How CFOs can navigate industrial policy and the energy transition

Speaker A: You're listening to the EY Better Finance CFO Insights Podcast, a series that explores the changing dynamics of the business world and what it means for finance leaders of today and tomorrow. I'm your host, Miles Courson. In this episode, I'm delighted to hand the mic over to my colleague Brian Tomlinson, an EY Managing Director focused UH, on esg, for a special conversation on the intersection of sustainability strategy and finance. He's speaking with Jan Rosenau, professor of Energy and Climate Policy at the Environmental Change Institute at the University of Oxford. So let's join their conversation.

Speaker B: Miles, thank you so much for the introduction. Delighted today to be here with Jan Rosenau. The context for this conversation is that we live in a time of extraordinary demand for energy, and a few secular trends are driving this. We have this imperative to electrify everything that can be electrified as part of this broader effort to decarbonize our, uh, economies. We also, around the world, have rising living standards, which are causing more people around the world to use more energy. We also have this increasing trend for focus and use of, uh, artificial intelligence AI, which has a huge demand for energy. So the question is, how are we going to meet that demand, and how are we going to then also meet that demand while ensuring that that demand is met with decarbonized electricity? Now, part of the answer to that question is actually one of the big developments in our economy and in our societies over the last decade, which is the return and rise of industrial policy, and specifically in this instance, industrial policy for decarbonization. It really is one of the big themes that we're facing. Obviously, industrial policy is not new. Governments have done industrial policy to achieve particular outcomes and elevate particular technologies, protect particular industries in prior decades. One of the things that's just very notable is that, uh, across the world, using a different set of toolkits, different series of ambitions, you can see that governments are pursuing industrial policy in a really targeted way to meet the kind of imperative of decarbonization. So there's quite a variety there. And for this conversation, it's really important for finance executives, CEO, CFO people who are thinking about the strategy of their companies to understand the implications for their companies of the different types of industrial policy that exist in the different geographies and markets in which they're operating. So with that brief overview. Yeah, and again, thanks so much for being with us today. I wanted to get your sense of the industrial policy for decarbonization landscape. I think we see a variety of different policy approaches being Taken. What are you seeing when you look out over the landscape of industrial policy?

Speaker C: Thanks, Brian. And I think you're absolutely on point that this is a fairly recent development that we're seeing. I mean, industrial policy is not new, but I think what is new is that we now see this being applied increasingly to the clean energy space in different varieties, some more successful than others. And that ranges from giving explicit financial incentives for factories to be opened in a particular location. But it could also mean that you incentivize the demand side, so you incentivize the uptake of these technologies in the industrial sector, um, in the building sector, transport sector, to drive the supply chain to particular locations. And it depends really where you're looking. In Europe, giving direct subsidies to industries to set up shop is not something that is common because it's prevented by regulation. That is different in the US where you have a much stronger history of giving direct subsidies to manufacturing to make sure it's locating in the US and it is also different in other parts of the world. So there's some real diversity. But I think there's a commonality in that governments pay much more attention to industrial policy in the energy space. I think partly because of energy security considerations, partly because of some of the geopolitical tensions that we've seen in recent years, and I think also partly to be ahead of the innovation race that we're seeing in the energy space. Given the pressures that you mentioned in your intro, that rising energy demand that we're seeing, the pressure being put on the energy system from a whole range of emerging sectors.

Speaker B: And there are a series of intersections here, I think, aren't there, uh, between geopolitics in a world that is increasingly becoming more fractured and more unstable, the way in which the green transition creates, I think, a new set of dependencies, potentially. This is some of the themes that we saw the EU talking about, for instance, in the Draghi report to note that, well, we have to decarbonize and compete, but actually in order to decarbonize, there are also a variety of materials and industries that we need to retain and we need to have access to. And that actually creates industry by industry, a whole set of complications. I know you've talked a little bit about that before, about this notion of the transition creating its own dependencies and vulnerabilities. Could you talk a little bit about, about that?

Speaker C: Yeah, happy to. The current setup is that most of the energy consumed, about 80% or so, is fossil fuels, and they get shipped to those countries that need to Import them. And that's been the energy world for a very long time. But we're now moving into a space where a lot of the new technology is technology that no longer requires a steady stream of fuel. So if you take a solar panel, yes, you manufacture it, you ship it, and you install it. But once it's installed, there's very little maintenance required and certainly no requirement for any fuel delivery. So that's a very different type of dependency. It's a dependency on equipment rather than on fuel, on energy carriers. And I think that is being recognized in some of the discussions that we now are seeing. Where you mentioned Europe, Brian, where there's dedicated efforts to at least set up some capability in Europe as a means to have an insurance policy. What if that supply chain gets disrupted? I think that's one issue. The other one, I think is access to critical raw materials, which are dominated by certain places around the world in the supply chain. And that provides a, uh, potential supply risk. So diversifying the supply of those critical raw materials, I think in addition to being able to manufacture some of the critical technologies, are both strategies that I see being adopted. It remains to be seen how successful, though it's still early days, and so far most of the equipment that we build is not manufactured in Europe and is being imported. You could look at many other places around the world too, where the same principles will apply. It's a fascinating transition, I think, in the way that it will really change the trade flows. It will mean a, uh, diminishing of trade flows when it comes to fossil fuel exporting countries shifting towards trade flows in terms of equipment exports. And I think that's a story that's just unfolding. We don't know yet where that will end, but it will certainly mean a very dramatic shift and will mean some countries will probably lose out under that regime and other countries will win. And it just basically redraws the energy security landscape quite fundamentally.

Speaker B: Very much agree with that. And I think that plays into also this broader point that the transition to a low carbon economy is one about economic transformation and that that is going to have very significant implications around geopolitics and as you say, trade flows, but also for many economies. This is an, um, extraordinary economic and business opportunity in a variety of different ways, whether it's creating and rolling out new technologies to meet the needs of the transition, whether it's transitioning existing businesses to survive the transition. There's a huge range of opportunities in this moment of significant disruption of our energy system as we try to transition to a low carbon footing? Are there examples of particular industries or particular interventions that you'd like to surface to kind of elevate some of the themes that you've talked about so far?

Speaker C: Just one more point on the previous conversation that we had. I think what this ultimately does is that in my view, the exposure that you have as a country once you have transitioned is significantly diminished. If you are a net importer of energy right now, and most of your energy needs are served by importing large quantities of fossil fuels, and if you then switch to a situation where you basically use a lot more electricity that's being generated with clean energy technologies, yes, you still need to replace some of the equipment when it breaks down, and certainly when you scale up. But once you've reached a point in the transition where you basically moved away from a lot of the technologies that consume molecules and move to a situation where you consume electricity, the only dependency is to replace equipment that breaks down, that needs to be renewed or maybe repaired. And that is a different dependency compared to one where you have a continuous dependency on importing vast quantities of energy. So I think that's an important qualification of how the dependencies will change. You asked me for specific examples of how this is playing out. Let's take the example of industrial heat pumps, which is one of the technologies widely seen as critical for decarbonizing industry. Currently, we have a relatively small number of suppliers. They're highly concentrated in Europe. And this is a market that can only grow, given the size of the challenge, only about 5%, perhaps a bit less than that even of industrial energy use is currently electrified. And if you think about the potential to electrify maybe 40% or so with just with heat pumps, that's the temperature range that is possible. That market could dramatically grow over the next 10, 20 years. So the question then becomes, where will that market be located? Where will it be headquartered? Who would be the supplier? And that creates, I think, a tremendous opportunity. Remains to be seen who lands that opportunity. I mean, there's now an auction and European level for heat electrification in the industry sector, where companies can basically bid and the lowest cost per ton of carbon avoided gets to be the winner in the auction that may succeed. It's very early days. They just started, and I think the deadline is in February, and then we're going to see which projects succeed. There are similar incentives in other places around the world, but it's a very early stage of the transition. I think that's, uh, going to be fascinating in the industrial decarbonization space, where perhaps it's less clear where the supply chain would be located compared to other markets. Batteries, solar pv, where it's pretty clear where production takes place. And that may not necessarily shift. I think it's probably unlikely to shift significantly in the coming years. But there's a lot of other sectors where technology is much more emergent, and that will be interesting to see to what extent that will locate in other regions. And I think actually there is reason to believe that it might, because it's more complex to decarbonize an industrial side. It's not so easily standardizable and modularizable like you can do with solar PV or batteries. And therefore I think there is a reason to believe that at least some of that supply chain will locate in a different location closer to where the demand is.

Speaker B: To me, that points out one of the absolutely critical features of this, which is just the specificity of the type of interventions that are required on a policy basis to potentially accelerate the transition, depending on which industry, which technology, which outcome you're looking at. You're talking specifically about the decarbonization of industrial heat and a specific intervention by the regulators to essentially enable that transition in the eu. Just gives you a sense of how specific this really is. And I was thinking equivalently about some of the conversations around the transition for the car industry, where if you look there, uh, if you have a clean mobility focus, there's so many different things that you need to do to enable the transition from incumbent internal combustion to EVs where you've got, okay, well actually you need your manufacturers to have access to not unreasonably expensive energy to just maintain that baseline of competitiveness. You then have to have the charging infrastructure for the EVs because you're replacing an incumbent infrastructure that's based on fossil fuels to one, um, that's based on electrons. So you need tools to elevate that infrastructure. And then you need, to your great point, I thought just about going from a reliance on fuel inputs to a reliance on essentially materials and technology in an electric vehicle. You then need what are those materials that are going into the battery? And so you need something to focus on the battery. And then potentially you have can we use public procurement to prime the pump to ensure that at least as a matter of fact, public spending governments are buying EVs and not internal combustion engines. But it just shows you that there's this policy stack to achieve these impacts industry by industry. And it really does. And the impact and the policy toolkit varies on an industry by industry basis. And the geographic impacts of that also will depend on. Are uh, you the wrong side of a tariff barrier? What are the other geopolitical conversations? And I just think that communicates that level of sophistication that companies are going to have to have to navigate this space and to capitalize on it from a commercial perspective.

Speaker C: Yeah, 100%. And I think in a way policy stability and clarity, directional clarity, will matter ever more than it ever has because these are big investments and companies will think very carefully where they make that investment. So I think that is an overlooked aspect. The supplement is not the perfect policy. That's the most important. If you know there's going to be a, uh, change in government in three or four years time and they're going to reverse everything that's just been implemented, that's not particularly helpful if you want to invest in assets that have a lifetime of 20 or 30 years. So I think policy stability is clearly one of the key preconditions to attract this new industry. I think the other aspect is the economics. We know that in places that have economics that just make it a no brainer to adopt certain technologies, you don't need a lot of policy. You can let the market do its thing. And that's kind of a situation where you want to end up, I think personally, because the alternative is that you have to keep pumping subsidies into a sector to adopt a certain technology. And that's first of all expensive and governments don't like to spend that much money. And also there's a reliance then on political stability and having the same grant program or the same tax rebate scheme being available in five years time. And it may not be, we know that because governments keep changing the conditions or even roll back some of these policies. So getting the underlying structural economics right. And by that I mean energy prices, the cost of electricity in particular, if that is very high, because we lump lots of taxes and levies and policy costs onto electricity, it's a lot harder to make the case to electrify. And in fact that's what we're seeing when you look at the deployment of maybe electric vehicles or heat pumps, where we have pretty good data, there's a clear correlation between having really low electricity prices compared to fossil fuels and the deployment of these technologies. So that to me seems a key ingredient in all of that, which is still not prioritized enough, I believe. And that's one of the areas where I would hope we have more consistent policy across different regions because the evidence is pretty Clear we know what to do and how to do it. Delivering it is hard and politically not always easy. But I think that's one of the areas in the next five to ten years that, uh, we have to take a much harder look at what are the underlying economic conditions that enable these technologies to thrive in the absence of subsidy.

Speaker B: I think one of the problems that we've seen, particularly over the last couple of years, is a significant increase in the volume of overall policy uncertainty. If you look at a lot of the public policy uncertainty indices, there have been huge swings. Now, many of those are around geopolitics, trade policy, other political disruption, and so on. But I think the point you make is absolutely critical, which is actually there are aspects of this transition that will take a significant amount of time to flow through, where you're often replacing high value incumbent assets with a new set of assets, moving from GHG intensive assets to renewable assets. And in order to do that, you need stability around the economics of that transition, the policies connected to that transition, because from a corporate perspective, you have to be investing in that transition. It has to make dollars and cents sense. And in order to do that, we need policy stability, which I think is just a core point for the regulators and policymakers to understand. So I did want to talk about the corporate intersection here because we've talked about that concept of dependencies and vulnerabilities. Many companies operating, for example, in manufacturing and other industries may have significant demand for energy that exposes them to the swings in energy costs. Many companies need a variety of materials that might expose them to tariff barriers and other geopolitical vulnerabilities. It feels like there's a pretty complex picture here for companies to navigate, which extends the, from the viability of our products in a low carbon environment, the length of our supply chains, where do they start, where do they finish? What does that expose us to? And that point around the access to the energy that we need. If we start to just think broadly about companies facing this picture of a secular accelerating transition, how can companies start to think about capitalizing on the themes of the transition?

Speaker C: There's a whole range of issues. I think if you are a manufacturer of incumbent technology, that could be one situation, or you might be an adopter of clean technology. I start with the manufacturers first. We've seen very different responses, haven't we, to the challenge that the transition clearly is where some have very early on pivoted and diversified and embraced the opportunities that are, uh, on offer. When you look at the transition, there are quite a Few companies that have done that very successfully and established a new, more diversified model that sets them up pretty well for what's to come. At the other end of the spectrum, I'm also seeing companies that completely resist the transition and will just do everything they can to keep the status quo alive, whether that's political lobbying or whether that is aggressive marketing of their products. And I think in the long run that will backfire. If we're serious about the transition, those companies, we know that from past transitions we lose out and we know that from other sectors. Look at the telecoms sector for example, or video. You could look at a whole range of sectors where you see that playing out. Not to name any particular companies, but you will see how some companies have been extremely skeptical and even very public about that. They don't believe this is ever going to happen and therefore they will maintain their existing business model and in some cases gone completely bankrupt and um, no longer exists today. So there's some serious, I think risks and I think a smart strategy is one of diversification and not just because you own assets. To believe because of that things will just keep going as they have in the past. I think that's a high risk strategy. I think for the companies that are uh, adopters of new technology, there's a kind of purist. We have to do everything we can to get to net zero tomorrow. That's an expensive endeavor. I mean if you think about an industrial facility, they may have multiple processes, multiple stages of production. I think it's a hybridization approach that makes most sense for most where you maybe part of your equipment is close to the end of its life, you replace that first and you do it in stages. Because the good news is we have some time. It's not that this has to happen overnight. And so identifying what are those low hanging fruits that really make sense today, where there's a strong economic case. And also look at efficiency improvements. I'm always astounded by how little attention efficiency is getting in the discussions around energy security or the transition overall decarbonization, innovation. There's good evidence that even today a lot of companies could save 15%, maybe even 20% just by optimizing how they use energy. And that's a really good starting point. So it's not always necessarily the shiny new thing or the expensive new kit. It could also be to just take a really hard look at how you use energy and whether you can optimize that. And I think that needs to be on the table actually. In fact, I think it shouldn't just be on the table, it should be the first thing that you look at as a company if you want to decarbonize. Is there something we can improve in terms of the efficiency of energy use?

Speaker B: I really like that point about tying back this energy transition to prior technological transitions that we've had in the past. And the question therefore is at what pace will that technological transition take place? You've seen that from whether you were, uh, living in a New York tenement building in the latter part of the 19th century, early 20th century, and you were wondering when your light was going to transition from being provided through gas to electricity. We've been through these transitions before. At what pace does it take place? And for companies just noting again that there is potentially a, uh, stack of solutions available to you and those will have a variety of cost implications and time horizons. So there might be short term moves you can make to, as you say, improve your energy efficiency within the incumbent ways in which your business operates. But then there may be a series of longer term, higher cost interventions to transition your core business to a new footing. And then the question is for companies, what are the potential incentives, grants, loans, others in the geographies in which you operate to potentially accelerate that transition? We've seen, or to rather make investing in that transition economic. Because I think one of the interesting things we've seen, for example in the EU is that you've had incumbent companies in the automotive sector. Much of their cash flow continues to be derived from selling internal combustion engine vehicles. But a lot of their, uh, capex is directed to changing their industrial infrastructure to enable it to produce electric vehicles. And so you see an industry that's significantly in transition and it's just, well, what is the pace of investment and what is the pace of uptake by governments and consumers of these newly calibrated products? It's a complex picture for companies to navigate, but I think there are a huge range of opportunities available.

Speaker C: We're seeing that already with the car market is an interesting one where we now have significant market share companies that export into regions where they previously did not have a market share at all. And that is already a, uh, fast changing landscape. And I think like the discussion that we're now seeing, where should we go a little slower on electrification of transport? Maybe in the short term that will allow you to continue selling internal combustion engine vehicles. But if at the same time your competition is just getting better and better in what they manufacture and cheaper and cheaper and the market as a whole is shifting, I Think that's a risky strategy. Again, maybe it will pay off in the short run, but certainly not in the long term. And there's a real risk that if you don't build that expertise, capability, brand, that there will be others who do. I think we underestimate often how fast these things can change. I'm always astounded by what people think, how long things take to change in the energy space. And then when you actually look at how fast these things can happen, and let me give you maybe just a couple of examples. I mean, look at Nepal. Nepal has now something like 70% electric vehicle share of new sales. That's not Norway. And Norway is a wealthy country. Nepal is not a wealthy country. That happened over the course of just a few years. And it's a small market, you may say, but it shows just how quickly things can change at the local level. Or take Pakistan, again, not a wealthy country. And the adoption of solar last year that we've seen, that made headlines around the world, that was unexpected. Not driven by policy, but driven by market forces. People voting with, uh, their feet. And I would not be surprised if we see more and more of these examples in the future in unexpected places. I mean, African countries have just started on that trajectory. When you look at the deployment of renewables in Africa, you see a lot of countries now that are scaling up which previously have not shown significant interest because of the high cost of capital. And that's really changed the situation entirely. So I think the pace of change will surprise many of us, including those who are on the more optimistic side of things, like myself. And that makes me hopeful. But it also creates, of course, risks for those who believe that it's not going to change fast and will all be very slow and painful. I don't believe that is going to be the case.

Speaker B: Yeah. And I follow your work looking at things like decline in the cost curve on solar energy over the last ten years or so. Uh, and just in so many geographies now, it is both the fastest new energy to install and then the cheapest energy to operate. Which I think is part of that story in those other, uh, jurisdictions that you talked about. And I love that point about, in the context of a large technological transition, the concern about potentially companies being left behind when there is new technology rapidly being deployed, new techniques rapidly being deployed, products becoming more sophisticated and lower cost over time. And there's a danger if companies aren't tracking those trends in their industry. There's a danger that you may get left behind. And then I think Again to, uh, uh, many of the points you made so far. There is potentially for a lot of companies, I think, a resilience benefit here. We've seen many companies who will identify some of their primary competitive pressures, depending on the geography in which they operate is, you know, the cost of the energy they use. And rapid installation or access to additional green energy, whether it's through solar, wind or other sources, is a potential way for companies to lower the cost and increase the resilience of their energy supply. So I think on an industry by industry, company by company, business model by business model basis, there are a range of approaches that companies can take here. And part of that is about understanding the policy objectives of the jurisdictions in which they operate. So if you operate in the eu, you need to know the outlines of the Clean Industrial Deal and the type of money that might be available to you through things like the Horizon Fund and so on. Like what are the objectives that the EU is trying to achieve. If you're in Japan, you need to know the outlines of the gx and if you're obviously in the us, it's a complex, uh, picture. But the transition from IRA to one big beautiful bill, you need to understand the incentive stack that sits in there and how that might be relevant to or impact the investability of technologies that you're looking at in your industry. We've covered an enormous amount of ground. I really appreciate the time. Are there any closing thoughts for the themes that we've talked about on industrial policy for decarbonisation, any takeaways that you might have for some of the companies and financial executives that we'll have on the line?

Speaker C: I mean, maybe I use just a short anecdote to close us off. So I went to Hungary in October and we went to a factory that had just installed electro thermal storage, which is a technology that is also being pioneered by some of the companies in the us, but also from other parts of the world. And the interesting facts about that particular installation was that it was unsubsidized. The first question I asked, how did you first fund this? And no subsidy. And it's working because they have a intermediary, a company that optimizes that facility using low cost electricity on the wholesale market. And the customer doesn't even own the asset, they just pay for what the heat they're getting from that electro thermal storage device. And the company that owns the asset operates it remotely using sensors and AI and what have you. And for me it was a really interesting symbol of what might happen going forward. Where you actually have solutions that are readily deployable today with no subsidy, if you're creative enough and you think through what those options might be. So it doesn't necessarily have to be a cost. It can be an investment that can actually deliver, uh, savings and provide an upside, even in the absence of policy. And again, that's something that gives me hope that this industrial policy, this transition to a different, transformed industry is possible. We just haven't done it at scale yet. But there are nuggets like the one I just mentioned that could be scaled. And I believe if we had the same conversation in five years, again, Ryan, we would probably have a very different world that we could look at where a lot of this has already happened.

Speaker B: That's a great optimistic note for us to end on. Yeah, and I really appreciate the time and the expertise you have demonstrated, uh, talking about this topic. And this is a picture where we're seeing huge opportunities for companies. Resilience, cost avoidance, cost reduction, product innovation. But the availability of those will really vary, industry by industry, sector by sector. And to that point that you made, it's about companies being aware of what's available to their industry and what's available to them in the markets in which they operate. So there is a real extent of complexity and specificity to navigating this space, but huge opportunities in there, and I think a very clear trajectory of economies that are unevenly and in different ways accelerating along our energy transition. So, great note to end, um, on. Thank you.

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