Russia's invasion of Ukraine could worsen microchip shortage

The vehicles and auto parts endangered by the Russian invasion of Ukraine may seem thousands of miles away from being a real problem.

But the war could bring new worries to an issue that is already bedeviling automakers: the global microchip shortage.

Ukraine is the source for 70 percent of the world's output of neon. Neon is the critical gas that runs the lasers that are needed to manufacture semiconductor chips, according to market research firm TrendForce.

Both Russia and Ukraine are home to key gases and raw materials needed for the production of semiconductors around the world. And the ripple effects of the war could exacerbate the microchip crisis as raw materials become harder to come by.

U.S. chipmakers rely "almost entirely" on laser gas from Russia and Ukraine, according to market research company Techcet.

"Of course, people will look for alternative sources of neon as quickly as they can — but that's not something that can just be switched on," said Carla Bailo, CEO of the Center for Automotive Research. "Eventually, if semiconductors do not come, we will be right back to where we were last year."

The semiconductor shortage, a byproduct of the COVID-19 pandemic and manufacturing shutdowns in 2020, has ravaged the auto industry and made life difficult for auto retailers and consumers. According to AutoForecast Solutions estimates, automakers had to cut 10.4 million vehicles out of global production plans last year because of the shortage, with an additional 656,200 axed so far in 2022. AFS expects automakers to cut at least 1.3 million vehicles by the end of this year.

Dan Hearsch, a managing director in the automotive and industrial practice at AlixPartners, said the Russian invasion should not cause an immediate impact on semiconductor production — his firm's intel indicates that major microchip companies have built up several months' worth of neon stock.

"They saw this coming a little bit," Hearsch said. "After the last couple years, [they] decided we're going to stock up on as much as we can."

But the longer the war in Ukraine persists, the more likely it is that companies will run low on neon, hampering semiconductor production worldwide just as some automotive officials hoped the crisis would begin to ease in the second half of this year.

Further complicating matters is the fact that Ukraine's neon-gas production is dependent on Russia. According to Techcet, neon gas is produced as a byproduct of Russian steel manufacturing. That gas is then purified in Ukraine, which exports neon to much of the world.

If history is any indication, neon prices could sharply rise as Ukrainian supplies dwindle. Neon prices rose 600 percent in the run-up to Russia's 2014 annexation of the Crimean peninsula from Ukraine, since chip companies relied on a few Ukrainian companies, according to the U.S. International Trade Commission.

But neon is not the only raw material at risk because of the war. Russia provides about one-third of the world's palladium, according to Techcet. Palladium is used in semiconductor manufacturing and is critical to catalytic converters.

Other materials from the region that are at risk include aluminum, nickel and pig iron, which feeds many of the world's steel mills, Hearsch said.

"In a global environment, there are global knock-on effects for all the raw materials," he said.

The Russian invasion of Ukraine is already having a significant impact on the auto industry worldwide, especially in Europe.

European auto production was quickly hampered due to transportation disruptions and parts shortages, particularly of wire harnesses, a critical piece of a vehicle's electrical system. Volkswagen, Audi, BMW and Porsche have been struggling to obtain harnesses, forcing production stops at factories in Germany, according to a report by Reuters.

Hearsch said two dozen auto suppliers have a presence in Ukraine, and many of them are in the wire harness business. While wire harnesses are not just-in-time delivery components, inventories are typically kept lean, and there is now little coming out of the region.

"Ukraine is a bit like Europe's Mexico in terms of low labor rates and the types of products that are made there," he said. "Most of the wire harness companies that we do business with are in Ukraine."

At the same time, many automakers said they are suspending business in Russia. Ford, Honda, Toyota, Volkswagen, Jaguar, Aston Martin, Volvo, General Motors and Daimler Truck are among the companies that have stopped shipments to Russia or halted vehicle assembly in the country, or both.

"We at Ford are deeply concerned about the invasion of Ukraine by Russia and the safety of the Ukrainian people," Ford CEO Jim Farley said on Twitter.

Suppliers with a presence in the region also have been monitoring the situation.

Tech supplier Aptiv said it shifted high-volume parts production out of Ukraine before the invasion. Magna International, the world's fourth-largest supplier, said last week that it suspended its Russian operations, which include six plants that employ about 2,500 people.

"Like most in the international community, we remain deeply concerned with the very unfortunate situation in Ukraine," Magna spokeswoman Tracy Fuerst said in a statement.

Companies with Russian ventures in their supply chains could also be affected by the economic sanctions being placed on the country. Some Russian banks have been shut out of the Society for Worldwide Interbank Financial Telecommunication, a secure messaging system to ensure rapid cross-border payments that has become the principal mechanism to finance international trade.

"For clients that have Russian or Russian-related companies in their supply chains, one of their main concerns is, will those companies be able to make payments — and will they be able to receive payments depending on their banking?" said Homayune Ghaussi, a partner at the Michigan law firm Warner Norcross & Judd.

"Ones in the U.S. probably w ill not be affected as much, but I expect that some of that banking will be tied back to Russian banks."

Hearsch said Russia's geopolitical ambitions are likely to cause Eastern European business to be viewed as risky in the near future. But he said it's unlikely that suppliers and automakers would attempt to pull their supply chains out of Eastern Europe and move them to higher-cost locations in the west.

"It's hard to move out," he said. "Moving in the middle of everything going on would be an additional level of disruption."

Ghaussi, who chairs his company's supply chain litigation practice group, said the new war will increase the importance of getting better visibility into supply chains to understand where their risks are.

"You might not have a direct relationship with someone who is affected by this, but there might be a supplier somewhere along the way that is," he said.

CAR's Bailo said the heightened uncertainty of the past two years is likely to force companies to re-examine their supply chains and risk management plans.

"There are elements in today's world that were not there before, in terms of supply chain chaos," she said. "It's not just the risks we used to look at, like if you were single-sourced — but political risk, and natural disaster risks that we are starting to see occur more frequently."

Reuters contributed to this report