🔋When The Dust Settles

Inflation reduction act raises questions about Indonesian battery resources which is bad for both sides in the global market, especially given US-China tensions.

Nov 30, 2022

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A Brief History of Settlers of Catan - The Fact Site

The Inflation Reduction Act (IRA - broken down nicely here) which was signed into existence in August has been referred to as the greatest piece of climate legislation yet. The title of the bill also claims it to be a driving force for lower prices for consumers for a variety of things from healthcare, electricity, and electric vehicles. For my initial thoughts on the legislation which naturally lead into the discussion here, you can find the piece here.

One of the strikingly complex topics that the IRA involves is geopolitics. Though the tax incentives laid out below, it becomes self evident that geography is a huge issue. The bill extends tax incentives for electric vehicles but with a few catches,

Increasingly stringent requirements for the battery materials to be mined, processes, or recycled within the US, or with nations that the US has free trade agreements with.
Increasingly stringent requirements that the manufacturing of battery cells be completed in the US.

Since the IRA incentives production of materials and cell assembly to countries with free trade agreements, that raises questions as to who this applies to and if this is a big deal or not. The United States currently has free trade agreements in place with these 20 countries,

Australia, Bahrain, Canada, Chile, Colombia, Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, Israel, Jordan, Korea, Mexico, Morocco, Nicaragua, Oman, Panama, Peru, and Singapore.

The US wants to increase domestic production of battery materials from a security concern perspective. China maintains power over much of the battery supply chain and with tensions between the countries rising, it makes sense that this would be a goal. What about other countries like Indonesia? Indonesia is the largest Nickel producer in the world. With high nickel content cathodes like NMC being popular for Li-ion batteries right now, this is a vital resource in the battery space. Indonesia is also set to become the second largest producer of cobalt, another important component of NMC cathodes.

Nickel and cobalt sourced from Indonesia will soon not allow automakers the ability to capitalize on the tax incentives in the IRA. This means automakers can’t charge as much this way. Many companies like Toyota, Ford, and GM have already announced battery cell manufacturing facilities in the US. The problem still remains where the materials are mined and processed.

Free trade agreements are far from what the name implies. In reality they are selective trade agreements that have benefits to certain members. Trade agreements are a tool that allows nations to maintain leverage and bargaining power over other countries through tariffs and admission to the agreements themselves. For general interactions between people, you exchange something of value that you have to someone else if they have something that you desire. This is the essence of trade. If you have ever played Settlers of Catan or other resource management games, you know that trying to win the game trading with no one or after deciding never to trade with one of your opponents can come back to haunt you and is a difficult path to success. If success is the goal, let the simple game act as a guide. A nation should trade with whoever offers something of value. If people do not agree with how they do things, it is in their power not to trade with them. Thus, it is not the governments job to be the arbiter of what trade between people and businesses is preferable in my opinion. These artificial incentives can cause companies to trade with people they normally would not, and pay prices they normally would not, distorting prices and the market.

For the IRA example, the selected pool of nations that automakers allow to get the incentives necessarily decreases the pool of available trading nations that automakers are going to trade with. This artificially lowers the available supply of usable materials, potentially raising costs of certain regions of materials. Furthermore, since automakers are able to charge more due to the IRA incentives, they will. The price of some vehicles has already gone up in proportion to the tax incentives offered thus increasing actual costs of goods which is contrary to the goal of the bill. Finally, it is worth noting again here that government intervention causes production of goods that wouldn’t otherwise be produced. Even if full battery electric vehicles are an inevitable wave, it is no doubt that they have been dramatically accelerated through the government programs, potentially causing further market distortions. For example pressure on the mining industry, what if full EVs are not the optimal path, and what about other technologies that may come along? [1,2]

Indonesia has a plethora of natural resources including nickel and cobalt for batteries. Unless the US goes and forms a free trade agreement with the nation, you can expect many automakers to turn their back on the nation for their US products and China to scoop up any discounted Indonesian resources. Given the US-China tensions, this is a shot in the foot so to speak. In the long run I would expect this to be a net negative to both sides who could’ve benefited from the exchange. What other second order consequences will the IRA prompt? Until next week,

-Grayson

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