Tariff tango - How will tariffs impact the energy transition?

The Biden Administration recently announced a range of tariff hikes on Chinese imports. Some of the tariffs will target goods related to the Energy Transition such as electric vehicles, batteries, and solar cells. President Biden said he was implementing the new tariffs to protect US workers and boost domestic manufacturing in critical industries. Anti-China policies have been popular with the US electorate, so its no surprise that both Biden and Trump have portrayed themselves as being tough on China in an election year. Following the lead of the US, the European Commission recently announced its own tariffs of up to 25% on Chinese electric vehicles (EVs).

Jonathan Waghorn, Sustainable Energy Portfolio Manager at Guinness Global Investors, has been analysing the electric vehicle market for years and notes that price competition in China has meant that electric vehicles are now cheaper than combustion engine cars. He states that “In China, the International Energy Agency (IEA) estimates that more than 60% of electric cars sold in 2023 were already cheaper than their average internal combustion engine (ICE) equivalent. However, electric cars remain 10% to 50% more expensive than combustion engine equivalents in Europe and the United States, depending on the country and car segment.” The Energy Transition is of strategic importance to China, and it has gained an advantage that is irking the US and EU.

The new tariff increases in the US for selected items are shown below.

Implications of the new tariffs

The impact of the new tariffs is not yet clear and will vary by sector, we discuss some of the potential impacts in the main sectors below.

Electric vehicles

The tariffs placed on electric vehicles (EVs) are the most extreme. According to the Boston Consulting Group, the tariffs will impact the following:

• US consumers: The tariffs are likely to impact EV adoption rates in the US. BCG research suggests that 70% of US consumers are considering buying an electric vehicle, but that future EV adopters expect both lower prices and increased performance and charging capabilities. The tariffs will buy time for US manufacturers to innovate and increase efficiency to bring prices down. The tariffs will be a big deterrent for US consumers considering the purchase of Chinese EVs. It is up to US automakers to fill the gap left by their Chinese counterparts.
• China's automakers: Given their scale, there are several avenues for growth available to Chinese automakers. Some players have facilities in Europe and the US that they could further scale. There are also options to double-down on emerging EV markets, including Southeast Asia and the Middle East. China’s automakers will continue to export, but the countries they export to are likely to change. It will be difficult for them to grow their exports to the US or Europe when the new tariffs are applied.
• US automakers: Once the new tariffs kick in, EVs manufactured in North America will be more cost-competitive than those imported from China. In the short to medium term, this will boost American EV makers. Longer term, US automakers cannot rely on tariffs to make their products attractive, they must continue to develop to ensure that their products are cost-efficient and ahead of the curve in terms of their technology.

Solar cells

US Tariffs on solar cell imports from China were increased from 25% to 50%. The last round of tariffs in 2018 failed to prevent the US market from being flooded with cheap solar imports from China due to the massive support being given by the Chinese government to solar manufacturers. It remains to be seen whether the new tariffs will have the desired impact. The tariffs aim to incentivise domestic solar cell and module production in the US. This would create jobs and strengthen the domestic solar industry in the long run, but its success depends on US manufacturers being able to ramp up production enough to bring prices down. One could argue that a stronger domestic industry will eventually lead to lower prices due to competition, but past tariffs haven't achieved this. The US solar sector has performed well since the announcement of the tariffs, indicating that investors believe this time is different!

Batteries

Tariffs on lithium-ion batteries for electric vehicles have also been increased to 25%. The impact of these tariffs will be like the direct tariffs on EVs. The long-term aim is to reduce reliance on China and build a strong domestic US battery industry. This would help EV adoption in the US and boost the industry.

Manager view

Will Riley, who also works at Guinness Global Investors as a Sustainable Energy Portfolio Manager, gave us his thoughts on the tariffs. “These tariffs represent one component of the support being offered to US sustainable energy companies. They follow the significant Inflation Reduction Act, a US$369bn direct funding and tax credit package, that is transforming the clean energy manufacturing landscape outside China. Since its announcement, over US$380bn of US-based clean energy investments have been announced (more than the prior seven years combined) across solar, battery and wind manufacturing chains. Already, this has created over 170,000 new jobs, predominantly in Republican states. The opportunity to invest outside China remains very significant at the current time.”

What is our conclusion?

In summary, the new tariffs will provide a boost to energy transition companies in Europe and the US. The sector has performed well in recent months, boosted by these new tariffs and a rate cut in Europe. For consumers, there may be some negative consequences in the short run due to fewer choices and a reduction in price competition from Chinese imports. In the long run, the tariffs could lead to a more diverse market rather than a market dominated by Chinese Government-backed imports.

As investors in the Energy Transition theme, we prefer to invest through an expert active manager who is better placed to determine the winners and losers from tariffs and other factors. It is our view that the energy transition represents a strong thematic investment opportunity, with or without tariffs. There is global policy support for the energy transition, electricity demand is surging due to data centres and other sources of demand, the macro backdrop is now more supportive and the sector trades at a favourable valuation after selling off during 2022 and 2023.