Inflation Reduction Act boosts renewable energy M&A for 2024 rebound

When the Inflation Reduction Act (IRA) was passed in August 2022, the rate of inflation had reached its highest level in 40 years and the effective federal funds rate (EFFR) was less than halfway through its 18-month climb from near zero to over 5%.¹ High costs, supply chain issues, and recession fears were already putting the brakes on renewable energy² M&A activity after a record-breaking 2021.³  The slide would continue through 2023, which saw the first decrease in M&A deals in five years.

While inflation remains elevated and uncertainty persists, recession fears have abated and equities markets have notched record highs.⁴ These improved economic conditions have fueled investor optimism and driven an uptick in M&A, with renewable energy-related deal activity in Q4 2023 increasing by 46% versus the previous quarter, according to GlobalData. As the recovery picks up steam, investors are expecting the tax and spending provisions outlined in the IRA to attract even more interest and activity in the sector.

While policies like the IRA will boost the near-term growth of renewables M&A, there are other factors working for — and against — the sector. Here are four key trends to watch in the second half of 2024 and beyond:

1. Momentum in societal pressures and sustainability-related regulations

The concept of sustainable development is more than 50 years old, and for decades the private sector has touted initiatives to combat climate change. Yet, global carbon emissions reached a record high in 2023.⁵ Whatever businesses have been doing to combat climate change, it’s clearly not enough. As individuals and governments turn up the pressure, sustainability has become a major corporate issue from boardrooms to factory floors, shaping business strategies and influencing consumer preferences worldwide.

The Securities and Exchange Commission (SEC) recently adopted final climate disclosure rules that will require public companies to report on their carbon footprints, the risks climate change presents to their businesses, and their actions to address those risks. In addition, regulations in California, New York, and elsewhere promise to hold companies accountable for climate inaction.

While the U.S. lacks a federal sustainability law, the European Union recently passed two sweeping laws: the Sustainable Finance Disclosure Regulation and Corporate Sustainability Reporting Directive.⁶ Many other countries are following suit. These regulations, and the cost of failing to comply, are steering capital away from activities that might add to an organization’s carbon footprint and toward investments, such as renewable energy, that can help them reduce it.

2. The challenge of high interest rates and financing costs

At the beginning of 2024, the Federal Reserve signaled that it might begin lowering the EFFR as early as March, and economists expected that at least two additional rate cuts would follow later in the year.⁷ While a return to the near-zero rates of 2021 was not in the cards, the hope was that lower interest rates would help stir up stagnant capital markets. Those expectations have been dashed, however, as inflation figures have continued to hover above the Fed’s 2% target for triggering rate reductions.

Interest rate hikes have had a chilling effect on M&A in recent years, with global deal volume shrinking by 25% in 2023 compared to 2022, according to an analysis by PricewaterhouseCoopers. But for a young sector like renewable energy, the impact of high interest rates on M&A is more substantial.

On one hand, the elevated cost of borrowing makes it harder for deals to “pencil,” constraining volume. The higher risk of default, and the uncertainty that accompanies a high-rate environment, also means that capital providers are scrutinizing deals more heavily. M&A deals can take longer to close or, in some cases, be put on hold.

On the other hand, the “land grab” mentality that was pervasive in renewables M&A in 2021 and early 2022 means that some smaller developers may choose to sell projects, portfolios, or even entire platforms. Investors who have access to dry powder may be able to pick up these distressed assets, buttressing M&A volume.⁸

Given these circumstances, experts agree that developers are taking a more targeted and strategic approach to acquisitions. This may be partly in response to a previous “acquire-first-and-ask-questions-later” approach, when developers loaded up on projects knowing that many of them would languish in interconnection queues (projects waiting to be connected to the power grid). Investors today are focusing on low-risk investments, such as those that already have an interconnection agreement in place.⁹

3. The Inflation Reduction Act reaches full power

While the IRA was signed into law almost two years ago, and many of its provisions went into effect at the beginning of 2023, some of the programs that are expected to have the greatest impact on renewables M&A have yet to be fully implemented. This includes the $27 billion Greenhouse Gas Reduction Fund and other elements of the $110 billion in grant money the IRA made available.

In addition, the Department of Energy’s Loan Programs Office (LPO) is accelerating efforts to allocate $400 billion in debt capital to high-impact energy and manufacturing projects. The IRA increased the LPO’s budget tenfold, and officials are rushing to distribute those funds before the November election.

Finalizing language on new tax credit programs and transferability has also taken much of the past year, and stakeholders needed time to figure out how best to navigate the changed renewables M&A landscape.

4. The reassessment of load growth

Over the past year, energy grid planners have nearly doubled the five-year growth load forecast, and next year it’s likely to see an even higher nationwide growth rate after forecasting measurements are further standardized. The nationwide forecast of electricity demand is also up from 2.6% to 4.7% growth over the next five years.¹⁰

Some of the drivers in load growth include new manufacturing, industrial, and data center facilities. In manufacturing, we’re seeing a huge amount of capital inflow in the supply chain. American manufacturing is hitting a 50-year high, fueled by new federal tax breaks to lift microchip and clean-tech production. Since 2021, companies have announced plans to spend at least $525 billion on factories for semiconductors, batteries, solar panels, and more.¹¹

Data center growth is being supercharged by the rise of artificial intelligence and will continue to grow year over year. In fact, data center power usage is expected to triple to 7.5% (~390Twh) of domestic power demand by 2030, the equivalent of the electricity used by about 40 million homes in the U.S.¹²

The electrification of transportation and buildings is another important contributor to load growth. In Georgia, where dozens of electric vehicle companies and suppliers are setting up shop, the state’s largest utility now expects 16 times as much growth in electricity demand this decade than it did even two years ago.¹¹ The electrification (or decarbonization) of buildings is using electricity rather than burning fossil fuels like oil, gas, and coal for heating and cooking. Today, in the U.S., nearly half of all homes use natural gas as their primary heating fuel.¹³ The goal is for all-electric buildings to be powered by solar, wind, and other sources of zero-carbon electricity. In addition, incentives and funding are also rapidly growing to replace onsite fossil fuel equipment with electric equipment.

These new drivers of growth are here to stay, underscoring the need for rapid planning for and construction of new generation and transmission projects.

Conclusion: Conditions are still challenging, but this is no time to sit on the sidelines

With the exception of inflated costs for materials and the high cost of capital, all the ingredients are in place for renewables M&A to rebound in 2024. With interest — and capital — flowing in from a broader range of sources, the IRA can only help propel the consolidation, higher valuations, and increased competition that are the hallmarks of any evolving industry.

KeyBanc Capital Markets Utilities, Power & Renewable Energy group, is a leading financial advisor and lender in the North American marketplace. As one of the first investment banks to embrace renewable energy, we bring together deep experience in traditional investor-owned utilities and the renewable energy sector that is powering the future.

To learn more or to discuss more about energy M&A, reach out to:

Andy Redinger, Managing Director and Head of Utility, Power and Renewable Energy

See our recent renewable energy deals and visit www.key.com/advisor to explore our strengths and latest financial results.