Plugged In: An EV Newsletter Vol. 2, No. 3

Most of us are well aware of the EV supply chains' reliance on foreign-based suppliers, most prominently China, to supply and process critical materials and minerals. However, during my recent interview with veteran automotive journalist John McElroy, I was intrigued by John highlighting the U.S.'s dependence on China (directly or indirectly) for critical materials and processing for national security assets, as well as the automotive industry. Many of these materials are the same as in the EV supply chain (e.g. lithium).

Scope of the Problem

Some commentators express concerns that increasing dependence on Chinese suppliers in U.S. defense contracting poses significant national security risks, including potential theft of sensitive information, sabotage of critical systems, and leverage for influencing U.S. government policies. For instance, a recent article gives us a sense of the magnitude of the problem. In that article, the authors cited to a report featured in a Forbes article by Govini, a commercial data analytics firm, that found that the Department of Defense (DOD) has 922 Tier One Chinese artificial intelligence (AI) suppliers, 552 Tier Two AI suppliers and 45 Chinese Tier One suppliers for optical sighting and ranging equipment. The authors concluded that, "the growing reliance on Chinese suppliers in U.S. defense contracting presents a number of risks to national security. For example, China could use its access to U.S. supply chains to steal sensitive information or sabotage critical systems. Additionally, China could use its leverage over U.S. suppliers to pressure the U.S. government to make concessions on policy issues."

An example of the potential scope of the problem is illustrated by an article appearing in the February 23rd edition of the Wall Street Journal entitled, "U.S. to Invest Billions to Replace China-Made Cranes at Nation's Ports."  The article opens by reporting, "The Biden administration plans to invest billions in the domestic manufacturing of cargo cranes, seeking to counter fears that the prevalent use of China built cranes with advanced software at many U.S. ports poses a potential national security risk." The article quotes Anne Neuberger, U.S. deputy national security adviser for cyber and emerging technology: "These cranes, because they are essentially moving the large-scale containers in and out of port, if they were encrypted in a criminal attack, or rented or operated by an adversary, that could have real impact on our economy's movement of goods and our military movement of goods through ports." Although Chinese officials dismiss these security concerns as "entirely paranoia…irresponsible and will harm the interests of the U.S. itself, Rear Admiral John Vann, who leads the Coast Guard cyber command disagrees, "By design these cranes may be controlled, serviced and programmed from remote locations. These features potentially leave the PRC-manufactured cranes vulnerable to exploitation."

In an article appearing in the March 7^th edition of the Wall Street Journal, it was reported that a congressional committee investigating Chinese built cargo cranes deployed in U.S. ports has discovered that a number of these cranes contain "communications equipment that don't appear to support normal operations, fueling concerns that the foreign machines may pose a covert national security risk." The manufacturer of the cranes involved is ZPMC, a Chinese manufacturer, which is reported to provide nearly 80% of ship-to-shore cranes in use in U.S. ports.

Relying on the same logic, the Biden Administration is also investigating whether Chinese vehicles may pose a risk to U.S. consumers. In an article entitled, "Biden calls Chinese Electric Vehicles a Security Threat" appearing in the February 29th edition of the New York Times, it was reported that the Commerce Department has opened an investigation to assess security risks to national security from entry of Chinese electric vehicles into the U.S. market. The focus of the assessment is the threat from technology/software embedded in the Chinese electric vehicles "... which could track where Americans drove and charge their vehicles ... and connect with the drivers' smartphone and nearby cars."

Approach to Address the Problem

Belatedly, some would argue, the U.S. government has begun to address U.S. dependence on foreign suppliers. Congress passed the National Defense Authorization Act (NDAA), the Bipartisan Infrastructure Act, and the CHIPS & Science Act and Inflation Reduction Act in an effort to begin the process of weaning American-based defense contractors from sourcing critical materials and processing from China and China dependent suppliers.

The Biden Administration has also taken actions to recognize the critical importance of a resilient supply chain, advocating for diversified inputs and strategic sourcing, particularly in sectors vital to national and economic security like semiconductors, energy production, transportation, and health, while acknowledging the complex challenge posed by China's significant role in key supply chains amidst the backdrop of escalating geopolitical tensions. In an Issue Brief of the White House dated November 30, 2023, the Biden Administration spoke of the need for a robust supply chain and noted that, "…diversified inputs and strategic sourcing can make a supply chain more robust." The Issue Brief continued that, "…the public sector has an important role to play in improving supply chain resilience. Legislation can prioritize investments in supply chain resilience in targeted sectors that are critical to national and economic security and have large spillover effects, including semiconductors, energy production, transportation, and health." In 2021, the administration issued an executive order directing the development of a government-wide approach to address threats to the United States most critical supply chains. The review identified "vulnerabilities" in a number of key sectors, including the fact that China controlled at least 60% of key battery inputs (lithium, cobalt, and graphites) and that 88% of semiconductor production occurs overseas. According to the White House, as of November, 2023, private companies have announced more than $614 billion in planned investment in industries, including semiconductors, electric vehicles, and batteries. However, given the staggering magnitude of China's involvement in the national-security-supply-chain, it will be a long and complicated process with the U.S. and its allies dependent upon China for the near and, in all likelihood, medium term. The present geopolitical environment makes this subject highly important on a strategic level.

The U.S. drive to decouple as much as possible from China has not been lost on China's competitors. Reuters recently reported that chipmaker Alchip Technologies is an example of this trend. In an article entitled, "Taiwan Chip Makers Flock to Japan as China Decoupling Accelerates," the authors report that a number of large Taiwanese chip makers are moving personnel and resources to Japan. It cites, as an example, Taiwanese chipmaker Alchip Technologies as "illustrative of the China decoupling trend." It reports, "In 2022, the bulk of its research and development engineers were based in China but Alchip has begun moving roles overseas, many to Japan.”

Although China's control of the supply chain represents the most obvious risks, the U.S. security concern is broader and includes an uncomfortable reliance on foreign manufacturers located in friendly countries. In an article entitled "Chipmakers Seek More than $70 Billion in Federal Subsidies" appearing in the February 27th edition of the New York Times, the authors reported that the Federal Government is distributing $39 billion in subsidies to incentivize companies to expand U.S. based production of chips…to reduce the country's reliance on foreign sources of chips." The focus of the incentives is to increase domestic production of the most technologically advanced chips, which are currently predominantly manufactured by U.S. ally, Taiwan. The authors state that with these incentives the U.S. would be on track to produce 20% of the world's most advanced types of logic chips by the end of the decade. The article quotes Gina Raimondo, Secretary of Commerce, that currently the U.S. produces zero of those high-end logic chips.

The challenges and risks inherent in foreign dominated supply chains are enormous and there are no short-term solutions.

Robert Weiss | Of Counsel | Co-Chair, EV Initiative