Could this further cloud the outlook for ASX 200 lithium shares?

S&P/ASX 200 Index (ASX: XJO) lithium shares counted amongst the hottest stocks to have in your portfolio through much of 2022.

That's because the rapid growth in EVs and the lithium-ion batteries that power them saw the demand for lithium outpace new supply to the market. Which in turn saw the price of the battery-critical metal notch all-time highs back in November.

As you'd expect, that was good news for investors in the big lithium stocks.

Yet, 2023 has seen the leading ASX 200 lithium shares fall back to earth. As new supplies are hitting the market, with further increases forecast, lithium prices have roughly halved since November's peak.

Despite a big surge amongst most lithium companies last Tuesday – spurred by US-based lithium giant Albemarle Corporation's (NYSE: ALB) takeover proposal of Liontown Resources Ltd (ASX: LTR) – the blue-chip lithium stocks are vastly trailing the benchmark over the past month.

The ASX 200 is down 0.8% since this time last month.

Here's how these ASX 200 lithium shares have performed over that same period:

• Pilbara Minerals Ltd (ASX: PLS) shares are down 8.7%
• Core Lithium Ltd (ASX: CXO) shares are down 9.9%
• Allkem Ltd (ASX: AKE) shares are down 5.3%
• IGO Ltd (ASX: IGO) shares are down 9.1%
• Mineral Resources Ltd (ASX: MIN) shares are down 10.4%

With that in mind, the latest compromise in the European Union's energy transition plan could throw up some fresh headwinds for the stocks down the road.

Could this further cloud the outlook for ASX 200 lithium shares?

With a population north of 445 million people and a GDP of some US$16 trillion, the EU's world-leading charge to carbon-neutral transportation is being closely watched by the rest of the world.

Among the recent proposals that were exciting for ASX 200 lithium shares was a law that would ban the sale of new internal combustion engine (ICE) vehicles in the EU by 2035.

EVs, mostly lithium powered, were the most likely candidates to take their place.

But EU negotiators ran into a roadblock with Germany and Italy. The two member nations argued new cars should also be allowed to run on e-fuels.

These combustion engines would then be fuelled via a process that takes carbon dioxide out of the air and hydrogen out of water using renewable energy sources. While the vehicles do emit carbon dioxide when running, this is balanced by what was taken from the air in creating the e-fuel.

Now, as Reuters reports, the European Commission has caved to the demands and will create a new category for vehicles that run on e-fuels post-2035. They have yet to determine how to prevent those vehicles from tapping into conventional petrol.

To be clear, this is unlikely to upend ASX 200 lithium shares in the short to medium term. Especially as e-fuels remain a niche product and are not yet available on a commercial level or at a competitive price.

But the EU's about-face on the legislation does highlight the reality that there is a large range of alternative ways to power the world's vehicles into the future. And lithium-ion batteries are only one of them.

Diversify your investments accordingly.