Today, citing people familiar with the matter, Bloomberg reported that Tesla (TSLA) had agreed to buy batteries from LG Chem (LGCLF). The batteries made by the South Korean company will be used in Model 3 cars manufactured in Tesla’s China Gigafactory.

Tesla’s supply agreement with LG Chem not exclusive

According to the source, LG Chem is currently expanding its battery capacity and modifying manufacturing facilities for making a different type of auto battery. LG Chem, however, will not be the sole supplier for Tesla’s Gigafactory 3. According to Bloomberg sources, Tesla is also in talks with Chinese battery maker Contemporary Amperex Technology about the supply of batteries. Until now, the company was sourcing its batteries from Panasonic (PCRFY). Panasonic is making batteries with Tesla in Nevada.

Gigafactory 3 in Shanghai, China

You may recall that Tesla is in the process of building its first factory outside the US in Shanghai, China. In Tesla Gigafactory: China Provides Vital Certificate, we wrote about how the company received an important acceptance certificate from the Chinese government on August 19. The construction work on the Gigafactory 3 started in January 2019, and it’s expected to start producing Model 3 units by the end of this year.

According to Teslarati, Tesla’s global vice president, Grace Tao, said during an interview that the Gigafactory 3 is almost complete. Teslarati also mentioned that according to recent reports, the factory might become operational as soon as the end of September barring any unexpected delays.

Importance of China’s factory to Tesla

This factory is important for the company for two major reasons.

Firstly, the domestic US market is showing signs of slowing down, and major automakers are looking for alternative markets. China is Tesla’s biggest market outside the US. The company reported an increase of 42% in Chinese revenue in the first half of 2019. Other legacy automakers Ford (F), General Motors (GM), and Fiat Chrysler (FCAU) have also increased their focus on their Chinese businesses in the last few quarters.

Secondly, it will be accretive for Tesla to make vehicles in China to sell in the domestic market. The ongoing trade war and related tariff uncertainty have made it hard for foreign automakers to operate profitably in China. Currently, Tesla imports all its vehicles from the US to sell in China. According to Electrek, the vehicles made in the Chinese factory will also have a 15% most-favored-nation tariff. This tariff, however, will still be much lower than the tariffs of up to 40% on US vehicles in China.

Tesla’s challenges in China

Tesla, however, is also facing challenges in China, including a slowdown in overall auto demand. Moreover, China’s strong phase of electric vehicle growth seems to be stalling as it phases out subsidies. China’s new energy vehicle sales dropped for the first time in two years in July. The shift in subsidy policy also negatively affected China’s Tesla equivalent, NIO.

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