The neon production industry is facing a decline due to Russia's invasion of Ukraine, posing a threat to the chip industry.

• Lithography, a chip production process used by companies such as Samsung, Intel, and TSMC, requires neon for the lasers that carve patterns onto tiny silicon pieces.
• These machines are produced by Dutch firm ASML.
• A small number of companies in Ukraine account for more than half of the world's neon production, as stated by Peter Hanbury, a semiconductor analyst at Bain & Co.

The ongoing conflict between Russia and Ukraine may lead to a decrease in the production of neon, a vital gas used in advanced semiconductor manufacturing, at a time when the global chip industry is already facing a shortage.

Lithography, a chip production process used by companies such as Intel and Samsung, requires neon for the lasers that etch patterns onto silicon.

A small number of companies in Ukraine account for more than half of the world's neon production, as stated by Peter Hanbury, a semiconductor analyst at Bain & Co.

Ingas, Cryoin, and Iceblick, all based in Odesa and Mariupol, are among the companies included.

Despite not responding to a CNBC request for comment, Ingas and Cryoin have halted operations due to attacks from Russian forces, as reported by Reuters.

The conflict in Ukraine has led to a decline in neon production as world-leading Ukrainian firms have shut down their operations.

If Ukraine's neon producers remain shut, worldwide neon consumption for semiconductor production could fall below 270 metric tons in 2022, according to estimates from consultancy firm Techcet.

According to Hanbury, the greatest potential challenge in the supply of materials used in chip-making due to the Ukraine conflict is neon.

The global chip shortage has caused disruptions in supply chains and resulted in extended waiting times for products including new cars and PlayStation 5 consoles.

A potential global neon shortage now threatens to make matters even worse.

How neon is made

Neon is a byproduct of large-scale steel production.

The process of fractional distillation involves cooling liquid air to extremely low temperatures and separating it through chemical means.

According to Hanbury, up to 90% of the neon used in the chip industry was previously produced as a by-product of Russian steel manufacturing and later refined by companies primarily located in Ukraine, including Cryoin, Ingas, and UMG RT.

Gartner analyst Alan Priestley stated that major chip manufacturers possess several months of neon inventory, but it's not a significant concern for them at present, according to CNBC.

Intel has evaluated the potential effects of the Russia-Ukraine conflict on its supply chain, as stated by a spokesperson to CNBC.

Intel's diverse, global supply chain strategy minimizes its risk from potential local interruptions. We continue to monitor the situation carefully.

Neither TSMC nor Samsung responded to requests for comment from CNBC.

Chip factories, or fabs, with limited supply may be affected earlier due to smaller size, according to Priestley. He stated that chip manufacturers are collaborating with their supply chains to minimize the effects.

Preparing for a neon shortage

For years, the global semiconductor industry has been readying for a scenario like this.

In response to Russia's annexation of Crimea in 2014, measures were taken to minimize potential risks associated with neon supplies.

After the Crimean annexation, the chip industry made efforts to reduce the use of neon in manufacturing, while simultaneously increasing gas stockpiles at two points in the supply chain, ensuring that both gas suppliers and semiconductor manufacturers have a three to 12-month supply on hand.

Semiconductor manufacturers established new suppliers outside of Ukraine and Russia, according to Hanbury.

Hanbury stated that approximately half of the neon used in global semiconductor production originates from Russia and Ukraine.

The Dutch firm that produces the intricate lithography machines used by major chip manufacturers has decreased its dependence on neon sourced from Ukraine to about 20% of its previous levels, according to Hanbury.

ASML acknowledges the significance of being ready to handle unexpected events, such as conflicts, that may disrupt our supply chain, as stated by a spokesperson to CNBC.

The company is closely monitoring the conflict and investigating with suppliers the potential impact and alternative sources if necessary.