Canada's Inflation Reduction Act stumbles in Windsor

Stellantis and LG Energy's move to halt construction of a $5-billion EV battery cell plant to demand more government money highlights perils of Canada's focus on industrial policy in race to claim a share of the wealth from green transition

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For months, a steady stream of heavy trucks rumbled through Windsor, Ont., and the sound of metal being pounded into bedrock at the site of Canada’s first proposed battery cell manufacturing plant jangled local residents’ nerves.

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Nonetheless, some of those residents were furious when all the noise suddenly stopped — NextStar Energy Ltd., a joint venture between European automaker Stellantis NV and South Korea’s LG Energy Solution Ltd., abruptly halted construction on May 15 and demanded more money from the Canadian government.

The move had a whiff of brinksmanship, and if it was indeed a negotiating tactic, Windsor’s mayor was there to amplify NextStar’s message.

“I’m non-partisan, but I think it would be decades before anyone would elect a Liberal in Windsor Essex if this thing fell on its face,” said Drew Dilkens. “I don’t know that I could control the raw emotion of the unions and the general public if the government didn’t follow through with what they’ve told the company they would do.”

The reasons for the work stoppage in Windsor are rooted in a debate that will be familiar to everyone: how to allocate scarce taxpayer resources.

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Windsor Mayor Drew Dinkens
Windsor, Ont., Mayor Drew Dilkens speaks at an announcement in May 2022 regarding upgrades to Stellantis automotive facilities. Photo by Dan Janisse/SunMedia

It could be a sign of things to come, as Canada and other rich countries embrace industrial policy after several decades of preferring corporate tax cuts and free-trade agreements to encourage economic growth. When governments bet on specific companies, those companies gain considerable leverage, especially when the investment is made in political battlegrounds like southern Ontario, a unique part of the country that is open to voting for all three major political parties.

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After a few days of finger pointing, Ontario Premier Doug Ford said May 19 that his province would add money to the pot, but did not say how much. That’s become a feature of Canada’s pursuit of green investment, as Ottawa, provincial governments and municipalities cut deals with global companies and then refuse to disclose the details, citing the need to protect their positions in negotiations with other companies.

Francois-Philippe Champagne and Drew Dilkens
Federal Industry Minister Francois-Philippe Champagne, left, shakes hands with Windsor Mayor Drew Dilkens at a press conference on March 23, 2022, when the $5-billion investment to build the NextStar EV battery cell plant was announced. Photo by Dan Janisse/The Windsor Star

The secrecy risks undermining confidence in the whole approach. No one involved in the Windsor plant has stated clearly and publicly how the projected returns from building a massive battery plant will exceed the projected subsidies, including the exact numbers that guided them to that conclusion.

So, it’s difficult to know if Ford’s decision to increase Ontario’s commitment to the project was an economic one, or whether he and Prime Minister Justin Trudeau are vainly chasing the massive subsidies available in the United States via the Inflation Reduction Act (IRA), which was signed into law roughly six months after the original deal with Stellantis and LG Energy.

The IRA radically changed the level of incentives needed to attract an automaker to build a battery plant. By many accounts, the passage of the IRA spurred NextStar to reopen negotiations about subsidies, and it appears ready to play a tough game of poker: the Windsor Star reported May 25 that NextStar was considering moving some of the battery production to Michigan, reducing the number of jobs and spinoff benefits in Canada.

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In this sense, the situation in Windsor offers up a case study in the perils of industrial policy, which has taken on a more central role in economic development as Canada and other countries race to claim a share of the wealth that will be created from the historic shift to a green economy.

Marisa Beck, clean growth director at the Canadian Climate Institute, said industrial policy is dependent on public support, which makes the analysis of the risks and opportunities of any particular investment crucial.

“We need to make sure we’re not over-subsidizing projects, that the support is really measured to leverage and bring in private capital without creating huge windfall profits for the private sector,” said Beck.

A new dawn

In March 2022, Stellantis and LG Energy announced they would team to create NextStar and agreed to start work on a sprawling 4.5-million square foot battery plant that they said would create at least 2,500 jobs, generate an untold amount of indirect investment and indirect jobs, and include a cutting-edge research and development centre for batteries.

Then, earlier this month, construction suddenly ceased. Behind the scenes, insiders said that NextStar had evaluated the subsidies it would receive by moving its battery plant to the U.S. and at some point in the past few months demanded more from the Canadian government. Politicians involved had maintained a unified front — at least publicly, until the May 15 work stoppage, at which point they all called on each other to meet NextStar’s demands.

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It’s a change from March 2022, when Dilkens lined up alongside Industry Minister François-Philippe Champagne and Ford to triumphantly announce the plant, which they described as a revitalization of the country’s auto sector.

“(Canada) can be part of the solution and I think it would be in your interest to listen to what we have to offer because we’re going to lead in this green industrial transformation,” Champagne declared.

Of course, it was difficult to gauge whether the government’s financial arrangements with NextStar made sense because neither Ottawa nor the province would disclose what type of deal they had cut to entice NextStar.

Well hold on a sec, this isn't small potatoes that we would be giving up

Windsor Mayor Drew Dilkens on comments by NextStar regarding U.S. subsidies

Still details leaked out. Dilkens said his city took on about $50 million in debt to facilitate the battery plant including purchasing the 220-acre site of the proposed plant, which it leases back to NextStar.

At the press conference to announce the plant, Ontario Premier Ford said his province and the federal government were contributing “hundreds of millions of dollars” towards the $5-billion facility.

Liberal member of Parliament Julie Dabrusin of Toronto, who also attended the ceremony, gave a more precise number: shortly afterwards, she tweeted that the federal government was contributing $500 million — a tweet that Dabrusin subsequently deleted as Ottawa sought to maintain a cone of silence around its subsidy arrangements with automakers.

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‘Everything was hunky dory’

“Everything was hunky dory and fine until the Inflation Reduction Act got passed in the U.S. just a few months later,” said Dilkens.

Five months later, to be precise. In August 2022, U.S. President Biden signed the IRA, which completely transformed his country’s approach to climate change and the energy transition. Some estimates suggest it will unlock more than $1 trillion in public and private spending in the next decade.

U.S. President Joe Biden
U.S. President Joe Biden signed the Inflation Reduction Act in August 2022, five months after Canada sealed the Windsor EV battery plant deal. Photo by Drew Angerer/Getty Images

The legislation offers subsidies that amount to around one-third of the cost of manufacturing battery cells, provided the plant is located in the United States. Suddenly, manufacturing battery cells in Canada — the single most valuable component in an electric vehicle — didn’t look so attractive.

Until that point, Dilkens said NextStar had negotiated subsidies to offset the cost of construction, but now it wanted subsidies for production too — as it would receive if it moved its plants several kilometres to the U.S. side of the border.

“Rightfully so, the company’s saying, ‘Well, hold on a sec, this isn’t small potatoes that we would be giving up,’” said Dilkens. “They do the mathematics, and they come back and they say, ‘Canada, you have to match this if you want to keep this deal.’”

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Beck, clean growth director at the Canadian Climate Institute, said the IRA has the potential to unleash so much investment that it completely transformed the global economy.

“Really the Inflation Reduction Act has put a huge spotlight on industrial policy, and what does it take for Canada to be competitive?” she said. “It was a game changer.”

Premier jurisdiction

Unlike the Canadian approach to industrial policy, which has involved piecemeal dealmaking in backrooms with individual companies, the IRA offers across the board subsidies available to any company willing to meet the requirements spelled out in the legislation.

For battery cell manufacturing, the IRA includes a tax credit of US$35 for every kilowatt of energy the battery produces, or US$45 in the case of battery modules. That’s out of a total cost of roughly US$153 to produce a battery, according to the U.S. Department of Energy.

There's one point of view that the U.S. is over-subsidizing batteries

Bentley Allan, research director at the Ottawa-based think-tank Transition Accelerator

“There’s one point of view that the U.S. is over-subsidizing batteries,” said Bentley Allan, a professor of political science at Johns Hopkins University and research director at the Ottawa-based think tank Transition Accelerator.

Allan said some analysts believe that one objective of the IRA is to turn the U.S. into the premier jurisdiction where batteries are manufactured — given that so much of the value of electric vehicles and other technology resides in the battery, which is exactly the reason Canada’s political leaders invested so much effort to attract NextStar to build its plant here.

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Against this backdrop, Allan and Michael Bernstein, executive director of Toronto-based think tank Clean Prosperity, released a policy paper in March that proposes how Canada should respond to the IRA. One suggestion was that the federal government could work to build the upstream supply chain for batteries, such as cathodes, the electrode from which a current flows out of a battery.

The IRA offers only a 10 per cent subsidy for cathodes. That could be a competition Canadian taxpayers, with their smaller purse, have a chance of winning.

“One dollar spent upstream is the same as one dollar spent in the downstream,” said Allan. “So if the subsidy downstream is three times as large, then that just tells you to subsidize the upstream.”

‘No public discussion’

Instead, somewhat inexplicably, Champagne and Ford doubled down on attracting battery cell manufacturing to Canada.

On the same day the deal with NextStar was announced, Champagne said he would soon be en route to Europe to woo Volkswagen AG to build a battery plant in Canada. Meanwhile, Vic Fedeli, Ontario’s minister of economic development, said he too courted the German automaker.

In March, more than six months after passage of the IRA, the federal government and Ontario announced that Volkswagen would build a $7-billion gigafactory in St. Thomas, Ont.

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But in April, that deal looked more circumspect after Bloomberg News reported the details of the financial arrangement with Volkswagen. It included capital costs to offset the cost of construction, plus ongoing production tax credits that could reach $13 billion by the end of a decade.

In a press release, the Prime Minister’s Office said it had simply matched the IRA’s production support of up to US$35 per kilowatt hour.

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Justin Trudeau at Volkswagen deal announcment
Prime Minister Justin Trudeau arrives last month at the Elgin County Railway Museum in St. Thomas to make an announcement about Volkswagen’s new electric vehicle battery plant in the southwestern Ontario town. Photo by Tara Walton/The Canadian Press

“Just like in the U.S., Canada’s support will only be for what is produced and sold and will phase out by 25 percentage points every year beginning in 2030 (after 2032, the credit would be eliminated),” the press release said.

But if the federal government copped to the fact that its subsidies would amount to between $8 billion and $13.2 billion, depending on production levels by the end of a decade, it failed to disclose its calculation of the return it would receive on this money during this timeframe.

Neither Champagne’s office nor Fedeli’s office would produce such a number, though they did cite jobs that could be created and other potential impacts. Laurie Bouchard, a spokesperson for Champagne, pointed to prior statements that the VW battery plant would create $200 billion to $400 billion in value over a 35-year time period.

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But the federal government has said its subsidies for VW will expire in 2032, and given that NextStar is threatening to walk away from the plant if there are no subsidies, it is not clear why it would operate without subsidies after 2032 given that it will not do this in 2023.

Dilkens also avoided the subject. “That’s above my pay band,” said Dilkens. “I would expect the federal government who has to negotiate this is going to do the math.”

Some policy analysts pointed to a September 2022 report by Clean Energy Canada, a think tank at Simon Fraser University, and the Trillium Network for Advancing Engineering, a non-profit at Western University, that estimated that battery cell manufacturing could add $11 billion annually to gross domestic product in Canada. The report also said the entire battery supply chain could contribute $48 billion to the economy. But the authors did not publish all of their assumptions, or discuss the impacts of the IRA on Canada’s competitiveness.

Without knowing what the federal government thinks the return is on a battery plant, it is difficult to evaluate whether it is a smart allocation of scarce capital or not.

“The problem is there’s no public discussion,” said Allan, who advocated for a transparent policy so there could be a public debate about whether the industrial strategy makes sense.

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In a corner

For the moment, there are only estimates of what things will cost, and the Stellantis battery plant is estimated to cost around $10 billion, according to insiders.

“Politically, I almost felt bad a bit because once I had some clarity on the number — I knew it was about $10 billion — I thought the prime minister is going to get zero political gain,” said Dilkens. “Whereas if he could take $10 billion, and start in Vancouver, British Columbia and fly to every province and give every province a billion dollars for their favourite project, there’d be far more political capital to be had in that type of approach.”

As it stands, the federal government appears to have painted itself into a corner: Having announced the Windsor plant before the IRA, it was already going to be difficult to cancel the project if the numbers no longer made sense after the U.S. legislation. Then, by agreeing to match IRA incentives to bring Volkswagen to Canada, it intensified the pressure it faces to provide the same level of subsidies so it can retain NextStar.

“Any sensible person recognizes that our country is 1/10 the size of the U.S.,” said Dilkens. “It doesn’t mean we have an unlimited purse to be able to get as many battery factories as the United States would have. That would be sort of preposterous thinking. But, you know, one, two, maybe three?”

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As the dispute over the Windsor battery plant stretches into its second week, a more pressing question is where the money will come from to provide IRA-level subsidies to NextStar.

In the initial aftermath of the work stoppage, Ford called on the federal government to put in more money, while Champagne said Ford’s unwillingness to ante up was the problem.

Ford responded that he would put more money into the project, although he did not disclose many details. Champagne has characterized the work stoppage as “normal negotiations.”

Any sensible person recognizes that our country is 1/10 the size of the U.S.

Windsor Mayor Drew Dilkens

Champagne had been doling out subsidies from the federal government’s Strategic Innovation Fund, but that appears to be winding down: already close to US$7 billion have been spent and the 2023 budget allotted only $500 million to the fund.

Some analysts have suggested that if NextStar is willing to walk away from the project, the federal government should jump at the chance: Other automakers such as Ford Motor Co. agreed to retrofit an assembly plant in Oakville, Ont., to produce EVs for just $595 million in government capital construction subsidies.

Perhaps it could persuade automakers to build several assembly plants for less than it would cost to build one battery plant, analysts have suggested.

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Others have suggested that backing out is not so easy. The negotiations with Volkswagen, for example, took eight months. Picking a site requires automakers to line up supply agreements, power agreements, and complex planning that cannot be easily undone.

Of course by that same token, it is also less likely that NextStar would back out of building its Windsor battery cell plant.

Dilkens said that he’s confident the “brinksmanship” will be resolved.

Windsor, he noted, had been through this before: in the past few decades, it saw numerous automakers pull up stakes and relocate operations to lower cost jurisdictions after the original North American Free Trade Agreement was signed in the 1990s.

Still, if Windsor has spent the past few decades enduring the whims of a free marketplace, the standoff over the battery plant is demonstrating that even an era in which industrial policy is ascendant is not free from risk either.

“We’re used to the ups and downs of the auto world,” Dilkens said. “We take our punches, and we get back up.”

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Gabriel Friedman


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