Recently, I was invited to write an essay for a journal on the opportunities and challenges that North America faces as the buildout of lithium-ion supply chains intensifies.
After submitting the piece, I was informed that it was rejected. In the interest of openness and in hopes of stimulating conversation, I am publishing the original piece here (with only minor editing to account for recent events with the labor unions in the United States). I welcome any and all feedback.
The Lithium-Ion Supply Chain View from North America
Shining City on a Hill or Fading Giant?
By Chris Berry
In President Ronald Reagan’s Farewell Address, he referred to a vision of the United States as a “shining city on a hill” [i]. As North America embarks on a Green Industrial Revolution, the reference from the 40th President of the United States is apt in that North America (and much of the world) is at a crossroads. This crossroads is marked by both geopolitical (a new Cold War, rising authoritarianism, resource nationalism) and environmental (climate change) tensions, but how North America responds may determine the balance of geopolitical power for decades to come.
The decarbonization of industry is a multi-trillion-dollar challenge on a global scale which won’t be solved by either the private or public sector alone. Success means technological leadership, stable economic growth, productivity, job creation, and a cleaner environment for future generations.
Winning this race (supposing one can actually define what winning means) requires confronting several challenges – all of which can be overcome with a combination of capital, political will, and time. There are four primary challenges:
· catching up to China’s lead in battery supply chain development and production
· decoupling critical supply chains
· increasing pricing and operational transparency along battery supply chains
· balancing domestic priorities such as negotiating with labor unions
This is an incomplete list of challenges, but all must be faced to set a course for growth able to withstand volatile global economic environments.
CATCH ME IF YOU CAN
Perhaps the biggest challenge facing North America as it aims to develop next generation battery supply chains is catching up to China. Forty years of increasingly globalized trade, where the lowest cost of production was relentlessly pursued and declining interest rates manifested as cheap capital, is over. In its place is a mirror opposite – protectionism, a focus on reshoring of supply chains, and higher interest rates. All are recent phenomena unfamiliar to many policymakers, business owners, and financiers today. This domestic focus on industrialization is designed to counter China’s multi-decade economic policy of “capitalism with Chinese characteristics” – state-sponsored industrial capacity expansion underpinned by theft of western technology. China’s mercantilist economic model has produced an almost-insurmountable lead in various economic sectors including the lithium-ion battery supply chain, where dominance across mining, refining, cathode and anode production, cell and pack production, and recycling has been hiding in plain sight for years. If it weren’t for President Trump’s trade war and the supply chain paralysis resulting from COVID, private sector companies in western markets may not have ever addressed these issues harming North American economic competitiveness.
Since President Joe Biden entered office in 2020, the solution to turbocharge US economic competitiveness has been to spend capital igniting a resurgence in industrial policy not seen since World War II. In the United States, both the Infrastructure Investment and Jobs Act (IIJA) in 2021[ii] and the Inflation Reduction Act (IRA) of 2022[iii] are designed to use carrots rather than sticks in the form of production and investment tax credits to incentivize domestic manufacturing of a host of green technologies including batteries. The IRA is a 730-page document which almost overnight has transformed the economics of lithium-ion battery production to the point where even US allies such as South Korea and the European Union are clutching their pearls and issuing pointed statements about the unfairness of new US industrial policy.[iv] As an example, Section 45X of the IRA offers a USD $45 per KWh tax credit for lithium-ion batteries produced in the United States. Though there is only a ten-year window to take advantage of this credit and the positive economics are undeniable, as the proverb says, “the road to hell is paved with good intentions” and an unintended consequence of the legislation may be a subsidy war, where companies hold out on investing until enormous subsidies are lavished on them. Case in point is the automaker Stellantis who halted construction of a gigafactory based in Canada until the Trudeau government and the province of Ontario came forward with billions more Loonies of financial support, lest the company move its operations to the US.[v]
While the argument over just what is the right level of subsidy to grow a business is fodder for another piece, the fact remains that the Biden Administration has thrown down the battery gauntlet in an attempt to catch up with a well-developed Chinese battery supply chain. Though the IRA doesn’t directly address more domestically mined supply of battery raw materials, mining companies seem particularly well-positioned. The competition and (non-Chinese) cooperation amongst allies this inspires will be the catalysts for lower costs in the long run through economies of scale and leveraging of technologies, though we may see a higher industry cost structure in the near-term given the time needed to achieve true scale.
CONSCIOUS DECOUPLING
The motive behind the legislative onslaught described above is the perceived need to decouple critical supply chains from China. The need was first laid bare during the early stages of President Trump’s trade war and was exacerbated during COVID when we all found out just how inflexible many globalized supply chains really were. Since then, and despite the table pounding in Washington, there seems to be a divergence of opinion between the public and private sectors with respect to China and decoupling. While dislike of China and its mercantilist business practices seems to be the only thing Republicans and Democrats agree on in Washington DC in 2023, the private sector, highlighted by automotive companies, seems to be singing from a different hymnal. Case in point is Ford Motor Co and their partnership with CATL, based in China, the largest lithium-ion battery manufacturer on Earth. While the goal of the partnership is to build battery capacity in the state of Michigan with Ford owning the infrastructure and making hiring decisions and CATL essentially providing technical assistance with battery production, the deal has invited a rather pointed request for more details from US Congressmen Gallagher and Smith, Chairman of the Select Committee on China and Chairman of the Committee on Ways and Means respectively.[vi] Is this deal between Ford and CATL a subtle admission that Ford needs Chinese battery technology to compete? Is company management tone deaf to the ultimate goals of legislation such as the IRA or the CHIPS Act? These are questions that will be answered more clearly as we lurch towards a presidential election in the US in 2024 and China remains a convenient villain. Interestingly enough, the deal was recently “paused” by Ford due to the economics of the plant. While the real reason for this pause in construction remains to be seen, the fact is that Chinese battery technology will remain vital to Western OEM ambitions.
If domestic OEMs really do need Chinese battery technology to survive, how do we work more closely with allies in other countries such as South Korea or Japan that are already taking full advantage of the financial benefits of building battery infrastructure in North America? We will have an answer here, but it will be measured in years, rather than in shorter and politically convenient election cycles. A longer-term view of policy goals and objectives is perhaps more important than any specific subsection of any legislation. The economic justification for decoupling and the policy justification for decoupling may be different.
PEERING THROUGH THE HAZE
Any supply chain rebuild cannot rely on federal funds alone to succeed. The private sector must participate. Historically, this has not happened widely due to the poor economics of building and operating manufacturing infrastructure in North America relative to Asia – a consequence of Globalization. The third challenge in North America involves building a supply chain that provides visibility and liquidity for financial markets participants. Lithium has historically been characterized as an oligopoly with a murky pricing structure at best. Ask five people what the price of lithium is, and you’ll receive five different answers, if that. While the China-based spot price accounts for a smaller portion of overall lithium traded volume, the roller coaster-like volatility of the spot price for lithium carbonate from $6,500 USD per tonne in late 2020 to a peak of $85,000 USD per tonne in late 2022 to the current level of $26,000 USD per tonne serves as an impediment to the enormous investment needed to build a lithium supply chain. Private capital is attracted to high returns and transparent pricing environments.
Given the focus on acquiring raw materials needed to achieve decarbonization goals, an unintended consequence may be increased pricing volatility as multiple companies and countries are now after a finite amount of available material. The implication here is that large pools of capital may sit on the sidelines or scan the investment horizon for opportunities downstream in the battery supply chain or in other technologies where a more appealing risk/reward ratio appears.
Fortunately, there are solutions in the works here with the London Metal Exchange, Chicago Mercantile Exchange, and the Guangzhou Futures Exchange offering futures contracts on specific types of lithium and cobalt with the goal of hedging against price volatility and protecting margins. While the liquidity in the futures contracts continues to build, this, coupled with more flexible and longer-term lithium off-take contracts between producers and end users, are keys to aid in sustainable growth of a regionalized battery industry. We have come a long way in a short period of time, however, more volume is needed across select battery metals markets to provide liquidity for financiers such as larger markets including nickel or copper.
KEEPING YOUR (ECONOMIC) HOUSE IN ORDER
A fourth and final challenge involves balancing domestic priorities while competing on a global stage. The costs of climate change are becoming clearer given recent examples of heat waves, wildfires, and floods both locally and globally. The cost of the IRA of just shy of USD $400 billion for clean energy investment coupled with a similar amount of capital available from the Department of Energy’s Loan Programs Office is designed to mitigate the effects of climate change through massive green infrastructure investments. These costs (both explicit and implicit) aren’t likely to abate, despite the presumed long-term economic benefits of the IRA and IIJA investments in North America and so devoting public and private capital on an accelerated basis is crucial.
According to the Center for Automotive Research, the United States has seen announced investment in EV and battery infrastructure of $112 billion since 2018[vii] and we are likely to see much more as the benefits of the IRA make themselves felt. However, for all of the bullishness and momentum on EV sales light duty EV sales are still a cost center for major OEMs with Ford recently forecasting an EBIT loss in their EV business of USD $4.5 billion for 2023 – up from USD $3 billion forecast in the previous quarter.[viii] Traditional ICE sales are stemming losses for now, but more ICE sales only delays the transition to EVs and doesn’t help corporate America compete with runaway Chinese EV sales and supply chain dominance. As if that weren’t enough, major North American auto manufacturers are facing a looming domestic issue in labor contract negotiations with the United Auto Workers. EVs require fewer parts relative to their ICE cousins and therefore require less labor to build. While union officials know this, they are not willing to accept lower pay, especially as auto executives reap in million dollar salaries and the overall health of the Big Three North American auto manufacturers is robust with billions of dollars in profits thanks to sales of ICE cars. With the current contract with the UAW having expired on September 14, this thorny issue will be dealt with shortly with an uncertain outcome.
CONCLUSION
Nobody claimed that the energy transition would be easy, fast, or economical in the short term. Despite the macroeconomic challenges faced by North American companies in this transition highlighted by higher interest rates, the momentum towards a more electrified society appears unstoppable. The US and Canadian governments have been more than generous in incentivizing companies and “friendly” countries to build battery supply chain capacity domestically. The economic opportunity is almost too good to ignore despite the lack of affordability of many EVs currently. A revamped green industrial policy is sure to inject volatility into commodity prices as friend and foe alike all look to access a finite amount of multiple critical materials, however this is the price to be paid to build infrastructure, create jobs, and provide a cleaner climate for future generations. Building these supply chains will require creative decisions in board rooms across North America. The success of these decisions will ultimately determine whether or not North America remains the “shining city on a hill” referenced earlier or is left behind by countries that moved faster.
[i] https://www.reaganfoundation.org/media/128652/farewell.pdf
[ii] https://www.whitehouse.gov/briefing-room/statements-releases/2021/11/06/fact-sheet-the-bipartisan-infrastructure-deal/
[iii] https://www.whitehouse.gov/briefing-room/statements-releases/2022/08/19/fact-sheet-the-inflation-reduction-act-supports-workers-and-families/#:~:text=The%20Inflation%20Reduction%20Act%20will%20raise%20revenue%20by%3A,minimum%20corporate%20tax%20of%2015%25.
[iv] https://www.europarl.europa.eu/doceo/document/CRE-9-2022-12-14-ITM-004_EN.html
[v] https://www.reuters.com/business/autos-transportation/stellantis-says-resume-battery-plant-construction-canada-after-reaching-deal-2023-07-05/
[vi] https://www.politico.com/news/2023/07/21/house-gop-pair-launch-investigation-into-ford-battery-deal-00107597
[vii]https://www.wsj.com/articles/uaw-says-costly-ev-transition-wont-change-unions-demands-1561a725
[viii] https://www.cnn.com/2023/07/27/business/ford-earnings/index.html