There are many definitions of what it means to be “net zero,” but the basic concept is that it is the balancing of greenhouse gas (GHG) emissions released to the atmosphere with equivalent or greater removal of GHGs from the atmosphere so that overall GHG emissions are less than or equal to zero. This fad “du jour” has some punch—with many companies making public-facing claims, commitments, and pledges to work towards and/or achieve net zero, there is real momentum building towards transitioning the way we think about and use energy. Simultaneously, federal and state governments have also set net-zero goals and are facilitating public and private efforts through a combination of incentives (so-called carrots) and regulations (or sticks). These carrots and sticks provide important opportunities for helping states, Tribes, and companies achieve their net-zero targets. But beyond the carrots and sticks, the power of market forces is a strong driver in this transition to net zero. This article discusses some of the carrots, sticks, and market forces that are affecting real change in energy use.
The movement towards net zero is already being aided by existing regulatory incentives, or carrots, which are providing opportunities and facilitating change. Many of the most significant incentives were created through recent bipartisan legislation, including the Inflation Reduction Act of 2022 (Pub. L. No. 117-169) (IRA). These incentives represent broad recognition of and support for a movement towards net zero.
Enacted in August 2022, the IRA includes a number of tax-related provisions designed to incentivize businesses to reduce GHG emissions and remove carbon dioxide from the atmosphere. The goal of the IRA is to make sufficient investments to drive significant emissions reductions in electricity generation and transportation, and to facilitate longer-term decarbonization efforts in industry, buildings, and agriculture.
Specifically, the IRA enhanced and extended several existing tax credits. For example, section 13702 of the IRA effectively extended the investment tax credit (ITC) through at least 2033, by extending the current ITC through 2024 and introducing a new technology-neutral credit that largely mirrors the ITC beginning in 2025. The ITC enables renewable energy project owners to claim a tax credit equal to 30% (or more) of the eligible costs of construction for qualifying facilities, including wind, solar, fuel cell, hydropower, and biomass facilities, as well as certain other types of renewable energy–generating facilities.
Likewise, section 13701 of the IRA effectively extended through at least 2033 the benefits of the production tax credit (PTC), which is an annual tax credit based on electricity produced at a qualifying facility, including wind, solar, biomass, hydropower, and certain other facilities. The PTC is available for 10 years after a project is placed in service, so a taxpayer claiming the PTC for a project that is placed in service in 2033 could reap the rewards for an additional 10 years thereafter. A taxpayer cannot claim both the ITC and the PTC with respect to the same project.
In addition to extending these existing credits for “traditional” renewable energy technologies, the IRA also added and enhanced tax credits for emerging technologies. In particular, section 13204 of the IRA added a new production tax credit for taxpayers producing and selling hydrogen fuel, and section 13102 added to the list of ITC-eligible technologies by making stand-alone battery energy storage devices, electrochromic glass, and renewable natural gas facilities ITC-eligible (though for renewable natural gas and electrochromic glass, the ITC is only available if construction of the project begins by the end of 2024).
Aside from changes directly relating to energy-producing equipment, section 13104 of the IRA greatly increased the dollar value of credits available for carbon capture and sequestration projects, and made more types of facilities eligible for the credit. The carbon capture and sequestration tax credit operates in a manner similar to the PTC; it permits taxpayers to claim annual tax credits for a 12-year period based on the amount of carbon captured and permanently sequestered or used in a manufacturing process in the applicable year. Although the carbon capture tax credit has been available since 2008, with the significant increase in the dollar value of these credits and expansion of eligible facilities, the hope is that more companies will invest more heavily in developing carbon capture technology (such as facilities that directly capture carbon from the air), and ultimately build more carbon capture projects.
Although the carbon capture tax credit has been available since 2008, with the significant increase in the dollar value of these credits and expansion of eligible facilities, the hope is that more companies will invest more heavily in developing carbon capture technology.
Finally, the IRA included several new provisions that will make it easier for project developers and tax-exempt entities to take advantage of these tax credits. Because tax credits are a dollar-for-dollar offset of federal income tax liability, historically many developers without tax liability could not directly utilize these credits and were forced to enter into complex joint venture arrangements with parties that do have significant tax liability (such as banks, insurance companies, and large corporate entities) to help finance the construction of these projects. New IRA rules allow project owners to directly sell tax credits for cash, so developers of renewable energy projects can avoid the complexity of engaging a joint venture partner who can claim the credits. Part 8 of Subtitle D of Title I of the IRA also now allows tax-exempt owners of eligible facilities (and, for certain credits, taxable entities) to claim a direct cash payment from the government equal to the value of the credits. The hope is that this spurs additional development of projects by tax-exempt entities such as schools, certain hospitals, and municipalities, which could not take advantage of these tax credits in a pre-IRA world because they had no tax liability.
As a whole, the IRA changes, including many additional provisions not described here, have the potential to provide significant government financial assistance in the development and construction of clean energy facilities and carbon capture equipment.
The IRA was not only a tax credit bill, but also included a number of other incentives to help facilitate the transition to net zero. Overall, these tools include billions of dollars in grant and loan programs, as well as direct investments in transition technology and projects, which will help achieve net-zero goals. One example of such incentives is the extensive and highly impactful funds allocated to the U.S. Environmental Protection Agency (EPA). Most of these funds are in the form of grant programs available to states to develop and implement programs, to change out equipment, or to develop infrastructure.
Some of the most significant grant funds are those being allocated to state, Tribal, and local governments for planning and implementation of climate pollution reduction policies to reduce GHG emissions or enhance carbon sinks. Section 60114 of the IRA authorized $5 billion for Climate Pollution Reduction Grants—$250 million in noncompetitive planning grants and $4.6 billion for competitive implementation grants. The agency accepted applications for the planning grants in early 2023 and is expected to announce the award recipients in the summer of 2023. The recipients can use the planning funds to update existing climate, energy, or sustainability plans, or to develop new plans. Entities that are covered by Climate Pollution Reduction Plans will then be eligible to apply for implementation funds starting in 2024. The implementation grants are intended to support the development and eventual deployment of technologies and solutions that will reduce GHG emissions and help transition our economy towards a clean energy economy. These funds will certainly help states, Tribes, and local governments achieve their net-zero goals, and the funding available for implementation is significant enough that it is likely to facilitate net-zero choices that will impact the market.
Another huge source of grant funds under the IRA allows EPA to give out grants to states and local communities to offset the costs of replacing heavy-duty commercial vehicles with zero emission vehicles; to develop and deploy infrastructure needed to charge, fuel, and maintain these zero-emission vehicles; and to develop and train the workforce necessary for this transportation transition. The Clean Heavy-Duty Vehicle Program provides for $1 billion in grant funds available through 2031. Similarly, the IRA provided for $3 million in grants to reduce air pollution at ports through the purchase and installation of zero emission technology as well as the development of climate action plans. Overall, through these grant programs, EPA will help states and local governments make the jump to clean transportation, which will also simultaneously spur market demand and build out of the vehicles and equipment needed for the transition.
Another “carrot” EPA has to facilitate a movement towards net zero is $50 million in grant funding authorized under section 40306 of the Infrastructure, Investment and Jobs Act of 2021. The agency is authorized to give out grants to states, Tribes, and territories to develop and implement programs for carbon sequestration wells, which should reduce certain existing regulatory hurdles. Under the Safe Drinking Water Act, EPA has the authority to regulate injections into the ground through the underground injection control (UIC) program. EPA has specific regulations for Class VI wells that can be used for injection of carbon dioxide for the purposes of permanent sequestration. As with many federal environmental laws, EPA can delegate primary responsibility for issuance and enforcement of UIC well permits to states, Tribes, and territories. Although many states have already obtained “primacy” for other types of UIC wells, to date, only North Dakota and Wyoming have obtained primacy for Class VI wells. The cost, time, and resources to develop the geological and hydrological regulations and expertise needed to obtain primacy for Class VI wells is not insignificant; but, in those states that have primacy for Class VI wells, the time to obtain the necessary project approvals to install a Class VI well and implement a carbon sequestration project has been much more efficient than obtaining that same approval from EPA. As such, there is a significant desire by states with interest in carbon sequestration to obtain primacy to facilitate the permitting more efficiently for these projects. The grant funds provided for in the IRA are expected to help states in their efforts to obtain Class VI well primacy. Specifically, these funds will facilitate the development of the necessary state programs. Once Class VI well primacy has been obtained, the process for obtaining the necessary approvals to facilitate these large-scale carbon sequestration projects is expected to be more efficient and to result in more projects being constructed.
On the flip side of these incentives, federal and state governments are using “sticks” in the form of increased regulation to address GHG emissions. Many such sticks are already promulgated, and more will continue to emerge.
One big driver that the administration is using to enact GHG regulation is its valuation and reliance on the social cost of carbon. On January 20, 2021, as one of its first acts, the Biden administration issued Executive Order 13990. EO 13990 required federal agencies to factor the social cost of carbon into their rulemaking with the specific purpose “to Tackle the Climate Crisis.” The social cost of carbon provides a financial metric for changes in net agricultural and labor productivity, human health impacts, property damage, and lost value of ecosystem services brought about by the impacts of climate change. With EO 13990, agencies were directed to look at global and not just domestic impacts of climate change. This more expansive interpretation of the social cost of carbon will allow agencies to more easily demonstrate that costs of implementing regulations will be offset by the benefits of the regulation.
So far, the Biden administration has addressed the social cost of carbon in 49 proposed and final rules, including promulgation of new energy efficiency standards for residential and commercial buildings; issuance of new national emission standards for hazardous air pollutants for industrial, commercial, and institutional boilers and process heaters; and modifications to GHG emissions standards for various vehicle classes. More regulation citing the social cost of carbon in its cost-benefit analysis is certainly on the horizon. However, given the financial implications to industry being pushed away from the status quo by such regulations, expect to see more rule challenges based on the application of social cost of carbon metrics in the future as well.
EPA has said it would propose new performance standards to reduce GHG emissions from existing power plants this year. This is despite a ruling last June in West Virginia v. EPA, 142 S. Ct. 2587 (2022), that applied the “major questions” doctrine to void the Clean Power Plan on the basis that the Clean Air Act did not give EPA the authority to regulate greenhouse gases. While it remains to be seen exactly what EPA will propose to try to drive reduction in carbon emissions from the traditional power sector, it seems likely that any regulation will be justified, at least in part, by reliance on the social cost of carbon metrics. This will give states and industry a new opportunity to challenge the application of social cost of carbon as a justification in rulemaking.
So far, the Biden administration has addressed the social cost of carbon in 49 proposed and final rules.
Increasing regulations around traditional energy sources like crude oil and natural gas production are also intended to promote reduction in GHG emissions. In November 2021, the EPA proposed standards under section 111 of the Clean Air Act to address methane and volatile organic compound emissions from existing oil and gas infrastructure. 86 Fed. Reg. 63,110 (Nov. 5, 2021). EPA published a supplemental proposal in December 2022 that took the proposed regulation further towards carbon reduction. 87 Fed. Reg. 74,702 (Dec. 6, 2022). The proposed rule, if adopted, would require routine monitoring for methane leaks and more comprehensive requirements for closure of wells to avoid unintentional releases. The proposed rule has been estimated to result in carbon emission reduction to 87% of 2005 levels by 2030. Such regulations, if adopted, will increase the costs associated with obtaining energy from traditional sources. This will likely have the effect of making lower carbon footprint technologies such as wind and solar more cost-efficient in comparison.
Interestingly, “sticks” to reduce methane emissions from traditional oil and gas are coming from outside government as well. Just this March, major insurance provider Chubb announced that it would stop insuring drilling projects unless operators reduce methane emissions from those projects. Their new policy would require implementation of methane leak detection and repair programs and require operators to limit venting of methane in nonemergency situations.
Efforts to encourage movement toward net zero have not been limited to regulation directly impacting the energy industry. In 2020, Congress adopted the American Innovation and Manufacturing Act, which established a phasedown for fluorinated gases. While such gases accounted for only 3% of GHG emissions by volume in 2020, they were responsible for 94% of the warming potential associated with GHG emissions that year. EPA has aggressively ratcheted down available credits for the manufacture and importation of such gases over the past two years and has pursued significant enforcement actions against those alleged to have brought regulated gases into the United States without sufficient allowances.
Another important tool as a regulatory stick is the Enhancement and Standardization of Climate-Related Disclosures for Investors rule that has been proposed by the SEC.
In addition, one of the primary authorities granted to EPA under the original 1970 Clean Air Act was the ability to regulate mobile sources—on- and off-road vehicles and trucks, as well as other mobile equipment—and fuels—gas, diesel, and other transportation fuels. Since that time, EPA has used that authority extensively: first, to require improvements to vehicles to reduce emissions (i.e., catalytic converters) and to remove the lead and sulfur that used to be present in gas that was used in cars. Fast-forward 50 years and despite continued reductions in emissions and tightening of fuel standards, mobile sources continue to be a significant source of annual GHG emissions in the United States (up to 28% as recently as 2021). With that in mind, EPA continues to use its CAA regulatory “stick” to continue efforts to reduce mobile source emissions of GHGs. Just this year, the agency has released additional and much-anticipated proposals to further reduce emissions from passenger vehicles and heavy trucks over the next 10 years. The proposed rule for passenger cars, light trucks, and medium-duty vehicles would set multi-pollutant standards that would kick in starting in 2027 and are estimated by the agency to result in a 56% reduction of light-duty fleet GHG emissions relative to existing standards.
Another important tool as a regulatory stick is the Enhancement and Standardization of Climate-Related Disclosures for Investors rule that has been proposed by the Securities and Exchange Commission (SEC). See 87 Fed. Reg. 36,654 (June 17, 2022). Proposed in spring 2022, the long-awaited disclosure requirements would obligate certain publicly traded companies to disclose in their annual reports certain GHG emissions. As proposed, the rule would have required disclosure of Scope 1 (direct GHG emissions from a company’s operations, equipment, vehicles, etc.) and Scope 2 (GHG emissions resulting from the electricity a company uses in its operations) emissions. Reporting of Scope 3 (all other indirect sources of GHG emissions not included in Scopes 1 or 2) would only be required if those emissions are a material part of a company’s GHG emissions, or if the company had set GHG (e.g., net zero) targets associated with those emissions. Although the proposed SEC rules in this space would not directly result in lowering GHG emissions, requiring this level of disclosure is expected to result in more transparency on public companies’ emissions and GHG reduction efforts. And if Scope 3 emissions are included in disclosure requirements, then there is likely to be a trickledown effect where private companies that supply intermediaries, parts, or products to public companies would also likely need to develop these data to provide for public companies’ use in Scope 3 emissions calculations.
As ESG requirements make carbon disclosures more universal, consumer demand has been changing, albeit slowly, to encourage this shift as well. Consumers across the country, including in traditional energy source states like Texas, are demanding and receiving access to energy options that don’t increase their carbon footprint. This consumer demand is not limited to the energy market. Due to market demands, airlines and travel companies are providing access to information about carbon emissions associated with particular travel itineraries. And consumer products are increasingly evaluating and addressing their carbon impact and making carbon-neutral claims to market their products.
This shift in consumer consciousness is driving innovation in industrial and consumer product development. Research has produced everything from developments in the production of green hydrogen as a fuel source, strategies to reduce carbon emissions associated with milk production by changing what cows eat, to more-effective plant-based alternatives to plastics. Consumer demand is also driving demand for carbon offsets, which in turn is driving innovation in carbon capture and sequestration. Innovators are exploring projects in carbon capture through oceanic algae farming, carbon sequestration in concrete, and scalable technology to remove carbon dioxide directly from the air. These changes in available technology and consumer taste will, in turn, drive new regulation and a competitive advantage for those making successful investments now.
On the producer side of the market, the so-called Brussels Effect—where the market power of regulations in the European Union (EU) result in companies making uniform decisions across boarders because of the efficiencies of having a single product and label that can be sold in any country—is propelling multinational companies to make changes and disclosures already. With the size and scope of the world economy, and at a global production scale, it is simply not reasonable to make different products or to have different product labels for different geographic locations. The value and efficiency of large-scale production results in restrictions and requirements across all products.
A similar effect is true of California, which continues to push the envelope in GHG reductions—especially in mobile source emissions. Even as the federal government has set a net-zero target for 2050, with a goal of 50% of new vehicle sales being electric by 2030, California has set a net-zero goal for 2045, with 68% of new vehicle sales being electric by 2030 and 100% of new vehicle sales being electric by 2035 (which is also the EU’s target). These electric vehicle targets in particular are market changing—the scope of production needed to achieve these will result in significant market shifts not only in the United States, but worldwide.
Even as the momentum towards net zero has grown exponentially in the last few years, there are still those who do not support these targets. Even as both the public and the private sectors seem to be doubling down on net-zero commitments, several states are pushing back. Legislators in North Carolina and Wisconsin have proposed bills that would limit or restrict municipalities or states from owning, operating, managing, leasing, or controlling electric vehicle charging stations. And legislators in Wyoming went farther—proposing an all-out ban on the sale of new electric vehicles starting in 2035. Though none of these proposals have yet passed, others have. Especially relevant are the anti-ESG investing laws. Several states have banned state funds from considering ESG characteristics in making investment decisions, including Idaho and North Dakota, and several states have passed anti-boycott laws that require the state to divest any investment in a company that has “boycotted” traditional energy companies, including Kentucky, Oklahoma, and Texas. However, considering the overwhelming momentum currently pushing the global market and demand towards net zero, it is hard to see how individual state efforts will be able to stop the net-zero progression.
The net-zero movement has gained significant momentum in the quest towards reducing GHG emissions. Although the concept of net-zero pledges, goals, and targets is relatively recent, for years there have been a growing number of bigger and bigger sticks guiding us towards a net-zero end. And recent government incentives, such as the infusion of tax credits and grant funding, have expedited that movement. Added to this is the push of market forces, including both consumer demand and corporate pledging, to achieve net zero. And although the various recently enacted “carrots” will only be available for the next five to ten years, they are likely only going to be needed for that time to fulfill their role of building the momentum of this movement to a point where it will carry itself forward until net zero is achieved.
