Taiwan’s Semiconductor Industry Faces Continual Risk From China, Key US Reshoring Efforts DelayedJul28

I. Today’s Thematic Investment Idea

A deep dive into a market driver with alpha generating potential.

Taiwan’s Semiconductor Industry Faces Continual Risk From China, Key US Reshoring Efforts Delayed

Summary: Taiwan Semiconductor Manufacturing Co’s decision to delay the opening of a much-lauded $40 billion Arizona plant into 2025 shows the US still has more hurdles to overcome in reshoring domestic chip capacity. Education and other elements of the complex ecosystems that Asia has developed will take time to scale up in the US, meaning that global semiconductor supply chains will continue to run heavily through the island of Taiwan.

Taiwan’s air defense zone has been violated hundreds of times by the Chinese military over the past several years, and increasingly strict trade restrictions targeting China’s chipmaking capabilities could increase the incentive for China to exhibit greater aggression toward the island. Though Taiwan has long benefitted from its “silicon shield”, the strategic value of the island’s advanced fabrication technologies, China’s desperation to avoid falling further behind its adversaries in chip tech, and Beijing’s widening ties with Moscow, may soon outweigh the global economic turmoil that would result from a war in Taiwan.

Related ETF and Stocks: iShares Trust – iShares Semiconductor ETF (SOXX), Taiwan Semiconductor Manufacturing Company Limited (TSM)

Earlier this week, Taiwan Semiconductor Manufacturing Co (TSMC) announced that the start of production at a planned facility in Arizona will have to be postponed from late 2024 until 2025, citing a shortage of skilled workers and expenses running higher than in Taiwan. Delays like this, if they become more common, will force the world to continue relying on Taiwan for an outsized portion of its most advanced chips. Per Voice of America, chip powerhouse TSMC accounts for more than 90% of output of advanced chips, and 65% of all semiconductors. It is the leading chip contractor as well, manufacturing chips for companies as large as Nvidia and Apple. While it was forced to push back the timetable on their new Arizona plant, TSMC said it would invest around $2.9 billion in an advanced packaging facility in Taiwan, meant to advance the integration of multiple semiconductors in a single package.

The US has tried to siphon off some of this capacity by bringing a larger share of chip fabrication back to its domestic market. A White House report states that 37% of global semiconductor production occurred in the US as recently as 1990, but that share tumbled to just 12% by 2022. Last year, congress enacted the distribution of tens of billions of dollars in investment tax credits and other incentives for chipmakers building in the US via the CHIPS and Science Act. That legislation will certainly have some positive impact but leaves other issues unaddressed – particularly education. A new study prepared by the Semiconductor Industry Association (SIA) and Oxford Economics finds the US will experience a projected shortfall of 67,000 technicians, computer scientists, and engineers by 2030 at the current rate that prospective employees are graduating from schools.

Bloomberg has reported that producing chips in the US still takes 25% longer and costs nearly 50% more than doing so in Asia. Some experts, like Singaporean Cyber Security Agency Chief David Koh, have highlighted specific issues with trying to rapidly re-deploy semiconductor capacity in the Western world, largely relating to key variables in semiconductor fabrication that will be difficult to scale up in short periods of time. During a recent POLITICO panel, Koh suggested that neither the US nor the EU possess the “complex ecosystems” required to support large-scale semiconductor operations. “There’s a challenge of whether you have the competence, you have the trained personnel, et cetera,” he said. Singapore produces 5% of the world’s semiconductor wafers.

Stumbling blocks in the way of the US’s ambition to reshore chip output means global semiconductor supply chains will continue to rely heavily on Taiwan. That situation is becoming an increasingly worrisome liability, given China’s ramping up of aggression in the region. MRP has long-highlighted the hundreds of violations of Taiwan’s Air Defense Identification Zone (ADIZ) by China throughout the past several years, with People’s Liberation Army (PLA) aircraft crossing the median line that separates the two countries in the Taiwan Strait as recently as last month. In April, Chinese military exercises focused on staged drills to “form a multi-directional island-encompassing blockade situation“; an encirclement maneuver around the island. 

China’s increased cooperation with Russia is also a concerning prospect, given the latter’s ongoing invasion of Ukraine, in defiance of Western sanctions and other measures taken to isolate the country from the international community. Just yesterday, the two countries’ militaries wrapped up four-days of joint exercises in the Sea of Japan. The fleet of around 10 vessels and 30 aircraft demonstrated their combined capabilities as a POLITICO investigation found that Chinese exports of ceramics to Russia, a component used in body armor, have risen by 69% to more than $225 million in 2023. More significantly, apparent shell companies, headquartered in Russia, have filed declarations this year detailing orders for hundreds of thousands of bulletproof vests and helmets from Chinese manufacturers.

Taiwan’s crucial position in the global semiconductor market makes its security a priority for the US, but some have speculated that it could also make it an even more critical target for China. MRP has continually highlighted the implementation of strict trade restrictions on semiconductor technologies and equipment in an effort to deprive China of high-quality chips and extreme ultraviolet (EUV) lithography machines, typically used to produce advanced 5 to 7 nanometer (nm) chips. China’s Semiconductor Manufacturing International Corporation (SMIC) had managed to quietly advance its semiconductor fabrication processes to include the production of 7 nanometer (nm) chips, a big jump from the 14nm capacity that most had thought SMIC was capable of, but is unlikely to achieve mass commercialization of the tech without EUV machines and associated equipment. China achieved its 7nm milestone by reverse engineering a “close copy” of chips utilized by TSMC, indicating that China has a good understanding of some of TSMC’s most advanced manufacturing techniques.

Though shipments of semiconductor manufacturing equipment from key markets like the US, Netherlands, and Japan has been rising on a global scale, Nikkei Asia reports that Japanese exports of such equipment to China slid -16% YoY in Q4 of last year while the US saw a -50% plunge and the Netherlands logged a -44% drop. Both Japan and the Netherlands have confirmed their commitment to US-backed limitations on semiconductor trade restrictions on China and new restrictions on exports of chip equipment from both have taken effect over the last month.

Outlets including GIS have highlighted the “Silicon Shield” concept as a potential deterrent to Chinese aggression toward the island, suggesting that Taiwan’s role in the global digital economy is so indispensable that damage caused to its chip fabrication operations would be great enough on its own to stop Beijing from declaring war on the island. While a conflict in Taiwan would hurt China as much, if not more, as anyone else, China’s economy and placement in the global political order will also be at risk if it is locked out of the world’s most advanced semiconductor technologies that are already available on an island that China already considers apart of their territory. Leslie Wu, a Taiwanese semiconductor industry consultant, has estimated that, without access to foreign technology, it could take at least 20 years for China to regain lost ground in their domestic semiconductor industry.

China may look to insulate itself from economic damage from warfare and international sanctions by expanding its trade and partnerships with Russia, Iran, and other countries already considered pariahs by most developed economies. For example, CNN reports that bilateral trade between Russia and China totaled more than $93.8 billion from January to May in 2023, a more than 40% increase compared to the same period last year, data from China’s General Administration of Customs showed. Meanwhile, trade between China and the US has dipped by -12.3% over the same period. Per Russian Prime Minister Mikhail Mishustin, trade between Russia and China will exceed $200 billion for the full-year 2023. China’s exports to Iran grew by 14% annually in 2022, totaling nearly $9.5 billion.