While the Inflation Reduction Act (IRA) has already successfully catalyzed investment in our domestic energy sector and supply chain, there is still more that it can do. As we have written, complementary policies addressing price volatility and supply chain vulnerability will need to be supported, in addition to permitting reform and other policies that unlock the full potential of the enacted legislation.
We are therefore especially pleased to see the Treasury Department make the right decision by including raw material costs in the 45X Advanced Manufacturing Tax Credit. The Treasury’s initially proposed rule took too narrow a view of the relevant production costs involved in producing components that rely on critical mineral inputs. Their final rule takes a more holistic view of the coordination problems and costs associated with standing up and onshoring strategic supply chains, including the capacity to extract, process, and utilize critical minerals.
Disclaimer: Employ America originally submitted a version of this piece as a comment to the Department of Treasury’s proposed rule for the 45X Advanced Manufacturing Tax Credit.
Introduction
In the aftermath of the pandemic, the United States has sought to reestablish its domestic industrial base. The COVID-19 pandemic exposed longstanding vulnerabilities in domestic supply chains. In response, the federal government intervened to stabilize markets and secure critical materials throughout the value chain. Over the past three years, this fiscal policy effort has advanced the United States’ competitiveness by supporting critical industries and promoting the domestic manufacturing of key commodities for the energy transition.
In the face of China’s dominance over clean energy technologies, policies like the IRA are essential to promote the onshoring of competitive and resilient clean energy supply chains. As the single largest investment in federal climate and clean energy programs, the passage of the IRA was a historic achievement. The legislation has sought to grow the nation’s industrial capacity in strategic sectors by crowding in private investment, ultimately adding to both job creation and economic growth.
The 45X Advanced Manufacturing Production Tax Credit is a key component of the IRA aimed to push domestic investment to secure supply chains. The 45X tax credit subsidizes the domestic production of specific eligible components that are vital for the energy transition. These include critical minerals, battery components, and other essential materials needed for wind and solar energy projects.
At the anniversary of the IRA, President Biden stated, “For years, China has dominated the clean energy supply chains–we let the American jobs and factories go overseas… Not anymore. We are building it here and sending the product over there.” The 45X tax credit certainly has the potential to bolster domestic manufacturing capabilities and accelerate the country’s decarbonization efforts on the path to net zero, so the specific implementation of the credit must promote the goals outlined by the White House.
Treasury’s proposed regulations governing the 45X tax credit originally limited the tax credit’s ability to onshore manufacturing efforts for the full value chain of critical minerals. The proposed regulations excluded indirect and direct material costs for eligible components as a safeguard to prevent production costs from being counted multiple times. However, Treasury has rectified its original proposal by including extraction, indirect, and direct material costs in the final rule.
Understanding the Critical Minerals Market
The critical minerals market is unique relative to other commodities and very new. For this reason, many markets for critical minerals are immature and shallow, with low market volume, fewer market participants, limited financial instruments, restricted supply, and limited production. In 2022, IEA estimated that the global critical minerals market was worth $320 billion, only 16% of the crude oil market, which hit more than $2 trillion in 2022. Mechanisms like the 45X tax credit could help provide financial incentives for producers to invest in increased production capacity for domestic critical minerals and help increase the United States' total market share of critical minerals. Currently, China dominates the market with 60% of the world’s rare earth mining and roughly 90% of the world’s processing and refining capacity.
Several factors constrain the United States’ ability to reduce its reliance on China for these critical minerals. For commodities like critical minerals, prices are set at the margin, which can imply high price volatility when supply-demand balances are vulnerable to shocks. High volatility can lead to particularly uncertain returns on investment, but this challenge then leaves producers reluctant to invest heavily enough to bring more capacity online.
This unpredictability would not be so bad if the coordination costs required were not so large, or so else so vulnerable to hyper-cyclicality. Developing new processing and refining facilities can often cost hundreds of millions or even billions of dollars. Given how volatile prices for these minerals have been, these investments are especially uncertain and risky. This problem also impacts the availability of financing, as banks and other financial institutions are often hesitant to provide funding given the perceived risk and long return timelines. Furthermore, without mature financial markets associated with their products, critical mineral producers are uniquely unable to hedge risks associated with price volatility. What we face in this sector is a ‘Which came first, the chicken or the egg?’ coordination failure. The viability of forming one key asset is mutually dependent on the viability and future presence of other key assets.
In light of all these challenges, critical mineral production could be forced into a state of underinvestment for the sake of maximizing risk-adjusted returns and profitability. By including the raw materials with other production costs, Treasury’s final rule helps boost the power of the IRA to relieve this situation.
Why Including Material Costs Was the Right Choice
In the law, the 45X tax credit for critical minerals is calculated as a percentage of the production costs, a substantial portion of which are raw materials. Specifically, the 45X tax credit subsidizes 10% of the production cost of eligible critical minerals. In the Treasury's proposed regulations, production costs excluded direct and indirect material costs related to the extraction of raw materials but included all direct and indirect costs related to labor, employee benefits, storage, insurance, cost recovery, and other service and overhead costs. However, now that the final regulations include material costs, the credit can unlock more savings for producers by expanding the scope of eligible production costs.
Let’s look at what this means through some examples. A lithium refiner purchasing hardrock to process into purified lithium hydroxide–an eligible critical mineral product–is now allowed to include the cost of the spodumene in its production costs. This is economically significant and could improve project viability for many producers. Albemarle, a leading lithium producer, noted that outside of the processing activities, direct and indirect material costs could determine around 70% or more of the price at which the mineral is sold.
As SAFE illustrated in their comment,
“The value of the eight tons of spodumene rock needed to make one ton of lithium carbonate was between $25,000 and $32,000 in summer 2022. The processing of spodumene, for example, to produce lithium carbonate costs about $3,000 per ton of lithium carbonate. This demonstrates that the primary cost of an applicable critical mineral is often the cost of the material input and not the cost of processing. If the cost of extraction is excluded from the production cost of the applicable critical mineral, the value of the tax credit is substantially reduced – in this example by perhaps 90 percent. Today, under different market dynamics, the material costs constitute upwards of 70 percent of the price of lithium hydroxide.”
Given substantial price volatility for raw materials and finished goods, producers are unintentionally forced to make directional bets on the future movements of commodity prices. A tax credit that helps producers purchase raw materials is beneficial because it can offset some of the financial risks associated with volatile commodity markets. In totality, including raw materials ensures that the 45X tax credit appropriately supports the full value chain of critical minerals production and the standing up of complete and resilient supply chains.
Conclusion
Treasury has now made sure that the final rule also captures the spirit of the IRA and the relevant economic realities of the critical mineral value chain. The 45X tax credit is designed to spur domestic manufacturing and innovation and is pivotal in mitigating national security concerns by reducing reliance on foreign supply chains for critical minerals. Now that Treasury’s final regulations include the costs of direct and indirect materials along with the extraction of raw materials from domestic sources, the 45X tax credit incentivizes the onshoring of mining, processing, and refining. Treasury’s final rule puts the United States closer to stabilizing our critical mineral supply chain while increasing our competitive edge against China.
