In September 2022, CPI and the Cities Climate Finance Leadership Appliance published Increasing Subnational Pension Funds’ Climate Investments, highlighting barriers and opportunities for state and city employee or occupational retirement pension funds to increase their investments in climate solutions, especially urban and infrastructure investments, and what policymakers can do to address some of these barriers.

The passage of the Inflation Reduction Act (IRA) is a momentous occasion as U.S. government spending and incentives are projected to put the United States’ 2030 goal of a 50-52% reduction in GHG emissions relative to 2005 within reach.

With the arrival of 2023 kickstarting the IRA’s implementation, the IRA has potential to address some of these key barriers that subnational pension funds face in making climate investments. While the bill primarily impacts the U.S., the policy approaches and incentives are broadly applicable. On top of the barriers specific to subnational pension funds, the IRA helps with barriers that all investors will face in investing in climate solutions, including overcoming perceived risks of new technologies, a lack of interest in moving on from the status quo, and high upfront costs of some climate solutions.

Some of the biggest barriers for subnational pension funds that are addressed by the IRA include:

  • Lack of project pipeline: one of the biggest challenges we consistently heard when speaking with pension funds for this report was the lack of bankable projects in which to invest. The IRA bolsters tax incentives for renewable energy and other climate solutions, which may lead to a dramatic increase in the number of clean energy infrastructure projects, a stable and popular investment for many long horizon, low-risk financiers like pension funds. In addition to an expansion of already mature technologies, the IRA is also likely to lead to an expansion of more nascent technologies in part through a technology-neutral investment and production tax credit. These technologies include hydrogen, battery storage, grid transmission, carbon capture, offshore wind, and advanced nuclear. By 2035, this could lead to a more than 4x increase in annual capital investment in energy supply related infrastructure.
  • Ticket size: By virtue of their size and the costs of conducting due diligence, subnational pension funds typically want to invest hundreds of millions of dollars in an infrastructure project or portfolio. That project or portfolio will typically need to be at least USD 500 million in total size because of a pension fund’s maximum holding percentage. Multiple incentives in the IRA have the potential to produce projects that are larger and more appropriate for subnational pension fund investments. As an example, the IRA contains a manufacturing production credit, which subsidizes the manufacturing of solar cells, U.S.-built electric vehicles and batteries, wind turbines, and offshore wind vessels. Projects that would take advantage of these credits, some of which have already been announced, consistently cost in the hundreds of millions or billions of dollars in upfront capital. While these projects do carry market risk, many of the manufacturing and large-scale projects like offshore wind farms (in which pension funds are already investing) are relatively mature technologies and represent projects more consistent with pension funds’ typical infrastructure investments. In addition to large infrastructure projects, climate solutions can reach sufficient scale through financial aggregation mechanisms, which the IRA may facilitate through, for example, joint procurement of renewable energy or virtual power plants that aggregate smart heat pumps, water heaters, or electric vehicle chargers.
  • Varied and unfavorable regulatory environments: the U.S. government has been subsidizing wind and solar projects through tax credits for more than a decade. However, to access these credits project developers or investors needed to have a sufficiently large tax base. Since many sub-national pension funds are tax-exempt, this meant that they were unable to access these benefits and therefore it was often cheaper for project developers to turn to other private investors to access capital. The tax credits in the IRA have been restructured to allow for transferability, meaning that project developers can sell the value of the tax credits to third parties in exchange for cash. Pension funds will no longer be penalized for not being able to access these credits on their own.
  • Risk appetite: many subnational pension funds are unwilling to invest in climate-smart infrastructure projects because of perceived and real concerns about these projects being too risky for a fund’s portfolio. The IRA addresses this, in part, by subsidizing the upfront costs of new projects. This doesn’t reduce overall project risk but does make the risk-return profile more attractive by lowering the investment cost. On top of this, the IRA contains funds to speed up permitting processes and smooth supply chains. This should reduce the risk of projects taking longer than expected to come to fruition (or getting cancelled altogether), which would imperil investments.
  • Changing market conditions: pension funds are resistant to make investments in both infrastructure and their own internal expertise when incentives are hard to predict. Past incentives were often only extended for a few years at a time and could change depending on political outcomes. In this environment, any specific project’s risk was higher since if development or construction timelines extended beyond the length of the tax credit, the cost of the project would go up. The IRA extends tax credits for ten years.

The IRA will not solve all challenges for institutional investors looking to invest in climate-smart infrastructure in the United States. There are still barriers like political headwinds, local and national regulations on planning, extended and inconsistent permitting processes, insufficient workforce, inflationary pressures and supply chain challenges, and difficulties interconnecting new renewable energy projects to the electrical grid. Without addressing these challenges, subnational pension funds may have to bid on a smaller number of subsidized projects, raising the relative cost and lowering expected returns. Despite these remaining challenges, the IRA remains promising in its ability to address barriers for subnational pension funds investing in climate-smart infrastructure in the United States.


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