By Dominic Jacobson
Analyst, Emerging Markets Equity
Senior Product Manager
As the world transitions to a low-carbon future, batteries are becoming critically important, given their key role in energy supply and global green transition. With battery supply chains still vulnerable to rising political tensions and China dominating a large part of the supply chain, we believe the U.S. Inflation Reduction Act (“IRA”) creates a pathway of a strong commitment from the U.S. government to boost battery self-sufficiency globally,1 emerging markets (“EM”) included (i.e. South Korea). From battery chemistry to components to battery recycling, the VanEck Emerging Markets Equity Investment Team’s recent trip to South Korea cements our investment thesis in South Korea’s battery space as a leading pathway to energy self-sufficiency globally.
South Korea | Geopolitics
Investor expectations were buoyed at the beginning of the year with the inauguration of pro-business President Yoon Suk-yeol. He has moved quickly to align South Korea with the U.S. – President Biden visited South Korea in May, and Samsung Group2 quickly thereafter pledged US$200B in an investment plan geared towards building out critical semiconductor infrastructure in the U.S. At the same time, South Koreans recognize that China remains a key export market for them and they need to keep China engaged as a trade partner.
The U.S. Inflation Reduction Act and Its Impact on South Korea
While more details are needed to understand the full impact of the IRA, underlying tones of protectionism against China are clear. Within our coverage universe, the obvious beneficiary of the IRA policy is the South Korean battery supply chain complex. South Korean battery makers are rapidly expanding capacities in the U.S. after building know-how and also fast enabling localization of the supply chain.3
One part of the Act that is worth highlighting is Section 45X, which covers “specifically advanced manufacturing production credits”, and allocates $35 per kilowatt-hour in subsidies to battery cell makers. This section will have a material impact on our portfolio company, LG Chem Ltd. (2.31% of Strategy assets), as it means that a 40-gigawatt battery plant in the U.S. would stand to receive approximately $1.5B each year in tax credits between now and 2032 (assuming there is no cap). This amounts to a big subsidy for battery makers with a presence in the U.S. (i.e., South Koreans). By 2026, South Korean battery makers will be operating plants in the U.S., accounting for at least 200-gigawatt hours each year, translating to an annual collective subsidy from the U.S. taxpayer north of $8B (again assuming no cap).
More critical minerals and battery components to be brought onshore over time
Source: IRA, UBS Research, VanEck Research. Data as of November 2022.
E is defined as Estimate.
* Localization requirement is defined as supply localization. Across the battery value chain, we assess that the U.S. could achieve supply localization in downstream battery cell manufacturing by 2025-27. Source: Goldman Sachs Global Investment Research. Data as of November 14, 2022.
South Korea | Demographic Shifts
Although aging demographics are a universal dilemma for developed countries, the problem is no more acute than it is in South Korea. Their population is beginning to shrink and it is estimated to more than halve by the end of the century. This poses significant challenges for the country’s economy and its ability to grow sustainably over time. In order to increase productivity to make up for this shortfall in labor, South Korea now has the highest robot density in the world, which all require batteries to function.
South Korea | Market Valuations
The MSCI Korea index, battery names included, is down ~40% since July 2021 and almost ~50% in U.S. dollar terms. Valuations are closing in on 10 years lows, the trade deficit has reached historical highs, retail sales have peaked, GDP estimates are being reduced and foreigners have exited the market in a meaningful way. We believe current valuation levels create an entry point to invest in leading South Korean battery companies.
As a result of the above statements and the Investment Team’s recent trip to South Korea, we have further solidified our investment thesis in LG Energy Solution Ltd. (“LGES”), which we believe is poised to be the largest battery cell manufacturer in the U.S. by 2025 and will take a large chunk of the South Korean battery supply chain with it. Our portfolio holding LG Chem Ltd. (2.31% of Strategy assets) owns 82% stake in LG Energy Solution Ltd.
LGES is targeting c.40-100% localization of its supply chain in North America over the mid to long term
Source: Goldman Sachs Global Investment Research, Company Data. Data as of November 14, 2022.
Anode is the negative electrode. It’s usually made of a metal that oxidizes and sends electrons to the cathode (the positive electrode). This is an electrochemical reaction that produces electrons (i.e., electricity).
Cathode is the positive electrode. It gains electrons rather than loses them. Therefore, anodes oxidize (lose electrons) while cathodes reduce (gain electrons).
Electrolyte is a substance that allows electrical current to flow between the anode and the cathode.
Critical Minerals in the battery space are lithium, nickel and cobalt.
Battery Chemistry Matters
Diversification of battery chemistries is important, as it will help reduce the dependence on critical, raw minerals.4 There is no single chemistry that will obtain 100% market share. Rather, different chemistries will serve different applications. Lithium iron phosphate (“LFP”) battery, for example, will gain share in ex-China markets, as they increase the affordability of mass market vehicles in the short to medium term. Hence, South Korean battery makers have begun to accelerate their capacity expansion plans to accommodate for this technology, especially given that the U.S. has effectively blocked China’s participation in their domestic market.
We expect LFP to gain market share in ex-China through 2030E and South Korea is well positioned to accomodate for this technology
Source: Goldman Sachs Global Investment Research, Company Data, Wood Mackenzie, UBS, VanEck Research. Data as of November 14, 2022; E is defined as Estimate.
Beyond battery chemistry, we also expect South Korean companies to be leading in the development of battery components (see definitions under Chart 2) as well as in the growth of the battery recycling space.
Battery Component – Anodes
Silicon (“Si”) anodes are the future, as they possess higher energy densities, allowing for greater range and faster recharge times – i.e., tangible characteristics that can help automakers differentiate from their peers. Si-anodes are also more environmentally friendly and theoretically cheaper to produce than graphite anodes once scale has been achieved. However, the adoption of this technology faces one key constraint – Si-anodes swell and deflate when charged and discharged, which can undermine the structural integrity of batteries causing safety/performance issues. We expect South Korean companies to play a prominent role in developing technologies and processes that will allow Si-anodes to be mass produced with improved safety and environmental characteristics.
Battery Component – Cathodes
Driving up the nickel content of cathodes continues to be an area of differentiation for cathode manufacturers, though the maximum theoretical limit is in sight. Creating high nickel content cathodes remains a high barrier to entry business, as it is challenging to mass produce these types of cathodes with high chemical stability. Only South Korean companies are currently dabbling in this space. The next leg of the roadmap will be in transitioning from multi- to single-crystal cathodes, which should extend cathode lifecycle by increasing its stability.
Battery recycling is a crucial part of the battery supply chain that remains relatively underdeveloped in ex-China markets. The reason is that the number of batteries that are nearing their expiration date is only just starting to reach a scale that would enable recyclers to generate high enough utilization rates to earn sufficient returns on their investments. The addressable market for the battery recycling sector is forecasted to grow from an estimated $400 million in 2022 to $5.3 billion in 2030, an annual rate of 40% over this period.5 As the overall market grows, we anticipate South Korean companies will seek to develop successful, fully integrated business models within this space.
We see the IRA 2022 as a positive for South Korean battery makers who are rapidly expanding capacities in the U.S. after years of building know-how and also fast enabling localization of the supply chain. We believe our portfolio holding LG Chem, which owns 82% stake in LG Energy Solution Ltd., is well positioned to benefit from the global battery self-sufficiency trend, given its exposure to high-growth chemicals and materials, delivering one of the highest EBITDA CAGR (32% in 2022E-25E) across global diversified chemicals and EV battery and materials plays while trading at an attractive valuation.6
Originally published by VanEck on November 21, 2022.
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1 Source: Goldman Sachs Investment Research. Data as of November 14, 2022.
2 Our portfolio holding Samsung Electronics Co Ltd Pfd Non-Voting (2.47% of Strategy assets) is a part of Samsung Group. We own it and believe it is well positioned to benefit from improving ties between the U.S. and South Korea.
3 Source: Goldman Sachs Investment Research. Data as of November 14, 2022.
4 Source: Goldman Sachs Global Investment Research. Data as of November 14, 2022.
5 Source: Macquarie Research, VanEck Research. Data as of November 2022.
6 Source: Goldman Sachs Global Investment Research, VanEck Research. Data as of November 14, 2022.
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