The US EV industry now faces a choice: Tax credits or Chinese batteries

Last week, the Biden administration released long-awaited proposed guidance for how it plans to enforce one of the most complex and controversial aspects of the electric vehicle incentives created by the Inflation Reduction Act: the requirement that the country’s fast-growing EV and battery industries avoid using materials supplied by China, a geopolitical rival that has so far dominated clean energy manufacturing.

Now, the companies that have spent more than $100 billion establishing U.S.-based EV and battery factories since the law was passed last year are striving to adapt to the coming restrictions — and confronting the reality that, under the proposed rules, virtually none of the EVs they are currently manufacturing will still be eligible for the law’s $7,500 federal tax credit as of 2025.

Under the proposed guidance from the U.S. Treasury Department, electric vehicles containing any battery component ​“manufactured or assembled by a foreign entity of concern” will no longer be eligible for the tax credit starting next year. In 2025, electric vehicles that ​“contain any critical minerals that were extracted, processed, or recycled” by a foreign entity of concern will no longer be eligible for the credit.

“The U.S. really has owned its own EV transition already. The vast majority of EVs on the road today are made here,” said Albert Gore, executive director of the Zero Emission Transportation Association, a trade group that includes automakers, battery manufacturers, mining companies, charging manufacturers and electric utilities. Now that the new guidance gives EV manufacturers clear incentives to secure battery supplies outside of China, ​“we ought to be putting policies in place that accelerate that, while putting the U.S. on a trajectory of owning all the upstream pieces” of the EV battery industry as well.

The prospects for U.S. manufacturers to secure sources outside of China for the processed minerals and components that go into lithium-ion EV batteries remain murky. ​“That is something the industry has been working on resolving since IRA was enacted,” said Nick Nigro, founder of research firm Atlas Public Policy. But once the proposed rules go into effect, ​“it’s going to be very hard to get an EV with a $7,500 tax credit in the U.S.”

Atlas Public Policy has tracked $67 billion in announced investments in U.S. battery manufacturing and another $11.7 billion in domestic critical minerals and processing since the law was passed. It also forecasts that the U.S. will receive $210 billion of the $860 billion in global EV and battery investment it expects to see through 2030.

Still, China has built a commanding lead in every step of the global EV supply chain, from the refining of minerals to the production of cathode and anode materials and the manufacture of battery cells and EVs. Today, it’s very difficult to find a lithium-ion EV battery that doesn’t contain some portion of minerals or components processed or made in China or by a Chinese-based company.

And while U.S. companies and partners from Europe and Asia are quickly building domestic EV and battery manufacturing capacity, they remain largely reliant on mineral and materials supply chains controlled by Chinese firms.

Friday’s proposed guidance from the Department of Energy doesn’t single out China. But of the four countries on its list of foreign entities of concern — China, Iran, North Korea and Russia — the latter three don’t really play a role in the global EV industry. China, by contrast, dominates it.

DOE’s guidance designates any company based in one of the countries on its list as a foreign entity of concern. The label would also apply to companies at which 25 percent or more of board seats, voting rights or equity interest are cumulatively held by officials of those governments or companies based in those countries, ​“whether directly or indirectly via one or more intermediate entities.”

The proposed rule would also require scrutiny of joint ventures, licensing agreements and other cooperative ventures with companies based in China (or other countries on the list). Any such agreements that would give those companies ​“effective control over the extraction, processing, recycling, manufacturing or assembly” of ​“critical minerals, battery components, or battery materials” will render the resulting products ineligible for the tax credit.

Just how these guidelines will impact the cooperative relationships being formed between U.S. and Chinese companies in the fields of battery manufacturing, materials processing and mining remains unclear, noted Pavel Molchanov, managing director and equity research analyst at Raymond James & Associates.

But these U.S.-Chinese EV partnerships have already sparked a backlash from U.S. politicians demanding a harder line against China — most notably in the form of attacks on Ford’s plans to build batteries in Michigan using technology licensed from Chinese-based lithium-ion battery giant Contemporary Amperex Technology Co., Limited, or CATL.

“The geographic aspect of all this is basically clear-cut,” Molchanov said. ​“Where I think the DOE guidance will run into some controversy is in trying to define which individual companies fall into the category of being government-controlled. This gets into dicey questions of relationships between businesses and officials, which can be quite opaque and subject to differing interpretations.”

The same rules could complicate how companies qualify for a $6 billion federal grant program created by 2021’s Bipartisan Infrastructure Law to boost domestic battery production, which imposes restrictions on manufacturers that source battery components from foreign entities of concern.

Earlier this year, DOE canceled a $200 million grant to Texas-based battery manufacturer Microvast after Republicans attacked it for appearing on a 2022 U.S. Securities and Exchange Commission list of companies suspected of intellectual-property violations in China.

A tightrope walk: Boosting the U.S. EV industry without hobbling it

There’s an inherent tension in the EV policy goals of the Inflation Reduction Act, which aim to both greatly expand EV manufacturing and at the same time limit the use of products and minerals from China. As John Bozzella, president and CEO of the automaker trade group Alliance for Automotive Innovation, explained in a Friday statement, the overarching strategy has been to ​“first, localize automotive supply chains, including battery production, from China to the U.S. and our allies. Second, support the current EV transition in the form of consumer tax credits and other market incentives.”

China’s dominance of the EV supply chain has ratcheted up these tensions in Washington, D.C. The Biden administration sees the $7,500 tax credit it made available to U.S. consumers who purchase new EVs as a key incentive that will help it meet its goal of making half of all new car sales EVs by 2030, and it has been in continual conflict with Republicans in Congress who have accused the administration of weakening U.S. competitiveness with China by favoring domestic EV production.

Republicans have had an ally in Senator Joe Manchin, the West Virginia Democrat who played a pivotal role in crafting the tax credit and shepherding the Inflation Reduction Act’s passage. Manchin criticized the Biden administration for a Treasury Department decision in March that relaxed some restrictions on EV battery domestic-production guidelines so that more vehicles would qualify for tax credits.

On Friday, Manchin accused the Biden administration of knuckling under to automakers by offering exceptions to the foreign entity of concern rules for certain trace minerals that make up less than 2 percent of the critical minerals used in batteries.

But Gore said that this trace-minerals provision, as well as another that would give automakers until 2026 to develop tracking standards for other ​“low-value materials” in batteries, are reasonable in light of the challenges that automakers and battery manufacturers face.

“There are many, many challenges ahead,” he said. ​“The best you can ask for is a rule that’s easy to understand, that’s rational, and that’s defensible.”

At the same time, automotive analysts have been predicting for the past year that the foreign entity of concern rules represented the highest bar yet for EV makers seeking to ensure that their vehicles would be eligible for the tax credit — one that may be insurmountable given China’s lock on key parts of the supply chain.

The Treasury Department’s rules on domestic and free-trade partner manufacturing requirements, released in March, narrowed the list of vehicles eligible for the full $7,500 tax credit to about 20 all-electric and plug-in hybrid models, out of more than 100 for sale in the U.S., Bozzella noted. But those previous rules allowed vehicles to claim at least a partial tax credit if they contain a majority of materials and components from U.S. or free-trade partner sources.

The foreign entity of concern rules are far more restrictive, essentially disqualifying any EV with a battery that can’t prove it is completely untouched by association with a company that falls under its designations.

The proposals must still go through a comment and rulemaking process before being finalized, which means restrictions may not go into effect until well into next year, Nigro pointed out. ​“I don’t expect this to have a negative effect on EV sales in 2024,” he said. In fact, he added, ​“I’d expect to see a bump in sales of vehicles that qualify for the $7,500 tax credits” in advance of the final rule being adopted.

But few, if any, automakers are ready to meet the newly proposed restrictions on batteries containing any critical minerals extracted, processed or recycled by a foreign entity of concern starting in 2025, he said.

This chart from the International Energy Agency illustrates why. China and Chinese companies control between half to three-quarters of global lithium-ion battery minerals and materials processing, about 70 percent of cathode production, about 90 percent of anode production and about 75 percent of battery cell production.

It won’t be easy for automakers to build up supply-chain relationships outside of China’s dominant position. Ford, General Motors and Tesla have already made investments in lithium mining operations in North America and South America. Reuters reported in June on moves by automakers including Mercedes-Benz, Renault, Stellantis, Tesla and Toyota to secure graphite supplies from sources outside of China.

“Establishing eligible processing facilities around the world is really, really important,” Gore added. But ​“I don’t know what the timeline will be.”

Supplying EV batteries untouched by China: A long road ahead

It will be easier to develop processing for some core battery minerals than for others, Gore noted. Most of the world’s lithium is mined in Australia and South America. In the U.S., companies are investing in extracting and processing lithium from sites in the Southeast’s emerging Battery Belt, in the Nevada desert and in California’s Salton Sea.

Other core battery minerals will be harder. ​“I think graphite is going to be challenging,” Gore said. The vast majority of this core structural battery material is made and processed in China, and the U.S. has only begun to invest in supply and processing chains outside of Chinese control.

Another challenging mineral is cobalt, a key ingredient in the nickel manganese cobalt (NMC) chemistries used for most lithium-ion EV batteries today, he said. About 70 percent of the world’s cobalt is in the Democratic Republic of Congo, and about 80 percent of that is mined by Chinese-owned companies, often under appalling conditions.

One option for U.S. automakers and battery manufacturers is to switch to lithium-ion battery chemistries that use less cobalt, as General Motors is doing with South Korean battery giant LG Energy Solution via its Ultium Cells joint venture. Another is to switch to battery chemistries that forgo cobalt completely — which explains the major investments being made into lithium iron phosphate, or LFP, battery chemistries. This technology has the added benefit of making batteries cheaper, which is a major factor in lowering the cost of EVs enough to make their price competitive with that of internal combustion vehicles.

“LFP has the best promise for low-cost vehicles,” Gore said. The problem is that ​“very few people are doing it.” And today, the race for LFP batteries for EVs is dominated by two Chinese companies, CATL and global EV manufacturing leader BYD.

One prominent partnership has already become a flashpoint in the political sparring over the EV tax credit. In February, Ford announced its plans to invest $3.5 billion in a Michigan battery factory that will produce LFP batteries using technology licensed from CATL. The project quickly sparked attacks by Republican lawmakers, who have ordered Ford representatives to provide documents detailing the partnership and have threatened to call top Ford executives to testify before Congress.

Ford insists that its factory in Marshall, Michigan will be 100 percent owned and operated by Ford through its BlueOval subsidiary. ​“CATL will have zero ownership interest,” Ford spokesperson Richard Binhammer told Canary in a Friday email. Ford also maintains that the licensing agreement with CATL does not give the Chinese company effective control over how the factory will be run.

“There are companies — Ford is the high-profile example — which are seeking to provide a wide array of affordable technologies to their customers and have identified this LFP technology” as the battery chemistry best suited for that purpose, Gore said. ​“They’ve signaled the intention to build several factories, wholly owned by Ford, to utilize this technology.”

Ford and CATL have not made public the terms of their agreement. In recent months, reports have surfaced of General Motors lobbying the Biden administration to deem Ford’s deal with CATL as a violation of its foreign entity of concern rules. GM, Ford and the Biden administration have declined to comment on these reports.

“Corporate lawyers will have a field day with all of this,” Molchanov said. ​“As it relates to a sensitive contract between two companies, there is virtually no circumstance for it to be disclosed publicly. This is something that will need to be discussed, on a confidential basis, between Ford and the DOE.”

But Gore highlighted that the DOE’s proposed guidance does offer some clarity that should clear Ford’s factory making batteries using CATL’s technology from being subject to the foreign entity of concern designation.

DOE’s proposed guidance offers some examples of arrangements that could trigger that designation, including ​“restrictive or overreaching licenses such as lack of access by the licensee or principal to information and data (e.g., control parameters or specification and quantities of material input for equipment) that are necessary to operate equipment critical to production at necessary quality and throughput levels.”

“That’s clearly not what was done with Ford-CATL,” Gore said. ​“But this rule provides a formal process for the government to verify that there is a good type of license agreement that does not give the character of control to a [foreign entity of concern] through a formal agreement.”

But Gore also pointed out that the vast majority of the U.S. battery factories that have been built or announced since the passage of the Inflation Reduction Act are using lithium-ion technologies developed by other companies. Examples include Ford’s joint venture with South Korea–based SK On, GM’s joint venture with LG Chem, and the deals between Stellantis, which makes brands of vehicles including Chrysler, Dodge and Fiat, and LG Chem and South Korea’s Samsung SDI to build batteries in North America, as well as a more recent memorandum of understanding with CATL to explore partnerships in Europe.

“We ought to center policies on what grows U.S. manufacturing now,” he said.

But even if DOE and Treasury approve these partnerships and joint ventures between Chinese and non-Chinese companies, the batteries they produce will still be subject to the foreign entity of concern restrictions. In other words, those batteries will still need to be able to prove that all of their constituent minerals, materials and components don’t run afoul of the rules.

“Years from now, there will be competitive technologies and manufacturing processes” that can comply with those rules, Gore said. ​“It’s important to set up principles that are durable, rational and consistent” to guide that development. ​“Frankly, we have to do what China did 15 years ago and start going around the world and investing.”