China: Europe's Green Problem

The EU, China, and the Issue of Strategic Independence

On Tuesday, February 14, 2023, the European Parliament gave its final approval to a proposal of the European Commission aiming to ban the production of combustion engine vehicles by 2035, as part of the FitFor55 environmental transition package.

Given the importance the automotive sector has in many EU countries, the measure immediately sparked controversy. No policymaker doubted its importance within the framework of reducing carbon emissions, but questions were raised as to whether the measure, which was not accompanied by a substantial package of industrial policy measures aimed at facilitating the transition, would cause more harm than good by erasing up to half a million jobs across the EU. As a result, the measure was blocked by a coalition of “sceptic” countries, composed of Poland, Italy, Germany and Bulgaria.

Another key reason why the measure was accompanied by much criticism, albeit less openly discussed, is the danger that such a transition would dramatically increase EU dependence on China, the largest manufacturer of lithium batteries in the world. As a result, by virtue of the lack of an appropriately-sized domestic lithium batteries industry, the EU automotive sector would become completely dependent on Chinese supplies for its production.

Chinese Market Control

This situation is not, however, limited to the production of lithium batteries. The PRC accounts for 63% of global rare earth mining activities, 85% of rare earth processing and 92% of rare earth magnet production. China, in essence, controls the global supply of precisely the resources, raw materials and components that are needed to transition from a fossil fuels-powered economy to a renewables-powered economy.

Europe does have rare earth deposits on the territory of its member states (such as a recently discovered deposit in Sweden). Their presence is not always accompanied by production sites, however: the mining process of rare earths is heavily polluting, and European governments would incur in heavy political costs, were they to push for national production. In fact, at the moment, no such site is operative in the EU. The result? Europe imports 16,000 tons of rare earth magnets per year, 98% of which from China.

Aside from rare earth materials, China also dominates the market for the majority of components needed in the manufacturing of renewable energy facilities, most notably as far as the photovoltaic industry is concerned. As things currently stand, China is responsible for 80% of global production of polysilicon, a raw material needed for every step of the photovoltaic supply chain. The PRC also dominates production in other parts of the supply chain: 96.8% of wafers (used to manufacture solar cells) is produced in China; 85.1% of solar cells are made in China, as is 74.7% of modules; 60% of solar panels are made-in-China.

In 2021, Chinese solar panel manufacturing capacity represented 84.0% of global manufacturing capacity in the sector, with Chinese demand for solar panels at 36.4% of global demand. European demand was at 16.8% of global demand, while European manufacturing capacity represented a measly 2.9% of global manufacturing capacity.

Furthermore, China is also a major player in the global supply of sulphates such as nickel and cobalt sulphate.

In the nickel refining market, China alone accounts for slightly less than 20% of all activities, but the cobalt refining sector is much more subject to PRC dominance. The supply chain of Cobalt, Bloomberg reported in 2018, starts in a number of countries of origin where the mineral is mined – these include the Philippines (5%), Cuba and Russia (both at 4%) and others, but primarily the Democratic Republic of the Congo, which accounts for 68% of global cobalt production, almost half of which is produced in mines operated by Chinese-owned companies (49% of the DRC’s production). The mineral is then sold to refiners, which turn it into cobalt metal, powder or sulphate – the first two are used to make superalloys included, among other things, in jet engines, while the latter is key for battery production.

Cobalt refining is overwhelmingly controlled by China: more than 80% of global cobalt sulphate production was made-in-China in 2017, as was more than 25% of cobalt metal production. In 2017, the aggregate production level of all cobalt refining activities stood at 104.85 thousand metric tons, 62.85 thousand of which were made-in-China – 59.94%.

Once again restricting this analysis to the field of essential components for EV manufacturing, we can see how China has managed to assert dominance over every part of the supply chain: according to an International Energy Agency report, China dominates the mining of graphite, controls more than 75% of lithium cobalt and graphite processing, between 70% and 80% of cell component production (70% ca. of cathode production and 80% ca. of anode production), accounts for 77% of global battery cell production, and accounts for roughly 50-55% of global EV production.

Implications for Europe

Europe, in essence, appears to find itself confined to a catch-22 situation: it wants to transition, but doing so means either opening polluting production sites or relinquishing strategic independence to Chinese economic influence in the name of ecological sustainability, neither option being particularly attractive.

A way out is, however, possible. State-led investment in the sector can be part of the solution, and the European Raw Materials Alliance or ERMA has already identified 14 projects across the value-chain and Europe that could supply 20% of the Continent’s demand by increasing domestic production to 7,000 tonnes for a total investment of €1.7 billion.

Additionally, Europe must step up its Africa game: despite being an underexplored Continent, Africa’s rare earths sites are incredibly productive, and developing a strategic partnerships with the Continent’s main players in the field is crucial in the direction of securing European strategic independence in the long term, while also countering Chinese influence and fostering economic development in Africa at the same time. The same can be said about Latin America, whose estimated rare earths reserves account for 40% of the world’s total.

There is, however, one “small” problem – the sheer monetary cost of localising clean energy supply chains. According to Bloomberg, the investment needed to establish the production capacity necessary to meet domestic clean-energy manufacturing demand in 2030 will be $113 billion in the United States and $149 billion in Europe. This estimate includes all parts of the supply chain – battery production, PV manufacturing, metal refining and electrolysers activities.

The cost will most likely be significantly lower, as these estimates assume that both Europe and the US will aim to satisfy domestic demand with entirely domestic production, and also accounts for non-EU countries in its estimate for Europe. However, these costs can be scaled down rather quickly to give a cursory idea of the cost of establishing mainly, not entirely, domestic supply chains: even if Europe were to aim for 50% of its demand being met by domestic suppliers, this would require investments of at least $70 billion. It must also be noted how Bloomberg’s estimate does not account for the establishment of metal mining operations, which would also come at a significant cost, with estimates of a single mine costing between $200 million and $1 billion to develop and operate.

Brussels’ Strategy

Since coming out with the plan to ban combustion engines starting in 2035, the EU has been trying to develop what it calls the “Green Deal Industrial Plan”, aiming to develop precisely the type of production capacity that Europe needs to wrestle itself free of China’s strategic influence.

This Industrial Plan has four key pillars: establishing a predictable and simplified regulatory environment, granting faster and easier access to funding, enhancing skills, and establishing open trade for resilient supply chains.

To facilitate open and fair trade, the EU aims to continue developing its already vast network of FTA’s (Free Trade Agreements) to support the transition. To enhance the skills necessary to support and facilitate the transition, the Union foresees the creation of “Net-Zero Industry Academies” to up-skill and re-skill workers in strategic industries. Finally, to enable easier and faster access to funding, the EU has revised both the Temporary State Aid Crisis and Transition Framework, and the General Block Exemption Regulation considering Green Deal objectives.

However, what really matters in the race to establish European strategic independence in light of an energy transition, are the Net-Zero Industry Act and the Critical Raw Materials Act. At time of writing, neither has been presented yet, but we already know some of the details of these plans.

At the moment, the EU imports the vast majority of all of the raw materials which are critical for an energy transition: China supplies 99% of the EU’s demand of rare earths, 98% of its rare earth permanent magnets requirements, 93% of its magnesium imports, as well as around 50% of Graphite and 17% germanium demand; the EU also imports heavily from Chile, Turkey and Canada, as well as the UK (from which Europe sources 98% of its scandium).

To change this, the Critical Raw Materials Act aims to supply from domestic sources 25% of the Union’s consumption of raw materials, with 10% being supplied by domestic production and the remaining 15% being supplied by domestic recycling activities. Additionally, the Act calls for domestic refining activities to supply 40% of all EU demand for raw materials. The Act also seeks to diversify supply to establish a 70% import ceiling for any given supplier of raw materials by 2030 – meaning that no foreign supplier should account for more than 70% of the Union’s imports of any given raw material. The Critical Raw Materials Act calls also for the establishment of a Critical Raw Materials Board, which will work together with the Commission to identify strategic projects in the field. Finally, the Act seeks to reduce the time it takes between the beginning of work on a mining project and the beginning of operations of the mine from the current 10 years to at most two years, if the project is deemed strategic.

The Net-Zero Industry Act, or NZIA for short, addresses the problem from the other end of the stick: whereas the Critical Raw Material Act seeks to establish domestic supply chains for raw materials, the NZIA aims to bolster domestic production of clean energy infrastructure. In its initial draft, the Act sought to have at least 40% of demand in specific sectors such as solar, wind, and batteries be satisfied by domestic producers; to be more precise, it requires domestic manufacturing capacity to be able to satisfy, by 2030 (art. 4):

1. 40% of annual solar PV deployments,

2. 85% of annual wind turbine deployments,

3. 60% of annual heat pump deployments,

4. 85% of annual battery deployments,

5. And 50% of annual electrolyser deployments.

The current version of the Act, however, simply calls (art. 1) for “manufacturing capacity in the Union of the strategic net-zero technologies” to approach or reach “a benchmark of at least 40% of the Union’s annual deployment needs for the corresponding technologies necessary to achieve the Union’s 2030 climate and energy targets”, without detailing more specific targets. The Act also defines so-called Net-Zero Strategic Projects – projects aimed at increasing the resilience and autonomy of the Union’s industry (the original draft specific this would only apply to sectors where the EU is more than 80% reliant on either a single country, or other countries with which it has no FTA, but this has been dropped in the Act’s final version). Another objective of the Act is to reduce the time needed to grant permits, by establishing single national authorities responsible for facilitating and coordinating the permit-granting process for net-zero technology manufacturing projects. Furthermore, the NZIA seeks to create the afore-mentioned Net-Zero Industry academies; Net-Zero Industry Valleys, localised national clusters of net-zero industry businesses, have been dropped from the Act in its final version. Finally, the Act establishes the Net-Zero Europe Platform, composed of representatives of the member states and of the commission, with the aim of assisting both the Commission and member states with technical and logistical support within the framework of a European green transition.

Future Challenges

Europe’s objectives, as set by the Net-Zero Industry and Critical Raw Materials Acts, are clearly very ambitious, both in their scope and in the actual targets being set.

However, questions remain as to the feasibility of these targets. For instance, the Net-Zero Industry Act does not include nuclear power in its list of supported energy source. Experts on the subject, such as Italian MoD Supply Chains and Raw Materials Councillor Giancarlo Torlizzi have been critical of both this decision and of the act in general: on the one hand, the ambitious goals set by article 4 of the NZIA risk being too ambitious and unfeasible; on the other, the EU not including nuclear power in its transition strategy risks undermining any serious effort at decarbonisations, as a stable energy source like nuclear is a must for a proper energy transition.

Other questions also remain with regards to the NZIA’s compatibility with WTO regulations, and the alleged haste with which it was put together. The EU was taken aback by the US announcement of the Inflation Reduction Act and its targets, and some argue that the NZIA is more of a reaction to its American counterpart than a serious, well-thought-out plan.

The Brussels-based Bruegel think tank, for instance, argues that the NZIA has three critical issues. First and foremost, it will harm decarbonisation and green transition because the pace of the project, which aims, for instance, for a four-fold increase of domestic PV panel production (current EU production satisfies 10% of domestic demand) in most likely slightly more than 5 years (considering the end of the legislative cycle) will make the cost of transitioning higher and therefore the transition less quick. Secondly, Bruegel argues that the Act, despite making investment in net-zero industry projects easier, does not even attempt to solve the underlying issues of the European market which hinder competitiveness. Finally, its clear protectionist inspiration will damage EU relations with partners and allies that could be critical in supporting Europe’s shift away from China such as Japan, the US and South Korea, as well as emerging third-world partners that could provide alternatives Chinese imports such as African and South American countries.

With regards to possible incompatibility with WTO regulations, meanwhile, the Act has come under fire for its “buy European clause in disguise”, as Euractiv puts it. In essence, unlike the American IRA’s explicit domestic content requirements, the Net-Zero Industry Act directs countries and public authorities to consider “a tender’s contribution to the security of supply”, which, among other things, includes the proportion of the product originating in third countries. Reading through Brussels’ bureaucratic lingo, this means that public authorities will need to favour domestic suppliers – what amounts to a Buy European clause, in all but name.

The EU’s plans are ambitious, but so was Icarus – Brussels needs to carefully consider that economic planning must be squared up to the realities of geopolitics and economics. There can be no real energy transition without European strategic independence, but there can also be no real transition without pragmatic policies and realistic goals.

Whether Brussels can course-correct and find that crucial balance will be key to the future of both the bloc and its member States, both economically and politically.