Weekly Wisdom – June 29, 2023

By Hightower Great Lakes on June 29, 2023

Mitigating Reliance on Global Supply Chain

For the past six decades, globalization has led to outsourcing production of goods to geographies with cheaper labor and better access to raw materials, which has led to greater profitability for large enterprises.

As a result, a massive dependence on foreign nations working together seamlessly has become a chokepoint in supply chains. The COVID-19 pandemic exposed the flaws in the just-in-time supply chain, which relies on a complex web of interconnected suppliers around the world. One small hiccup in this chain can have devastating impacts, as was seen during the pandemic.

Nearshoring is the concept of consolidating supply chains to one or a few geographies to lessen the dependence on many moving parts. Companies benefit from nearshoring as it reduces risk and improves resilience, oversight and quality control in their supply chains.

While the COVID pandemic was the event that exposed chokepoints in the globalized supply chain, the onset of nearshoring began during the Trump administration’s push for a lesser dependence on Chinese manufacturing, which came with tariffs imposed in 2018 along with the deterioration in China-United States relations.

Companies and governments are working in tandem to move manufacturing infrastructure outside of China and into North America.

US CHIPS and Science Act Encourages Domestic Investments

Nearshoring is becoming increasingly popular in the semiconductor industry. Semiconductors are the brains behind everything from your toaster oven to the most sophisticated military weapons. As of 1990, 37% of the world’s chips were manufactured in the US. That number stands at 12% today.

The production has shifted to Taiwan, where 60% of all semiconductors and 90% of all advanced semiconductors are currently produced. Given the current geopolitical struggle in the region, this poses a significant national security risk and bringing production of these precious chips to the United States is of the utmost importance.

To help encourage domestic investment, the US government recently approved the US CHIPS and Science Act. This act allocates $54 billion in government grants toward semiconductor research and development along with workforce programs.

According to a McKinsey report from earlier this year, domestic semiconductor projects that are “under way, announced or under consideration total $223 billion to over $260 billion through 2030.”[1]

Included in this figure is a $100 billion investment “Megafab” in Central New York that is expected to create 50,000 jobs and 9,000 high paying Micron (MU) jobs, as well as a $40 billion investment in an Arizona fab by Taiwan Semiconductor (TSMC). Once in production in the coming years, the heavy reliance on Taiwan will be partially mitigated.

While YTD performance tells a different story, semiconductor manufacturing companies are currently experiencing a sharp decline in demand following the record revenues during the pandemic. As a result, many companies are likely withholding plans to invest in domestic production. When demand for chips returns to normalized levels in the coming quarters, it would make sense to see even more investments in domestic plants across the United States.

Increasing Rare Earth Materials Mining and Refining Capabilities

Another industry participating in the onshoring trend is the metals and mining business. Metals like copper, lithium and cobalt are growing exponentially in importance due to electrification. China has the largest reserves of rare earth metals in the world, and as a result, comprises 63% and 85% of the global mining refining capabilities, respectively.[2]

The pandemic showed the globe that this disproportionate share of rare earth metals coming from China poses a significant supply chain risk.

Considering lithium demand alone is projected by the IEA to grow by 4,200% by 2040, many metals and mining corporations have decided to geographically diversify their operations.[3] Some companies have chosen to take up mining and refining rare earth in North America, like MP Materials (MP) who is now the largest miner of rare earth metals outside of China.

While not investing specifically in rare earth mining, but rather in refining, Tesla (TSLA) plans to invest $375 million in a lithium refinery in Corpus Christi, Texas, to support the construction of its batteries. The United States is very much behind in rare earth refining, only controlling a mere 1% of total lithium refining capacity.[4]

The statistics show that our geopolitical adversaries control much of the mining and refining of key resources, an issue that will only grow in importance. This realization that little to none of the rare earth mining and refining is done within North America is driving the onshoring boom for the metals and mining industry.

United States and Mexico Partnership

While the United States manufacturing industry is a clear benefactor of the nearshoring trend, its neighbors stand to benefit as well. The United Sates and Mexican governments are collaborating to maximize the potential benefits.

So far, they have made commitments such as investing in border infrastructure and modernization projects. The White House has dedicated $3.4 billion in addition to the $1.5 billion investment by the Mexican government for 26 major construction projects aimed at land ports of entry on both sides of the border.

The benefits of these projects are visible as exports out of Mexico in May were the second largest on record, while machinery and equipment imports to Mexico are up about 8% on a year-over-year basis. Mexico stands in a comfortable position, as they are the only developing country that has free trade agreements with the US, Canada, European Union and Japan[5].

Chart 1: Mexico Trade Exports ’93 – ‘23[6]

Chart 2: Mexico Machinery & Equipment Imports ’08 – ‘23[7]

Mexico’s relatively young demographic is a driving force in the nearshoring trend. Around 42% of its population is between the ages of 20 and 29 – giving them an edge in the world on a comparative basis. Industrial real estate fundamentals are strong, particularly in Mexico.

Demand for industrial space doubled in 2022 versus 2019 levels, reported by Prologis (PLD).[8] Boosted by nearshoring, this also led to sharp decline in vacancy to approximately 1%. Stemming from higher demand, Prologis was able to increase rents by 16% in 2022, while expecting double digit rent growth in 2023.

Future Is Bright but Obstacles Remain

While there are clear benefits to nearshoring, such as increased national security, better oversight, more jobs and higher quality products, higher costs in the United States and lacking infrastructure in Mexico present hurdles. Samsung (SSHNZ) initially anticipated costs to build their Texas fab to be $17 billion, however, that number is now expected to exceed $25 billion, due in part to inflation.

It was not until the pandemic that leaders fully appreciated the issues that can stem from a global supply chain. As a result, sufficient funding to make the United States competitive in chip manufacturing has not been in place for decades.

According to U.S. Secretary of Commerce Gina Raimondo, the US will likely face a shortfall of 100,000 technicians unless sufficient funding is put in place to train the workforce.[9] Until that day comes, enterprises will be faced with the dilemma of balancing the higher cost of doing business in the United States with the benefit of mitigating risk.

Click here to read last week’s Weekly Wisdom (6/21).

Disclosures

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[1] McKinsey.com as of January 27, 2023

[2] Politico.com as of December 14, 2022

[3] Foreignpolicy.com as of February 7, 2022

[4] CNBC.com as of May 8, 2023.

[5] Trade.gov. As of September 23, 2022.

[6] Factset (chart). As of June 27, 2023.

[7] Factset (chart). As of June 27, 2023.

[8] Prologis. As of June 6, 2023.

[9] Koreajoongangdaily.com. As of May 6, 2023.