China's Electric Vehicle Supply Chain and Its Future Prospects – China Briefing

Electric vehicles (EVs) have emerged as the sole growth area in the automotive market, amid a decline in overall car sales since their peak in 2017. As the world transitions towards a sustainable future, the EV market is expected to foster innovation and drive growth in one of the economy’s crucial sectors. China stands at the forefront of this transformation with its thriving EV industry, offering foreign companies a plethora of opportunities driven by government incentives, environmental regulations, favorable policies, and technological innovation.

We discuss investment prospects in China’s EV industry from a supply chain perspective in this industry brief.

China’s leading position in the global EV industry

China is the world’s largest new energy vehicle (NEV) market. According to the Ministry of Public Security, NEV ownership in China reached an impressive 13.1 million by the end of 2022, showcasing a substantial increase of 5.26 million vehicles (a remarkable growth rate of 67.13 percent) compared to 2021. Of this vast NEV fleet, electric vehicles accounted for an astounding 79.78 percent at 10.45 million.

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Enterprise search data show that China has more than 600,000 existing NEV-related enterprises. The year 2022 saw 239,400 newly added enterprises, an increase of 40.34 percent year-on-year. China’s new energy vehicle market has been developing rapidly in recent years, with growing market participants and competition in the industry. Major industry players include BYD Auto, Tesla China, SAIC-GM-Wuling, Aion, and Changan Automobile. These five players have more than 50 percent market share combined.

Globally, China holds a dominant position in the EV supply chain, with over three-quarters of the world’s battery production capacity. The battery is among the most important components of an EV and accounts for 40 percent of the vehicle’s total price. Moreover, China houses more than half of the world’s processing and refining capacity for lithium, cobalt, and graphite, which are essential materials for making EV batteries. Specifically, China boasts 70 percent of the global production capacity for cathodes and 85 percent for anodes.

China benefits from its inherent supply chain advantages, lowering costs in logistics, labor, and land management. Moreover, the large EV market enables economies of scale. Compared with Western markets in the US and Europe, China’s EV manufacturing industry has a cost advantage of 20 percent.

State support

The Chinese government has implemented supportive policies to bolster the growth of the EV industry. In line with the dual-carbon target, the State Council introduced the “New Energy Vehicle Industry Development Plan (2021-2035)” on November 2, 2020. This plan outlines a national strategy aimed at achieving a sustainable automotive future with reduced emissions.

On June 21, 2023, China unveiled a substantial RMB 520 billion (US$72.3 billion) tax incentive package spanning four years. This package is designed to offer tax breaks for EVs and environmentally friendly vehicles. Notably, it provides a complete exemption from purchase tax for NEVs purchased in 2024 and 2025, with savings of up to RMB 30,000 (US$4,170) per vehicle. From 2026 to 2027, the exemption will be halved and capped at RMB 15,000 (US$2,078). The goal of this initiative is to stimulate growth in the automotive industry, especially in light of sluggish auto sales.

Many regions have also introduced local initiatives. For instance, Shenzhen released the “Guidelines for Financial Support to the High-Quality Development of New Energy Vehicle Industry Supply Chain” in 2023. This proposal aims to enhance cross-border financial services to support NEV enterprises. Similarly, Shanghai issued the “Implementation Plan for Accelerating the Development of New Energy Vehicle Industry (2021-2025)” to drive the growth of the NEV industry in their region.

Currently, in China, the distribution of the NEV industry is similar to that of the traditional automobile sector, with a concentration in key areas such as Beijing-Tianjin-Hebei, the Yangtze River Delta, the Pearl River Delta, and the central region.

What does the EV industry supply chain look like and how does it work?

The EV supply chain can be divided into three main stages of production activity: upstream, midstream, and downstream.

The upstream industry involves the supply of raw materials and components for vehicle manufacturing. It encompasses extraction of minerals, namely lithium and cobalt, and manufacturing of major parts, including power battery, drive motor, and electronic control system. Most of these minerals are concentrated in a few countries, including the Democratic Republic of Congo, Argentina, Chile, and Australia. The dispersion and concentration of these key materials make the global supply chain vulnerable and susceptible to disruptions caused by developments linked to geopolitics, shifts in trade alliances, and corporate consolidation.

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China currently holds a prominent position in this stage, accounting for 75 percent of global lithium-ion battery production and 70 percent of cathode capacity. It stands as the leading refiner of battery metals globally and currently hosts a significant share of battery cell manufacturing capacity, anode, and electrolyte production as well as battery component manufacturing.

The midstream industry covers the vehicle manufacturing process. China is a major player in this industry stage, with a robust manufacturing ecosystem in place for electric cars, commercial vehicles, and special-purpose vehicles. Supportive government policies and investments have contributed to the rapid growth of the automotive manufacturing industry, making China a leading force in the global electric vehicle market.

The downstream segment of the EV supply chain comprises charging services and after-market services. This includes charging equipment infrastructure, automobile finance, insurance, trading, automobile repair and maintenance, and automobile dismantling and recycling. In recent years, the number of EV charging piles in China has been steadily increasing. Private charging piles are growing at an even faster rate compared to public charging piles. However, there is still a significant gap between the current number of charging piles and the market demand, leaving ample room for further development in the charging infrastructure. According to industry researchers, in 2020, China had a total of 1,751,000 charging piles—874,000 private charging piles and 807,000 public charging piles. By September 2021, the number of publicly owned charging piles rose to 1.044 million units.

China’s EV supply chain development trends and overseas investment

The existing automotive supply chain features a vertical distribution with Tier-1, Tier-2, and Tier-3 suppliers. Parts manufacturers and original equipment manufacturers (OEMs) generally take a tier-by-tier supply approach—Tier-1 suppliers support OEMs, while Tier-2 and Tier-3 suppliers support Tier-1 suppliers. Tier-1 suppliers, which may be subsidiaries or shareholding companies of OEMs, mainly supply system assemblies or modularized parts, while Tier-2 and Tier-3 suppliers mainly supply individual products, such as transmission gears, etc.

With the accelerating pace of digitization and electrification, automobile products, as well as its operation and consumption, have changed dramatically. Specialized components, such as battery, power semiconductor devices, chips, system software, video sensors, LIDAR, etc., have become integrated sections of the supply chain. The automotive industry is transforming from a traditional manufacturing-assembly industry to a technology-intensive industry.

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In fact, EV companies work with a flatter and more flexible supply chain system, with a faster pace of product iteration, to adapt to market changes. Significantly, Tier-2 and Tier-3 suppliers can now directly supply new car manufacturers like Tesla, bypassing traditional Tier-1 companies. This has led to a rapid integration of these manufacturing and service suppliers into the automotive sector. Internet giants, such as Baidu, Tencent, Alibaba, as well as electronic communications giants like Huawei and Xiaomi, are making their way into the field of new energy vehicles and intelligent driving cars through various means. These trends impact how traditional automotive enterprises operate.

For example, BMW AG announced in 2022 that it will be procuring large cylindrical batteries for its upcoming generation of electric vehicles (EVs) from CATL and EVE Energy (a Tier-2 Chinese battery supplier). This collaboration signifies the growing trend of automakers partnering with battery manufacturers to produce batteries specifically for their own vehicles.

However, such an ideal case may not always work out. Tier-2 and Tier-3 producers face significant challenges to remain competitive in the EV market. This is because established battery incumbents like CATL can offer preferential pricing due to their large-scale operations. Further, while there is a growing demand in China, the pace of capacity expansion seems to be outstripping actual demand, resulting in oversupply and forcing producers into fierce competition. As a result, it becomes crucial for these producers to find customers in non-China markets.

Chinese battery suppliers venturing into overseas markets also hope to service the supply shortages in Europe and the US, besides establishing production facilities near OEM clients. In 2022, the total number of NEV exports reached 679,000 units, showing a significant year-on-year increase of 1.2 times. The demand outlook for the overseas market remains promising, driven by the accelerated shift of global automakers towards EVs and the ongoing lag in battery supplies. Leading Chinese suppliers are expected to maintain their technological and cost advantages over their global counterparts.

Challenges in the EV supply chain

The EV industry faces multifold challenges in both domestic and international markets. The demand for EVs in China has experienced a slowdown, as indicated by the leading industry association’s forecast of 35 percent growth in 2023, in contrast to the significant 90 percent growth observed in 2022. The domestic battery market in China has become saturated, leading to a decline in battery prices over the past decade. CATL, as a dominant player in the market, has offered lower prices to secure a fixed share of future orders. However, such a move towards a price war has instigated resistance from other producers.

Further, the price surge of battery-grade lithium carbonate has pushed up the manufacturing costs of vehicle manufacturers. The fast growth of global demand for EVs, batteries, and materials may even drive up the price of EVs, not to mention the volatility resulted from a concentrated supply chain.

These supply chain issues are compounded by hindering regulatory developments. One major obstacle is the shortage of chips, due to the CHIPS and Science Act, which has significantly impacted the entire automotive industry. Tight control over semiconductor chips have resulted in insufficient production and a structural imbalance, thereby driving up the production costs for vehicles. In addition, competing legislation, such as the Inflation Reduction Act (IRA), aiming to strengthen the supply chain in the US, may bar Chinese companies’ direct investments in the US market.

How foreign companies can participate in China’s EV industry?

As the world’s largest EV market, driven by government incentives and environmental regulations, China presents an enticing opportunity for foreign investors. Supportive sectoral policies and a focus on technological innovation further encourage foreign investment. To succeed in this market, however, adaptation to local preferences and the establishment of robust partnerships are essential.

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Under China’s latest Negative Lists for Foreign Investment Access, there are no special restrictions on foreign investors to invest in the EV industry. That is to say, foreign investors can build wholly foreign owned enterprises (WFOEs) in specific areas of the EV supply chain, such as EV auto parts, batteries, chargers, and related industries. For example, Tesla’s success with its Gigafactory in Shanghai showcases the impact of increased foreign competition in China’s EV market. WFOEs encourage technological transfer and innovation. Yet, with the rise of Chinese domestic companies and challenges in the global supply chain structure emanating from geopolitical factors, foreign enterprises are advised to carefully consider market entry.

Another approach that foreign companies can adopt is to establish joint ventures with Chinese partners. Joint ventures enable collaboration in multiple areas, such as manufacturing, technology development, and distribution. This can involve forming alliances for specific projects, sharing research and development efforts, or jointly exploring new business opportunities.

Further, foreign companies can invest directly in Chinese EV startups, manufacturers, or related infrastructure projects. Investors can also engage in technology transfer agreements with Chinese partners, sharing technological expertise, patents, or licensing agreements to facilitate the development and production of EVs in China. Such collaboration can help foreign companies gain access to the Chinese market while benefiting from local manufacturing capabilities.