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The trade war that the United States and China are embroiled in has taken most of the headlines recently, yet there is another trade spat brewing in Northeast Asia that will affect global memory prices in a very big way. The current relationship between Japan and South Korea took a turn for the worse when a South Korean court ruled that Nippon Steele, who used forced Korean labor during World War 2, owed Korean survivors $89,000 each in damages.
The Japanese have countered saying reparations were made complete in the 1965 accord that saw the two countries reestablish in peaceful diplomatic relations. Japan's Prime Minister Shinzo Abe had threatened earlier this year that a failure to reverse the ruling would result in Japanese retaliation via economic means. Japan has put a serious choke on the export of a few crucial chemicals used in processor and memory semiconductor manufacturing, of which South Korea is its largest customer.
Memory prices already up 15 percent in the last week
South Korea is home to the world's two largest memory manufacturers Samsung (KRX:005930) and SK Hynix (KRX:000660). Together the two produce about 75 percent of the global DRAM supply and 40 percent of total NAND capacity.
Samsung and SK Hynix both rely heavily on Japan for some crucial chemicals which we detailed here. In short, South Korea imports 92 percent of its photoresists from Japan and a little less than half of the hydrogen fluoride is sourced there as well. Hydrogen fluoride, which is used in gas etching of wafers is toxic and difficult to stockpile and the photoresists quickly degrade over time which makes building up inventory impossible.
DRAM memory prices are up for the very first time this year and its no small price increase either, current levels up are up 15 percent over the last two weeks. Analysts are increasingly starting to issue warnings about potential price spikes for DRAM and NAND through the year since SK and Japan have been signaling that no agreement will be made anytime soon.
Mark Newman, Bernstein analyst, believes that since South Korea accounts for three-quarters of the world's supply, prices are bound to shoot up like "never before seen". The situation has grown bad enough that TSMC (NYSE:TSM), based in Taiwan, has warned that Japan's export block is the company's "biggest uncertainty heading into the remainder of 2H 2019.
Looking at the situation, DRAM and NAND will most likely be extremely vulnerable to price hikes in the coming months. South Korean chip-makers are probably going to have a fairly easy time when it comes to finding alternative sources of the gas etching chemicals, as there are major suppliers of hydrogen fluoride based out of China and Russia that can step in. Those chemicals might see, at worst, low double digit material cost increases which when baked into the price of memory chips, will have a negligible impact when considering total manufacturing costs.
All about the photoresists
The photoresists are the really crucial item and the story is completely different here. South Korea will be hard-pressed to easily alt-source enough material when 92 percent comes from the Japanese. Further, these photoresist chemicals are comprised of complex molecules and quality is of utmost importance as TSMC's half a billion dollar blunder earlier this year illustrates. TSMC used either expired or tainted photoresist and had to throw out thousands of costly wafers.
Japanese suppliers will attempt to max out production of the photoresists from plants outside of Japan, but these same suppliers may be hesitant to invest in major capacity upgrades as Japan could reverse its block overnight rendering all that new capacity outside of Japan unnecessary. Of course, should vendors choose to ramp up capacity at these production lines, it will still take a good amount of time.
It speaks to reason that DRAM prices and NAND prices are set for a big price increase if Japan holds its current course. Some companies, such as American memory giant Micron (NASDAQ:MU), stand to benefit as its own production will remain unhindered while its products' market prices soar. Micron has historically crushed its earnings targets when memory prices quickly increase and there's no reason to think it will be any different this time.
Japan holds all the cards, and the reality is Samsung and SK Hynix can only do so much to mitigate the export ban. One can imagine these two will be lobbying Prime Minister Abe and his government quite hard for relief over the next few months. The thing is, a disagreement like this is as emotional as it is volatile. Japan and SK aren't arguing over simply a trade deficit's or an unfair economic practice, they are arguing over blood money. Its an extremely politicized, and polarizing topic and citizens on both sides will be placing additional pressure on their respective governments to not back down. One gets the feeling that the U.S.-China trade war isn't nearly as emotional, while this trade conflict runs much deeper. We could be in for a long ride.