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US climate spending – How does it reduce inflation?

Billions of dollars are set to be allocated to bolstering US infrastructure under the Inflation Reduction Act, a belated but still welcome boost to tackling climate change and runaway inflation. Truly two birds with one stone!

So how does the multi-billion dollar package help lower inflation over time?

Next to lowering drug prices and healthcare premiums, the spending is set to create infrastructure that should – ultimately – have a deflationary effect on ‘everyday energy costs’ and household expenses (see Exhibit 1).

The White House has touted the USD 430 billion bill as tackling decade-high inflation, although it is not clear (yet) to what extent it could replace the need for action by an inflation-busting Federal Reserve in the middle of a rate rising cycle.

Exhibit 1: The IRA could reduce inflation rate somewhat in the first two years
and do more to reduce inflation by the late 2020s

Let’s first note that much of the US infrastructure is in a dire state. Indeed, greater use of clean energy could be derailed without an overhaul of the electricity infrastructure – a task some experts say requires more than USD 2 trillion. The network is decaying thanks to underinvestment and age, its condition underscored by the failures we have seen during increasingly frequent and severe weather events.

Household bills benefit

But what of the cost benefits? Just think of the costs of running an electric vehicle versus that of a petrol car these days (with petrol at just over USD 4 a gallon now, up by 27% from a year ago). Consider also the incentives for buying a new or used EV, which then leaves money for other outlays.

There are ample savings to be had on electricity bills from rooftop solar panels compared to the rates charged by utilities (which have gone up by just over 10% from 2021 levels1).

We believe that electrification and leveraging renewables, such as solar and wind, will bring future costs down. Greater scale will allow these costs to continue to decline – something that is not the case with fossil fuels.

Or with nuclear energy for that matter. While nuclear energy can be seen as low-carbon – it emits four times less CO2 than solar power, two times less than hydroelectricity, and the same amount as wind power – the source is non-renewable (although uranium can be recycled).

The related costs of climate change

Additionally, one cannot ignore related costs. While there is indeed a marginal cost of running a nuclear plant (to say nothing about the initial capital outlay), it is impossible to ignore decommissioning and disaster costs. The clean-up at Fukushima in Japan was estimated at over USD 180 billion.

Preventable costs can also take the form of money needed now to tackle the effects of climate change such as floods, drought, wildfires and hurricanes. Natural disasters cost the US over USD 300 billion in 2021. The White House estimates that this could rise to USD 2 trillion a year by 2100.

Global warming looks set to cost us dearly if no action is taken. As climate change makes the impact of weather-related natural disasters more severe, it can lead to substantial income and productivity losses over time. Rising sea levels would take over land that could have been used productively; heat stress could lead to crop failures.

A UCL study predicts that by 2100, global GDP could be 37% lower than it would be without the effects of global warming. Economies in Asia would be hardest hit. China is at risk of losing nearly 24% of its GDP in a severe scenario, while the world’s biggest economy, the US, stands to lose close to 10% and Europe almost 11%.

Finally, on the cost of inaction, there are the health aspects of rising temperatures, air, water and land pollution, and other effects of climate change. The NRDC estimates annual healthcare costs related to climate change and fossil fuel use to be more than USD 820 billion a year in the US. Just consider what freeing up some of those monies could mean for living conditions.

Long before average temperatures get much higher, tail events will likely spike in severity and frequency. Witness typically rainy England subjected to 40C temperatures and drought this summer.

Do not ignore the outliers

People will ignore the outliers but these are rapidly increasing and their effects will be felt in the form of more fires, heat waves, drought, and pressure on food supplies – and not in the distant future. Expect increasing deaths and people moving home, something which can spark conflict.

The US Inflation Reduction Act can rightly be seen as a game changer. The US is the world’s second-largest greenhouse gas emitter and this legislation comes at a time when energy security is a hotter topic than it has been for years and when the need for climate action is unmitigated.

The passing of the bill could have a positive effect on global action, by restoring the US as a credible international partner on fighting climate change as the world gears up for COP27 later this year.

From an investor perspective, the US news, alongside Australia recently passing a bill to reduce the country’s emissions by 43% on 2005 levels by 2030 and India’s cabinet approving the country’s updated Nationally Determined Contribution (NDC), could result in significant further opportunities for clean energy investment not just in the US, but further afield.

[1] Source: BLS statistics

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