HORIZONS

Boom time:

What the Inflation Reduction Act means for US renewables manufacturers

January 2023

Daniel Liu, Head of Asset Commercial Performance, Power and Renewables

High stakes for US equipment sales

Onshore wind: a fair wind is blowing for OEMs

We expect the US onshore wind manufacturing community to take full advantage of the AMPC. The credits will help original equipment manufacturers (OEMs) improve equipment sales margins in the short term and incentivise investment in manufacturing capacity. Demand for domestic equipment will see mothballed facilities re-established and manufacturing capacity expand to meet domestic demand.

Daniel Liu

Head of Asset Commercial Performance, Power and Renewables

Daniel is part of our Power and Renewables Assets team, where he leads product development and research into asset performance benchmarking, cost analysis and valuations. Besides coordinating LCOE activities, his particular focus is in operations strategy, cost benchmarking, digital technology and asset management. He joined Wood Mackenzie in 2018 after completing an MBA at London Business School, where he chaired the school’s Energy Conference in 2017. Daniel previously worked as an operations project manager overseeing key maintenance and upgrade campaigns, production improvements and data management for a fleet of 800 wind turbines in Europe and North America. He also has experience in renewables project financing, having worked on the buy-side for two boutique investment firms.

Join the debate. Get in touch with Daniel.

Without doubt, 2022 will be remembered as one of the most pivotal years in the history of power generation. It was the year that highlighted the folly of concentrated supply. In Europe, the war in Ukraine raised energy security issues caused by heavy reliance on Russian gas. Concurrently, China’s dominance of the solar and energy storage supply chains posed national security questions for energy policy planners. These concerns have spurred European and North American policy makers to reshape renewable energy industry supply chains to reduce dependence on imported equipment. On 16 August, the United States took its first and most significant steps to reshape the renewables supply chain, with President Biden’s signing of the Inflation Reduction Act. Two key provisions are likely to be game-changing for equipment manufacturers. First, the Act provides a tax credit, known as the advanced manufacturing production credits (AMPC), for US-made renewable equipment. Second, it incentivises developers of US renewable projects to purchase domestically produced equipment by providing an additional tax credit if they meet domestic content requirement (DCR) thresholds. To qualify, projects installed before 2025 must source 40% (20% for offshore wind) of all equipment in the US. This rises to 55% after 2026 (2027 for offshore wind). In addition, 100% of steel and iron construction materials must be manufactured in the United States. Taken together, this spells boom time for US renewables manufacturers. We assess the Act will greatly aid the expansion of US renewables equipment manufacturing capacity, though specific opportunities will vary from segment to segment.

We estimate that around 70% of all photovoltaic (PV) modules and 80% of lithium-ion cell manufacturing currently occur in China. In the wind market, China produces nearly 70% of all powertrains and 65% of castings. By comparison, US manufacturers met just 2% of global demand for PV modules, 7% of demand for battery cells and 0% of demand for powertrains and castings in 2021. The stakes are high. The Inflation Reduction Act provides incentives that cut the cost of solar, wind and storage equipment by anywhere from 20% to 60%. This improves the competitiveness of renewables in the US as a source of new generation. We expect the Act to boost annual investment in US renewables from US$64 billion in 2022 to nearly US$114 billion by 2031.

HORIZONS

Bio-liquid gold:

How biofuel circularity could unlock the energy transition

August 2022

Alan Gelder Vice President, Refining, Chemicals & Oil Markets Gerrit Venter Director, Corporate Analysis, Head of Corporate Research Operations Gordon McManus Research Director, EMEARC Oils & Refining Guy Bailey Head of Intermediates & Applications

Investment and new capacity additions for US renewables power generation by year

Source: Wood Mackenzie

Incentives encourage reopening of mothballed capacity The US has enough manufacturing capacity to supply most domestic demand for turbine equipment to 2031, though the industry faces a near-term shortage of US equipment. This creates an opportune pricing environment for manufacturers, as not all developers will be able to meet DCR thresholds. Major components, such as turbine nacelles and steel towers, enjoy relative cost parity with imports due to tariffs and logistics costs, minimising developer incentives for using imported equipment. Coupled with demand for locally made equipment, the AMPC gives OEMs the opportunity to recuperate diminishing profit margins. This situation does not hold for all equipment. Domestic blade manufacturers – hit by high labour costs – have moved production to facilities in Mexico to take advantage of a 20% decrease in manufacturing costs, mothballing the equivalent of 5.2 GW of US manufacturing capacity. These decommissioned facilities will need retooling to cater for the latest 4 MW-plus platforms now entering the US market. AMPC should help boost bottom lines and investment Developers can potentially meet pre-2025 DCR thresholds with domestic foundations, towers and balance-of-plant equipment. Turbine blades will help developers reach the 55% threshold after 2026. Much also depends on steel pricing; a big drop could reduce overall manufacturing costs globally and make it more difficult to meet DCR thresholds. Meeting DCR thresholds increases developer equipment costs by up to 8%. Bonus adders return 4% of equipment costs back to developers on a net present basis, bringing domestic equipment configurations to near parity with projects using imported equipment. Given the marginal cost difference, we expect developers to source domestic equipment where available, which will give OEMs the opportunity to retain most of the AMPCs they receive.

Onshore wind equipment costs as a percentage of US manufacturing

What the Inflation Reduction Act means for US renewables manufacturers

Ultimately, the decision to invest in equipment manufacturing capacity expansion depends on the interplay between the following factors:

The AMPC gives OEMs the opportunity to recuperate diminishing profit margins

Conclusion: Brace for the boom

Overall, we expect the AMPC and DCR to help spur investment in US renewables manufacturing – incentivising the reopening of shuttered facilities and potentially building entire equipment supply chains from scratch. Clear beneficiaries of the AMPC are onshore and offshore wind equipment manufacturers, which, for the most part, are already cost competitive with imported equipment. PV panel manufacturers face considerable challenges when it comes to developing a self-sufficient domestic manufacturing capability. US manufacturing costs are 16-33% higher than imported equipment, though the AMPC can help close this gap. That said, equipment-purchasing consortia are one way to de-risk investment in manufacturing capacity expansion. More consortia may be announced in future as developers search for ways to secure PV panel supply in a demand-constrained environment. Battery cell manufacturers can use the AMPC to help offset the costs of manufacturing capacity expansion as they strive to meet short-term domestic demand. Residual issues surrounding manufacturing costs and Chinese-centric materials supply need to be resolved. For manufacturers: The AMPC is a key way to recoup costs in an era of declining profit margins on equipment sales, something that wind OEMs, in particular, have faced. Strategic capacity expansion decisions will need to balance AMPCs received on equipment, forecast demand, manufacturing costs and the likelihood of domestic manufacturing qualifying for the AMPC. For developers: DCR bonuses provide an incentive to purchase domestically made equipment. Development considerations may dictate the choice between domestic products and imports. Domestic manufacturing expansion will need a few years before capacity can meet US equipment demand. Sourcing domestic equipment could result in project delays, as well as potentially higher development costs. For investors: Decisions to invest in domestic manufacturing need to take into account expectations as to build-out timelines. Manufacturing capacity expansion takes several years, and capital investment needs to be recovered by equipment sales. Whether demand for domestic equipment will continue after the AMPC expires in 2032 will depend entirely on how much manufacturers can reduce their cost base by then.

the cost of manufacturing equipment in the US compared with imports, taking into account the benefits the AMPC provides the expected supply/demand imbalance for renewables equipment.

• •

Key investability factors for renewables equipment manufacturing

Source: Wood Mackenzie

*Including mothballed facilities.

** Includes assembly in US facilities with imported powertrains.

***Cell annual demand includes EV and ESS demand.

Offshore wind: AMPC to fuel manufacturing capacity expansion

Logistics alone give US manufacturing sufficient cost advantages compared with imported equipment. We expect manufacturers to capture the full value of the AMPC given the limited capacity of US manufacturing, the natural cost advantages versus imports and the need to invest in domestic manufacturing capacity.

Starting from zero, but with huge growth potential Despite the nascency of US offshore wind manufacturing, the country is one of the most attractive markets for offshore wind suppliers due to its ambitious targets, lack of existing supply chain, focus on local content in tenders and large-scale players who are placing huge equipment order volumes. Equally important is the fact that global offshore wind supply-chain capacity needs to expand to meet explosive demand. Shipping-based logistics costs give domestic equipment production a key advantage. Difficult-to-transport components, such as monopiles and towers, carry a large overseas shipping premium. Add to that, US labour costs are lower than in Europe. These cost benefits are helping to encourage the development of dedicated offshore nacelle assembly hubs near major offshore wind projects. Consequently, significant orders for offshore wind equipment have been placed with domestic manufacturers, and more orders are in the pipeline. Over 4 GW of blade orders, 2 GW of offshore towers, 1.5 GW of monopole foundations and inter-array cables for nearly 8 GW of projects are slated to be delivered through to 2027. OEMs have room to raise US-made equipment prices Orders for monopile foundations, steel towers, cables and blades have spurred the development of domestic production capacity. Together, these components make up 58% of the overall equipment cost stack, exceeding the post-2027 installation DCR thresholds. Whether enough capacity will come online to supply all US developments slated to be installed by 2027 remains a key issue. Meeting DCR thresholds can increase developer equipment costs by up to 3%. Bonus adders return up to 7% of equipment costs to the developer on a net present value for a net gain of 4%. Forecast project capacity build-out currently outstrips existing order backlogs – up to six years for equipment order lead times, suggesting potential future equipment supply issues. In such an environment, we expect OEMS to use the AMPC to boost their underlying profit margins.

Offshore wind equipment costs as a percentage of US manufacturing

Note: Base case project utilizes 10MW turbines on monopile foundations Source: Wood Mackenzie. Includes manufacturer uplifts and import tariffs.

Shipping-based logistics costs give domestic equipment production a key advantage

Current domestic module capacity expansion plans will not be enough to supply all forecast US demand, while manufacturing capacity for critical panel components – namely, wafers and cells – will need to be rebuilt from scratch. US manufacturing costs for PV panels can be as much as 32% more expensive than their Southeast Asian counterparts. The outcome of the Department of Commerce anti-dumping and countervailing duties (AD/CVD) investigation could result in tariffs being reimposed on some importers, helping domestic manufacturing become more cost competitive.

Utility PV equipment costs as a percentage of US manufacturing

Note: Base case project utilizes 5MW turbines. “Nacelle Unit” includes power train and nacelle balance excluding blades Source: Wood Mackenzie. Includes manufacturer uplifts and import tariffs. Panel imports do not include potential AD/CVD tariffs.

Solar hangover from tariffs and high manufacturing costs Preliminary determinations of the Department of Commerce anti-circumvention investigation were released in November. It found manufacturers in four countries – Cambodia, Malaysia, Thailand and Vietnam – to be engaging in circumvention practices. Nearly 50 GW of module production capacity from these countries now needs to certify that it is not circumventing AD/CVD orders, or it will face higher duties and import delays. Module manufacturers from Southeast Asia enjoy significant labour-cost advantages over US manufacturing. These are largely offset by Section 201 and 301 tariffs on monofacial modules, reducing the cost advantages to 16% for utility-scale panels. Sourcing module components in the US would raise the overall cost stack of domestic panels by an additional 17%. If US manufacturers fully integrate manufacturing, the stacked value of AMPC credits is worth up to 29% of US manufacturing costs – potentially making equipment pricing competitive with Southeast Asian imports. Since the passage of the Inflation Reduction Act, a substantial number of manufacturers have announced plans to expand manufacturing capacity. Module expansion plans now total 45 GW of supply, but there is much less certainty about expansion of the supply chain into polysilicon production, wager/ingots, and cell manufacturing. While much uncertainty remains around expansion of the supply chain, it is very unlikely that expansion of the supply chain will be able to keep pace with growth in US renewable additions. Meeting DCR thresholds very unlikely without US panels Meeting DCR thresholds on a utility PV project could increase a developer’s total equipment costs by up to 27%. Depending on the equipment configuration, PV modules can account for up to 70% of equipment costs. This makes it difficult for developers to meet the pre-2025 installation DCR threshold without domestic modules, and almost certainly requires their use after 2026. DCR bonus adders return up to 5% of equipment costs to developers on a net present basis – far less than the equipment cost premium developers will face in order to meet the thresholds. However, developers also struggle with higher panel costs and delivery delays caused by Uyghur Forced Labor Prevention Act (UFLPA)-related withhold release orders. Solar buyer consortia, such as the AES consortium, act as a means of securing supply and circumventing these issues. Longer term, should global supply chains resolve, US panel manufacturers may need to share some of the AMPC value with developers to boost module sales.

A substantial number of manufacturers have announced plans to expand manufacturing capacity

Utility solar PV: a somewhat foggier outlook

Demand for battery cells for storage projects and electric vehicles (EVs) will encourage manufacturing capacity growth in the US and create a favourable environment for investment in the short term. Potential supply issues persist with regard to battery materials, given the Chinese-centric supply of cathodes and anodes.

FTM ESS equipment costs as a percentage of US manufacturing

Source: Wood Mackenzie. Includes manufacturer uplifts and import tariffs.

Front of meter (FTM) battery storage: exploding demand

Critical component supply controlled by Chinese manufacturers Materials and labour costs are the two primary barriers to the US localisation of battery cell production. The localisation of cathode and anode precursors would help offset logistics costs, but sourcing materials from non-Chinese markets could be difficult, as China controls 92% and 79% of global cathode and anode precursor supply, respectively. The AMPC provides an avenue for US cells to become cost competitive with Chinese imports – but only if existing Section 301 tariffs are maintained. Over time, economies of scale and technological improvements offer domestic manufacturers alternative ways to reduce costs, but stringent environmental sustainability requirements will offset this to some extent. Currently, US manufacturing capacity can only meet a fifth of expected annual combined EV/energy storage system (ESS) battery cell demand through to 2031. Capacity is primarily geared towards serving EV-specific demand, which adds to equipment shortage issues for ESS projects. DCR thresholds may be achievable without US battery modules Meeting DCR thresholds could increase a developer’s equipment costs by up to 13%, with most of the increase coming from domestic battery modules. Imported battery modules accounted for 44% of 2022 energy storage equipment costs, with prices expected to peak at US $147/kWh in 2023. Towards the latter half of this decade, module prices will decline by 33%, we estimate, and potentially allow developers to meet DCR thresholds without using domestic battery modules. Bonus adders return up to 8% of equipment costs to developers on a net present basis, when also factoring in depreciation and tax benefits. Including the aggregate value of the AMPCs, this gives utility-scale energy storage developers headroom of up to 12% on equipment pricing before meeting DCR thresholds becomes uneconomical.

Materials and labour costs are the two primary barriers to the US localisation of battery cell production

Key remaining uncertainties: implementation of the new law and the international response

Despite the Act’s potential to be a major driver for US manufacturing capacity expansion, the industry’s path forward is not so clear-cut. Additional factors that will have a significant impact on US renewables capacity expansion include:

Ongoing negotiations between the European Union (EU) and the US over perceived trade barriers created by the Act. EU leaders believe the Act violates World Trade Organization rules, but negotiations are underway to prevent a trans-Atlantic trade dispute. Whether manufacturers can reduce their cost base to competitive levels before the AMPC expires in 2032. The response from overseas manufacturers, who will strive to protect their existing cost advantages. Internal Revenue Service (IRS) and Treasury Department interpretation of the key provisions of the Act.

• • • •

IRS guidance will significantly impact the ability of developers and manufacturers to access DCR bonus adders and the AMPC. Investment decisions to expand domestic manufacturing capacity will be influenced by IRS determination on the following questions:

How much of the manufacturing process must be conducted in the US? How will imported subcomponents used in domestically assembled equipment be treated? How much of steel and iron manufacturing processes need to be conducted in the US?

1. 2. 3.

Global law firm Norton Rose Fulbright’s interpretation of manufacturing processes is: “altering the form or function of the components by ‘adding value and transforming’ the components into a new product functionally different from that which would result from mere assembly.” The Inflation Reduction Act provides that the regulations under the “Buy America Act” apply to steel and iron construction materials. Under these regulations, all manufacturing processes except the refining of steel additives must take place in the US. If enforced, meeting this requirement will undoubtedly raise the cost of turbine towers, monopile foundations, PV racking and battery enclosures.

Get this insight as a PDF

December 2022 Silver linings playbook: Five reasons to be cheerful November 2022 Avoiding pand-ammonia: How to kick-start a global low-carbon ammonia industry October 2022 Red metal, green demand: Copper’s critical role in achieving net zero September 2022 Pedal to the metal: Iron and steel's US$1.4 trillion shot at decarbonisation

Missed our previous editions of Horizons?

Ultimately, the decision to invest in equipment manufacturing capacity expansion depends on the interplay between the following factors:

Key investability factors for renewables equipment manufacturing

Source: Wood Mackenzie

Note: Base case project utilizes 5MW turbines. “Nacelle Unit” includes power train and nacelle balance excluding blades. Source: Wood Mackenzie. Includes manufacturer uplifts and import tariffs.

Onshore wind equipment costs as a percentage of US manufacturing

Note: Base case project utilizes 5MW turbines. “Nacelle Unit” includes power train and nacelle balance excluding blades. Source: Wood Mackenzie. Includes manufacturer uplifts and import tariffs.

Starting from zero, but with huge growth potential Despite the nascency of US offshore wind manufacturing, the country is one of the most attractive markets for offshore wind suppliers due to its ambitious targets, lack of existing supply chain, focus on local content in tenders and consolidated client base. Equally important is the fact that global offshore wind supply-chain capacity needs to expand to meet explosive demand. Shipping-based logistics costs give domestic equipment production a key advantage. Difficult-to-transport components, such as monopiles and towers, carry a large overseas shipping premium. Add to that, US labour costs are lower than in Europe. These cost benefits are helping to encourage the development of dedicated offshore nacelle assembly hubs near major offshore wind projects. Consequently, significant orders for offshore wind equipment have been placed with domestic manufacturers, and more orders are in the pipeline. Over 4 GW of blade orders, 2 GW of offshore towers, 1.5 GW of monopole foundations and inter-array cables for nearly 8 GW of projects are slated to be delivered through to 2027. OEMs have room to raise US-made equipment prices Orders for monopile foundations, steel towers, cables and blades have spurred the development of domestic production capacity. Together, these components make up 58% of the overall equipment cost stack, exceeding the post-2027 installation DCR thresholds. Whether enough capacity will come online to supply all US developments slated to be installed by 2027 remains a key issue. Meeting DCR thresholds can increase developer equipment costs by up to 3%. Bonus adders return up to 7% of equipment costs to the developer on a net present value for a net gain of 4%. Forecast project capacity build-out currently outstrips existing order backlogs – up to six years for equipment order lead times, suggesting potential future equipment supply issues. In such an environment, we expect OEMS to use the AMPC to boost their underlying profit margins.

Get this insight as a PDF

November 2022 Avoiding pand-ammonia: How to kick-start a global low-carbon ammonia industry October 2022 Red metal, green demand: Copper’s critical role in achieving net zero September 2022 Pedal to the metal: Iron and steel's US$1.4 trillion shot at decarbonisation August 2022 Bio-liquid gold: How biofuel circularity could unlock the energy transition

Missed our previous editions of Horizons?

Daniel Liu

Head of Asset Commercial Performance, Power and Renewables

Join the debate. Get in touch with Daniel.