U.S./EU Green Tensions

The U.S. Inflation Reduction Act (IRA) 2022 has accelerated private sector investment plans in renewables, but also caused tensions with the EU. Will U.S. and EU green tensions grow to protectionism and how does geopolitics with China play a part?

Figure 1: U.S. and EU Electricity Production by Source (% of total) 

Source: BP 2021 (here)

U.S. Leap Forward, But EU More Sustainable 

The U.S. IRA act has provided a leap forward for renewables in the U.S., with private sector investors scrambling to look at investments that have been made more attractive by the tax breaks for renewable electricity production in the act. Meanwhile, tax breaks for manufacturing, plus subsides for electric vehicles with U.S. origins, are prompting major multinationals to consider North America rather than Europe e.g. VW new car factory U.S. and battery factory to Canada rather than Europe.

European politicians are accusing the U.S. of not having a level playing field in contrast to the EU, which is causing tensions with the Biden administration. The EU Commission is suggesting that the EU should have its own minimum input of 40% in its new proposal for a net zero industry act (NZIA) on certain key green goods. Meanwhile, the EU also wants to impose a tax on goods from outside the EU (CBAM certificates) in carbon intensive industries and avoid EU companies being at a disadvantage due to EU carbon taxes (EU ETS emission scheme). This carbon border adjustment mechanism (CBAM) is due to start in 2026 on a free basis with the taxes kicking in between 2030-34. Finally, the EU wants to champion a critical rare earth materials act (heavily used in renewable products) to diversify supplies away from China. 

China is also accelerating renewables (mainly solar) in electricity production, both for domestic energy security reasons and to avoid price spikes in gas and oil. China wants to sustain leadership in production in the renewables fields (e.g. solar panels) to sustain exports and knowledge leadership but does wants to be selective in sourcing renewables goods abroad to protect domestic industries.

Climate change tensions are thus growing between the EU and U.S., as well as between the West and China.Could we see an outbreak of more green protectionism on one of the key growth drivers for the 2020’s?

Some context is worthwhile. The EU has felt that it has leadership in the renewables field and now finds the U.S. is trying to make a leap forward. However, the U.S. has lagged behind with cheap gas meaning that renewables electricity production is less than the U.S. (Figure 1). Meanwhile, big oil and autos have slowed the rollout of electric vehicles and the associated charging structure with sales of electric vehicles being 5% in 2021 versus 16 and 17% for the EU and China respectively. EU tensions with the U.S. thus reflect concerns about the EU losing its advantage.Europe does have its own set of green loans and grants that were a key part of the Next Gen RRP funds out of the 2020 COVID crisis. It is estimated that these total €223bln over the next 10 years, which contrasts with the estimated $369bkn (the tax credits are uncapped). The critique is that the U.S. IRA will likely be more powerful in drawing in private funding due to tax breaks compared to the EU politically targeted grants and loans (e.g. €24bln for high speed trains in Italy).

Figure 2: U.S./China and Europe Share of Electric Cars Sold (%) 

Source: IEA 2021 (here)

The U.S. is also lagging in control of emissions of CO2 equivalents, with 2020 seeing emissions in the U.S. dip below 1990 levels but the EU 30% below. The U.S. also emits more CO2 equivalents than Europe and will be 50% higher in than the EU in absolute terms in 2030. We would thus see EU tensions with the Biden administration as being friendly competition but both blocs trying to move towards net zero goals at their own political speed. Two important issues do exist however.

Figure 3: U.S. and EU Emissions CO2e (1990 = 100) 

Source: Climate Action Tracker (here)

The U.S. wants to see the EU taking a more proactive stance in restraining China’s rise. EU commission President Von de Leyden echoed hawkish tones towards China in last Friday’s press conference with President Joe Biden, but Germany and other countries want to protect trade relationships with China and do not want to take similar action that the U.S. has done or is planning in the future. How this plays out will be interesting to watch as a sub plot in geopolitical relations. Ideally, U.S./EU/China should try to align to speed up climate change commitments before the key G20 Summit in India September 9-10 and COP 28 in Abu Dhabi starting November 30 (where the key five year stock take is due to take place). The problem is that U.S. and China relationships remains weak over the Ukraine war/other issues and EU countries are suspicious of China peace objectives.

The 2nd issue is that the November 2024 U.S. presidential election could alter the U.S. commitment to climate change. Already the GOP control of the House curtails follow-through legislation by the Biden administration. While the outcome of the U.S. president election remains uncertain this far out it currently looks like Biden v Trump or De Santos. A Republican president in the White House could then stop or partially reverse momentum from the Biden administration’s climate change initiatives. Alternatively, a reelected Biden could still face a split Congress. In contrast, Russia invasion of Ukraine has been an existential crisis for European energy and redoubled the EU commitment to achieving a 55% reduction of CO2e emission by 2030 versus 1990, with most coming from extra renewables electricity production. Though the U.S. IRA is giving a welcome boost to U.S. renewables energy production, EU27 grants and loans are complimented by a huge financial commitment from individual EU government to subsidies and drive renewables energy production (around Eur800-900bln over the next 10 years).