Catalyst with Shayle Kann - What the new Treasury rules mean for EV supply chains

Episode Date: April 6, 2023

The battery manufacturing announcements have been coming one after another—a VW cathode facility in Canada; a Tesla factory in Mexico; a Ford battery plant in Michigan. These companies hope to take advantage of the Inflation Reduction Act’s lucrative EV tax credits: Up to $3,750 for strategic minerals mined in the U.S. or its many free trade partner countries Up to $3,750 for battery components produced only in the U.S., Mexico, or Canada. But there’s a catch. A whole bunch of intermediate battery products don’t fit neatly into either bucket. For example, lithium gets processed into precursor cathode active material before it becomes cathode active material, the powder that actually makes it onto the factory floor of a battery manufacturer. Battery electrolytes go through multiple processing steps, too. Until last week, suppliers of these products were left wondering: Where should we manufacture to qualify? And for which credit? Congress had left these details up to the Treasury Department, and on Friday regulators released guidance for these intermediate products, or “constituent materials.” The new rules pleased some and angered others. So what do the changes mean for EV supply chains?  In this episode, Shayle talks to Sam Jaffe, our resident EV-supply-chain whisperer. He’s the vice president of Battery Storage Solutions at E Source. He’s come on the show before to talk about the holy grail of batteries and the basics of the IRA’s EV tax credits.  This time, Sam explains the new Treasury guidance.They cover topics like: Incentivizing domestic manufacturing while also giving auto companies the flexibility to qualify for credits Why Joe Manchin and European countries are upset about the new rules Japan’s last-minute free trade agreement before the rules came out How hard it will be for EV manufacturers to get qualifying constituent materials anytime soon, especially as they launch new mass market models What we still don’t know about how the Treasury will implement the IRA, including which countries or companies will qualify as “foreign entities of concern” Recommended Resources: U.S. Treasury: Anticipated Direction of Forthcoming Proposed Guidance on Critical Mineral and Battery Component Value Calculations for the New Clean Vehicle Credit The New York Times: New Rules Will Make Many Electric Cars Ineligible for Tax Credits Politico: Bitter friends: Inside the summit aiming to heal EU-US trade rift Catalyst is a co-production of Post Script Media and Canary Media. Support for Catalyst comes from Climate Positive, a podcast by HASI, that features candid conversations with the leaders, innovators, and changemakers who are at the forefront of the transition to a sustainable economy. Listen and subscribe wherever you get your podcasts. Catalyst is supported by Scale Microgrids, the distributed energy company dedicated to transforming the way modern energy infrastructure is designed, constructed, and financed. Distributed generation can be complex. Scale makes it easy. Learn more: scalemicrogrids.com.

from the studios of PostScript Media and Canary Media. I'm Shail Khan, and this is Catalyst. We can ridicule these politicians for making such an incredible octopus of difficult and complicated regulations, but I respect them because they're trying to add a whole way of regulating and incentivizing an entire supply chain, and that's incredibly hard to do. that devil always hiding in the details. When utilities need flexible capacity they can count on, they turn to Energy Hub. Energy Hub works with more than 170 utilities, coordinating over 2.5 million devices

to manage 3.4 gigawatts of flexibility, built for the moments when utilities can't afford uncertainty. Energy Hub builds and operates virtual power plants that utilities actually stake their grid planning on, coordinating EVs, batteries, thermostats, and more through a single platform built for utility scale. Predictive, verifiable, and designed to perform when it counts. Learn more at energy hub.com. Trillions of dollars are flowing into clean and critical infrastructure,

but those investments aren't driven by technology alone. They're shaped by markets, by policy, by capital, and by the institutions that connect them. I'm Alfred Johnson, CEO of Crux, and host of a brand new podcast, Critical Capital. Each episode, I talk with people deploying capital, shaping policy and building the clean economy. Tune in as we unpack how progress is actually made.

Listen to critical capital on Spotify, Apple, or wherever you get your podcasts. I'm Shayal Khan. I invest in revolutionary climate technologies at energy impact partners. Welcome. Ah, so we're entering the brief but wondrous era of extremely wonky, extremely important treasury guidance. It's been almost nine months since the Inflation Reduction Act passed in the United States. And multiple industries have been waiting with bated breath to learn how the Treasury Department will interpret a number of key clauses in the bill.

There are lots of important nuances. We've talked before about another one, which is how Treasury will interpret the life cycle emissions calculations for hydrogen production. But now we have the first big piece of guidance, I would say, which is the battery sourcing rules. One of the clearest impacts of the IRA has been to supercharge the buildout of a domestic supply chain for EV batteries. It's also been.

one of the most controversial globally with a huge public outcry from leaders in Europe and Asia, as well as some automakers. And last week, Treasury finally released draft guidance of their interpretation of those rules. So time to dig in. And of course, our chief digger is Sam Jaffe, who is the VP of Battery Storage Solutions at ESource and my personal battery supply chain whisperer. Here's Sam. Sam, welcome back to Catalyst. Thank you very much, Shale. Good to be here. So we're recording this in the afternoon of the day that Treasury released its guidance. Initial guidance? Final guidance? What is this? Final initial guidance.

Treasury released its final initial, partway done, totally done, baked and halfway baked guidance on how to qualify for the EV tax credits that were in the Inflation Reduction Act. And I want to talk through the details of it and the ramifications of it. But first, let's bring ourselves up to the present. you and I chatted on this podcast some months back in the wake of the Inflation Reduction Act passing where the bill had set all these rules for qualifying for up to a $7,500 tax credit for electric vehicles and complex set of rules. But despite the complexity of those rules, I think you, at the time, and this was soon after the bill passed, you were pretty bullish on the impacts that it would have on the domestic supply chain in the United States

for everything from battery minerals to battery manufacturing. So bring me up to speed from then to now. What have we seen happen? So we've had a lot of activity. On the guidance perspective, we've had the Treasury Department issue of white paper in December that talked about this concept of constituent materials. So it's kind of an interim step between strategic minerals,

which is one half of the tax, of the EV tax credit. and component, battery components, which is the other half of the EV tax credit. And in between there's this constituent materials. And they said, we don't know how we're going to handle this. We'll let you know by the end of March. And then this morning, they issued their full guidance on how constituent materials will be qualified. So that's on the update and guidance of the IRA. In terms of the actual progress of building out a supply chain in North America, there's been

enormous amount of activity. And I still think there's going to be another big jump in activity over the next six months with this guidance. So among that is the announcements of several large cathode production plants, most of which are going to be located in Canada. We have the Tesla factory in Mexico that was announced, a new gigafactory and car factory that will be built in Mexico. We have the CATL Ford battery plant. It's really a Ford battery plant with CATL technology guidance, but that was announced. That's going to be a 30-Gigawatt hour plant, making LFP batteries. And then just before this morning,

late afternoon yesterday, news broke that it looks like Tesla and CATL also are talking about building a Texas-based LFP battery plant. So the announcements have just been coming fast and furious throughout the entire supply chain. And can we attribute that basically as a direct result of the IRA?

Do you think there's any of those plants would have, I mean, presumably if you're announcing a plant, like it's been in the works a bit longer, or is it possible that, you know, folks woke up to the IRA nine, ten months ago and said, okay, like, hyperspeed, we need to cite and announce a new battery manufacturing plant. I think that companies throughout the supply chain have been planning on building plants regardless. But the location of those plants in North America and free trade partner countries is what's new. And we've actually seen a shift, in some cases,

a shift of battery plants that were planned for Europe, where they said, we're going to stop developing this and instead turn to building a plant in the U.S. Friar did that, Northwold did that, and a couple others have, and Volkswagen also talked about doing that. So I think we could pretty safely say then that the indications over the nine months since the bill passed

are that it was sort of working as intended, right? because the point of having all these domestic content provisions in the tax credit was to attract manufacturing to the U.S. predominantly, right? So it seems to have been working, basically. It seems to have been working, and not just in building car factories, which I think probably would have been happening anyway, but also in building battery factories and the entire supply chain along there. It definitely is happening, and it probably wouldn't be happening. A very small proportion of this would be happening without the IRA. So let's talk about the controversy that that caused then, and in sort of two categories. One is with our geopolitical allies in other countries who have generally

not been super excited about all these domestic content provisions. And the second being even domestically, where as the guidance has started to come out, there's been sort of an internal fight in the United States about are we taking this, the domestic content, uh, intent of the legislation seriously enough. So can you kind of walk me through the,

like how you think about all the noisy fighting that has taken place about this? Yeah, I think internationally, there's certainly been a big, uh, disagreement from coming, especially from Europe and Japan, from Western Europe and Eastern Europe, the UK and Japan, all of which are strong U.S. allies, but do not have free trade treaties.

And interestingly, Biden slipped in just before the shot clock went away. He slipped in a Japan battery materials free trade agreement through executive order. And we can come back to that because I think there's significance in that. But clearly there are international disputes between allies that have to be, that are going to be handled and probably negotiated through. I think that the biggest winners, though, of the other countries that are involved, Australia and Korea and Chile are by far the biggest winners. they all have free trade agreements with the U.S. and are going to come out looking very good from this. In particular, because of lithium, I assume.

I mean, Australia and Chile is where most of the lithium in brines comes from. Australia is where most of the lithium in hard rock comes from. So that's why those two and then Korea, because companies like LG can make batteries. Make batteries. And also there's quite a big entire battery supply chain in Korea also. compared to what's in China, but it is significant too. All right, so I think we'll come back to that because the significance of what the Treasury guidance today is impacted by these countries and what exists in these countries.

Before we get to that, maybe let's just do a quick refresher. Can you just walk through the two components of the EV tax credit and what it takes at the high level from the bill to comply with each? Sure. So there are two parts to the EV tax credit. One is battery components and one is strategic minerals. Strategic minerals are the minerals that are extracted from the ground and then processed into battery materials. The battery components are the finished electrolyte where the electrolyte slurry is put onto the foil,

which happens at the battery factory, as well as the separator, the electrolyte, the foils, themselves. And in the case of the strategic minerals, there is a percentage requirement of the total value of all the strategic minerals that must come from the U.S. or free trade partner countries. And that percent starts at, for strategic minerals, it starts this year at 40 percent of the value has to come from the U.S. or free trade partner countries. And that goes up 10 percent a year until eventually you get to 80 percent requirement. For the components portion, it's starting at 50 percent this year, has to be made in North America, and it goes up 10 percent a year until eventually 100 percent. So in other words, you have to make the battery cell itself

has to be manufactured in North America, U.S., Mexico, or Canada, and the minerals have to come from the U.S. or free trade partner countries. Now, interestingly, there's a big gap. There's a big hole in the donut there between minerals and components. And that's what today's guidance really laid out was they're calling us constituent material. So in other words, you take the lithium itself that's been processed into, let's say, lithium hydroxide, and you turn it into, you combine that with the nickel and the cobalt into a cathode active material. And that's the powder that's sent to the battery factory in North America. Now, according to this guidance, those constituent materials essentially fall under the category

of strategic minerals. The cathode material can be made in a free trade partner country and then ship to the U.S., and it will count as strategic towards that strategic. general number. Right. So that's the crux, I think, of where most of the debate has been around this guidance. So before we get to it, Critical Minerals side of this always was U.S. or free trade agreement countries. Within the list of free trade agreement countries includes the countries that happen to produce the most, at least lithium, which is Chile and Australia. So that makes lithium sourcing all else equal relatively easy.

right? Not necessarily so for nickel, cobalt, manganese, et cetera, et cetera, where the supply chains are a little bit different. But from a qualification perspective, and from a, again, it comes down to sort of the portion of the total value of those critical minerals that comes from a U.S. or free trade agreement country, like, is lithium a big enough piece of the stack that, you know, if you source your lithium from a free trade agreement country plus maybe some of your copper or something like that, then you're in good shape? Or do you really need to go like mineral by mineral and say, okay, every one of these

or most of these big ones we need to get from one of these countries? So two things. One is you're talking about the lithium from the ground or the water in the ground, which is coming from Chile and Australia. However, in the case of Australia, they dig up the rock called spodgamine

and then they ship it to China to be processed into lithium hydroxide or lithium carbonate. And that processing part of the supply chain is actually done outside of a free trade partner country. So that raises complexities. In terms of your question about the value of the lithium as a proportion of overall, no, that's a pretty small portion. By far the biggest for most of these electric vehicle batteries

of all of the minerals is going to be nickel. And then lithium and cobalt probably fall in second. But the single biggest number to shoot for is the nickel itself. And that's a problem because most nickel is coming from Indonesia, which is not a free trade partner country. Okay. So then on balance, critical minerals component here, sort of difficult to qualify for.

How about the – let's flip to the other side for a second. And then we'll talk about this in-betweener category. But how hard are we learning the battery components part is to qualify for? In this case, again, not free trade agreement country. So you need to be making the battery itself, or at least the battery components in North America, which presumably is why we've seen all these announcements that you described before about battery manufacturing in North America. Does it look like we are going to have sufficient domestic supply to meet the market in the near term? So let's define your term. Over the next 12 to 24 months, we're still going to be living in a world where most electric vehicles sold are luxury or near luxury vehicles, whether it's a Hummer EV or even a Kia EV6, it's still a 50,000 plus vehicle.

And in that environment, does $7,500 really matter that much to those buyers? This is all kind of a little bit of a thought exercise more than a true economic harbinger. However, we're about to see the launch of a whole lot of mass market vehicles. A lot of them coming from U.S. manufacturers, both from Jeep, from Stalanta, and from the Blazer EV is coming out from GM, those types of vehicles are going to fall into the $35,000 type purchase price car. And when you get there, $7,500 really matters. So what's going to really matter the most is when those vehicles come out in 2024

and really get pushed to large volume in 2025, what will be the state. And at that point, we're going to have the LG. GM, Ultium, Joint Venture, making over 100 gigawatt hours of batteries throughout this country. LG Stalantis will be making 35 gigawatt hours. Stalantis, Samsung, SDI, will be making another 30. And then Ford will have its CATL LFP plant making another 30 gigawatt hour. So, you know, right there we've got almost 200 or maybe more than 200 gigawatt hours worth of production, which is going to satisfy 2025 needs.

Virtual power plants are becoming a reliable way for utilities to manage capacity, but enrolling devices is just the start. What really matters is confidence, knowing those resources will perform when dispatched and being able to prove it from the control room to the living room. Energy Hub's platform handles the full picture, from near-real-time forecasting, locational dispatch, and the kind of rigorous verification that holds up when regulators, grid operators or leadership ask,

did it deliver? Easy enrollment creates momentum, proven performance builds trust. That's why more than 170 utilities rely on Energy Hub to manage over 2.5 million devices delivering 3.4 gigawatts of flexible capacity. See what that looks like at energyhub.com. We're living through a profound economic shift,

and energy sits at the center of all of it. Trillions of dollars are flowing into power plants, transmission lines, battery factories, data centers, but the future of energy isn't shaped by technology alone. It's shaped by markets, by policy, by capital, and by the institutions that connect them. I'm Alfred Johnson, CEO of Crux, the capital platform for the clean economy. Join me for my brand new show, Critical Capital, as I talk with people deploying capital, shaping policy, and building projects. Together, we unpack how risk is priced, how incentives are structured, and how progress is actually made.

Listen to Critical Capital on Spotify, Apple, or wherever you get your podcasts. Okay. Now let's get into the weeds. So this question, you mentioned, constituent materials. It's wonky, but it has been controversial. I'll read you a quote here from Joe Manchin as of, I think, a couple weeks ago. Because he has been, so there was this initial treasury guidance, I think in December, as you described, or at least white paper, sorry, the guidance was.

was just now. And the white paper laid out this middle category of constituent materials, which you can describe in just a moment. The question is, do you classify those constituent materials as critical minerals, or do you classify them as battery components? Turns out that's very controversial. Joe Manchin said, quote, it seems that Treasury is yet again ignoring the will of Congress by looking to blatantly expand the definition of a critical mineral to include constituent materials. So, and he again, today, after the guidance came out, blasted the guidance and said that sort of Biden is ignoring the intent of the law. So it's been controversial there from a political standpoint, but then also, you know,

there's been a bunch of reporting of companies who are trying to build domestic cathode manufacturing who've come out strongly with opinions about this as well. So let's talk about what the controversy has been and then where Treasury has landed on it. So what is a constituent material as Treasury has defined? and why do we care which category it goes into? So in the battery supply chain, you go from the mine where you extract the minerals to multiple steps of precursor materials in most cases for each one of these minerals to the battery component itself, to the battery cell, right?

And it's that middle part of all those precursor materials that has not been clear where it falls. And it's different, a little bit different for each of these materials. So for instance, with lithium, you start, let's say you're mining the hard rock in Australia, then you process it into lithium hydroxide. That's the actual mineral that's defined as a strategic mineral in the law, the hydroxide or the carbonate, the lithium hydroxide or lithium carbonate. Then you take that and you're going to add it to a precursor cathode active material or PCAM to turn it into a cathode active material.

And that's the actual cathode powder that's going to go to the battery factory. And that PCAM is not a mineral. It is a chemical. It's a precursor chemical. And when you add the lithium to it and make the cathode active material, what is that? Is that a strategic mineral or a battery component? It's not entirely clear from the language of the law itself. you go into something like electrolyte and it gets even more complicated because now you have multiple

finished chemicals such as the electrolyte salt like li pf6 or li fsi which goes through multiple precursor steps before that and multiple processing steps before that only to make a component of a component the electrolyte and and each of those steps how are you going to make sure how are you going to ensure that each of those steps is falling under, you know, the, whether it's the U.S. and free trade partner countries or North America or the U.S. itself, all of that is, is up for, for, has been up for definition, which finally we do have that definition. But it is, I mean, you know, we can, we can ridicule these, these politicians for making such an incredible octopus of difficult and complicated regulations. But I, you know, I respect them because they're trying

to add a whole way of regulating and incentivizing an entire supply chain. And that's incredibly hard to do. So I think what essentially what the guidance said was constituent materials, which is going to be any of these precursor steps up to the battery component itself, essentially falls under strategic minerals and the strategic minerals qualification. Now, they added this 50% rule, which says at each step of processing, from extraction to each of the processing steps that this, whatever the material you're talking about goes through, 50% of the value has to have been added by a free trade partner country or in the U.S. itself. So in other words, if the lithium is mined in Australia, that counts.

That's a free trade partner country. If it's processed in China, boom, it doesn't count because we don't have a free trade treaty with China. what if it's processed in Korea that counts if and then if and let's go away from lithium because that's the easiest one that's only one step to a shipable material but something like something like manganese which has four separate stages of processing and refining it has to come it has to be mined and then it has to be processed into electrolytic manganese metal in at least 50% of the value of that has to be done in a free trade partner country or the U.S.

Then it has to be turned into manganese sulfate. Again, has to be done in a qualified country. Then it's combined with the nickel and the cobalt to make the P-cam. It has to be done in the right country. Then it's made into the cathode. It has to be done in the right country, et cetera. And so each step along the way, you're allowed to, add some element of, you know, something can be added from another country that's not qualified,

but as long as 50% of the value added to that product in that processing step counts, then it counts. So let's talk about Korea for a minute, because I think this is where a lot of the controversy ultimately lies. So imagine that you are a cathode material producer. In fact, imagine you're somebody, like redwood materials who's building cathode manufacturing in the United States. If you had been qualified, if cathode active materials, which is in this constituent materials category, had been considered as a battery component, then only North American production of cathode materials would count, and clearly that's a big advantage to you. But instead, because Treasury went the other direction and said constituent materials are more like critical minerals,

it is U.S. or free trade agreement countries. And critically, I think, Korea is a free trade agreement country. And correct me if I'm wrong, Korea is where a lot of cathode manufacturing or anode material manufacturing takes place. So does that basically remove the incentive for domestic cathode and anode material manufacturing that otherwise would have been there? I wouldn't say it removes it, but it does place it on a level playing field with, building a new plant in Korea or with Japan in the case of the new treaty with Japan.

So now if you are going to build a new cathode plant, you have to choose, do I do it in North America or do I do it in Japan or Korea, basically? You could do it in any one of those 14 countries that we have free trade agreements with, but there's not much advantage elsewhere to do it there. What it does do is existing facilities in Korea and Japan will be able to qualify for this agreement. And that's a big deal because if they had to rebuild that production capacity in North America in 2023, they wouldn't have been able to do that. And that goes back to the Japan agreement. Essentially, my conspiracy theory is that essentially this was a, a bone that was thrown to Tesla because Tesla makes its battery cells in North America with Panasonic.

It makes some of its materials in North America. The electrolyte is made here, the separator, the cans, some other things are made in North America. But the cathode, which is by far the most expensive part of the battery, is made in Japan by Sumitomo metals of mining. And by sneaking this free trade agreement in, they allowed Tesla to qualify for the components and the, I'm sorry, they allowed them to qualify for the strategic minerals portion of the EV tax credit that otherwise they wouldn't have if Japan wasn't allowed. Okay, so that's where this controversy has been. Clearly the administration, or the Treasury at least, was kind of trying to thread this needle,

where like on one hand, you know, the whole point of this legislation is to protect domestic manufacturing and build up a supply chain. On the other hand, there was clearly, they were getting pushed. I think both by our free trade agreement countries, possibly by auto manufacturers, maybe Tesla included on this. And so they were sort of trying to figure out what the right solution was. They fell on this side of it and we'll see what happens. Is this the, this is guidance?

Is this what comes next? Like what's left to be done here? So I think that there is one big hole in what we don't know, which is foreign entity of concern. And they did not give guidance on how they define foreign entity of concern for the purposes of the EV tax credit. And, you know, they didn't give any guidance. They were asked very specifically, is a country a foreign entity of concern? Do you have to name the company itself as a foreign entity of concern? And they wouldn't even say that.

So they still have another six months or so to provide that guidance. And that's important because if you are today shipping your spodumine to China to be made into lithium hydroxide, then that's if China does turn out to be a foreign entity of concern, that will disqualify that material for the tax credit. So right now, it is going to be qualified. but as soon as they name specifically what they mean by foreign entity of concern, that could change. Is there realistically any possibility China is not a foreign entity of concern? I mean, again, to the point of this sort of like intent of the law,

feels like pretty clearly a significant portion of the intent of the law is to shut China out of manufacturing of batteries for EVs in the U.S. So the question is, will they say China overall is the foreign entity of concern, or will they have to name specific companies within China as foreign entity of concern? And therefore, and then start playing the game of that you're in, you're out. So that's going to be kind of difficult to do, but it could, you know, they could look at companies that have a financial relationship with the central government would be disqualified and private companies might not be. We'll see how that works out.

Or they could just say anything in China is off limits. So putting back on your prognostication hat then, what is your sense of what this guidance does to the market over the next, until we get final clarity on everything? Everything proceeds apace as it had been. Does it divert any decisions, accelerate anything? I think it definitely, it definitely

so the regulators are walking a fine line between do we make this doable or do we make it too complex and take into account every little nuance but then it's just too hard to qualify

for these things or do we make some broad brush measures and make it doable for the car makers to qualify and what I see and what they've done is that they've erred toward the side of broad brush measures. And by that, I mean, you know,

specifically identifying constituent materials as strategic minerals and therefore allowing for not just U.S. production or North American production, but, you know, are an alliance of countries that is going to be able to make this happen. All right, Sam, as you said, It's an octopus of, I don't remember what you call it, but it's an octopus of complex regulation, but so is the battery industry. That's why we talk about it so much.

Thank you for helping to illuminate it once again. All right. Thanks very much, Shale. Sam Jaffe is the vice president of battery storage solutions at eSource. This show is a co-production of PostScript Media and Canary Media. You can head over to canarymedia.com for links to topics on today's show. PostScript is supported by Prelude Ventures. a venture capital firm that partners with entrepreneurs

to address climate change across a range of sectors, including advanced energy, food and ag, transportation and logistics, advanced materials in manufacturing, and advanced computing. This episode was produced by Camille Stennis and Daniel Waldorf, mixing by Roy Campanella and Sean Markwand, theme song by Sean Marquand. I'm Shale Khan, and this is Catalyst.