The Risk in Outline: Will Omicron cut chip supply from the Philippines?

• A vertical increase in COVID-19 cases in the Philippines in recent days poses the threat of government lockdowns that could temporally sever its important Outsourced Semiconductor Assembly and Test facilities (OSAT) from the already stressed and fragile global supply chain.
  
  
• In effect the Philippines could become a replay of the 'back-end' bottlenecks to semiconductor supply seen in Malaysia during Q3 2021 that had a significant impact on global Auto production.
  
  
• Potential exposure is likely to be less than for Malaysia but is still estimated at up to maximum of 1.4m units of lost vehicle output within the next six months if full manufacturing lockdowns were to be enforced.
  
  
• Philippines Government has enacted several COVID restrictions in recent days to control the climb of cases hoping to head off the need for these more stringent lockdowns. However, the extensive use of the Sinovac vaccination means that even two-dose vaccine efficacy against Omicron may be weak or uncertain so the risks of a hospitalisation surge could be high even with the reported milder symptoms of Omicron variant

Context:

The Autos industry started 2022 on a more optimistic note than seen for many months. Weekly production losses tracked and attributed to Semiconductor shortages had thinned out significantly compared to Summer and early Fall and manufacturers were starting to signal stronger production schedules for early 2022. However, the fragility of the current semiconductor supply chain was once again highlighted when Toyota announced a significant cut to its production plan for February 2022. Our understanding is that this particular case is mainly the result of a lagged disruption to final semiconductor assembly units in Malaysia from late December. This had been recovering well following hard COVID lockdowns of the summer months but was severely impacted by extensive flooding in the second half of December disrupting logistics and closing manufacturing plants including semiconductor facilities. Toyota is unlikely to be the only OEM to be impacted from this one-off storm in Q1 vehicle build this year.

The highly stressed dependency on outsourced semiconductor testing, packaging and assembly facilities in Malaysia has now been highlighted for a second time in six months. Given the extremely tight current supply of semiconductors to automotive applications there is a heightened risk from any other potential disruption to OSAT locations.

We are particularly concerned of 'potential' supply disruptions from similar OSAT facilities in the Philippines in coming weeks and suggest putting this on a close observation risk watch.

COVID surge risks more aggressive lockdowns in the Philippines.

In the last two weeks there has been a significant surge in COVID cases recorded in the Philippines. In mid-January community transmission of Omicron Variant was reported by the Department of Health. Average case rates have increased to over 300 cases per million of the population from just a few cases at the start of the year. This is still low by Western experience but is now the highest in Asia and is already past the threshold at which Malaysia decided to impose a full lockdown in the summer of last year.

In January 2022 a report published in Nature magazine showed weak performance of inactivated vaccines. These inactivated vaccines include Sinovac and Sinopharm which are widely used in the Philippines. Suggesting that Philippines may not have the same options available in the face of Omicron that have been seen in the West.

One worrying study at a local Manila hospital showed that 45% of hospitalised patients had already been fully vaccinated. Booster doses widely seen as necessary for stronger protection against Omicron have been given to only 5% the population at the time of writing.

Taken together the government was forced in recent days to impose several strong restrictions on the non-vaccinated - such as a controversial ban on access to public transport for non-vaccinated individuals. These will impact mobility and even cause labour shortages but so far, the measures stop short of a national or regional lockdown and to date no direct containment measures prevent the operation of manufacturing plants. The government has stated that it is trying to avoid a full-scale lockdown.

The biggest risk right now is that COVID cases driven by the Omicron variant continue to climb out of control (despite these latest restrictions) and hospitalisation cases start to surge given the low rate of full booster vaccination and a mix of potentially less-effective vaccines. In this event the government may be forced to act with a full lockdown that would likely shutter manufacturing plants including key semiconductor facilities in the country.

Critical Semiconductor Exposure.

According to data from SEMI WW OSAT Manufacturing Database October 2019 the Philippines has 12 manufacturing facilities engaged in OSAT or outsourced semiconductor assembly and testing. That puts it 7^th out of over 20 countries with such operations, behind Malaysia but well ahead of Singapore or Thailand. In particular, AMKOR Technology has four facilities in or in close proximity to the national capital region of the Philippines representing a quarter of their global facilities. AMKOR is one of the world's largest OSAT suppliers and headquartered in Texas.

We do not have detailed data on specific size of each facility, or its automotive end market mix so can only make a rough estimate of the potential loss of global vehicle production if the Philippines semiconductor went offline because of full hard lockdown in the country. We estimate that the hard lockdowns in Malaysia last year was responsible for around 2m units of lost vehicle production. On that basis a similar length of lockdown in the Philippines would see about 1.4m units of vehicle production at risk. Again, using the earlier Malaysian experience as a blueprint, this would start to pull back assembly lines withing 4-5 weeks- impacting build schedules by early March 2022 and take several months to normalise.

The good news is that chip fabrication itself would not necessarily be disrupted (only the backend operations) so there would be a possibility of making up some part of the lost volume in the second half of the year, but this would depend on stretching assembly capacity and labour conditions at the time.

Bottom Line:

It is clear that the extremely rapid grow of COVID cases in the Philippines can outpace vaccination progress and leaves a dilemma for the government. Given the situation there is a risk that current containment measures are insufficient, and they must act more forcefully in the face of the Omicron variant. Even if a full manufacturing lockdown is not imposed there is still the prospect of milder curtailment in semiconductor output because of logistics and labour difficulties in coming weeks.

At this stage we have not included this lockdown risk to semiconductor supply in our base case forecasts. We have been monitoring this as potential issue for several key semiconductor source countries in Southeast Asia for several months and we have been including the risk of a Philippines supply shock as one element of our pessimistic contingency planning forecasts published each month since late October 2021. (Our January update of this is due to be published in the week of 24^th Jan)

Quick Take Table:

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