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North American Decade Part II-International Businesses Increasing U.S. Investments—Biden Industrial Policy for Select Industries Taking Hold—Expanding Legacy Chip Fabs Now–Leading Edge Chip Fabs by Decade End—AI Drives Accelerating Electric Demand–Electric Energy Demand Forecasts Doubled in Two Years—IRA Tax Incentives Aid U.S. Solar Cost Competitiveness–Energy Department Financing Critical BatteryMetal Domestic Source Development—Invest Using Specialized Sector ETF’s

Date Posted: March 21, 2024

Focus on Domestic Production—Incentivizes International Businesses to Increase U.S. Investments
The Administration’s Industrial Policy initiatives, in place for nearly two years, focus on advancing clean energy development and promoting leading-edge chip production through a series of key legislation. With the head wind of higher interest rates likely diminishing, we now see these measures beginning to strengthen domestic production and enhance the long-term competitiveness of this country and North America. Incentives like direct investments, loan guarantees, and investment/production tax credits drive domestic investments in these key sectors and attract international manufacturers to increase their presence in the United States. As a result of the domestic focus and lower U.S. energy costs, German companies now invest more in the United States than in China—highlighting the economic benefits of these measures for North America in the coming decade (See Figure 1.)

Figure 1
German Capital Expenditures—U.S. vs China ($bn)

Sources: DI Markets, FT

Biden Administration-Industrial Policy-Winding Up and Winding Down Select Sectors
In his 2022 Brookings Institution speech, Renewing American Economic Leadership, Jake Sullivan, President Biden’s National Security Advisor, included a notable quote stating: “There was one assumption at the heart of all past policies: that markets always allocate capital productively and efficiently, regardless of competitive challenges or regulatory changes.” In contrast, Sullivan then outlined the Administration’s current Industrial Policy strategies using public/private models to guide economic policies. The administrations’ effort will be to wind up select industries while also using industrial policies to wind down industries like fossil fuel. Ultimately, success or failure of businesses will hinge on their strategies and returns rather than government incentives. The impact of these policies on the domestic and North American economy will be briefly reviewed in the remainder of this Commentary.


CHIPS Act—Restore Leading Edge Logic Chips Production to the U.S.—End of the Decade
The pandemic and global instability underscored the need for domestic chip production for national defense. The primary objectives of the 2022 CHIPS and Science Act aims to develop a resilient domestic chip supply chain with advanced technology. While no North American companies produce leading-edge chips, the government continues to pursue its plans to finance a least two new large-scale clusters of leading-edge logic plus adding on to legacy chip fabs. Over the last two years, the potential of significant government financial support led to seventy-nine proposals presented to the government for semiconductor projects (see Figure 2.) Recently, the Commerce Department approved $8.5 billion in grants to Intel plus $11 billion in loans for construction of a leading-edge chip fab and supporting facilities. Earlier, the government approved three proposals totaling $1.7 billion for legacy chips fabs crucial to the production of automobiles and consumer products. However, achieving the goal of domestic leading-edge chip production may take until the end of the decade due to regulatory issues and the complexities of construction to bring up operations. At the same time, the rest of the world will not be standing still and will also be increasing their investment in semiconductor production capacity but able to open at a faster rate absent the U.S. regulatory burden (see Figure 3.)

Figure 2
U,S, Semiconductor Ecosystem–Announced New/Expansion Proposals

Source: Semiconductor Industry Association
Figure 3
China Adding more Chip Capacity than the R-O-W Combined

Sources: SEMI, Gavekal Dragonomics/Macrobond, The Daily Shot
Electric Energy Demand Forecasts Doubled–Inflation Reduction Act Tax Incentives Designed to Improve the Cost Competitiveness of American Solar Production to Meet Accelerating Demand
The acceleration in electric demand from new sources including heating and transport, as well as generative AI doubled projections for long-term electric demand in North America, since the passage of the IRA two years ago (see Figure 4.) This led to a four-fold increase in Wood Mackenzie’s forecast for solar deployment investments by 2034. Tax credits from the 2022 Inflation Reduction Act (IRA) will play a crucial role in enabling the American Solar Industry to compete with China’s dominant, low cost production. Figure 5 highlights the positive initial effects of the IRA act on increasing investments in sustainable technologies. The future strengthening of transmission lines and improved interconnection between regions will critically determine the overall growth of clean energy and its impact on the U.S. economy in the next decade.

Figure 4
Projected New North American Energy Demand—9-Year Growth Forecast (gigawatt hours)

Source: North American Electric Reliability Corporation
Figure 5
Manufacturing Investment by Technology (Billion US$)

Sources: Rhodium/MIT-CEPR Clean Investment Monitor
Clean Energy Increases use of Select Minerals—Metal Sources Now outside North America—IRA Prioritizes Sourcing from North America—Energy Department Loans Finance New Domestic Sources
Transitioning to clean energy with metals like copper will require a significant increased use of select minerals compared to current energy sources. This will initially lead to a shift away from North America in terms of sourcing and processing (see Figure 6.) The trade of minerals and clean energy components may face similar challenges when compared to the current oil and gas trade (see Figure 7.) Regulations will ultimately drive the adoption of battery-powered vehicles prompting capital investment in North American mineral production, processing facilities, and battery manufacturing plants over the next decade. To advance domestic mining and processing of lithium, the Energy Department just recently announced a $2.26 billion loan to fund a refining plant at the largest lithium mine in this country. Those and other efforts will take time but ultimately lead to a gradual transition to select minerals produced and refined in North America.

Figure 6
Share of Top Three Producing Countries in Production of Selected Minerals and Fossil Fuels (2019)

Sources: IEA-2020, World Bureau of Metal Statistics-2020, Adamas Intelligence 2020
Figure 7
Supply Chains—Oil and Gas and Selected Clean Energy Technologies

Source: International Energy Agency
AI Drives Growth of Hyperscale Data Centers and the Resulting Electric Demand—Creates Difficult Environmental Issues–On-Site Renewable Energy Help Meet These Demands and Environmental Issues
In the U.S., roughly 2,200 data centers operate with the largest concentrations found in California, Texas, and Virginia (see Figure 8.) The rise of generative AI use will accelerate electricity demand in the data center (see Figure 9) throughout the decade (see Figure 10.) Hyperscale data centers will increase concerns about environmental impact due to escalating demand for land, electricity, and water for cooling from new centers. These concerns will ultimately lead data centers away from the utility grid to alternate sources of electricity such as micro-grids and on-site solar and battery energy technologies.
Figure 8
USA Data Centers

Sources: International Energy Agency-Electricity 2024, DATAVERGE
Figure 9
Typical Data Center Energy Use

Source: Baldor Reliance Motors in Data Centers
Figure 10
U.S Electricity Demand from Data Centers, 2014-2029-Gigawatts

Source: McKinsey and Company
Investment Conclusions
Equity:
The complexity and timing of when these sectors will benefit from new growth on this continent will require a broad investment approach. This suggests using a diversified group of specialized sub-sector ETF’s for the sectors outlined in this Commentary. Alternatively, investors could opt to use actively managed funds led by managers and their teams who possess specialized experience and knowledge of these industries. These specialized teams can selectively invest in those quality companies most likely to profit from the domestic development of these sectors. They can also adapt to changes these sectors may face as production and distribution gradually will be redirected to this country and North America.


Fixed Income-The Fed seems likely to reduce the funds rate sometime this year. If this scenario unfolds, investors in short-term fixed income investments will then face increasing reinvestment risk. To offset this potential risk, Treasury note and bond rates continue to offer attractive real rates of return for the first time since the Great Financial Crisis. Therefore, extending fixed income duration continues to be an attractive option for investors.

Alternatives: Amidst changes in the financial industry and markets, alternatives offer diversification benefits by being less correlated with stocks and bonds. In this uncertain investment environment, alternative investments can both help manage risk and potentially enhance returns.