Why Taiwan’s Chip Manufacturing Woes Should Matter to Arizona
The pandemic continues to expose the world’s reliance on and insatiable appetite for semiconductor chips. The US and other countries have taken note and are initiating or expanding chip manufacturing operations on their own turf. Arizona is one such location that has received a substantial amount of press on this front as plans for new and updates on existing manufacturing sites in the desert state are announced. This manufacturing diversification is long overdue for myriad reasons – from national security to business resiliency, and beyond.
The future of manufacturing in Arizona may not be as rosy as officials and the press proclaim, however. One only needs to look to Taiwan to get an idea of two of the potential issues that the state will likely face. Taiwan is negotiating multiple short and long-term challenges with power supplies and droughts—not to mention the looming concern over potential Chinese actions against the island. These former issues currently exist in Arizona or are trending in that direction; both will likely be amplified in the coming years.
Sustained pressure on and demand for larger green energy footprints and the reduction or deactivation of state and regional legacy generating capacity by interest groups and the US federal government could result in a higher likelihood of rolling blackouts, particularly as states compete for excess electricity generation during peak summer months. Water shortages and droughts, which are already a problem in Arizona, could exacerbate the energy conundrum and lead to water rationing measures for businesses and residents.
US domestic chip manufacturing production capacity may be expanding and accelerating, but Arizona manufacturers’ abilities to sustain output and meet demand in the future are contingent on reliable power and water supplies. As such, businesses reliant on semiconductor components should be mindful of these risks—as should investors—while synthesizing through the fervent press coverage that seem to indicate expansion of production capabilities in Arizona is a panacea for the resolution of supply chain issues in this industry segment.
Background
Taiwan accounts for around 21 percent of global installed Integrated Circuit (IC) capacity, followed by South Korea (around 20 percent) and Japan (around 16 percent).[i] The remaining balance comes from a combination of countries—namely China, North America, and Europe.
An important distinction with this apparent diversity of production is that the most cutting-edge chips (<10-nanometer) are only manufactured in Taiwan and South Korea. These two countries accounted for around 92 percent and 8 percent, respectively in 2019.[ii] This advanced work is not done anywhere else in the world.
Semiconductor manufacturing is typically a cyclical industry, meaning there are spikes in production at key times of the year when demand is anticipated. The pandemic-driven Work From Home (WFH) shift, along with increased demand for products, industry shortages, factory closures, and supply chain bottlenecks have disrupted this cycle.
The effects the shortages and disruptions have on society has prompted governments and private sectors to respond. President Biden announced in early 2021 that he would seek additional funding to help infuse capital into US chip manufacturing and encourage industry leaders to come up with solutions to the shortages.[iii] The EU is also pushing for legislation for greater resilience in semiconductor supple chains[iv]; the goal is to increase Europe’s global share of semiconductor production to 20 percent by 2030.[v][vi]China has made it no secret that it would like to prioritize the semiconductor space and is spending vast sums of money and offering tax breaks to spur growth and become self-sufficient.[vii] US sanctions on the manufacturing equipment used in advanced chip production has stymied efforts thus far.[viii]
On the private front, TSMC broke ground on a new 5-nanometer chip manufacturing site in Arizona this year[ix], with an expected completion date of 2024. Expansion plans are allegedly under consideration for TSMC’s site in Arizona.[x] Additional capacity in Singapore for advanced chips[xi] and in Japan for 22/28-nanometer manufacturing has also been announced.[xii]
Global efforts to coalesce around increasing the combined manufacturing capacity for chips is necessary and long overdue. Many existing manufacturing operations are likely running above 80 percent capacity, with some potentially running as high as 90-100 percent to meet demand.[xiii] Increasing production may be possible for some operations, but most are likely at capacity. Some downstream businesses have adjusted their products to operate with fewer chips.[xiv] This solution may work for now but is not sustainable for future business.
It is important to recognize that announcements and groundbreakings for new manufacturing facilities will not immediately translate into increased capacity. Even when manufacturing facilities are complete, it can take many additional months to optimize production runs and physically manufacture the chips (especially the most advanced chips). With new projects not slated to come online until 2023/2024 and beyond, global demand will almost certainly exceed supply through mid-2024.
There are other important considerations and ramifications that must be considered as governments and private sectors work to alleviate the shortage crisis. The first is the overwhelming concentration of advanced chip manufacturing facilities (<10-nanometer) in Taiwan and South Korea, which together account for 100 percent of the global supply.[xv] Moris Chang, the founder of TSMC, warned that efforts to move manufacturing away from Taiwan to other locations could increase costs and slow technological advancements.[xvi] This may be true; however, it is a necessary risk that governments and businesses must accept.
Issues
A lopsided concentration of overall chipmaking and specifically advanced chip manufacturing within Asia Pacific could leave the world in a significant predicament if China decides to impose embargos on raw materials and supplies to Taiwan, blockades the island, implements airspace controls, or takes the country by force. A peripheral conflict or skirmish in the seas around Taiwan would have far-reaching consequences as well.
Potential Chinese aggression against the island has been discussed and debated for some time but in recent months has taken on a new sense of urgency given China’s increasingly aggressive statements[xvii], military developments[xviii][xix], and actions.[xx][xxi] These statements, developments, and actions do not necessarily indicate Chinese action against the island is imminent; Taiwanese officials nonetheless remain concerned about a possible invasion by China—some say by 2025.[xxii]
How would the global chip predicament look if most of the advanced chip production went offline for an extended period or fell under the control of the Chinese government and military? If that situation seems dire, consider the consequences if China tacitly encouraged its North Korean brethren to increase provocations against South Korea at any point leading up to, during, or following China’s own operations against Taiwan.
Even if a portion of South Korean chip operations came to a temporary halt during this time, the effects could be severe. Under normal cyclical periods excess stock held in warehouses may alleviate any short-term disruption or temporary increases in demand. In the current and projected environment with shortages[xxiii] and supply chain bottlenecks[xxiv], there may not be enough reserve stock to meet global demand.
Apart from China-Taiwan conflict scenario, there are other impending issues within Taiwan that pose both immediate and long-term threats to the sustainability of uninterrupted chip manufacturing on the island.
The first issue pertains to electricity generation on the island. Taiwan’s generation capacity is predominately from crude oil, coal, natural gas, and nuclear power, which collectively accounts for around 98 percent of the total energy supply.[xxv] The rest is a mixture of biomass and renewables (geothermal, photovoltaic, wind, and hydroelectric).[xxvi] On the consumption side, 31 percent of this generation goes to the industrial sector.[xxvii]
Apart from the island’s obvious reliance on fuel imports for energy, the government is moving toward phasing out nuclear energy entirely by 2025 and looking to become less reliant on coal. [xxviii][xxix]Renewables will continue to play a larger role in energy production. These developments will almost certainly exacerbate the existing energy conundrum on the island.
Within recent years, increased energy consumption during heat spells, drops in electricity margins, human error, and natural disasters have all contributed to both unexpected and mandatory power cuts across the island—with varying degrees of interruption on businesses and residents. [xxx][xxxi][xxxii][xxxiii]
Chip manufacturers like TSMC have backup generators and contingency plans for such situations; these stopgap solutions are not sustainable for extended periods or during severe natural disasters, such as earthquakes or typhoons. Taiwan’s government faces a similar predicament. Increased demand for electricity during the summer of 2021 led to the activation of hydroelectric power reserves. [xxxiv] These reserves only work when water levels within the country’s reservoirs are at acceptable levels.
This brings us to the second issue. Droughts, which have plagued the island for years, have the potential to further disrupt energy supplies and chip manufacturing operations. Chip operations rely on vast quantities of ultra-pure water to clean wafers. Seasonal monsoons and reservoirs help keep cities and manufacturing sites supplied with water throughout the year.
When rain fails to materialize and reservoirs fall below certain levels (as they did in 2015, 2017, and 2021), the Taiwanese government resorts to a phased water rationing system to conserve water. Under Phase 1, the government lowers the water pressure in pipes and reduces water to agriculture sites.[xxxv] Phase 2 restricts water usage for projects that are not deemed urgent, such as street cleaning and window washing; additionally, certain businesses whose water usage exceed certain thresholds per month will have their water reduced by 20 percent (five percent to industrial users).[xxxvi] During the third and final phase, water supplies for residents and industrial sites within the most affected areas are cut off for two days a week.[xxxvii][xxxviii]
Onsite storage tanks, efficient water recycling programs (TSMC is up to around 86 percent[xxxix]) and supplying water by tanker truck[xl] helps alleviate the shortage for chip manufacturers during dry spells and water restriction periods. These strategies, while effective, are not long-term solutions. At some point in the future droughts and inadequate power supplies will cease to be short term inconveniences—they will become burdensome realities.
Arizona’s Looming Challenges
There are some striking parallels to electricity and water dilemmas the US—and particularly Arizona—will likely face as chip manufacturing increases stateside. Like Taiwan, Arizona is subjected to seasonal heatwaves, which in turn place additional burdens on the electricity grid. Natural gas, nuclear power, and coal provide approximately 88 percent of the state’s net electricity generation.[xli] When high demand is anticipated during heat spells, Arizona utilities can purchase additional energy from nearby states.[xlii]
This strategy has worked thus far; however, as neighboring states experience simultaneous heatwaves or other crises that affect power generation and supply, they will almost certainly ration excess electricity generation or purchase larger quantities for their own consumption.[xliii] As more states push to reduce or eliminate fossil fuel generating capacity, guarantees of stable energy supplies for Arizona during critical periods will be less reliable. This challenge is compounded even more by the influx of new residents and expanded business and manufacturing within the state.
TSMC is slated to open its chip manufacturing site in Phoenix in 2024, with the potential for five more additional factories in the future.[xliv] Intel has announced similar chip manufacturing initiatives in Chandler, Arizona.[xlv] It is fair to say that TSMC and Intel will likely incorporate some level of power generation capacity (e.g., solar) and backup generation into its onsite infrastructure. This generating capacity will not offset the power used, nor can it replace grid power during extended outages or disruptions.
Once these sites are established and running, how will local governments respond and prioritize supply when overall energy demands exceed what can be produced or purchased on the open market? Will inhabitants of Phoenix and other cities curb their own power consumption for TSMC, Intel, and essential manufacturers or absorb higher electricity rates? Will Phoenix officials be forced to implement reduced operating hours for chip plants to conserve electricity during peak heat periods? These are real possibilities as the Phoenix area continues its transition into a US semiconductor manufacturing hub.
Arizona, one of the hottest areas of the US, is not the first state that comes to mind when one thinks of a state with a water surplus. In fact, the US federal government declared a water-shortage—the first ever—on the Colorado River in August 2021 due to declining levels in Lake Mead.[xlvi] This announcement followed a red alert notice in June 2021 when the reservoir declined to its lowest level since it was first filled in the 1930s.[xlvii] Additional declines are likely and could lead to forced water reductions throughout the Southwest.[xlviii]
Farmers and farmland will be the first casualties of these reductions and cuts, which will likely occur in 2022; larger cuts are possible in the 2023 to 2024 timeframe that could lead to water restrictions to some of Arizona’s cities.[xlix] If the projections are correct, increased cuts could arrive around the same time TSMC’s operations at its new Arizona fab come online.
A potential side effect of reduced water supplies to agriculture land are dust storms. These storms not only can lead to respiratory issues amongst residents, but also interfere or delay chip manufacturing. Chip manufacturing plants are essentially giant clean rooms that require ultra-pure air. This dust free air is made possible by industrial filtration systems. Filtration systems that are required to work harder to clean the air demand additional power and are prone to more frequent breakdowns. Solutions could include supplemental filtration systems that work in tandem with existing infrastructure during peak particulate periods, but such solutions still require excess power.
What to Watch
On the power generation front, efforts to increase Arizona’s reliance on renewable energy sources were defeated by Arizona utility regulators in early 2021.[l] Sustained pressure from interest groups, the federal government, neighboring states, and Arizona inhabitants to rely more on green energy could lead to future measures to curb or halt coal, natural gas, and nuclear power generation systems entirely.
These systems are important and have a role to play in diversified electricity generation, but should not be used in lieu of coal, natural gas, and nuclear power. If the green energy wave makes landfall in Arizona without due consideration given for the future demand implications on chip manufacturing and population growth, then local populations and industries are due for a rude awaking.
Chip manufacturers like TSMC and Intel will almost certainly duplicate their robust water recycling programs and onsite water storage solutions that are found in Taiwan. Tanker trucks could be utilized to some extent during exceptionally dry periods. Trucking in water supplies along with the power consumption and chemical processing that likely goes into water purification and recycling may lead to increased public frustration and animosity in Arizona and in neighboring states toward these manufacturers. This is especially true if local governments restrict or ration water supplies to residents and farmers before curbing supply to high-use manufacturers.
Given the surge in Environmental, Social, and Governance (ESG) investing and dwindling tolerance for processes and endeavors that are not sustainable and hurt the environment, chip manufacturers may find that they are more susceptible to shareholder sentiment and calls to curb expansion plans, no matter how efficient their processes are. These calls for curbed expansion and new development could even extend to Taiwan amid public outcry over the increased frequency of droughts and the accompanying water restrictions.
Arizona’s local governments, like Taiwan’s government, will continue to go to great lengths to minimize the effects of water rationing and energy disruptions on chip manufacturers, businesses, and residents. Droughts, dwindling energy supplies, and geopolitical tensions with neighbors (for Taiwan) will almost certainly become more pronounced in the coming years. Efforts to return processed water back to cities, conservation efforts, and more efficient water recycling programs can offset some of the environmental effects, but the reality is governments and businesses cannot continue to expand and sustain operations in regions that continue to show worrying signs of more frequent water shortages and energy disruptions.
Near shoring chip manufacturing to the US and other areas outside the Asia Pacific region is essential and necessary for the sustained global output of chips. TSMC and Intel’s existing investments in manufacturing sites in Arizona will offer important and diversified contributions to the US’s overall chip output; however, the parallels to Taiwan’s near and long-term challenges cannot be ignored.
Sources:
[i] No Author, “Local chip prowess could spur China attack”, Taipei Times, October 18, 2021.
[ii] No Author, “2021 State of the U.S. Semiconductor Industry”, Semiconductor Industry Association, 2021.
[iii] Trevor Hunnicutt, Nandita Bose, “Biden to press for $37 billion to boost chip manufacturing amid shortfall”, Reuters, February 21, 2021.
[iv] Natasha Lomas, “Europe plans a Chip Act to boost semiconductor sovereignty”, Tech Crunch, September 15, 2021.
[v] Vivienne Machi, “How will Europe’s planned semiconductor strategy affect its nations’ military ambitions?”, Defense News,October 10, 2021.
[vi] James Vincent, “EU aims to double chip manufacturing amid growing fears about ‘digital sovereignty”, The Verge, March 10, 2021.
[vii] No Author, “China Cuts Taxes to Spur Semiconductor Development”, U.S. News & World Report, March 29, 2021.
[viii] Arjun Kharpal, “U.S. sanctions on chipmaker SMIC hit at the very heart of China’s tech ambitions”, CNBC, September 28, 2020.
[ix] Chang Chien-chung and Evelyn Kao, “TSMC starts construction on 5nm chip plant in Arizona”, Focus Taiwan, June 2, 2021.
[x] Yimou Lee, “Chipmaker TSMC eyeing expansion of planned Arizona plant-sources”, Reuters, May 4, 2021.
[xi] Jonathan Burgos, “GlobalFoundaries To Build $4 Billion Chipmaking Plant in Singapore To Address Semiconductor Shortage”, Forbes, June 22, 2021.
[xii] No Author, “TSMC to Build Technology Fan in Japan with Sony Semiconductor Solutions as Minority Shareholder”, TSMC,November 9, 2021.
[xiii] Falan Yinug, “Chipmakers Are Ramping Up Production to Address Semiconductor Shortage. Here’s Why that Takes Time”, Semiconductor Industry Association, February 26, 2021.
[xiv] Austen Hufford, “Chip Shortage Has Manufacturers Turning to Lower-End Models”, The Wall Street Journal, November 14, 2021.
[xv] No Author, “2021 State of the U.S. Semiconductor Industry”, Semiconductor Industry Association, 2021.
[xvi] Robyn Mak, “TSMC’s global expansion will chip away at its edge”, Reuters, November 11, 2021.
[xvii] No Author, “China says U.S. senators visiting Taiwan on military plane a ‘vile provocation’”, Reuters, June 8, 2021.
[xviii] Jordan Williams, “Chinese hypersonic missile test ‘went around the world,’ top US general says”, The Hill, November 17, 2021.
[xix] Mike Yeo, “China is boosting intel gathering capabilities aimed at Taiwan, says new report from Taipei”, Defense News,November 10, 2021.
[xx] No Author, “Taiwan says dozens of Chinese planes entered defense zone”, BBC News, October 3, 2021.
[xxi] James Areddy, “China Has Built Mock-Ups of U.S. Aircraft Carrier, Warships in Desert”, The Wall Street Journal, November 8, 2021.
[xxii] Helen Davidson, Julian Borger, “China could mount full-scale invasion by 2025, Taiwan defense minister says”, The Guardian,October 6, 2021.
[xxiii] Stephanie Yang, Jiyoung Sohn, “Global Chip Shortage ‘Is Far From Over’ as Wait Times Get Longer”, The Wall Street Journal,October 29, 2021.
[xxiv] Paul Berger, “U.S. Ports See Shipping Logjams Likely Extending Far Into 2020”, The Wall Street Journal, September 5, 2021.
[xxv] No Author, “Energy Statistical annual Reports, Energy Supply”, Taiwan Bureau of Energy, Ministry of Economic Affairs, September 10, 2021.
[xxvi] No Author, “Energy Statistical annual Reports, Energy Supply”, Taiwan Bureau of Energy, Ministry of Economic Affairs, September 10, 2021.
[xxvii] No Author, “Energy Statistical annual Reports, Energy Supply and Consumption Flowchart (2020)”, Taiwan Bureau of Energy, Ministry of Economic Affairs, September 10, 2021.
[xxviii] No Author, “Nuclear Power in Taiwan”, World Nuclear Association, July 2021.
[xxix] No Author, “Power generation in Taiwan in 2025 is estimated to be free from nuclear power”, Power Technology, June 28, 2021.
[xxx] Jess Macy Yu, “Millions of People Were Left in the Dark as a Massive Power Cut Hit Taiwan”, Time, August 15, 2017.
[xxxi] Ben Blanchard, “More forced power outages in Taiwan as demand spikes amid heatwave, drought”, Reuters, May 17, 2021.
[xxxii] Josh Horwitz, “Taiwan, at the heart of the world’s tech supply chain, has a serious electricity problem”, Quartz, August 17, 2017.
[xxxiii] Scott Morgan, “Hot weather causes Taiwan to record highest June peak power usage”, Taiwan News, September 6, 2018.
[xxxiv] Tseng Chih-yi, Matthew Mazzetta, “Taiwan records highest-ever peak electricity demand”, Focus Taiwan News Channel, July 13, 2021.
[xxxv] Judy Lin, “Taiwan rolls out first phase of water rationing this year”, Taiwan News, March 1, 2017.
[xxxvi] No Author, “Water rationing introduced in south”, Taipei Times, May 7, 2011.
[xxxvii] Lauly Li, “Kaohsiung faces third-phase water rationing”, Taipei Times, April 25, 2015.
[xxxviii] Eric Chang, “Central Taiwan begins water rationing amid severe drought”, Taiwan News, April 6, 2021.
[xxxix] No Author, “TSMC 2020 TCFD Report”, TSMC, 2020.
[xl] Matthew Strong, “Taiwan’s TSMC orders water from trucks amid shortage”, Taiwan News, February 23, 2021.
[xli] No Author, “Arizona State Profile and Energy Estimates”, U.S. Energy Information Administration, March 18, 2021.
[xlii] Jason Barry, “Texas power outage disaster raises concerns about whether it could happen in Arizona”, AZFamiy.com, February 19, 2021.
[xliii] David Wichner, “California blackouts put the spotlight on reliability, planning for Arizona utilities”, Tuscon.com, August 29, 2020.
[xliv] Yimou Lee, “Chipmaker TSMC eyeing expansion of planned Arizona plant-sources”, Reuters, May 4, 2021.
[xlv] Kif Leswing, “Intel is spending $20 billion to build two new chip plants in Arizona”, CNBC, March 23, 2021.
[xlvi] Ian James, Zayna Syed, “First-ever water shortage on the Colorado River will bring cuts for Arizona farmers”, AZ Central, August 16, 2021.
[xlvii] Ian James, “’Red Alert’: Lake Mead falls to record-low level, a milestone in Colorado River’s crisis”, AZCentral, June 10, 2021.
[xlviii] Ian James, “’Red Alert’: Lake Mead falls to record-low level, a milestone in Colorado River’s crisis”, AZCentral, June 10, 2021.
[xlix] Ian James and Zayna Syed, “First-ever water shortage on the Colorado River will bring cuts for Arizona farmers”, AZCentral,August 16, 2021.
[l] Bob Christie, “Arizona utility regulators reject 100% clean energy rules”, AP News, May 6, 2021.
