Korea Inc’s big battery bet on Indonesia at risk from US restrictions

South Korean companies are relying on the US showing greater flexibility over China’s role in electric vehicle supply chains, as they invest heavily — often with Chinese partners — in battery materials production in Indonesia.

A $441mn investment last month by Korean metals giant Posco in a nickel smelting plant on the Indonesian island of Halmahera has taken South Korea’s hard-cash dealmaking in the south-east Asian country to more than $3bn since the start of 2022, the bulk of it being battery-related.

Indonesia is the world’s largest producer of nickel, a crucial ingredient that Korea’s leading EV battery companies need for the multibillion-dollar factories they are building in the US.

Yet the majority of Indonesia’s nickel production and processing is controlled by Chinese companies, complicating Korean efforts to construct a supply chain that fulfils US demands for batteries free of Chinese ownership of key components.

“South Korea was planning to use Indonesia as a major global hub for electric vehicle production,” said Kyunghoon Kim, an associate research fellow at the Korea Institute for International Economic Policy.

“But without concessions from the US, it will be difficult,” he added. At best, Indonesia could end up “as a regional production hub”.

The US Inflation Reduction Act offers billions of dollars in tax credits to battery companies only if a certain percentage of the value of critical minerals contained in their products is processed or extracted in the US or by partners with free trade agreements. 

Indonesia lacks a free trade agreement with the US, and Washington is yet to spell out how it will define the “foreign entities of concern” — a reference to China — that it wants to be phased out of the US battery supply chain by the beginning of 2025.

Korean investment has intensified under Indonesian president Joko Widodo, who implemented an export ban on raw nickel ore in 2020. The move spurred international companies to invest in nickel processing within the country’s borders, with many of those deals involving partners from mainland China.

South Korea’s LG Energy Solution, the world’s leading non-Chinese producer of EV batteries, announced a partnership in April last year with Posco, two Indonesian state-owned companies and Chinese miner Zhejiang Huayou Cobalt, with a series of investments that would eventually total $9bn.

Then, in November, a partnership was announced between fellow Korean battery maker SK On with Korean cathode producer EcoPro and Chinese battery component producer Green Eco-Manufacture to produce an intermediate nickel product called mixed hydroxide precipitate (MHP) on the Indonesian island of Sulawesi.

Posco, whose chemicals subsidiary has a $33bn supply agreement with Korea’s other battery major, Samsung SDI, signed a preliminary agreement in February with Chinese mining firm Ningbo Liqin to produce nickel and MHP on Sulawesi.

The problem, said Tim Bush, a Seoul-based battery analyst at UBS, is the Inflation Reduction Act has given companies until the beginning of 2025 — just over 18 months away — to complete the construction of a new, “IRA-compliant” supply chain, despite them having no clear sense of what level of Chinese involvement will be permitted.

“It is extremely difficult for the Korean companies to pull the trigger on the multibillion-dollar investments that will be required to diversify their supply chain when they still haven’t been informed of the rules of the road,” said Bush.

In May, the chief financial officer of LG Chem, the parent of LG Energy Solution, told investors its working assumption was that the US government would apply the same definition of “foreign entities of concern” that it uses for legislation concerning the semiconductor industry.

That would mean that joint ventures with a Chinese equity stake of over 25 per cent would not qualify for the credits, in effect excluding most of Indonesia’s nickel supplies from the alternative supply chains the US is hoping to build.

“The Korean companies have gone all-in on Indonesia and now they are in a quandary,” said Ross Gregory, Seoul-based executive director of EV consultancy New Electric Partners.

Gregory also noted environmental concerns surrounding carbon-intensive mining practices in Indonesia. “The risk is that the nickel they get will be both non-IRA compliant and not clean enough. They urgently need to diversify.”

However, a Europe-based nickel trader observed that Indonesian nickel is discounted about 30 per cent compared to London Metal Exchange prices for alternative products such as Australian briquettes. 

“They’re sitting there saying we can’t survive [without it],” they said. “I can carry on buying expensive nickel or I can put myself in the game to buy the cheapest nickel in the world.”

Posco, which took a 30 per cent stake in Australia’s Ravensthorpe Nickel in 2021, told the Financial Times that “we are diversifying nickel sourcing to Australia and New Caledonia to reduce our dependence on Indonesia, although we are not particularly concerned about our exposure to Indonesia”.

Earlier this year, the US treasury issued guidelines that will make it easier for Korean companies to produce more components domestically. It means that nickel products sourced in Indonesia but processed in Korea could still be designated as IRA-compliant.

Jakarta is also lobbying Washington for Indonesia to receive a tailored trade deal on critical minerals similar to one agreed with Japan in March.

A Korean battery executive who did not wish to be named acknowledged that “we have no option but to rely on Chinese technology and knowhow for nickel processing at low cost”, but added this meant that Washington was likely to adopt a definition of “foreign entities of concern” tailored to the specific needs of the battery industry.

“If they say any joint venture in which China holds even a 1 per cent stake is an entity of concern, the US could be strangling itself, as no company would be able actually to meet the Inflation Reduction Act’s conditions,” he warned.

Additional reporting by Harry Dempsey in London