Defying an oversupply of memory chips and subsequent weakened earnings – and in the face of potentially catastrophic export restrictions by Japan that could choke off supplies of key semiconductor components – Samsung Electronics is not considering a memory-chip production cut, the company said on Wednesday.

“We do not consider reducing the production of memory chip wafers,” Chun Sewon, an executive vice-president of Samsung Electronics’ DS division, said in a conference call on the firm’s second-quarter earnings.

That is bold talk; the company’s operating profits fell 55% from a year earlier. And prior to Samsung’s announcement, South Korea’s other main memory-chip maker, SK Hynix, as well as US-based Micron Technology, had announced production cuts.

The global sector is currently overshadowed by a cyclical downturn in chip prices. Moreover, the Korean sector is facing an additional threat. Tokyo’s long-simmering diplomatic/history war with Seoul seems to have leaped barriers and crashed into the economic space, after Tokyo announced new export restrictions for South Korea on three key chemicals essential for chip production, imposing a 90-day export-approval process.

Key materials for chip production secured?

Even so, it is not yet clear whether Tokyo will embargo or simply delay the exports. On that critical question, Samsung hedged.

“The Japanese move is not a ban on exports of materials, but the burden [on Korean chip makers] has increased due to the licensing process,” Lee Myung-jin, vice-president of IR at Samsung Electronics, said in a conference call. “The situation is difficult to assess, due to uncertainty. In any case, we will make our best efforts by setting up various measures to minimize any negative impact on production.”

Samsung Electronics and SK Hynix are reportedly working to secure alternative semiconductor materials. “Korean chip makers are working on some alternative plans for the three materials. It doesn’t mean that all supply issues on the key materials have been resolved, but means that they are making their best efforts, conducting tests for non-Japanese products,” an industry source told Asia Times. “How quickly they will secure alternative materials is ultimately up to suppliers.”

It would appear that non-Japanese suppliers need to improve the quality of their products and raise production capacity as quickly as possible. Industry experts pointed out that if the quality of those critical materials does not reach the level of Japanese products, it could lead to lower productivity or quality in the short term.

But one industry source was cautiously upbeat. “I understand that Korean chipmakers have found some solutions at home and abroad,” he told Asia Times.

More risk is imminent. Tokyo also looks set to exclude South Korea from a “white list” of countries favored in trade this week, on security grounds. If that move goes ahead, countries not on the list will be unable to import strategically important Japanese products quickly and easily. That would be a massive upgrade to the current export controls on the three semiconductor materials.

“If Korea is excluded from the white list, uncertainties will be amplified as we don’t know which materials or equipment will be subject to regulation,” said an industry source.

Industry oversupply

While a Japanese ax hangs over exports of the materials, Samsung also faces a more mundane problem: Oversupply in the highly commoditized memory chip is still unresolved.

“Although demand for memory chips is expected to increase a little bit in the second half, there is still an oversupply when looking at the balance between supply and demand,” said another industry source.

Samsung Electronics said its second-quarter operating profit fell 55.6% to 6.6 trillion won ($5.6 billion) from a year earlier; revenues fell 4% to 56.13 trillion won. The ratio of operating profit to sales stood at 11.8%, the lowest since a 10.9% result in the third quarter of 2016. The second-quarter operating profit is up 100 billion won from the earnings guidance of 6.5 trillion won announced on July 5 – but is only one-third of the 17.57 trillion won in the third quarter of last year, when Samsung posted record-high earnings.

While prices of memory chips continued to decrease because of oversupply, the smartphone and display businesses also remained sluggish. Regarding the poor performance of its semiconductor business, Samsung explained, “Although demand has recovered in part due to the resumed purchases of memory chips by data-center customers and demand for high-capacity mobile devices, performance has weakened as overall business conditions and prices have continued to be weak due to inventory adjustment by major customers.”

And clouds hang over the second half. Regarding the second-half outlook for the semiconductor sector, Samsung predicted, “The outlook for the business of memory chips is uncertain due to Japan’s regulations on exports of key materials despite the seasonal recovery in demand.”

Also read: Industrial output down in South Korea in June