Trust and trade-offs: How to manage Europe’s green technology dependence on China – Part II

Importance to the EU

 

Reduced Russian oil supply since 2022 quickly raised demand across Europe for alternative sources of energy, including solar power. In 2023, solar comprised about 9 per cent of Europe’s total electricity generation. But solar energy is becoming ever more important in the renewable sector, where it currently provides 17 per cent of Europe’s total renewable energy production. In 2023, the total amount of newly installed solar capacity of 56 gigawatts (GW) was more than a third greater than in 2022. The EU’s Solar Energy Strategy aims to scale up the bloc’s total deployed solar capacity from 263GW today to almost 600GW by 2030. If it meets its goal, on some measures solar will become the EU’s largest single source of energy production. Installation rates are already increasing rapidly; continuing this will mean it becomes crucial to maintain a stable supply of solar panels.

Dependence on China

The global supply chain for solar panels was once heterogeneous but is now dominated by China. In Europe, Chinese firms provide 90 per cent of the supply of solar photovoltaic modules. This represents a significant supply chain risk. Chinese companies also dominate the downstream supply chain, where they produce two-thirds of the world’s polysilicon supply. Moreover, 40 per cent of global polysilicon manufacturing occurs are located in the Xinjiang province, which is a target of critics and regulators due to the prevalent use of forced labour and other human rights violations by the Chinese leadership against ethnic minorities. For Europeans this brings political risk for being complicit with Chinese practices by purchasing products from the region.

The competitiveness risk Chinese manufacturers pose for European solar photovoltaic firms is very high. The EU and other major players have been unable to match China’s scaled-up production, which benefits from lower energy and labour costs and vertical integration along the supply chain. In 2023, production costs for solar modules in China shrank to $0.15/W – compared $0.30/W in Europe and $0.40/W in the US. These collapsing prices have caused manufacturing capacity in Europe to decline markedly. Europe’s share of polysilicon production is increasingly marginal. Wacker Chemie EG remains the sole European company among the global top five firms in this area and has large operations in China itself. Europeans are not alone in this: north American and Asia-Pacific countries have also experienced a steep relative decline compared to China along the solar photovoltaic supply chain.

The EU imports many of the materials and components that it uses in solar module and cell production from China, Malaysia, and Vietnam. It is especially dependent on China for key components such as ingots and wafers. Furthermore, high levels of bankruptcy risk and low profitability are inherent to the solar industry, especially in the early stages of new projects; this discourages private investment. The EU aims to reach an indigenous production capacity of 30GW by 2030 across the whole supply chain. However, European manufacturers’ cost-efficiency significantly lags behind that of their Chinese rivals, requiring significant investment of public resources to realise this goal.

 

As the significance of solar in the EU’s energy mix grows, this high exposure to China bears a weaponisation risk that has consequences for energy security and climate risks. A disruption in supply, such as for geopolitical reasons, could hamper the EU’s ability to keep pace with the rising demand for renewable electricity and the rollout of installations. That being said, there are ways to mitigate this risk, such as by stockpiling solar panels to deploy if supply disruptions occur.

In terms of the wider national security risk, includingforcybersecurity, Chinese solar panels pose no greater problem than European modules. This is because these are mostly a ‘dumb’ technology. However, the risk to national security comes from inverters, which are the equipment that enable the energy generated by solar panels to be fed into power grids. As inverters connect individual households to national energy grids, they transmit and receive sensitive data on national electricity consumption. They can thus serve as an entry point for malicious incursions into smart grids, with the possibility to cause widespread blackouts. Among the top ten vendors of inverters are eight Chinese companies and two European companies (SMA and Power Electronics). Chinese firm Huawei is the leading vendor. Dependencies on China are higher for solar panels than they are for inverters, for which Europe already has a 60GW manufacturing capacity. Nevertheless, more than 60 per cent of new photovoltaic installations in Europe are equipped with Chinese inverters and Huawei’s share alone stands at almost 30 per cent. However, this paper addresses only the risks associated with solar panels.

Current EU toolbox

The EU has several tools available to address the threat of Chinese over-dependency and reverse the decline of its solar industry. Firstly, its REPowerEU plan seeks to accelerate the financing of the green transition and has close to €300 billion ready to spend in wind, solar, and other renewable sectors. Secondly, the EU’s €40 billion Innovation Fund, fed by revenue generated through the EU emissions trading system, offers investments in next generation solar technologies such as thin-film solar cells and perovskites. Thirdly, the recently adopted Net Zero Industry Act will force member states to diversify their sources of solar panels as well as fast-track the permitting of new renewable projects, with a target of 40 per cent European manufacturing capacity of annual deployment needs by 2030. Lastly, a deal has been agreed with the European Parliament on the European Commission’s proposed forced labour regulation. This will give member states three years to apply rules that will affect imports of photovoltaics or photovoltaic parts from China’s Xinjiang region.

Third countries

The EU’s goal to diversify the sources of its solar panel imports will create opportunities for new partnerships with emerging third country producers. Several countries are already actively seeking to build alternative manufacturing hubs or develop new solar technologies, endeavours which could benefit from European investment and research collaboration. Under President Joe Biden, the US has attempted to boost its domestic solar sector through the IRA, which offers a 30 per cent tax credit for solar projects. Japan, meanwhile, is investing in thin-film solar technologies to restore its edge in the industry, opening the door for research collaboration for next generation solar panels. Meanwhile, India’s solar photovoltaic production capacity is set to reach 110GW by 2026, propelled by the government’s mix of fiscal incentives for domestic manufacturers and barriers to imports. Nonetheless, the country remains dependent on China for upstream components such as polysilicon, ingots and wafers, ancillaries, and photovoltaic machinery. In terms of global supply, China’s low-cost production has generated a surplus in cells and modules, creating opportunities for emerging countries to access affordable solar panels, but at the same making it harder for them to set up their own solar supply chains.

Solar panels scenario 1: Do everything … Ramp up domestic production

In this scenario, European policymakers adopt an ambitious – and expensive – industrial policy to build up a potent domestic industrial base for making solar photovoltaics and markedly reduce dependence on imports from China.

The result is that import dependencies decrease but at high cost for a product that has only limited national security risk. Europeans fail to strategically develop closer ties with the rest of the world through this sector and instead foster what is effectively a boutique industry that enjoys no competitive edge on global markets. Fiscal space shrinks for investment in research and development in other important green industries where Europe has a stronger competitive edge, including wind energy.

The actions

The EU decides to invest heavily to expand domestic production. It uses the REPowerEU plan to direct seed funding to new solar photovoltaic equipment and facilities, and follows this up with a 30 per cent manufacturing tax credit and electricity subsidies. This drives the expansion of wafer and ingot processing plants and cell and module developers and helps consolidate European producers of polysilicon. At estimated capital expenditure costs of around €120m/GW in polysilicon production, €55m/GW in ingot and wafer production, and €80m/GW in both cell and module production, the EU spends around €20 billion annually to close the production gap and reach the 70GW annual production capacity needed to achieve 600GW installed solar capacity by 2030 without using Chinese products at any step of the supply chain. Decision-makers allocate the majority of the REPowerEU plan’s long-term €300 billion investment towards solar rather than wind, batteries, or hydropower. Meanwhile, member states accelerate the application of the forced labour ban after it passes in spring 2024 and transpose it into national legislation long before the 2027 deadline. This restricts European consumers from purchasing photovoltaics products made in the Xinjiang region from as early as 2025. The EU also reintroduces anti-dumping and anti-subsidy measures that apply to the remaining imports from China; this equalises the costs between European and Chinese products.

The trade-offs

The massive subsidies for European firms and entry barriers erected against Chinese photovoltaics significantly lower the competitiveness risk for European manufacturers. In the medium term, reshoring the solar supply chain alleviates the risk of supply disruptions from geopolitical or economic shocks. This thereby reduces the national security and energy security risks. It solves the bottleneck issue in polysilicon and increases the sustainability of the supply chain for producers and consumers. By investing in the domestic solar panel ecosystem, policymakers reduce the supply chain risk of imports from China for a significant section of its targeted 600GW solar capacity.

However, one of the principal drawbacks stems from the pre-existing price competitiveness gap between European and Chinese manufacturers, which is extreme. This forces European companies to ambitiously scale their production to compete with the efficiency of Chinese industry. But this is only achievable by sustaining substantial support through state aid. At the same time, although the reshoring of manufacturing creates some new employment along the supply chain, automation is key to driving costs

down. This dampens job creation. Meanwhile, in the service-heavy deployment phase, which has long benefited from a cheap supply of Chinese inputs, the higher prices of European-made photovoltaics leads to a slowdown in solar panel adoption despite the greater abundance of domestic supply. This aggravates Europe’s climate risk by decelerating the electrification of the power sector. Additionally, because the EU does everything it can to reshore production along the supply chain, alternative third country suppliers of inputs and solar panels, such as the US, India, Japan, and Indonesia, reap no benefit from the EU’s investments.

Solar panels scenario 2: Do something … Diversify and stockpile

In this scenario, European policymakers adopt a less maximalist de-risking approach. Instead of trying to completely reshore the solar supply chain to the EU through an expensive subsidy programme, they focus on working with friendly third countries to diversify imports of intermediate inputs and finished solar panels. They also build up a strategic domestic stockpile of solar photovoltaic modules.

The result is an approach that comes closest to the idea of ‘de-risk and diversify’ that says: ‘Do a little bit, but not too much, and make friends along the way.’ It comes at a cost, however, as it requires creating attractive market incentives for third countries – difficult in such a narrowly based industry. Putting together a larger package of market openings and preferential access for third countries could also meet opposition from domestic industries and become harder to square within existing global trading rules. The EU’s chosen ‘stockpile and diversify’ measures alleviate some of the risks associated with supply chain risk and help it build new partnerships that create new supply of solar photovoltaics. But they do not fundamentally end the bloc’s dependence on China for critical inputs and they have limited impact on European firms’ competitiveness.

The actions

The European Commission recommends that member states mandate the maintenance of a solar panel stockpile equal to 30 per cent of their total deployment (in GW) in the EU. Similar to the Critical Raw Materials Act, the EU also sets a clear benchmark stating that 25 per cent of member states’ total solar panel imports must come from non-Chinese suppliers. The commission then shifts the Innovation Fund’s financial means entirely towards research, development, and technology subsidies for developing next-generation solar panels, such as thin film and perovskites. Finally, the EU uses its Global Gateway infrastructure investment programme to actively build manufacturing capacity in India and Indonesia for panel production. This provides access to cheaper capital for solar producers in these countries and enables medium-term purchasing guarantees and the establishment of ‘solar hubs’ in Delhi and Jakarta that facilitate communication between European deployment companies and the new wave of manufacturers. Meanwhile, within the scope of the G7, EU countries and the EU itself strike deals with the US and Japan to support new suppliers for materials and components for the next five years to boost solar diversification in the upstream supply chain. The forced labour ban comes into effect, but member states interpret the three-year grace period generously, which allows Chinese manufacturers to continue to sell to the European market. The ban obliges most export-orientated production to move out of Xinjiang, but human rights violations in the region continue largely unabated.

The trade-offs

In this scenario, solar panels deployed in the EU continue to come from Chinese suppliers in the medium term. The EU’s chosen mix of stockpiling, innovation, and import diversification creates resilience to any Chinese decision to cut off photovoltaic imports, such as in the case of geopolitical escalation. The supply chain risk remains high for the EU, but the bloc’s measures significantly reduce the weaponisation risk – and by extension the energy security risk – as they enable the EU to scale up solar panel purchases from outside China. The stockpile adds to this resilience. Some calculations show that in the case of a complete and sudden halt to Chinese supply, the EU’s current estimated stockpile of roughly 40GW could potentially buy enough time for it to develop alternative manufacturing capacities and reduce potential supply disruptions to a less dramatic level. The official stockpile mandate ensures that this buffer, which had built up unintentionally through market forces, is strategically maintained over the medium and long term and scales with total solar deployment levels in the EU so that it always covers a year’s worth of deployment.

In contrast to the previous scenario’s dependence on heavy subsidies to keep the European solar industry competitive, this scenario drives up competition within the single market over the medium term. It does so through a combination of investing in domestic research and development and forging outward-looking partnerships that enable non-Chinese companies to gain market share in the EU. Such a strategy creates significant opportunities to strengthen the bloc’s economic and diplomatic relations with third countries. European investment to establish and scale up solar industries in countries such as India and Indonesia goes some way towards repairing the diplomatic damage from the controversy around the EU’s carbon border adjustment mechanism. Nonetheless, the EU and its partners still face economic and political barriers to procuring and strengthening alternative supply chains to compete with the scale of China’s operations. Dominance of Chinese supply in inputs remains a chokehold that Beijing makes the most of with aggressive pricing.

Solar panels scenario 3: Do nothing … At least on solar

In this scenario, European policymakers opt for no market interventions – and effectively let Chinese producers gain virtually 100 per cent market share in solar panels in the EU. Rather than blocking Chinese products and reshoring manufacturing, the EU instead invests existing resources in wind energy and hydropower. It thereby offsets the risks emanating from the dependency on China in solar by developing greater capacity in sectors where European companies are still more competitive. European policymakers introduce strict measures to reduce market distortions linked to Chinese subsidies and overcapacities in wind and hydropower.

By scaling up wind and hydropower beyond current forecasts, European companies gain advantages of scale and become more competitive on global markets. Third countries selling solar panels have virtually no chance to compete against Chinese suppliers on the large European market. This further consolidates global solar panel production and drives up costs for those countries seeking greater independence from Chinese supply (such as the US).

The actions

The EU decides against protecting its remaining domestic solar industry. In contrast to solar, the wind and hydropower sectors in Europe offer the resources, technological leadership, and expertise in these areas to yield better returns on investment in these industries. The EU is already forecast to produce 262GW of extra wind energy capacity by 2030, while hydropower is estimated to generate a quarter of

Europe’s total power mix by 2050. To this end, the EU directs resources from REPowerEU, the Innovation Fund, and Global Gateway into developing competitive and diversified supply chains in wind and hydro. The bloc and its member states also provide tax credits, electricity subsidies, purchase guarantees, and seed capital for the manufacturing needed to ramp up production in these industries and fend off the rapidly expanding presence of Chinese producers in these sectors. The European Commission additionally introduces anti-dumping measures, investment screening, and revised security requirements that restrict Chinese imports and investments in these industries. This provides European companies with vital breathing space. European leaders reach a milestone political agreement to deploy the EU anti-coercion tool if China weaponises its now-complete dominance in solar for political reasons. This collective decision signals strong readiness to counter any attempt to choke European markets off from solar supply. Finally, the EU still implements the forced labour regulation, giving member states three years to apply the rules. Almost all member states decide to take their time implementing the regulation. Chinese vendors make the most of this to adapt to the new rules by moving their polysilicon production destined for Europe out of Xinjiang and into neighbouring provinces, allowing them to continue to sell to the EU market without necessarily improving the human rights situation on the ground.

The trade-offs

The continued supply of cheap Chinese solar panels helps the EU reach its 600GW deployment goal by 2030 at the lowest price possible, reducing its climate risk. European policymakers in member states also avoid the high economic costs of onshoring the solar manufacturing supply chain integral to the most defensive scenario, although they have to spend some money to scale up alternative industries. Conversely, the competitiveness risk to the European solar industry remains so high that the sector cannot survive in any meaningful form. The energy security risk associated with the dependency on Chinese products is alleviated through investments and reshoring in wind and hydropower, scenario-planning for potential weaponisation, and EU coordination to ensure that those countries more dependent on solar in their energy mix are integrated into contingency planning.

Batteries

Importance to the EU

The batteries industry is central to the EU’s commitment to reach net zero by 2050. Batteries power the electric vehicles necessary for the bloc to reach its decarbonisation goals in the road transport sector, which accounts for 77 per cent of the EU’s transport emissions and 20 per cent of its overall greenhouse gas emissions. Batteries are also required for the new grid storage facilities needed to enable the wider electrification of the economy, which will rely on intermittent renewable energy. As the share of renewable energy increases in the EU’s energy mix, the demand for energy storage capacity to satisfy flexibility requirements is expected to grow from 60GW currently (mostly in hydropower storage) to 200GW in 2030 and 600GW in 2050. Batteries are needed to provide the bulk of this storage capacity.

Dependence on China

Around 30 per cent of batteries in electric vehicles sold in the EU in 2023 were made by Chinese producers. Globally, at an average of $126 per kilowatt hour, batteries were cheapest in China, with prices 11 per cent and 20 per cent higher in the US and the EU respectively. The lower prices are caused

by massive industrial output in the Chinese market. In 2023, manufacturers in China produced 747 gigawatt hours (GWh) of battery power – more than the entire global demand for electric vehicle batteries of 706GWh, with only 387GWh of that total actually installed in products domestically. Chinese companies’ experience with efficient production processes, along with their technological edge when it comes to the more energy-efficient and cheap lithium iron phosphate batteries, also contributes to these low prices.

Crucially, Chinese manufacturers dominate the entire upstream supply chain of battery manufacturing. Following years of investments in mining assets across the world, China controls around 41 per cent of the world’s cobalt, 28 per cent of its lithium, and 78 per cent of its graphite, which is mostly mined in China directly. This dominance is even more pronounced in the processing of these minerals. Ninety-five per cent of manganese, 73 per cent of cobalt, 70 per cent of graphite, 67 per cent of lithium, and 63 per cent of nickel are refined at facilities located in China. Moreover, China produces 77 per cent of cathodes and 92 per cent of anodes, which are crucial intermediary inputs for battery cells. This dominance, above all else, poses a serious supply chain risk and choke-point for European battery manufacturers and consumers. It also means that the risk of weaponisation by China is potentially high in the case of geopolitical tensions or outright conflict. As battery storage becomes increasingly important for stability in electricity grids increasingly powered by intermittent renewable energy, this also has negative consequences for the EU’s energy security. If there was a disruption to the supply of Chinese batteries or their inputs, which alternative manufacturers such as those from South Korea are dependent on, this could lead to a shortage of the batteries needed for sufficient grid storage.

The investment environment in the US has lately deteriorated for Chinese battery manufacturers, following the exclusion of batteries with Chinese inputs from IRA tax credits, a recent hike in tariffs, and continuing political uncertainty over even stricter measures. As a result, they are increasingly moving production to Europe, with $17.5 billion of investments announced between 2018 and 2022. Slovakia recently welcomed its first foreign battery investment by Chinese Gotion High Tech and Hungary has attracted massive investment from Chinese manufacturers, amounting to some €10 billion in the last year alone. Germany has also attracted investment and similar projects are planned in France and Spain. Chinese stakes in the European battery sector can bring opportunities to Europe in the form of jobs and potential technology transfer. But they also increase the risk of European and other third country manufacturers being pushed out of the European market, further increasing Europe’s dependency on Chinese batteries.

Current EU toolbox

The EU has several framework initiatives in place to advance the European battery sector. One of the bloc’s main roles is to provide strategic vision and targets for the industry. To that end, in 2017 the European Commission launched the European Battery Alliance, bringing together the commission itself, EU member states, industry, and the scientific community with the goal of making Europe a global leader in sustainable battery production. Using the expertise gathered in this forum, the European Commission adopted a strategic action plan for batteries, which set out six priority areas for strengthening Europe’s battery supply chain, including access to raw materials, financial support for battery manufacturing in Europe, and research and innovation.

Over the years, the EU has adopted several regulatory tools to address some of the biggest challenges in reshoring the battery supply chain. The Critical Raw Materials Act sets 2030 domestic production goals

for extraction, processing, and recycling and defines a ceiling of 65 per cent for the consumption of critical raw material that can be sourced from any one third country. It also aims to diversify imports of raw materials through partnerships with third countries, boosted by Global Gateway investment.

As a key technology listed in the EU’s proposed Net Zero Industry Act, batteries play a central part in the bloc’s Green Deal Industrial Plan. The batteries sector is set to benefit from eased regulatory barriers for new projects and public financing, for example through the Innovation Fund and the Recovery and Resilience Facility, which can provide grants and loan guarantees for both research and development and new manufacturing projects. The European Commission can also promote financing in the sector by relaxing usually strict single market state aid rules, as it did in 2023. This has, for example, allowed Germany to provide nearly €1 billion to Swedish battery manufacturer Northvolt to set up an electric vehicle battery plant in northern Germany; this figure represents around a third of the total investment sum.

Third countries

As in the solar industry, European attempts to diversify away from China across the supply chain have the potential to create positive synergies with third countries. There are investment and partnership opportunities in the mining and processing of the raw materials needed to make battery cells and their inputs. The EU could also seek to attract big non-Chinese players in the battery industry to set up shop in Europe. With a market share in Europe of around 60 per cent in 2023, South Korea is already the continent’s largest supplier of batteries and operates factories in Poland and Hungary. An expansion of this sort of production capacity will not happen automatically, however. Incentives in the United States’ IRA have already put at risk up to 68 per cent of planned European battery production, which could scale down or decamp to the US entirely, hurting EU competitiveness in the battery sector. With the EU’s demand for electric vehicle and grid storage batteries rapidly accelerating, the EU is poised to become an attractive market for batteries. But it needs to provide incentives to also draw in manufacturing capacity from third countries or to build capacity elsewhere to diversify supply. Outside the EU, countries with good access to renewable energy, or to critical raw materials, are potential partners for a global battery industry that remains competitive against the backdrop of China’s push for dominance.

Batteries scenario 1: Do everything … Push Chinese players out

In this scenario, the EU and its member states use all tools available to them, including a new joint debt-funded investment mechanism, to replace Chinese lithium-ion batteries and upstream components in their electric vehicle supply chains and grid energy storage projects.

As a result, and fuelled by a massive subsidy programme, by 2030 Europe manages to supply all the batteries needed to satisfy its own demand for electric vehicle batteries, fed by more diversified sources of critical minerals and other inputs. This allows the EU to capture the battery industry’s massive potential value and it creates up to 3 million jobs. Relations with third countries improve, as the bloc invests in mining and production facilities abroad. However, China will likely consider economic retaliation, fostering existing divisions within the EU.

The actions

The European Commission levies import tariffs of up to 40 per cent on Chinese batteries. This effectively blocks them from the European market. Alongside this defensive measure, EU member states agree to

collectively shift into offence and establish a European Green Tech Sovereignty Fund, using joint debt to capitalise the fund with up to €350 billion. These steps complement those already taken, including the establishment of REPowerEU. Decision-makers use this array of funds to create a mix of incentives in form of grants, loans, tax breaks, and guarantees for new battery cell manufacturing plants. They mobilise new investment in research and development to close the innovation gap with Chinese manufacturers. The European Commission also extends the relaxation of state aid rules beyond summer 2024, allowing individual member states to additionally use their own money to fund battery projects. By 2030, this allows Europe to produce 100 per cent of the battery supply needed for projected electric vehicle production at home, made both by European companies and those from like-minded countries such as Japan and South Korea. Companies from third countries are thus incentivised not only to stay but also to expand their operations in the European market. Chinese firms are excluded from receiving these subsidies based on joint criteria on trustworthiness and sustainability in supply chains agreed at the G7 level. As a consequence, they cease expanding their investments in the EU.

Using the Green Tech Sovereignty Fund, the EU also incentivises European cathode producers and lithium refiners to expand their production facilities within the bloc. This enables it to meet up to two-thirds of its cathode demand and more than half of its refined lithium demand by 2030. With the help of the Critical Raw Materials Act, the EU produces 10 per cent of the rapidly growing demand for lithium domestically, with supply coming from mines in locations such as Portugal and Serbia. To source the remaining lithium needed, the EU negotiates critical raw material partnerships with like-minded partners such as Australia, whose output currently accounts for almost half of global production, and other countries, including Mexico, Brazil, and Ghana, whose lithium industries are promising and growing rapidly. The EU directs its Global Gateway investments towards supporting battery industrialisation in these countries. It ensures a strict adherence to environmental, social, and governance (ESG) standards, which makes these investments significantly more attractive than competing Chinese offers.

 

The trade-offs

Although the EU continues to be dependent on imports of critical raw materials and other items needed to make batteries domestically, it significantly de-risks the upstream supply chain by diversifying away from China. This reduces the supply chain risk. What import dependencies remain are now much more dispersed, reducing their weaponisation risk by China, at least over the medium term. Rules for input diversification also drive down the single sourcing of critical components such as graphite.

Through these massive trade interventions and subsidies, the EU also begins to mitigate the competition risk it faces from Chinese battery suppliers and successfully captures the massive potential economic value of this industry. It produces up to 1,200 GWh worth of battery capacity a year by 2030. This is enough to power the entire projected annual production of electric vehicles, creating up to 3 million jobs and capturing around €250 billion annually in economic value. In turn, this equips policymakers with the arguments to persuade the public of the economic benefits of a swift implementation of green industry transition policies.

On the downside, making nearly all of its batteries domestically means these become more expensive than Chinese imports, despite the large sums of money poured into the subsidy programme. Even with subsidies, setting up a new battery plant in Europe costs almost twice as much as it does in China.

Batteries make up a significant portion of the total price of electric vehicles, which means that this European self-sufficiency has a significant knock-on effect on the cost of European electric vehicles, making them less affordable for much of the population and slowing the path towards achieving transport decarbonisation goals. This puts the EU in the same situation as the US; Washington already excluded electric vehicles containing Chinese battery components from eligibility for tax credits, introduced new requirements around the sourcing of materials to drive diversification, and restricted Chinese investments in production in the US.

Relations with third countries hold potential, as the EU provides ample funding to boost mining and manufacturing abroad, in a more sustainable manner than Chinese investors. However, there is also a significant political risk the EU needs to grapple with. After being essentially banned from the European market, China does not hesitate to push Chinese narratives that paint de-risking as trade protection in disguise. This gains traction in resource-rich third countries, worsening their opinion of Europe further. A Chinese complaint in the WTO further boosts the Chinese narrative that the EU only defends the international rules-based order when it suits its interests.

Given the drastic nature of the EU’s new policies, China retaliates with punitive economic measures, imposing export controls on critical minerals, which severely constrain the European battery industry in the short term and actions in unrelated industries, such as luxury and agricultural goods. This impacts on different member states in different ways, fostering political division between and within European countries and pitting various interest groups against each other.

 

Batteries scenario 2: Do something … Keep China in

In this scenario, the EU allows Chinese firms to operate but takes steps to help European firms compete, through targeted subsidies for European firms and diversified content requirements for battery inputs.

The more limited financial measures are enough to ensure European firms’ survival, although their Chinese rivals still manage to capture half of the European battery market. Attracted by higher subsidies in the US, third country producers from South Korea and Japan opt for the American market. Diversified content requirements ensure some degree of upstream diversification, but the lack of significant European investment means that Chinese investment in Europe moves in. The Chinese batteries that are produced in Europe create some jobs for Europeans, but labour standards disputes lead to friction and strikes. The risk of weaponisation remains but is lower, as it shifts from the mere potential to deny supply to the potential to divest and relocate, which is more costly for Chinese firms. Internal European competition for Chinese investments leads to political tensions within the EU.

The actions

The EU is unable to agree joint debt mechanisms to support domestic production, forcing the bloc to rely on existing instruments, which are financially more limited, such as the Innovation Fund, the Recovery and Resilience Facility, and REPowerEU. It also extends state aid rule exceptions beyond 2024. This falls significantly short of the sums needed for full autonomy in comparison to the first scenario. Member states are mostly left to fend for themselves in trying to attract battery investments while simultaneously attempting to diversify supply and build at least some domestic capacity. However, the EU also recognises there is a cost to removing Chinese firms entirely from battery supply chains in Europe and,

with them, their leading position in cutting-edge battery technology and production processes. The bloc therefore decides to take a reshoring policy approach that does not exclude Chinese firms on trustworthiness or sustainability grounds. This enables Chinese firms to invest and build factories in Europe, although they are excluded from subsidy benefits on the grounds as they are already benefiting from subsidies in China. The EU and its member states attempt to counter Chinese dominance by specifically offering European and like-minded countries’ companies subsidies from the available limited instruments to create fairer conditions at least within the European market (in a similar fashion to Germany’s recent Northvolt investment). They also tie battery production investments in Europe to diversified content requirements, including for battery cells, refined lithium, and graphite in order to push back against further entrenching Chinese dominance on essential inputs in the battery supply chain.

Chinese greenfield investments in Europe rise further from the $7.6 billion in 2023, focusing on battery production and other upstream inputs such as refined lithium, anodes, and cathodes. This brings in a steady – and more affordable – supply of batteries for Europe’s electric vehicle industry. However, it also enables the effective import of know-how about efficient battery production processes and new battery technologies such as the lithium iron phosphate battery, in which China currently enjoys a technological lead compared to its European and Asian competitors.

The trade-offs

The targeted subsidies for European and other non-Chinese producers ensure they initially survive against their Chinese rivals. Increased competition in the European market, including from Chinese firms, also spurs European companies on to innovate and improve production facilities. By the end of the decade, 50 per cent of European demand for batteries is satisfied by non-Chinese companies, with the other half covered by Chinese firms producing mostly in Europe. Although half of the economic value of the battery supply chain is captured by Chinese firms, the job creation effect in this scenario is similar to the ‘Do everything’ scenario, although more Europeans are employed by Chinese firms. However, this results in labour standards disputes similar to those already seen with recycling company SRW Metalfloat, which was taken over by Chinese owners and experienced one of the longest strikes in German history in a sign of what is likely to come with more Europeans employed by Chinese companies in Europe.

While diversified content requirement rules ensure that some upstream diversification takes place, significant dependencies remain in the inputs to the batteries produced in Europe by Chinese and European firms. These dependencies are still vulnerable to becoming weaponised to exert political pressure on Europe. However, the high amount of Chinese greenfield investment in Europe is double-edged. On the one hand, the potential sunk cost in these investments is a deterrent to Beijing to use economic coercion against European actors, as this would risk the EU retaliating by seizing assets. On the other hand, it is a geopolitical liability for Europe to be dependent on Chinese producers of batteries for half of its battery demand and a considerable amount of intermediary inputs. Chinese investments could also exacerbate existing political tensions within the EU as some member states, such as France, Germany, and Hungary, disproportionately profit from Chinese investments while others end up empty-handed. And lastly, the more Europeans are employed by Chinese companies, the more leverage Europeans lose in negotiations.