By Robert Gephardt
Recent U.S. legislation alters the trajectory of GHG emissions and expands the opportunity set for midstream issuers.
The recent passage of the Inflation Reduction Act, or IRA, in the U.S. was a significant event for climate policy and the energy industry. The bill enhances and expands the incentives for a diverse array of investments, enabling decarbonization across the U.S. economy.
The strength of IRA lies not just in the improvement in economics, but also from the 10+ years of visibility being offered to companies and investors. This represents a shift from the past where cliffs in incentives consistently loomed on the horizon.
As a result, studies have provided preliminary projections indicating the new policies could result in an incremental reduction in annual U.S. emissions by 2030 (relative to prior policies) equal to approximately 20% of current emissions. It would not be surprising if these estimates ultimately prove conservative.
At face value, an acceleration in the pace of decarbonization screens as negative for the traditional energy industry. We think this is correct when considering the long-term prospects for most oil-focused exploration and production companies.
The significant enhancement to incentives for electric vehicles could accelerate pressures on oil demand, presenting challenges for issuers that do not effectively utilize current elevated prices to appropriately reposition their balance sheets and businesses.
However, the significant improvement in support for carbon capture and the inclusion of hydrogen in IRA have transformed the opportunity in deployment of these technologies. Both require significant pipeline infrastructure to be constructed or repurposed while the sequestration of carbon requires geologic expertise.
The U.S. midstream industry, and select upstream companies, are ideally positioned to fulfill these needs given their existing asset footprint and organizational capabilities in developing and operating energy infrastructure. Many forward-thinking issuers were already pursuing projects in carbon capture and hydrogen, which should give them another competitive edge as downstream customers such as the industrial, chemical and power generation sectors look to decarbonize using the new incentives.
The implications on credit quality for midstream issuers may be significant. Given the structure of the incentives, projects providing infrastructure solutions in the energy transition are likely to utilize long-term contracts from non-energy customers, providing high-quality cash flows and diversifying the businesses.
The risk of cannibalizing their legacy business is mitigated by their limited direct commodity price exposure and the position of the U.S. as a low-cost supplier that will likely be critical even under aggressive decarbonization scenarios.
The midstream industry has been given a significant opportunity; now it needs to execute.
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