Uncertainty Prevails: European Businesses Navigate US Inflation Reduction Act

On February 1, 2023, the European Commission proposed its Green Deal Industrial Plan with the aim of “enhancing the competitiveness of Europe's net-zero industry.” The plan is seen by many as the EU’s response to the US Inflation Reduction Act (IRA), which is focused on energy and climate change and aims to reshape the US energy industry and accelerate the transition to nonfossil fuels. While some European businesses have welcomed the intent of the IRA in relation to climate action, others are concerned about the impact it might have on the EU industry.

Insights for What’s Ahead

• European businesses are calling for a clearer and more comprehensive EU response to the IRA.The Green Deal Industrial Plan is not entirely new, and many specific measures simply reinforce previous commitments. While the business community welcomes the EU’s intent to reduce red tape—one of the four pillars of the plan is a predictable and simplified regulatory environment—there is skepticism about how it will be done and how soon it will be realized. The Green Deal Industrial Plan is a step in the right direction but falls short of being a holistic policy response that considers climate as well as geopolitical reality.
• While the IRA has changed the rule on clean energy funding, its impact on European industrial competitiveness remains uncertain. European policymakers have concerns regarding the IRA’s “local content provision” (for example, it expands the tax credit for new purchases of electric vehicles with final assembly in the US up to $7,500 for 10 years) as they fear that such requirements could steer investments away from Europe toward the US. Several, but not all, of the green subsidies require content to be produced in the US. Of the $355 billion to $552 billion in climate mitigation and adaptation spending over 10 years included in the IRA, only 9 to 15 percent is for a subset of tax credits where the domestic bonuses or local input requirements could have a meaningful impact on US-EU clean energy trade and investment.^[1]
• Efforts to limit global warming below 2°C, including the Paris Accord’s objectives, will benefit from large-scale global involvement. Climate change is a global problem that requires a global solution. It is essential for all countries to work together to reduce emissions. The IRA could encourage similar market-based initiatives (such as tax credits or subsidies, as well as emissions trading programs) in other jurisdictions that can accelerate clean energy deployment and help drive the transition to a low-carbon economy.
• Green subsidies will see a major change in the coming decade, presenting new business opportunities. The energy transition and, more broadly, the transformation toward a net-zero economy will create new business opportunities. Businesses operating in the renewable, green technology, and ancillary sectors may want to closely follow regulatory developments and industrial policy to inform their investment decisions.

The IRA in Brief

The IRA, which came into effect in 2022, is the single largest action to date to reduce US greenhouse gas emissions and includes $369 billion of spending on climate mitigation and adaptation over 10 years. The IRA addresses inflationary pressures on the US economy by promoting investments in green industries, modernizing infrastructure, and increasing support for workers and families. Tax incentives, grants, and loan guarantees are some of the components of the funding envisaged under the IRA. Clean electricity and transmission command the biggest slice, followed by clean transportation, including electric vehicle (EV) incentives. While some European businesses have welcomed the intent of the IRA in relation to climate action, others are concerned about the impact it might have on the EU industry.

The EU has long been committed to assisting the green transition with various grants, projects, and programs. Nonetheless, significant new green subsidies under the IRA are anticipated to revolutionize the market for renewable energy. This may put pressure on European businesses and decision makers to also prioritize sustainability and invest in low-carbon industries. As a result, many decision makers and business executives are urging the EU to step up its game.

The Green Deal Industrial Plan

The four pillars of the Green Deal Industrial Plan are 1) a predictable and simplified regulatory environment, 2) faster access to funding, 3) enhancing skills, and 4) open trade for resilient supply chains.^[2] While collectively the package may seem impressive, it is not entirely new, and many of the specific measures simply reinforce previous commitments.

Source: European Commission

The EU proposes to fund the initiative using the NextGenerationEU program, which is already established as the primary financial source for the Green Deal. This program offers up to €723.8 billion in grants and loans, which will be distributed to support reforms and investments in the EU member states. If US Department of Energy loans are excluded, the amount is comparable to the estimated total spending under the IRA. However, EU countries have already spent around €600 billion in just one year to shield consumers from rising energy prices. The total amount of money under the IRA is not restricted, and tax credits without a limit could provide up to $250 billion for the production of solar, wind, and batteries—eight times more than the official projections. The commission is also expected to propose a relaxation of government aid regulations and the creation of a new European sovereignty fund to ensure the competitiveness of EU businesses against subsidies granted to the US economy and to prevent the relocation of private investments.^[3]

The EU has also proposed a Carbon Border Adjustment Mechanism (CBAM), legislated as part of the European Green Deal, that aims to protect EU companies from so-called carbon leakage—the practice of moving company operations to countries with weaker environmental regulations to avoid paying for emissions—by imposing a carbon price on imported goods from countries with lower climate standards. This measure would encourage companies to reduce their emissions and invest in cleaner technologies.^[4] CBAM will take effect in 2026, with reporting starting in 2023.

By incentivizing clean energy manufacturing and encouraging renewable energy investment, the EU can ensure it remains a key player in the transition to green energy. The framework will be complemented by the Critical Raw Materials Act and the Net Zero Industry Act.

The Critical Raw Materials Act seeks to ensure sufficient access to the raw materials vital for manufacturing key technologies and to reform the electricity market. Hence, consumers benefit from the lower costs of renewables. The Critical Raw Materials Act sets specific targets for the EU’s domestic capacities and diversification of its strategic raw material supply chain by 2030. By setting these targets, the EU aims to increase its self-sufficiency in critical raw materials, reduce dependence on other countries for these materials, and promote sustainable sourcing and use of these materials. These targets include:

• The EU should extract at least 10 percent of the strategic raw materials for its own consumption.
• The EU should process along the value chain at least 40 percent of its strategic raw materials.
• The EU’s recycling capacity should be able to produce at least 15 percent of the EU’s annual consumption of each strategic raw material.
• The EU should not be dependent on any single outside country for more than 65 percent of imports of any strategic raw material at any relevant stage of processing.

The EU, through the Net Zero Industry Act, seeks to establish a framework of measures to strengthen Europe’s net-zero technology product manufacturing ecosystem and thus accelerate the transformation to net zero. The plan intends to increase the industrial competitiveness of the EU, laying the groundwork to attract investment in the net-zero industrial base and green industrial innovation.

The Green Deal Industrial Plan reinforces the EU’s commitment to climate neutrality and will provide business opportunities, especially in the renewable, green technology, and ancillary sectors. It is a step in the right direction, but many businesses might not see the plan as transformational. But it is important for businesses to consider that various member states within the bloc are not necessarily aligned on the green transition.

Net-zero transition will require collective action and US$32 trillion of investment over the next decade. The IRA, as well as the Green Deal Industrial Plan, will contribute significantly to global efforts to reduce emissions and is likely to help catalyze energy transition by lowering costs for green technologies.