Breaking Down the Inflation Reduction Act with Chris Ito, CEO of FFI Solutions

The transition away from fossil fuels to a low-carbon economy is a consistent focus among sustainable and responsible investors. The recently passed Inflation Reduction Act promises to meaningfully affect that energy transition, so the CEO of FFI, Chris Ito, joins the podcast to discuss the provisions of the legislation and their implications for capital markets.

Transcript:

This transcript has been edited for clarity.

Dan Carreno, Ethos ESG

Welcome to The Ethos ESG Podcast where we break down the latest developments in the world of sustainable and responsible investing. I'm your host, Dan Carreno and our guest today is the CEO of FFI, Chris ITO. Chris has over 30 years of experience in financial services and portfolio management has been a veteran in the world of hedge funds and energy transition investing. I thought Chris would be the perfect person to have on to talk about the new Inflation Reduction Act, which of course is geared towards accelerating the energy transition. So, Chris, thank you very much for being on today, and how's it going?

Chris Ito, FFI

Thanks Dan. I appreciate you having me on.

Dan Carreno, Ethos ESG

I tried to provide a bit of background on your experience, but before we start talking about the Inflation Reduction Act, what it means in terms of impact on carbon emissions, climate change, and capital markets, I want to give you the floor for a little bit longer to talk about your background.

Chris Ito, FFI

I would describe the evolution of my investing career as something that really started off focused on investments through a risk management lens then shifting toward investing strategies and looking at things through the lens of an allocator to managers. And now with FFI, I'm focused on themes related to the energy transition, specifically renewables and fossil fuels. I started my professional career as a capital markets consultant at Deloitte, helping corporates and asset management clients model and use derivative strategies to manage some of the big risks that they were facing around currencies and commodity prices. At Deloitte, I started an investment advisory business that was dedicated to helping pensions manage assets according to their funded status, rather than just simply looking at the portfolio in isolation from a risk-return perspective, what today is known as liability driven investing. Then, in the next phase of my career, I got deeper into the manager selection. I spent about five years allocating to managers at one of the largest fund of hedge funds in the world. This was when the concept of sustainable investing was really nascent and just starting to emerge. I remember that we did a little bit of due diligence on managers that were starting to invest in more climate-friendly strategies. Then the financial crisis hit and left me a little bit disillusioned with the whole hedge fund industry, and I started to really get interested in the topic of climate change. So, the opportunity with FFI came up where the mission is to help accelerate the transition to a low carbon economy. At FFI, were known for research that we do on fossil fuel companies that is packaged into an exclusion list that that's called the Carbon Underground 200. This is a list that investors use to create fossil free investment strategies. Then, we thought that a natural extension of strategies like fossil fuel divestment would be to short certain fossil fuel companies that we thought were most exposed to the energy transition. On the flip side of the shorts, the thesis was that clean energy was going to replace fossil fuels. We ended up partnering with a research and index firm called Clean Edge. I want to give a shout out to my friend, Ron Pernick, who is the founder of Clean Edge. They helped us develop the strategy that was eventually long clean energy and short fossil fuels.

Dan Carreno, Ethos ESG

I thought maybe what I would do is provide a little bit of context about what is in the Inflation Reduction Act and then turn it over to you to get your perspective. What policymakers have done here is largely favored incentives and subsidies in lieu of carbon taxes, cap and trade schemes. It's discarding the sticks in favor of the carrots. Overall, the design is to scale the production of climate solutions like renewable energy, and at the same time, stimulate demand for those products and services. That means is things like $30 billion in subsidies for solar, wind and battery manufacturing. Over $20 billion in loans to automakers to scale the production of electric vehicles. There's $27billion in the legislation for a cleantech accelerator to develop the climate solutions of tomorrow. On the demand side, we have $30 billion in grants and loans for states and utilities to adopt renewable energy. There's $9 billion in rebate programs to electrify homes, both heating, and also improve energy efficiency. There's the electric vehicle tax credits, $7,500 for new electric vehicles and $4,000 for used cars. Of course, there are restrictions that will be applied to those. Hopefully, this gives our listeners a sense of the different carrots that are being dangled out there to scale production side and stimulate demand. So, with all of that background, let me turn it over to you, Chris. Based on your experience researching both sides of that energy trade, how do you think this changes the trajectory of your long-term investment thesis?

Chris Ito, FFI

Overall, fossil fuels are going to have to stay in the ground. And I think the act is going to help with that. And you alluded to this by making renewables increasingly cheaper and easier to deploy for both electrification and for transportation. Our view is that it's going to have a really big impact. I think this is going to impact demand in a really big way by making clean energy and electrified transportation cheaper. I think about the act as having like three big goals. One is to decrease emissions. Two is to make climate change less impactful on people. And then the last thing is to make the US a center for manufacturing while creating good jobs. Its going to incentivize power producers to adopt renewables. If you're thinking about renewables from a geographic standpoint, perhaps some of those allocations that were going to be made in China, perhaps those are going to be rethought in the future. There could be a geographical shift of capital from China to the US in terms of clean sector manufacturing. And there's this also this notion of some of the dollars to keep nuclear open. If you meet certain wage and apprenticeship requirements, there will be funds available for nuclear. What that means from an investment standpoint, we've not necessarily focused on. So, it's a little hard for us to comment specifically on that, but that that's also a consideration. And certainly, the EV tax credits will be impactful for the fact that they are going to extend for 10years. But maybe many of the cars that are on the market today might not be eligible. So, we're going to see how that ultimately plays out. All that said, it is going to drive up demand for renewables, make them more competitive and far superior from an economic standpoint. As it relates to fossil fuels, you're going to see demand ultimately peak, ultimately fall and perhaps fall in a way that's faster than I think a lot of investment practitioners are thinking right now. So, while the law doesn't impose carbon taxes, it will clearly impact fossil fuel companies in a similar way by making clean energy cheaper. But I think the Act could have another impact on the industry. A lot of integrated oil and gas companies have advanced over the last few years in terms of making commitments around net zero and taking some action to transition their businesses to a low carbon economy. I think that the law might even further incentivize some of those oil and gas companies to allocate capex to energy transition strategies. So, I think that investors will take a more nuanced look at companies in that sector, rather than sort of painting it with a broad brush.

Dan Carreno, Ethos ESG

I think one of the most critical parts of this legislation from a capital market standpoint is the duration of the incentives. We've had things before like the Investment Tax Credit and the EV purchase incentives, but those things have always been written into law with shorter runways. There was always uncertainty as to whether or not Congress would renew those programs. Now, there's a decade of clarity. I completely agree with you that even some of the traditional fossil fuel players might choose to start allocating capital towards energy transition strategies in a way that they haven't before. Now, they have more clarity about the way the world is moving. So, Chris, if I could pose another question: I wonder how much does this change your existing thesis? I looked up some numbers from Federal Energy Regulatory Commission, and in the first half of 2022, 67% of all the new electricity electric generating capacity in the United States has been renewables. They are already winning regardless of this law going into effect. So how much does this change the trajectory that we're already on?

Chris Ito, FFI

I don't think it necessarily changes the overall direction. I think it increases the slope of the line. There are also a lot of things that are in the Act that I look at as enablers. Transmission is an example. I think there are about $2 billion in loan guarantees to help build new transmission lines. Proponents of clean energy will say is that it is the cheapest form of energy on a levelized cost basis, but there are still challenges with getting renewables deployed at the scale. The Act also addresses all of those little things.

Dan Carreno, Ethos ESG

I agree. It's really accelerating the energy transition in a meaningful way.

Chris Ito, FFI

And that's just new generating capacity. We also have to think about existing capacity.

Dan Carreno, Ethos ESG

That's a great point. Energy producers might say it's going to be cheaper for us to build brand new wind and solar than it is to operate an existing fossil fuel fired plant. And that's a significant change in the marketplace if we really get to that tipping point.

Chris Ito, FFI

That's where the area of transmission, which typically gets overlooked, is going to be critical.

Dan Carreno, Ethos ESG

Last question for you, Chris. Since the beginning of 2021, the fossil fuel industry has been surging. What would your response be to people that say fossil fuels have been good investments for the last 18 months and that trend may continue?

Chris Ito, FFI

I don't know that this recent resurgence has changed my perspective on the trajectory. We always knew that the energy transition was going to be volatile. There are going to be ebbs and flows, stops and starts. It's complicated. You have an intersection of policies, economics, and geopolitical instability. Things get hard to predict over short periods of time. The resurgence was one of those things. Fossil fuels benefited from both the pandemic and the war in Ukraine, which caused prices to rise and the stock prices of those companies to rise. But I don't think anything has ultimately changed. Our view is really pretty simple. Science tells us that we have this thing called the carbon budget, which means there's a limited amount of carbon that we can put into the atmosphere. I have to give a shout out to our friends at Carbon Tracker who coined the phrase carbon budget. We have these reserves that are in the ground that simply can't be extracted and burned. It tells us that this is a risk from a societal perspective that we have to manage. Ultimately, we'll have demand destruction for fossil fuels and that the transition is going to occur faster than a lot of people are expecting. And I think this Act is going to help to accelerate that.

Dan Carreno, Ethos ESG

Excellent. The last thing that we have to mention is that the third-party analyses of the Inflation Reduction Act from a climate perspective have been pretty encouraging. Look at the reporting from the Rhodium Group and from The Repeat Project where the consensus looks to be that this is going to reduce carbon emissions from the United States by about 40% compared to 2005 levels by the end of the decade. That puts us about 75% of the way to meeting our commitments to the Paris Climate Accord. So, it's pretty encouraging.

Chris Ito, FFI

I agree. Those groups have done an amazing job at really studying the legislation and projecting and modelling the impacts. There are uncertainties, but their work should be commended.

Dan Carreno, Ethos ESG

Chris, thank you for coming on the podcast today and for sharing your perspectives and your insights. I do want to remind our listeners that if you have any questions or feedback for us, you can always reach us through our website, www.ethosesg.com, or you can email us directly at support@ethosesg.com. Thank you again for tuning in today, and we will be back soon with another episode of The Ethos ESG Podcast.

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