The global battle to reduce inflation is well and truly on. One of the first casualties could be transatlantic competitiveness.
The US Inflation Reduction Act has led to EU complaints that subsidies and tax credits discriminate against products imported into the US, to the potential detriment of EU companies. Could the EU now respond with legislation of its own?
The EU has two broad complaints with the Inflation Reduction Act.
First, they are concerned that European-produced products will be disadvantaged in the US. Secondly, they also note that US companies won’t be similarly disadvantaged in Europe. As such, US players can receive scale benefits through protection in their home markets and use these to drive market share gains in Europe too.
The EU is reported to have noted “at least nine points” in the IRA which may be deemed a breach of international trade rules. It is important to note that the key concern appears to be with the domestic content requirements, rather than the subsidies per se.
European green energy installations are lagging |
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This issue is made even more potent by the EU’s dependence on the green transition in its industrial strategy. Europe has fallen behind in many industries of the future, with ‘green’ sectors such as wind turbines now one of the few where it holds something of a leadership position. Moreover, it still holds a disproportionate share of the legacy auto industry. Should the US and China steal a march on Europe here, it would be painful for the EU’s ambitions.
The Inflation Reduction Act (IRA), through its subsidy largesse, has substantially shifted the playing field towards the USA in renewables development. Firstly, by making project returns so attractive, it makes renewables development more appealing in the US than the EU. Developers who are capacity-constrained are likely to direct their investment dollars to the US over Europe.
Secondly, its domestic content provisions are a threat to European suppliers and supply chains.
The nationality of the overall manufacturer is not a factor, but having a local supply chain is. The EU thus faces the risk that investment in manufacturing capacity, and thus jobs, may also become skewed to the USA.
Under the IRA, wind projects meeting domestic content requirements can receive a 10% uplift to the tax credit they may receive. For projects starting construction before January 2026, this requirement is 45% of total content, rising to 50% for those starting before January 2027, and 55% for subsequent projects.
BEV and PHEV monthly penetration rates in Europe since 2019 |
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For electric vehicles to be eligible for tax credits, they must meet two local content hurdles (Institut Montaigne, 15 Dec 22):
- At least 40% of the critical raw materials used in the battery must be extracted in the US or a country with which it has a free trade agreement, rising to 80% by 2026.
- At least 50% of battery components must be made or assembled in NAFTA countries, rising to 100% by 2029.
Note that, for the purpose of the tax credits, manufacturing in Canada or Mexico counts towards local content requirements, which is helpful for non-US players.
The inflation reduction act includes a number of measures aimed at supporting green technologies in the US. Key highlights include:
- Production tax credits (PTC) for generation of renewable energy, including wind and solar. These have been incorporated for the following 10 years, to 2032.
- For hydrogen, the IRA introduces a new tax credit of $3/kg for clean hydrogen production (i.e. production with >95% reduction in CO2 emissions compared to conventional hydrogen production using fossil fuels).
- For light-duty electric vehicles, the tax credit of up to $7,500 per vehicle was also extended to 2032. To qualify for the credit, vehicles must be below a certain price ($80k for SUVs, vans and pick-up trucks, $55k for other vehicles), and purchasers must be below a certain income.
- Heat pumps and heat pump water heaters are eligible for tax credits of up to 30%, with a cap of $2,000 per consumer.
What can Europe do?
The most likely response by the EU is to look to pass legislation mimicking the US’s support to its companies, in order to level the playing field between the two regions. Citi Research analysts say WTO arbitration is unlikely to achieve a rapid and meaningful resolution of the situation, while the chances of the US allowing EU-produced products to qualify for its products seem remote. Instead, the most likely scenario seems to be an ‘EU Clean Tech Act’, under which state-aid rules are relaxed, enabling more subsidies. The European Chips Act may be a blueprint for the EU’s response. Efforts to make a ‘Buy Europe Act’ may be hindered by fears of retaliation by China though. For more information on this subject, please see European Industrials - Implications from a potential EU “Inflation Reduction Act”
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