Onshoring and Friend-Shoring in U.S. EV Supply Chains: What Are the Boundaries?

The Inflation Reduction Act (IRA) was intended to reinvigorate U.S. support for electric vehicles (EVs). The law made subsidies for EVs more plentiful by removing per-company caps on the number of cars that can be sold with tax credits, but it also introduced new requirements for how and where EV supply chains should develop. The legislation was meant to onshore and friend-shore the EV supply chain, to capture the benefits of a new supply chain and reduce entanglement with China.  

The IRA defines the onshoring and friend-shoring agenda by incentivizing investment in the United States, North America, and countries with a free trade agreement with the United States. As the Biden administration is setting up to achieve the goals of the IRA, doing so effectively and without angering close allies and trading partners is fraught. It needs to work to align the implementation of a new batch of tax credits through Treasury Department rulemaking with new diplomatic efforts abroad and on the Hill, as unrest over the boundaries of onshoring and friend-shoring is brewing.

Q1: What are the latest developments?

A1: Last week, the Biden administration took two relevant actions:

  1. The U.S. Trade Representative announced an agreement with Japan under which the two would not levy export duties on critical minerals they trade, and coordinate labor standards in minerals production, among others. The administration expects this to make batteries made by Japanese companies eligible for tax credits under the IRA.
  2. The U.S. Department of the Treasury proposed guidance on the new clean vehicle provisions of the IRA. The long-awaited document was released on March 31, and vehicles put into service after April 18 will be subject to the latest requirements to be eligible for tax credits. For 2023, that means that 50 percent of battery components and 40 percent of critical mineral content must come from a U.S.-centric supply chain.

Q2: Who can be in the EV circle of friends?

A2: Eligibility for the Clean Vehicle tax credits (30D) requires EVs to be built of minerals and components sourced through North America or countries with which the United States has a free trade agreement. That second condition was meant to allow cooperation with friendly countries and allies, but alienated trading partners in Japan and Europe (countries with which the United States does not have a free trade agreement).

Allied nations like Japan and South Korea have EV battery mineral and material processing capacity that the United States largely lacks. Together, they account for about 29 percent of the global cathode material production capacity, while China accounts for the remainder. To counter that Chinese supply chain, the United States may need to rely on the efforts of these allies and treat them as “friends.” The recent Japanese equity investment in the Australian heavy rare earth project at Mount Weld, due to enter in operation in the next few years, could supply up to 30 percent of Japan’s rare earth demand. Japanese-processed rare earth from non-Chinese sources, such as Australia, could make more EV battery minerals eligible for the IRA 30D tax credits, thereby aiding the deployment of EV batteries increasingly less dependent on China.

The Biden administration is aiming for the announced minerals agreement with Japan to make EV tax credits apply to goods sourced from that country. This carries significant legal and political risk. It raises the legal question of whether the administration can establish a sectoral trade agreement and call it a free trade agreement for the purposes of awarding tax credits. Members of Congress on both sides of the aisle have already voiced concern about the maneuver, as it skirts Congress’s traditional role in trade authority. Such an executive branch move is also vulnerable to being challenged and dismantled should there be a change in the administration.

Q3: Will Europe follow?

A3: In the months following the IRA’s enactment, political leaders in Europe strongly protested the U.S. action, which they characterize as protectionist. European leaders have repeatedly met with the White House officials to raise their concern and demanded concessions or exemptions that would soften a presumed blow to EU competitiveness in clean energy technology.

In response to the IRA, the European Union has discussed allowing member states to deploy more industrial policy, raising some concerns that this may lead to a subsidy race. Others, including some U.S. officials, have lauded such a trend arguing it would bring more investment to deploy clean energy technologies quicker.

Seeing the IRA as a major economic threat to its industrial competitiveness, the European Union in February presented a Green Deal Industrial Plan to enhance EU competitiveness in clean energy industry. Included in this plan is the Net Zero Industry Act, which seeks to provide a regulatory framework for speedy clean energy technology deployment and simplified permitting to ensure industrial capacity. Another part of the industrial plan is the Critical Raw Materials Act. The act seeks to ensure the European Union has sufficient access to minerals and materials for clean energy technology. Specifically, the minerals act would provide numerical benchmarks for domestic capacities in extraction, processing, and recycling, as well as in coordinating stockpiling of minerals and material among member states.

Additionally, despite considerable uncertainty over the political and legal viability of the aforementioned mineral specific agreement between the United States and Japan, a similar trade deal is reportedly in making between the United States and the European Union, as the latter seeks ways in which its member states would not be disadvantaged from the lack of a free trade agreement with the United States. One of the outcomes of European Commission president Ursula von der Leyen’s meeting with President Biden in March was a joint statement which reiterated both parties’ commitment to finding a solution to the issue and enhancing cooperation on diversifying supply chains for batteries and critical minerals.

Q4: Who will be outside the EV circle of friends?

A4: The IRA also imposes an additional condition prohibiting the application of EV tax credits where any components or critical minerals is sourced from a “Foreign Entity of Concern,” but who exactly falls under this category and how the sourcing is tracked and enforced remain unclear. The definition will matter since having components sourced from a Foreign Entity of Concern will exclude eligibility starting in January 2024 for battery components and January 2025 for critical minerals used in the battery.

The provisions seem intended to exclude entities with associations with countries like Russia and China. In addition to China’s supply chain dominance, Russia is a major source of nickel and other metals. Against anticipation, the Treasury Department guidance document indicates that future guidance will address these issues.

Q5: What role will Chinese companies and technology play in U.S. EVs?

A5: Whether policymakers like it or not, Chinese companies will loom large in the EV sector. In the near-term, companies will encounter challenges avoiding battery components from China. Second, more Chinese firms may enter the U.S. market, either by exporting vehicles and batteries from China or manufacturing them in the United States. After all, nothing in the IRA prohibits consumers from purchasing a Chinese EV. Contemporary Amperex Technology Co. Limited (CATL)’s partnership with Ford to make batteries in Michigan has received significant political scrutiny, even though the U.S. automaker will be the sole owner of the new factory and will license the technology from the Chinese company. CATL may be the first, but it is probably not the last Chinese company to seek expansion in the United States. The demand for batteries is particularly high, making this a good opportunity for Chinese firms with a good track record in mass production.

Chinese EV companies are also vying for international markets at the moment. Several Chinese firms, including Volvo and Geely's Polestar, are expanding in Europe. It seems natural that at least some of China's top EV companies will try to reach U.S. consumers. Whether they can do so by exporting vehicles from China at competitive prices or will invest in U.S. manufacturing remains to be seen. Either option will carry its own risks, given the political attention on the sector and Chinese companies more broadly.

Joseph Majkut is the director of the Energy Security and Climate Change Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Ilaria Mazzocco is a senior fellow with the Trustee Chair for Chinese Business and Economics at CSIS. Jane Nakano is a senior fellow with the CSIS Energy Security and Climate Change Program.

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Joseph Majkut
Director, Energy Security and Climate Change Program
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5Mazzocco
Senior Fellow, Trustee Chair in Chinese Business and Economics
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Jane Nakano
Senior Fellow, Energy Security and Climate Change Program