How does energy transition policy differ in the US and Europe?

On the one hand we have the US, which, via the Inflation Reduction Act (IRA) of 2022, has introduced a subsidy and tax credit package covering renewable power, hydrogen, biofuels, carbon capture, battery materials, hardware components, electric vehicles, grid expansion and critical minerals. 

“The investment climates in each region, both in corporate and financial terms, are nonetheless starting to diverge in a meaningful way, with visible results.”
 

On the other hand we have Europe, which has a long track record of setting world-leading top-down ambitions, but is now awkwardly coupling them with windfall taxes and power market reform. Central to the European approach has always been a cap-and-trade emissions system for polluters, tied to a carbon price which escalates by design. 

This is not to dismiss what Europe has achieved since Russia’s invasion of Ukraine: 80% of Russian piped gas imports were replaced within eight months¹, a region-wide target to cut gas consumption by 15% was exceeded, and record capacity additions were made in both wind and solar. Including hydro-electric, roughly 40% of European power is now generated from renewable sources², vastly better than the 22% achieved by the US. In addition, in response to the IRA, the “temporary crisis and transition framework” (TCTF) has been creatively applied to allow member states to provide subsidies to transition companies. The scale of incentives that the IRA provides, however, have proven difficult to match. 

Diverging investment climates

The investment climates in each region, both in corporate and financial terms, are nonetheless starting to diverge in a meaningful way, with visible results. Take the example of Norwegian battery technology company Freyr. Launched in 2018, the business was conceived around the idea that manufacturing Electric Vehicle (EV) batteries in Norway would both capitalise on clean hydro-power and provide proximate supply to Europe’s transitioning automobile industry. 

Construction of the company’s first giga-factory began in Mo-i-Rana, Norway in 2021. Following the announcement of the US Inflation Reduction Act in 2022, Freyr designed, site-selected and took final investment decision on an entirely separate giga-factory in the US State of Georgia. This US plant is now on ‘fast-track’, with the company pointing out that $2.5 billion of the project’s $8 billion Net Present Value (NPV) stems directly from IRA subsidies. Of the Norwegian plant, the company notes “construction of Giga Arctic continues to proceed at a measured pace in accordance with previously authorized capital spending and in anticipation of a Norwegian IRA response.”

Elsewhere, Linde, one of the world’s largest industrial gas companies, sees a $50 billion investment pipeline linked to its customer’s decarbonisation plans, but the company is keen to point out the majority of this, at $30 billion, is sourced from US projects. Linde is in the business of producing hydrogen, so if subsidies are available for using renewable power to produce green hydrogen, and for capturing CO2 in the production of blue hydrogen, and for converting that hydrogen into alternative fuels, as is the case in the US, it is easy to see how such a regional skew can develop. Linde’s emphasis of the scale of US opportunity is also notable for a business which de-listed its German shares in March, and now trades solely on the New York Stock Exchange.

What will the future bring?

Thinking more broadly, in terms of new renewable power capacity, industry forecasts paint a positive picture across all three of the major activity centres (the US, Europe and China) in the coming years. Dig deeper however and some interesting dynamics emerge.

One data series we like to follow is how expectations for activity levels change through time. This allows us to monitor how project permitting, supply chains, cost inflation and corporate risk appetite stack up in reality, versus what should theoretically happen according to the forecasting models.

Notably, over the past year, Bloomberg New Energy Finance’s 2024 forecasts for combined onshore wind installations in Germany, France, Spain and the UK have been revised down collectively by almost 10%. The same forecast for activity in the US has been revised upwards by an eye-catching 30%, while China has seen more modest upgrades.

How do the companies on the ground diagnose the problem? The CEO of Vestas, one of the world’s largest wind turbine manufacturer, cited the market design and permitting process as barriers to new installations. A recent German federal report³ agrees, concluding that only half of the land area needed to meet Germany’s 2030 renewable power targets had so far been ear-marked for future development. In the slowest state, Hesse, the average time for approving documentation for a new renewable project was a remarkable 27 months.

Further real-life examples are provided by Ørsted’s diverging experiences in offshore wind in the US versus the UK. In March, the company warned that Hornsea 3 in the UK, set to be the world’s largest offshore wind farm when it starts up in 2027, would need revised terms or better government support to balance out the supply chain inflation of the past few years. A similar debate has been underway in New Jersey, at another Ørsted project, and specifically whether the company should be allowed to keep some of the federal tax credits granted under the IRA, or pass them back to power consumers. The situation in the US has recently resolved in Ørsted’s favour, while the debate in the UK rumbles on.

For the more than 200 companies we monitor globally, which we consider to be meaningful climate solutions providers, we calculate a median 2024 price/earnings ratio of 21x for the US players, and 17x for the Europeans. This, admittedly, is a narrower premium than observed for the wider regional equity markets (the Stoxx 600 trades on 13x forward earnings at the time of writing, versus the S&P 500 on 20.6x*), but we should bear in mind that the clean technology businesses should theoretically be exposed to the same structural growth drivers, making a regional discount less justifiable. The market as a whole appears more comfortable paying for the growth of US companies, versus Europeans. Perhaps unsurprisingly, share price performance of the US clean technology space has been better in recent years, too.

Can Europe catch up?

It is possible that Europe can re-assert the balance via its Net Zero Industry Act, which is currently under negotiation. The proposal is wide-ranging, aiming to simplify regulations, scale up manufacturing of net-zero technologies and increase the competitiveness and resilience of net-zero related industry. 

These are all commendable goals, but the initial response from industry has been lukewarm on the Act’s scope and ambition. If the US’s success is anything to go by, pace, simplicity and the grandfathering of many of the tax credits for 10 years are key to building an attractive investment environment.

However, the over-riding conclusion is that, whether in the form of radically simplified permitting, more emphatic subsidies or most likely some combination of the two, Europe needs a rewarding policy environment.

*Share prices and valuations as at 13/07/2023.

¹ Reuters, ‘Insight: Moscow’s decades-old gas ties with Europe lie in ruins’, (reuters.com), February 2023.
² Energy Monitor, ‘Europe: Renewables in 2022 in five charts’, (energymonitor.ai), January 2023.
³ Second report of the Federation-Länder Cooperation Committee, (bmwk.de), October 2022.

The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast.