Does the IRA allow the United States to steal the spotlight from the European Green Deal?
By Stanislas Duval de la Guierce, sustainable finance referent
Since the conclusion of the Paris Agreements, the European Union’s aspirations have centered on breaking away from fossil fuel overconsumption and transitioning towards “clean energy”, thereby positioning the region advantageously to take global leadership on this issue. This was without taking China into account, which has accounted for a significant share of global investments in recent years. In 2021, they account for 37%1 of global spending on the energy transition, compared to 19% for the European Union and 15% for the United States. The latter, thanks to the Inflation Reduction Act (IRA), are now serious contenders for second spot on the podium.
The American-style energy transition is underway, not without tension and compromise, while the Green Deal for Europe remains more scattered in its implementation. Both programs, though initiated, are still in the development phase and subject to constant evolution.
What is the IRA?
The ambitious climate plan, signed into law by the Democrats on August 16, 2022, aims to achieve, over a ten-year period, an increase in the share of green energy, a reduction in costs in the healthcare sector and an increase in income taxes, all within the framework of a protectionist approach. This plan is one of three major pieces of legislation developed since 2021 to improve the U.S. economy, with substantial expenditures2 :
· IRA: climate & green energy financing ($392bn) and healthcare ($108bn) ;
· Bipartisan Infrastructure Law (BIL): transport ($284bn) and infrastructure ($266bn) ;
· CHIPS & Science Act: semiconductors and R&D ($278 bn).
Congressional Budget Office (CBO) estimates IRA spending at $500bn3 over the next decade. Of this amount, $392 billion will be dedicated to stimulating climate-impacting sectors such as energy, industry, transport, agriculture and water management. The remaining spending ($108 billion) will support healthcare reform, including an extension of the Affordable Care Act (better known as “Obamacare”) and an overhaul of Medicare (health insurance for people over 65 or meeting certain criteria).
Investments in sustainable development will mainly be carried out through tax credits (55% for businesses and 11% for individuals), while federal grants, loans and subsidies will cover the remainder.
The IRA forecasts several sources of revenue totaling $737 billion, including :
· Prescription drug reform to reduce prices and costs for government and consumers
· Tax reform to raise taxes on corporations (minimum 15%), high incomes and capital gains
· Introduction of a 1% tax on share buybacks ;
· Expansion and modernization of the Internal Revenue Service (IRS)
According to CBO estimates, between spending and revenues, the IRA should reduce the US public deficit by $237 billion by 2031.
Although signed in August 2022, many aspects of the plan are currently being defined, particularly with regard to the eligibility of tax credits4 including protectionist measures. The plan’s assumed dimension could penalize European industry, raising concerns among French and European players about a possible downgrading in areas linked to climate change. A significant example is the funding allocated to electric vehicles, where the administrative and protectionist conditions are convincing.
An individual can benefit from a tax credit of up to $7,5005 for the purchase of an electric vehicle. Of this amount, $3,750 is granted if the vehicle contains critical minerals mined or processed (up to a certain limit) in the USA or a country with a free trade agreement. The remaining $3,750 is available if the vehicle’s battery components are assembled in North America (USA, Canada and Mexico). Japan is the latest country to sign a free trade agreement for critical minerals, while the European Union is currently negotiating.
Credits linked to electricity generation or clean hydrogen have not yet been defined, making certain IRA impacts difficult to estimate.
The European response?
At the end of 2019, the European executive presented the Green Deal as “the new growth strategy”6 of the European Union, aiming to reduce greenhouse gas emissions “while creating jobs and improving our quality of life” over a 10-year period. The IRA has disrupted European schedules. Fearing a migration of talents and companies to the United States, the EU wants to speed up its initiatives. This apprehension is justified, as evidenced by a DIHK survey showing that 10% of German companies7 would consider relocating part of their production to the USA to benefit from the IRA.
It is worth noting that the protectionist aspect of the IRA is at odds with the free trade agreement principles of the World Trade Organization (WTO). However, a European complaint along these lines is unlikely to succeed. At present, Europe is focusing more on free-trade negotiations with the United States.
Europe’s response is called the “Green Deal Industrial Plan”, and rests on four pillars: a predictable and simplified regulatory environment, faster access to finance, enhancing skills, and opening up trade for resilient supply chains. Three initiatives revolve around this plan:
1. Net-Zero Industry Act
2. Critical Raw Materials Act
3. Reform of electricity market design
Unlike the Americans, the budget for this plan comes from mainly public funds already deployed in various mechanisms such as:
· InvestEU: a program to mobilize €370 billion of public and private investment between now and 2027 in strategic projects for the EU, particularly in the fields of green and digital transition, research and innovation, infrastructure, SMEs and social affairs.
· REPowerEU: an initiative aimed at accelerating the deployment of renewable energies in the EU, by facilitating access to financing, simplifying administrative procedures, strengthening cross-border cooperation and supporting the participation of citizens and local communities. The EU aims to mobilize €300 billion, in particular through the InvestEU program.
· Innovation Fund: a fund (€40 billion between 2020 and 2030) to finance innovative projects in carbon-intensive sectors such as industry, energy, transport and carbon capture, use and storage. It is fed by the European Union Emissions Trading Scheme (EU ETS).
· Individual country financing via their own funds, as in Germany with the special Climate and Transformation Fund (KTF) or in Italy with the National Recovery and Resilience Plan (NRRP).
The total budget is difficult to estimate, making it arduous to compare with the IRA. What’s more, access to funding is tricky, with onerous eligibility criteria that do not guarantee funding, as some are controlled by member countries and not by the European Union directly.
Despite it’s free trade approach, the Green Deal includes a protectionist measure. In addition to the “Green Deal Industrial Plan”, the “Fit for 55” package comprises 12 legislative proposals8 aimed at reducing greenhouse gas emissions by at least 55% by 2030 compared with 1990 levels. Among these, the Carbon Border Adjustment Mechanism (CBAM) aims to prevent multinationals based on the Old Continent from being tempted to relocate their activities to pollute ” freely ” elsewhere. This mechanism is linked to the European carbon market.
Moreover, the carbon market is not exclusive to Europe, since China has also launched its own in 2021, unlike the United States, which does not have one.
Positive impacts?
The green energy financing battle between the IRA and the European Green Deal is a major challenge for the energy transition and the fight against climate change. In particular, this battle will help develop the technology and make it more affordable. Consequently, stimulating competitiveness and innovation will generate promising environmental, social and economic benefits.
The first categories of companies benefiting from the IRA include electric car producers such as Tesla, Ford and General Motors, as well as renewable energy producers like NextEra Energy. For the latter, developments in smart grids (Siemens, Schneider Electric, Eaton, Enphase) will be essential. Many products require often rare minerals such as lithium, mined by companies such as Lithium Americas Corp, Albemarle, or Freeport-McMoRan. It is essential to note that, for the moment, the United States mines lithium, cobalt and nickel, but not yet graphite or manganese, which could benefit niche players in Canada (Nouveau Monde Graphite), even as China may limit its rare metals exports9.
Some oil and oil-related companies are also looking to step up their research efforts in carbon capture (e.g. Schlumberger) in connection with IRA-related tax credits. However, this technology remains costly, uncertain and controversial. Chevron, for example, has not announced a new project since 2019, while BlackRock announced in November that it was investing in an Occidental Petroleum carbon capture project10.
To conclude on the beneficiaries of the IRA, it’s surprising that Republican states seem to benefit more than Democrats, even though no Republican voted in favor when it passed the House of Representatives. According to the White House, it is estimated that “red” states could attract $337 billion in renewable energy investment over ten years, compared with $183 billion for “blue” states.
In the case of the European Green Deal, it is more difficult to generalize about the beneficiaries, since funding is provided via calls for tender and according to eligibility criteria that are still vague. Therefore, only certain companies will be able to obtain the Holy Grail. Recently, as part of REPowerEU, the EIB (European Investment Bank) and Denmark’s Ørsted signed a €400 million loan11 for offshore wind farms. EIB financing for the transition had already begun in 2021, such as the signing of 3 loans totaling €732m to Galp Energia12 promoting climate action and social cohesion. Even small-cap family businesses like Solaria are benefiting from European funding, with €1.7 billion from the InvestEU programme13.
As part of this resolutely “green” approach, the European Commission initiated a new €4 billion tender in November for hydrogen development, with €1.4 billion specifically earmarked for the creation of environmentally-friendly technologies. At the same time, the Commission will organize the first-ever EU-wide auction dedicated to renewable hydrogen production, with a budget of €800 million from the Innovation Fund14.
Finally, the reform of the European electricity market will benefit companies investing in low-carbon technologies, including nuclear, such as EDF, Engie, Iberdrola and others.
Negative impacts?
As the benefits of the IRA are more readily available, combined with protectionist measures, it is the European Union that finds itself at a disadvantage. There is a risk that private projects in Europe will be abandoned in favor of the USA, particularly in regions such as Texas, California and the Midwest. For example, in March 2023, Volkswagen reports15 to wait for the EU’s response to the IRA before choosing a location for its future battery plant, initially planned for Europe.
Within the IRA, healthcare reform will have an impact above all on the pharmaceutical companies with the strongest presence in the US. Companies such as AstraZeneca, Bristol-Myers, Gilead and Novo Nordisk are likely to be the most exposed to changes16.
As far as the 15% minimum tax is concerned, the US Congress estimates that 150 out of the 470 groups meeting the criteria will be affected. To conclude on the IRA, methane emitters such as Hilcorp, Exxon Mobil and ConocoPhillips will be hit by additional taxes.
The players impacted by the European Green Deal are those linked to carbon mechanisms, in particular sectors integrating the ETS, such as shipping, as well as those concerned by a future secondary carbon market (fuel, road transport), distinct from the current one.
In addition, the Carbon Border Adjustment Mechanism (CBAM) will apply, for example, to companies importing steel or aluminum from China. These companies will have to pay CBAM certificates corresponding to the difference between the Chinese and European carbon prices. Nitrogen fertilizer, cement, hydrogen and electricity are also affected.
The reform of the electricity market will have an impact on suppliers using fossil fuels, such as the coal-fired power plants owned by German utility RWE.
Review or reconsider the plans?
Both programs have been officially launched, but their impact could be subject to various geopolitical and future events. In 2024, more than 20 countries around the world will be holding elections, and the rise of populism is likely to put the brakes on efforts already underway.
The European Union is currently facing a rising tide of populism, which means fewer votes in favor of the Green Deal17. A recent example of this trend is illustrated by the case of Frans Timmermans, the European Commissioner in charge of the Green Deal, who was defeated in the Dutch presidential elections by the far-right climate sceptic leader18 Geert Wilders.
The upcoming US elections, scheduled for November 2024, raise the question of a possible new confrontation between Trump and Biden. The electric car is in the former president’s sights, and he pledges to cancel out his successor’s efforts to promote it, if he returns to power. Donald Trump’s teams announce preparations to minimize IRA influence19. However, repealing the IRA will require Congressional approval. However, the popularity of this law among manufacturers is likely to make it difficult to overturn, even within the Republican clan, particularly in view of the protectionist criteria and future investments in “Red states”. China’s influence in this context should not be underestimated, as the USA and Europe depend on this country for supplies of rare and critical metals.
Conclusion
The Americans favor tax credits and protectionist mechanisms, while the Europeans adopt a free- trade approach with loans and taxes. Clearly, companies prefer the American model because of its superior guarantees and 10-year stability. This provides greater visibility for industrial companies with long cycles.
The options available to Europeans remain limited to counter American initiatives and face Chinese dominance in low- carbon technologies. Against this backdrop, the question arises: should Europe react by introducing a similar plan, such as a “Buy European Act” (BEA)? Opinions differ on this subject. Some consider that a BEA would be a retaliatory measure that contradicts the principles of free trade, likely to trigger a trade war with uncertain consequences. Others believe that a BEA would represent a legitimate and necessary response to protect European interests and promote the continent’s ecological transition.
Thus, the American Inflation Reduction Act (IRA) represents a major challenge for Europe, which has to strike a delicate balance between defending its economic interests and meeting its international commitments. Europe also needs to step up cooperation, both internally and externally, to face competition from the USA and China, and make an active contribution to the fight against climate change.
Sources
(1) Bloomberg: “Even With Biggest-Ever Climate Bill, US Lags China’s Green Spending”
(2) Mckinsey “The Inflation Reduction Act: Here’s what’s in it”.
(3) US Congressional Budget office “Estimated Budgetary Effects of H.R. 5376, the Inflation Reduction Act of 2022,”
(4) Internal Revenue Service (IRS) : “Credits and deductions under the Inflation Reduction Act of 2022”
(5) Whitehouse: “Inflation Reduction Act Guidebook”.
(6) Quote from Commission President Ursula von der Leyen
(7) Reuters : “US subsidies appealing to German companies, survey shows”
(8) European Council: “Adjustment to Objective 55”.
(9) Reuters : “China, world’s top graphite producer, tightens exports of key battery material” (Oct. 23)
(10) Reuters :” BlackRock to invest $550 mln in Occidental’s carbon capture project”
(11) EIB : ” Denmark: REPowerEU – EIB and Ørsted sign EUR 400 million framework loan for offshore wind farms “
(12) EIB : ” Spain and Portugal: EIB to provide Galp with EUR 732 million to promote climate action and social cohesion “
(13) EIB : ” Spain, Italy, Portugal: InvestEU – EIB approves framework financing of up to EUR 1.7 billion for Solaria’s renewable energy deployment program “
(14) Les Echos: “Renewable hydrogen: can Europe lead the way?
(15) Reuters : ” Volkswagen pauses on Europe battery plants, awaits EU response to IRA “
(16) MorningStar : ” Health: the impact of the IRA is manageable “
(17) Novethic ” In Finland, after Sweden and the Netherlands, the electoral revenge of nationalist and anti-environmental parties “
(18) Les Echos: “Who is Geert Wilders, the new Dutch strongman who is scaring Europe? “
(19) FT : “Donald Trump would gut Joe Biden’s landmark IRA climate law if elected”
Richelieu Gestion | Focus • Janvier 2024
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