A margin of safety

"The purpose of the margin of safety is to render the forecast unnecessary." - Ben Graham

Arguably one of the most important pieces of climate legislation over the past twelve months is the Inflation Reduction Act (IRA). Signed into law in mid-August 2022, the IRA includes almost $370 billion that should (among many of its aims) accelerate the decarbonisation of America’s power generation sector. Understandably, investors are keen to understand the potential impact on the power generation mix, and crucially given state level compliance markets (i.e., California, RGGI and Washington State), what it might mean for future emissions (see The only number that matters).

The key takeaway from comparing two recent reports that analyse the impact of the policy on US power sector emissions is the importance of growing long-distance transmission capacity - additional capacity enables access to more remote, but high-quality renewable resources.

But there are two broader lessons that we can learn simply by delving into the history of power generation emission forecasts. The first is that climate and energy policy rarely stands still, and even though you can guess at what it means for power generation right now, an evolving regulatory framework in the future can accelerate change, especially when it incentivises the adoption of new technologies. Secondly, as the risk of not achieving the Paris Agreement goal of limiting global warming to 1.5° looms larger, investors should consider how governments might begin to assign a margin of safety.