Can we save the planet and still keep the wheels turning?
Tim Richardson CFA, Investment Specialist
Developed economies are striving to decarbonise transport. But China dominates the EV battery supply chain, leaving the west vulnerable to delivery interruptions or monopolistic pricing. US Government incentives are fuelling capital investment in battery technology, bringing exciting opportunities for companies across the EV value chain.
“I do not believe it is wise for America to substitute dependence on foreign oil for dependence on Chinese batteries.”
Aubrey McClendon, CEO American Energy Partners
Why the west is worried
Transport is responsible for 27%1 of greenhouse gas emissions (GHG), according to the United States Environmental Protection Agency. Decarbonising transport depends on transitioning to electric vehicles (EV).
However, China produces 75% of electric vehicle batteries worldwide; it also manufactures key components and processes critical minerals. This leaves western economies vulnerable to supply chain interruptions.
Moreover, ceding pricing power of such a key component to a strategic rival risks future “battery-shocks”, reminiscent of oil shocks that brought deep recessions and stagflation in the 1970s.
Rising demand and constrained supply are reflected in EV battery prices increasing for the first time in a decade. This follows a steep increase in lithium hydroxide, the key EV battery compound.
Taking steps to safeguard battery supply chains
The Biden Administration’s (strangely named) Inflation Reduction Act aims to reduce GHGs by 43%2 below 2005 levels by 2030. It aims to ensure EV batteries do not include Chinese components which could be withheld in the future.
The long-standing US$7,500 federal EV tax incentive will be restricted to locally assembled vehicles. It requires 80% of an EV battery’s critical minerals and 100% of its components to be locally produced by 2028. Cars with any critical minerals or battery components from China or Russia will be excluded.
This requires major changes in supply chains to avoid a $7,500 per vehicle cost disadvantage, driving significant investment in North American EV battery and component production capacity. Similar concerns are supporting investment in Europe and Japan. A recent Goldman Sachs report forecast US and European EV battery capital investment of US$160 billion by 2030.
Where are the opportunities?
This is bringing large-scale investment in new battery and component factories in the US and Europe, attracted by generous government subsidies. Over 20 gigafactories will be built in the EU alone within the next few years.
This investment will benefit mining companies and battery producers, while in many other sectors, dynamic companies are recognising the opportunities. Costs currently being incurred will help to ultimately position these businesses for long term growth. Many European battery investments include challenger auto brands such as Tesla or established car manufacturers such as Volkswagen. All are focussing on their EV future and seeking secure supply chains.
Despite strong political momentum, higher labour costs disadvantage production in developed markets. This creates exciting opportunities for factory automation companies. Great examples that have historically generated higher growth rates while displaying quality characteristics include Rockwell Automation and Schneider Electric. Keyence which automates manufacturing visual inspection through machine vision is similarly focussing on this investment wave.
More critical minerals will be processed outside China, (which currently undertakes 55% of lithium, 65% of cobalt, and 90% of rare earth elements processing3). This strategic shift may create broader opportunities in countries that hold the largest reserves of lithium, such as Chile followed by Australia and Argentina. This is illustrated by companies engaged in processing lithium for EV batteries experiencing strong revenue growth as demand accelerates.
The transition to EV batteries will reduce GHG emissions over the car’s lifecycle, although significantly more carbon is generated in production. Yet mining and minerals processing carry inherent environmental, social, and governance (ESG) risks. EV production requires far more minerals, especially copper, than a conventional vehicle. This does not negate the value of EV technology, but investors should ensure ESG risks are appropriately managed through ongoing company engagement.
What does this mean for investors?
The drive to diversify battery production away from China is bringing vast capital investment by a range of companies.
These include not just mining companies and battery producers, but quality growth companies positioned along a much wider value chain that are discovering opportunities.
Innovative businesses with strong balance sheets and far-sighted management now have the opportunity to deliver long-term growth.
1 United States Environmental Protection Agency, ‘Carbon Pollution from Transportation’, May 2022
2 Energy Innovation Policy and Technology LLC, ‘Updated Inflation Reduction Act modeling using the energy policy simulator’, August 2022
3 International Energy Agency, ‘The Role of Critical Minerals in Clean Energy Transitions, May 2021
