Positive January news came from an unlikely quarter in recent weeks – Germany. The Berlin government already has its challenges due to a disastrous energy policy bet on Russia and a growth-killing constitutional ban on government deficit spending. Add official confirmation of a GDP recession to the sclerotic mix and you would half-expect a fresh raft of headlines declaring Berlin’s return to 1990s “sick man of Europe” status accompanied by euro-sceptic fears of a potential implosion of the European single market ‘experiment’. But, no. The most significant headline of recent days put Germany and Europe at the forefront of moves to meet a challenge of global rather than national budget dimensions. The climate crisis is not new but financing the industrial revolution and new technologies to remove fossil fuels from the global economy has required new thinking.
Clearly, providers of capital funding require a degree of certainty and visibility. But… these start-up projects and their financial models can’t fully envisage the future. Nor, is there any certainty about whether these new technologies will be commercially viable or not. That makes it very difficult to structure the financing of projects with huge up-front capital needs. However, market demand and market-fit can be hugely helpful as a confidence-builder for providers of investment capital. So, where better to start than with one of the planet’s biggest industries, the auto sector. The shift to electric vehicles (EVs) continues to exceed analyst projections and is expected to hit the critical 20% market penetration threshold globally in 2024 (Source: HSBC). The sheer pace of EV adoption has exposed two potential growth hurdles;
i) Charging infrastructure needs to catch up with consumer buy-in and
ii) The manufacture of batteries to power EVs is too dependent on China (56% of global total).
In particular, EV battery manufacturing capacity has become a critical focus for European and US governments. And, it’s at governmental level where the new thinking is emerging.
The cleantech research team at Buck Consultants estimates Europe alone needs to build 250 battery manufacturing facilities by 2033. Meanwhile, the US and the Biden White House has recognized a once-in-a-generation opportunity to reinvent the manufacturing base of the US with legislation (the IRA and CHIPS Acts) to allow Federal funding assistance for multi-billion dollar projects building renewable energy infrastructure, battery gigafactories and economy-critical semiconductor manufacturing fabs. Furthermore, Covid-19 and Ukraine have focused minds on economy-critical supply chain disruption which, in turn, has catapulted EV batteries very close to the top of national vulnerability lists.
This has resulted in the US and European governments competing for battery gigafactory construction projects. But… Europe up until recently had strict rules on how governments can use state-aid to lure big investment projects of private companies and potentially breach competition and single market (EU) protections. Until now. Under a new EU state-aid framework the German government last week was able to commit €902 million of funding to Swedish battery manufacturer, Northvolt, for the construction of a facility in Heide, located in Schleswig-Holstein. By creating funding flexibility, the EU were able for the first time to ensure Germany secured the Northvolt project AND prevent the probable migration of the factory to the US. This hybrid public-private financing model is a ‘must have’ given the huge up-front cash costs of these projects. Note also the cleantech reality that traditional taxation offsets and incentives on future profits don’t get projects built. In fact, there is a third unique financing leg to these cleantech projects, and Germany again is playing a prominent role.
In a recent Wall Street Journal article, Ed Ballard highlighted how two Swedish companies had to reconfigure the financing model for green start-ups. The traditional build-it-and-they-will-come strategy was way too risky for the future visibility and technology reasons touched upon earlier. So, two private investors – Harald Mix and Carl-Erik Lagercrantz – spotted the opportunity to de-risk these projects by lining up customers first. This was the critical third leg of the financing model which enabled these founders of battery maker, Northvolt, and green-hydrogen steel manufacturer, H2 Green Steel, to raise money.
Now, for another German starring role…. the first customers to pre-purchase product from Northvolt and invest in the project were German auto giants, BMW and VW. In the case of H2 Green Steel, its first customers to commit to buy green steel at a 25% premium to normal steel market prices were another German auto icon, Mercedez-Benz, and VW-owned truck maker Scania. Note these companies have invested in H2 Green Steel as well as ordering product. This is an interesting twist on the not-so-new practice of customers committing in advance to power supplied by capital-intensive renewable energy projects. In the case of Northvolt and H2 Green Steel the interests of all investors, government/state and private, are aligned with committed future customers. Arguably, market demand is more visible. Indeed, Harald Mix, one of Northvolt’s founders, has said, “The demand is becoming predictable”.
In a European context, the prospect of 250 more battery factories to be built further demonstrates that demand. However, Europe’s cleantech ecosystem features a few extra drivers which add to investment visibility and opportunity. Prices of credits in the EU emissions (CO2) trading system have been rising in recent years prompting companies to model the potential growth in the cost of meeting emissions targets. Furthermore, the EU’s new import tax on carbon-intensive goods (Carbon Border Adjustment Mechanism) entering the EU was a further incentive to upgrade company supply chains using non-EU steel, cement, fertilizer, aluminium, electricity and hydrogen which previously incurred lower carbon costs. All has potentially changed since the new regulations became law on Nov 1st 2023. For H2 Green Steel the timing of CBAM was excellent.
The sale of 40% of H2 Green Steel’s early production to customer investors underpinned the largest private equity funding round (€1.5 billion) completed in Europe in 2023, and we will be watching closely to see who participates in a further €3.5 billion debt funding round scheduled for later this year. In fact, at time of writing, news is breaking that 24 commercial banks plus the European Commission – via the European Investment Bank (EIB) – have just completed the largest ‘green loan’ raised in Europe to date; a whopping $5 billion of funding for Northvolt’s Swedish operation in Skellefteå. Clearly, for risk-averse lenders, the aligning of an equity risk buffer across public/state, private and customer investors plus emission credits and taxation incentives is a unique selling point for these European cleantech projects and many more to come. Be under no illusions, the “land-grab” for investment in the global decarbonisation race is very real. So, despite the downbeat front page economic headlines, consider Germany’s financing of the Northvolt Heide project as a significant positive illustration of Europe’s determination to strongly compete for investment capital.