Preamble
The first article I discussed the potential impact of export restrictions on the US semiconductor industry, particularly on Intel, was written in April. Thereafter, I’ve covered Applied materials and Qualcomm.
since April, The Federal Reserve Bank of New York has produced a report that confirms that US companies, either equipment suppliers or US manufacturers of semiconductors have been adversely affected by these sanctions. In fact, according to the report, these shipment controls have encouraged the Chinese to develop their own equipment and chips in an attempt to become less reliant on the US.
To quote from the report; “As a result of these disruptions, affected suppliers have negative abnormal stock returns, wiping out $130 billion in market capitalization, and experience a drop in bank lending, profitability, and employment.” If I may borrow Homer Simpson’s iconic exclamation of frustration; D’ohh!!
In response to US restrictions, China has introduced its own export controls, which includes a reduction in the supply of graphite, leading to a number of US companies experiencing a host of severe problems.
My thesis is that there is the potential for negotiations to rescind US sanctions on the semiconductor industry, and therefore the iShares Semiconductor ETF (NYSEACRA: SOXX), in exchange for a resumption in the supply of essential minerals. One such beneficiary of any easing of export controls could be Nvidia Corporation (NASDAQ:NVDA).
However, since sanctions were introduced, Chinese companies have made progress in replacing US technology. For instance, due to Huawei’s advances in its Ascend range of chips, any easing of restrictions may not necessarily translate into to a hike in revenues and profits for US companies such as Nvidia.
Graphite
Graphite plays a crucial role in various US manufacturing sectors, with its application in batteries taking centre stage as the nation shifts toward electric vehicles and renewable energy storage.
Primarily, graphite’s unique properties make it ideal for manufacturing anodes, the negative electrodes in lithium-ion batteries. In fact, most EV batteries are composed of around 28% graphite. So, good luck trying to make EV batteries and the like without graphite.
As the US ramps up domestic battery production to reduce reliance on foreign supply chains, the demand for graphite, especially the high-purity spherical graphite produced in China, is soaring.
Beyond batteries, graphite finds use in various US manufacturing sectors. Its high heat resistance makes it vital for refractory materials in steelmaking and other high-temperature industrial processes. It’s also used in lubricants, brake linings, and electrical components like carbon brushes.
There is the problem of supply of graphite as there are few sources of this vital material in the US and most of it comes from China. To quote a report from S&P Global; “Mainland China is the world’s largest graphite producer, producing 77% of the world’s graphite demand in 2023, with the US importing 42% of its graphite requirements from China. US graphite demand gets to the crux of the problem — it imported 84,000 metric tons of graphite, while consuming 76,000 metric tons, meaning its production is negligible.”
Battery Factories
Seemingly, in the order of $100 billion has already been invested by various manufacturers to produce batteries for the EV industry. This is in addition to those companies currently producing batteries, Tesla for instance. There is even what has been termed a “battery belt”, which consists of Michigan, Indiana, Ohio, Kentucky, Tennessee, North Carolina, South Carolina and Georgia.
The only problem is that if graphite supply drops, then these facilities will, I guess, need to be mothballed. Again, if I may commandeer Homer Simpsons well-known expletive; D’ohh!!
Given that, “Natural graphite shipments slumped 91% in December from November,” how long will it be until manufactures begin imploring the powers that be to initiate discussions with their Chinese counterparts to address the issue? Not long is my guess, especially given the huge numbers of new jobs associated with clean energy.
But graphite is not the only element that is being denied to US companies. Both gallium and germanium, which are essential for many products, are subject to similar controls to graphite.
Nvidia Products For China
For Nvidia, designing chips for Chinese customers is similar to a game of whack-a-mole, once they design to overcome restrictions, the product has the potential to be banned the “very next day” by US Secretary of Commerce Gina Raimondo.
Nvidia was barred from selling its A100 and H100 GPUs, two of the most in-demand chips for training and running AI models, to China in August 2022. It later modified those chips to create the A800 and H800 to get around those restrictions, but the A800 and H800 were also barred from export to China last October.
Nvidia has developed the B20 for Chinese customers, which is a downgraded version of its most powerful Blackwell B200 graphics processing unit launched earlier this year.
Nvidia originally planned to start shipping the new chip in the fourth quarter, but that timeline has entered la-la land as new concerns have risen that an expansion of export controls reportedly being considered by Washington.
Importance Of The Chinese Market
The latest Form 10-Q report states that the revenue from China (including Hong Kong) for the three months ended ‘Apr 28, 2024’ was $2,491 million and for the three months ended ‘Apr 30, 2023’, it was $1,590 million, which represents an increase of 56.67%.
The report also notes that; “Our Data Center revenue in China is down significantly from the level prior to the imposition of new export control restrictions in October 2023.”
Despite the impressive rise in revenues from China, the overall revenue from China represents only around 9% of the total revenue. Clearly, if the data center market in China were to become more accessible, a huge potential jump in revenues would be possible.
However, Huawei is catching up fast, so, if indeed negotiations do take place that enables Nvidia to have greater access to the Chinese markets, it may be too late as Huawei are catching up fast.
Huawei
Huawei’s latest processor, the Ascend 910C, is reportedly being tested by Chinese internet and telecom companies in recent weeks, and Huawei claim that the chip is comparable to Nvidia’s H100. It is believed that the 910C will be launched in October 2024.
The 910C comes hot on the heels of the 910B, which came onto the radar only last year. According to some reports, the 910B was said to rival Nvidia’s A100 chip.
SMIC, Huawei’s manufacturing partner, seems to be having some issues with yield. One report states that; “despite being in mass production for over half a year, SMIC’s manufacturing of the Ascend 910B is still facing challenges, as four out of five chips still have defects. Meanwhile, due to increased U.S. export restrictions, the supply of equipment parts has been disrupted, causing production output to fall far short of targets.”
Risks To Thesis
As you may well imagine, there are advanced plans to develop local production of graphite. For instance, “The Department of Defense announced today a $3.2 million agreement with South Star Battery Metals Corporation (South Star) to support domestic production of Coated, Spheronized, Purified Graphite (CSPG) at their BamaStar Graphite Project (BGP) in Coosa County, Alabama.” Whilst deposits of graphite are being developed, it may be a few years before supplies come on stream.
It is within the realms of possibility that the Chinese government may decline to discuss these issues on the grounds that any such agreements to recommence trade in semiconductors and equipment may be short lived, given that plans are afoot to develop homegrown supplies of materials such as graphite.
Summary
The US semiconductor industry, particularly companies like Nvidia, has been significantly impacted by export restrictions. The sanctions have not only affected US businesses but have also spurred China to accelerate its domestic chip development, potentially reducing its reliance on US technology.
The situation is further complicated by China’s retaliatory export controls on critical materials like graphite, which are essential for US manufacturing, particularly in the burgeoning electric vehicle sector.
There’s a possibility that negotiations could lead to the lifting of US sanctions on chips in exchange for easing Chinese export controls on materials like graphite. However, even if restrictions are eased, the potential revenue boost for companies like Nvidia might be limited due to the rapid advancements in Huawei’s domestic chip capabilities.
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