated.
It was an all-of-the-above energy menu shaped by competing concerns
about energy security, economic growth and environmental quality.
But Congress did not try to pick winners and losers by showing a
preference for one energy technology or source over another.

Now, for the first time, if these fossil fuel provisions remain
in the bill, the development of renewables like solar power and
onshore and offshore wind energy is being held hostage to the
granting of millions of acres of new oil and gas leases on federal
land and the continental shelf for at least the next decade. What
is unusual is not that the proposed Inflation Reduction Act
simultaneously stimulates investment in both “dirty, old”
and “clean, new” energy technologies. What is new is that
one is contingent on the other and, specifically, that renewables
could be blocked if more areas are not opened up on public lands
and offshore waters – consistently, at scale and for many
years – to expanded oil and gas development. It is like
telling your obese uncle, who is trying to break bad habits and eat
a healthier diet, that each order of fresh fish and salad must be
accompanied by a large bowl of nacho cheese fries topped with sour
cream. Otherwise, no healthy food for him.

Energy Security & Price Volatility

Oil and gas lobbyists and other supporters of the fossil fuel
provisions, including Senator Joe Manchin (Democrat from West
Virginia), stress the need for continued development of
conventional hydrocarbons to maintain energy security and domestic
fuel supplies. Political pressure to address those concerns along
with inflation is strong (as the Inflation Reduction Act’s
euphemistic rebranding of the energy and climate provisions of the
Biden-Harris Administration’s original, more ambitious Build
Back Better bill suggests). Hence, the bill is a long-awaited
compromise between Senator Manchin, Majority Leader Chuck Schumer
(New York) and other Democratic leaders in the Senate in
coordination with the House Democratic leadership.

A supply/demand imbalance in global oil and gas commodity
markets due to a combination of geopolitics (Russia’s invasion
of Ukraine), strong demand recovery from the pandemic lows of the
past year or two, and very tight domestic refining capacity have
led to volatile and recently very high gasoline prices, renewed
demand for coal, and an increase in natural gas prices. Gasoline
prices have since retreated materially over the past month, but
anxiety at the pump (and the ballot box) remains high. The
wholesale U.S. spot price for natural gas (Henry Hub) has risen
sharply from $3.75/MMBtu in January 2022 to a high of $9.46/MMBtu
at the end of July, though options prices imply that gas prices
should come back down to around $4.75/MMBtu by the second quarter
of 2023. Energy prices in Europe are significantly higher and could
rise even further and faster if there are additional disruptions in
supplies of Russian natural gas to Germany, Italy and other
European countries that depend on it. U.S. exports of liquified
natural gas (LNLN 0.0%G) and coal are seen as a near- to
medium-term salve to Europe’s energy challenges, and that would
require significant investment in U.S. upstream and midstream
capacity.

Of course, investments in new oil and gas wells, gas
liquefaction plants, export terminals, pipelines and storage tanks
today will do little or nothing to address prices or volumes over
the next one or two years. We may be at the top of the market, with
commodity prices falling rapidly as high prices erode demand.
Commodity boom/bust cycles are endemic to the oil and gas industry.
New capital investments on this scale may simply be too risky at
this stage of the business cycle for many investors.

Longer term decarbonization trends globally are strong and, with
passage of legislation like the Inflation Reduction Act, those
trends would be reinforced. The “energy transition” to
renewable power, alternative fuels, energy efficiency and storage,
hydrogen and electrification of transportation and transit is still
gathering steam. Over time, as the transportation sector
electrifies and the power grid greens, and with geopolitics driving
up energy prices globally, there will likely be additional demand
destruction for fossil fuels, making new leases even less
attractive.

Consequently, many investors fear the risk of making large new
capital expenditures in oil, gas and coal assets that may become
obsolete, stranded investments. Private equity, institutional
investors and energy funds have shown a high degree of restraint
and discipline in the current cycle in allocating capital,
preferring operating assets with stable cash flows to risky,
capital-intensive E&P projects. Some investors have an eye on
potential future regulation and, for some, ESG sentiments. Market
factors still dominate their thinking, though, especially with
ongoing supply chain disruptions for materials and skilled labor
and challenging forward price curves due to price volatility,
uncertainty and rising interest rates that lower discount rates and
thus the net present value of future cash flows.

Energy Incentives: Something for Everyone

The main thrust of the Inflation Reduction Act is to promote
cleaner and greener energy sources and technologies so as to reduce
the greenhouse gas emissions that contribute to global climate
change. The legislative process often requires compromises to
function. The bill supports continued investment in fossil fuels
– chiefly oil and gas – and supports communities and
companies adversely affected by the transition away from coal to
cleaner energy sources. The bill also helps other communities that
have been disproportionately impacted by energy operations.

There are criticisms even from the bill’s supporters of the
provisions that encourage more fossil fuel exploration and
production, especially on federal lands. Whether they will survive
or be modified or cut by amendment in the Senate or the House, or
in a possible House-Senate conference committee remains to be seen.
As this is a reconciliation bill, the rules (though different in
the Senate from the House) limit amendments. Senators Schumer and
Manchin have separately agreed that this bill will be followed by
further legislation streamlining the federal permitting process.
Perhaps that legislation can provide an avenue to remedy some of
the imperfections in the current bill.

Most environmentalists, utilities, labor unions and clean energy
advocates strongly support the bill’s passage, noting its net
climate benefits and the economic stimulus for innovative
technologies and renewables. On balance, the reductions in carbon
dioxide, methane and other greenhouse gases vastly outweigh the
impact of the fossil fuel provisions. Perfection should not be the
enemy of the good.

Originally Published by Forbes

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.



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