The Crash of the Auto Supply Chain - For Batteries, Dependence on China is a No-Go

Dear Shareholders & Friends,

Volkswagen, the largest car manufacturer in the world, is ramping up production in Europe again. The plants in Bratislava, Slovakia, and Zwickau (Saxony), are the first to start production. In Zwickau, VW builds the ID.3, its first purely electric car. Other locations follow. Other European manufacturers such as Daimler, BMW and Renault are also in the process of restarting production.

Starting up a car plant is much more complex than shutting it down. Production can be stopped within hours while the complete resumption of operations can take weeks. This is due to the complexity of the supply chains.  

Take China, for example: 32 of the 33 plants in the People's Republic, where VW operates with cooperation partners, are already producing again. However, this only works because the component plants in Europe have already resumed production and can thus compensate for possible shortages of supplier parts in China.

In Europe this could be more complicated. Here, car manufacturers depend to a considerable extent on suppliers from Italy, where Covid-19 has struck particularly hard. How many of them will survive the current crisis cannot be predicted at the moment.

Tearing apart supply chains

But not only the car manufacturers, but also the suppliers themselves are dependent on supplies. Example: Continental. The company, which is one of the world's largest manufacturers of automotive components such as brakes or driver assistance systems, works with around 2,300 other suppliers. Dozens of them are reportedly on the verge of collapse. A quote from Jacques Aschenbroich, CEO of Valeo, shows how fragile these supply chains are. Mr. Aschenbroich told the Financial Times: "We know that we are as weak as the weakest link in our supply chain." Valeo is one of the biggest French parts suppliers. You can count on five fingers what this means for Conti with 2,300 cooperation partners.

A vivid example of the vulnerability of supply chains dates back to 2016, when a dispute arose between VW and Prevent involving a mid-double-digit million Euro amount. In the context of VW's annual revenues, this seemed to be a small matter; however, Prevent stopped deliveries and forced five VW plants to temporarily stop production. 28,000 VW workers were condemned to do nothing.

Since the financial crisis of 2008 the car companies consider it a safeguard that every part must be purchased from at least two suppliers. If one supplier fails, the other will take over - this is the theory. In practice this is not so simple. It is hardly possible for a supplier to double production from one day to the next. A backup alone is not enough in times of crisis.

Supply chains for e-cars particularly vulnerable - Asian dominance

The production of electric cars is special in that the battery cells here come from only a few Chinese and South Korean manufacturers. While the car companies normally have the upper hand, the situation here is exactly the opposite. CATL, LG Chem, Samsung and Co. have it in their own hands whether the car manufacturers achieve their production targets for electric cars. Bottlenecks at Audi, a VW subsidiary, or at Mercedes have shown this even before the Corona crisis.
The following chart shows the dramatic dominance of the Chinese in the battery supply chain:

When it comes to "batteries, dependence on China is a no-go"

As I learned this week from a leading car manager, various car companies have changed their strategy against this background. While the industry is expecting and hoping that supply chains will stabilize in the short term, the situation for batteries for electric cars is different: because of the strategic importance of electric vehicles the dependency is a no-go and must end. Consequently, car manufacturers now want to build their own factories for battery cells in Europe, especially Germany. In addition, they are trying to distribute the purchase of battery cells among several manufacturers.

This change of strategy is basically correct, but it is not thought through to the end. This is because the supply chains start with the battery raw materials. The situation with cobalt and lithium, in particular, is not unproblematic. Cobalt is produced to a large extent in the politically unstable Democratic Republic of Congo. In the case of lithium, the situation looks a bit, but not much better. The majority of the world's reserves come from Chile, where they are exploited primarily by the two world market leaders Albemarle and SQM. Like the Congo, Chile is not considered as sufficiently politically stable. It is true that politically stable Australia comes in second place. In third place, however, Argentina, which has just gone bankrupt once again, is another unstable candidate. In fourth place is China, which repeatedly uses raw materials as a means of exerting political pressure. The problem: The costs of the battery cells depend largely on the cost of raw materials (Source: Benchmark Mineral Intelligence):

One lesson from the Corona crisis will be that OEMs will broaden their supply chains, especially for e-cars, in order to avoid crashes in supply. Valeo is already hearing from customers that the components they supply must in the future come from different countries. Similarly, manufacturers of electric cars will probably insist that the lithium they need will come from several producers in different regions of the world. The main beneficiaries of this will be the producers in the second and third ranks so far - and especially those whose deposits are stored in politically secure countries - for example in Canada as at Rock Tech.

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