By David Barrosse, Capstone CEO
March 13, 2023 — At the peak of the energy crisis in Europe, scores of industries such as cement, glass, and petrochemicals were at 50% capacity or shuttered altogether. These companies could not operate in an environment where natural gas prices were 10x higher than the year before. At the time, much was written about the “deindustrialization of Europe.” The idea being that the spike in energy prices would moderate but likely remain structurally higher than they had ever been. Since the passage of the Inflation Reduction Act (IRA) in the US, a new area of concern has arisen for Europe. European capitals perceived the IRA as a strong inducement for clean energy and technology to relocate to the US. This resulting panic led the EU to rollout a series of proposals to counteract the impact of the IRA. The Green Deal Industrial Plan was announced by the European Commission’s President Ursula von der Leyen on February 1. It contains a variety of proposals including matching subsidies for green industries, streamlined permitting processes and other subsidies. On its face a potent response to the IRA.
I believe the EU proposals will ultimately disappoint European manufacturers. What’s more I believe the IRA will act as a magnet for European manufacturing well beyond traditionally green industries. Part of my reasoning rests on what I believe is an under appreciation of the size and impact of the IRA. However, I also believe that the knock-on effects of the bill will make reaching net zero targets far easier in the US than in Europe or Asia.
The IRA has been consistently misunderstood by pundits and journalists who see it as akin to the $1 trillion infrastructure bill passed in November of 2021. Newspapers have consistently implied that the $396 billion Inflation Reduction Act has a finite appropriation of money attached to it. Nothing could be further from the truth. Unlike the infrastructure bill, which is a finite pool of money, the IRA is largely a series of tax credits that can expand based on the number of people who apply for them. The Congressional Budget Office (CBO) in scoring the bill, estimated that the demand for the tax credits contained in the bill would cost the US government $396 billion over ten years. However, as an example, if twice as many companies apply for the tax credits, the cost of the bill will be twice as much. The IRA can expand to meet whatever demand occurs—there is no cap. Much to the chagrin of EU policymakers there is also no discrimination against foreign companies applying for the tax credits to build green energy facilities in the US.
Capstone has received scores of enquiries from corporate clients in the US, the EU, and Asia about major investments spurred by the IRA. This is anecdotal evidence, certainly, but it is a lot of anecdotal evidence and the investments being discussed are significant. One major source of investment comes from global oil companies who are flush with cash. These companies are rapidly investing in green energy and the IRA has acted as a major accelerant. Some of our clients, especially the ones with large research departments, have suggested that the IRA could end up being much larger than the CBO estimates. In fact, one highly credible client has suggested that the IRA could cost the US government 3x the CBO estimate, nearly $1 trillion. In order to make this happen, the next five years will see a massive increase in domestic and foreign investment in the US.
Overinvestment is likely in many areas as these type of tax credits often warps normal investment decisions. Some of the tax credits (e.g. hydrogen) will “stack” with existing federal and state programs making them even more attractive to producers. The net result of all of this investment will be very cheap green energy. This cheap green energy leads to my second argument of why the IRA is likely to lead to a deindustrialization of Europe. Any company that has made a “net zero” pledge will find it significantly easier to comply with that pledge in the US relative to the EU in the future. The vast majority of large manufacturing concerns in Europe, even industries totally unrelated to green energy, have made net zero pledges. In many cases these pledges were made prior to calculating the costs of meeting the commitments, leading to some uncomfortable internal conversations. The IRA provides a lower cost pathway to net zero for many European manufacturing companies that are able to move facilities or build any new facilities in the US.
The EU Commission responded quickly to the threat of the IRA. However, in its current form the EU proposals are unlikely to fully counteract the sheer size of the US package of tax incentives. Of course, policy is dynamic so it is likely that the EU will augment their response if it proves ineffective. In the long run it may prove difficult for EU national budgets to boost spending on their own defense, new energy infrastructure, and go toe to toe with the US over green energy subsidies.