The US Inflation Reduction Act: Europe’s response

The US Inflation Reduction Act (IRA) will catalyse clean energy investment activity in the US, in our view. By contrast, the main concern for investors and policymakers in Europe is that R&D and project development activity will be lured away to the more attractive subsidies on offer in the US. In response, the EU plans to mobilise various forms of state aid to boost investment in green transition through the Green Deal Industrial Plan (GDIP).

In principle, the total amount and recipients of subsidies are roughly equivalent in the EU and the US. While estimates of total subsidy spend can vary significantly, the EU and US packages each offer support to clean energy and other low-carbon investment to the tune of hundreds of billions of dollars.

Deploying capital – faster in the US

The key difference is the way in which funds are being disbursed. In the US, this is done mainly via tax credits – an established mechanism with clear rules with which market participants are familiar.  By contrast, the EU plans to repurpose various existing funds to support the GDIP ambitions. While the total amount available within the existing funds looks impressive, the complexity of schemes will make it harder for clean energy companies to access the subsidies they need. Applications for funding can take years, with outcomes far from certain. Meanwhile, in the US, firms eligible for non-repayable tax credits can deploy capital much faster and have more visibility and control over project timelines and costs.   

Another potential hurdle in accessing subsidies is local content requirements. Both the EU and the US have mandated minimum local content requirements and will need to successfully build significant manufacturing facilities locally. Failure to do this could weigh on the build-out of clean energy projects such as wind and solar farms and battery storage facilities.

The areas where the EU faces the biggest competition from the US under the IRA are battery and hydrogen manufacturing. The EU was hoping to spearhead the development of these industries, advancing its leadership in clean energy deployment to beyond just renewables. However, subsidies under the IRA now make clean hydrogen production more competitive against the currently produced grey[1] hydrogen. With the stroke of a pen, clean hydrogen producers have been made cost-competitive in the US – a country with a large existing hydrogen market. Similarly, battery production is being given a competitive advantage in the US – and the EU will need to intensify its policy efforts to retain its most innovative cleantech companies, in our view.

Not a zero-sum game

The EU does hold an advantage in creating and supporting demand for clean energy projects. For the better part of a decade, clean energy has been procured through a system of auctions underwritten by member states. The auctions give developers long-term visibility on future demand and long-term offtake agreements guaranteeing a fixed price, which in some cases is indexed to inflation. This significantly de-risks projects, lowers the cost of capital and allows for relatively fast capital deployment into renewables. If applied to new sectors such as green hydrogen at scale, the auction system may offer long-term fixed-price offtake contracts underwritten by member-state governments or possibly even Brussels – a powerful draw in a nascent sector.

The generosity of US subsidies has prompted various analysts to describe the competition between the US and the EU as a zero-sum game whereby one region will hoover up the capital at the expense of another. In reality, however, the situation is more nuanced and may develop into a regulatory race benefiting clean energy sectors in both regions, where new policies attract developers from other industries and geographies, expediting the energy transition on both sides of the Atlantic.

[1] There are various methods for producing hydrogen. Hydrogen produced using renewable energy is referred to as green hydrogen. Hydrogen produced from coal is referred to as brown or black hydrogen; hydrogen produced from natural gas or petroleum as grey hydrogen.