Car manufacturers’ strategies for maintaining their position in the Chinese market are forcing treasury teams to explore new options as well as refine established approaches.
With car sales in 2021 almost equal to the total for the US, Japan and India combined, the Chinese market is fundamental to the success of the automotive industry.
In this context the most recent data from the China Association of Automobile Manufacturers is encouraging, with more than 2.4 million vehicles sold in July as production returned to normal as government incentives – including a reduction in purchase taxes – began to take effect.
So-called ‘new energy’ (electric and plug-in hybrid) vehicles accounted for just under a quarter of total sales. BYD overtook Tesla as the world’s best-selling electric vehicle manufacturer in the first half of this year and a number of other Chinese companies are now among the largest producers of electric and plug-in hybrid vehicles globally.
In July, a briefing held by the State Council Information Office underscored the importance of promoting sales of new energy vehicles and ensuring the supply of auto chips and related raw materials at a relatively stable price. Guo Shougang, an official with the industry ministry, was quoted as saying that efforts were underway to expedite a study into extending purchase tax exemptions for electric cars.
These comments echo an earlier observation by foreign direct investment consultancy Dezan Shira & Associates that a number of ministries including the Ministry of Information and Industrial Technology were negotiating with manufacturers about extending electric vehicle subsidies that were originally set to expire at the end of this year.
The Ministry of Commerce has committed to other measures to encourage consumption, including incentives for using electric vehicles, improving the availability of charging facilities, and encouraging the replacement of older vehicles.
However, Dezan Shira & Associates observes that China’s long-term strategy of reducing subsidies, coupled with supply chain issues and Covid lockdowns, is likely to drive up the price of electric vehicles over the coming months.
Manufacturers such as XPeng and NIO have responded by either absorbing the subsidy loss or cancelling preferential lending programmes for potential purchasers.
The surging cost of a number of automotive components has required Chinese car manufacturers to rapidly adjust their procurement strategies and increase budgets for procurement explains Jing Yang, Director of China Corporate Research at capital markets credit rating, commentary and research provider Fitch Ratings. “Larger inventories of parts and unfinished cars, and larger prepayments all have an impact on their working capital cycle,” she says. “Meanwhile, as car manufacturers are increasingly involved in critical parts production and sourcing, they need to allocate additional capital for such investments – in the form of capital expenditure, joint venture investments, or equity investments in upstream suppliers.”
For example, suppliers of electric vehicle batteries may demand joint investment in production lines from car manufacturers to secure battery supplies.
“These strategies require the finance and treasury team to provide professional assessments of the project returns and also to facilitate internal or external financing,” adds Jing.
Richard Hilgert, Senior Equity Analyst – Automotive at financial services firm Morningstar says finance and treasury teams play a vital role in supporting the procurement and supply chain strategies of the major car manufacturers in China by maintaining availability of funds in a volatile commodities market and by working with senior executives to understand future funding needs as the bill of materials changes in the shift to vehicle electrification.
As car manufacturers are increasingly involved in critical parts production and sourcing, they need to allocate additional capital for such investments – either in the form of capital expenditure, joint venture investments, or equity investments in upstream suppliers.
Jing Yang, Director of China Corporate Research, Fitch Ratings
Gao Tao, Associate Director Light Vehicle Production Forecasting at automotive solution provider S&P Global Mobility refers to BYD as a success story in this respect, noting that its sales are up by 77% year-on-year despite the difficulties faced by all manufacturers since the start of 2022.
“The major driver of this growth is a stable in-house supply chain in the face of restrictions in semiconductor availability and increased material prices,” he says. “For other OEMs [original equipment manufacturers] relying on external supply chains, most new energy vehicle producers have increased their vehicle prices since the start of the year and some features have been cut off to save chips for major functions.”
The new automotive business model in China is customer service-centric and in this new world, mobility becomes both shared and autonomous explains Purshottam Purswani, APAC Chief Technology Officer for information technology service and consulting company Atos.
“The industry is evolving with many banks either providing the billing platform or integrating with car manufacturers’ procurement or supplier management systems to provide supply chain finance,” he says.
Purswani observes that car manufacturers’ own financial service companies are offering digital buying platforms or integrating with well-known e-commerce platforms. “This reinforces manufacturers’ investment in digital services for their consumers or sales channels,” he adds.
The China Association of Automobile Manufacturers has acknowledged that car production has been severely affected by the shortage of chips and the increase in the price of raw materials for batteries this year. Manufacturers have adopted a variety of strategies to address these issues.
Earlier this year, Matteo Fini, Vice President Automotive Supply Chain Technology and Aftermarket at S&P Global Mobility noted that LFP or lithium iron phosphate-cathode batteries would stand to gain further competitiveness in the market should nickel and cobalt prices continue to stay elevated.
LFP chemistry was initially favoured by Chinese manufacturers BYD and CATL as a low cost alternative to nickel and cobalt-rich chemistries. Chinese manufacturers hold a virtual monopoly on this technology thanks to key patents registered by a consortium of Chinese academic research institutions which agreed with local battery manufacturers to forego licensing fees provided these batteries were only produced in China, although these patents will start expiring from this year.
In 2014, Tesla reportedly tried and failed to acquire Californian lithium extraction start-up Simbol Materials, which later ceased operations.
At Tesla’s Battery Day event in 2020, the car manufacturer seemed to indicate that it was seriously considering establishing its own mining operations through the purchase of a 10,000 acre site in Nevada, although nothing appears to have come of this to date.
Industry experts reckon Tesla is more interested in securing long-term supply agreements with existing and potential new mines. But with lithium prices having increased by around 400% over the last two years it appears that the prospect of the car manufacturer acquiring and running a mining company cannot be discounted.
According to the United States Geological Survey (USGS), five mineral operations in Australia, two brine operations each in Argentina and Chile, and two brine and one mineral operation in China account for the majority of world lithium production with a number of additional Chinese operations under development.
But demand from Chinese car manufacturers far outstrips supply. A paper published in Frontiers in Environmental Science in June noted that the country accounts for just 6.8% of global lithium reserves and that 86.5% of its requirements are imported.
Hilgert notes that Chinese electric car manufacturers seeking to ensure sufficient supplies of commodities such as nickel, graphite and lithium are increasingly going directly to the raw material mine operators to secure supplies.
Most Chinese electric car manufacturers still rely on the battery suppliers and a cost pass-through mechanism was established this year which typically links battery procurement costs with the cost of the key battery metals.
Electric vehicle makers are paying larger amounts upfront, making joint investments in battery production lines and even establishing joint ventures with battery cell producers to ensure battery supplies, observes Jing.
It may be easier to secure supplies for Chinese manufacturers than those in other countries, but eventually they will face similar challenges in the supply chain given the rapid increase in battery demand.
Rico Luman, Senior Sector Economist, ING
“A small number have also started to make equity investments in upstream battery materials,” he says. “Yet with the exception of BYD, few Chinese electric vehicle manufacturers have taken further steps to acquire battery metal mines themselves.”
One exception is BYD, which earlier this summer announced that it would invest more than US$4bn in a battery factory and mining project in China’s Jiangxi province that could produce up to 100,000 tonnes of lithium annually in addition to a recently commissioned plant in Shaoxing. At current consumption levels the new facility would produce about 125% of the battery cell volume produced by BYD in the first six months of this year.
“Some OEMs are cooperating with battery producers who have either already established subsidiary companies or acquired lithium enterprises,” adds Gao. “Vehicle manufacturers with in-house supplies are expanding their lithium mining businesses in South America and Africa.”
Supply of battery metals is about to lag demand as manufacturers ramp up production and demand soars. This means a new supply chain crunch could emerge around these metals in the next few years – especially for lithium.
That is the view of Rico Luman, Senior Sector Economist at Dutch multinational banking and financial services corporation ING, who notes that concentration of supply in a small number of countries makes it more vulnerable to disruption.
“Large international car manufacturers such as Ford, GM and Tesla have moved to secure supplies via direct agreements with mining companies,” he says. “Chinese manufacturers are competing in the same global markets for raw materials and with China now taking the lead in the electric vehicle transition – not only in terms of absolute numbers, but also relatively in terms of share of new sales – sufficient supply of batteries is even more important to accommodate rising short term demand.”
The fact that most battery production capacity is still based in Asia offers an advantage to Chinese manufacturers.
“It also helps that Chinese market leader BYD is a battery manufacturer itself and thus it will also negotiate to secure supplies of raw materials,” explains Luman. “China produces lithium and nickel, but when it comes to ramping up production to keep up with demand it may also need to rely on supply from elsewhere. It may be easier to secure supplies for Chinese manufacturers than those in other countries, but eventually they will face similar challenges in the supply chain given the rapid increase in battery demand.”
In contrast, the introduction of new digital buying platforms and the ‘car as a service model’ has made relatively little impact on the finances of car manufacturers in China, although Gao acknowledges that greater use of digital buying platforms has reduced the number of dealerships and made it cheaper for manufacturers to expand their distribution networks.
According to Hilgert these trends have required manufacturers to increase their investment in IT infrastructure, software engineers, and digitisation of their vehicles.
Jing notes that although the direct sales model has been adopted by many electric vehicle start-up companies as a means of directly accessing customers without having to provide funding to dealers – the approach taken by traditional car makers – it comes with downsides.
For example, manufacturers have to bear the inventory risks themselves and invest intensively in distribution networks, which are typically a combination of an online platform and a large number of offline showrooms.
“Under the car as a service model, car manufacturers (or their service subsidiaries) typically hold the vehicle fleet on their own balance sheet, so it is an asset heavy business model,” he explains. “Car makers can opt to move such vehicle assets off the balance sheet through asset-backed securities or other structured finance products, or they may introduce strategic/financial investors to the car as a service companies to dilute their own stakes. However, e-commerce penetration is yet to improve in China’s retail car market.”