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China and the Rare Earths Conundrum

October 22, 2010


There have been a number of articles written over the past few months discussing China’s stranglehold on the rare earth market. For more background on this subject, read my post entitled The Future of Rare Minerals. One recent article comes from Nobel laureate Paul Krugman [“Rare and Foolish,” New York Times, 17 October 2010]. He writes:

“[In September] a Chinese trawler operating in Japanese-controlled waters collided with two vessels of Japan’s Coast Guard. Japan detained the trawler’s captain; China responded by cutting off Japan’s access to crucial raw materials. And there was nowhere else to turn: China accounts for 97 percent of the world’s supply of rare earths, minerals that play an essential role in many high-technology products, including military equipment. Sure enough, Japan soon let the captain go. I don’t know about you, but I find this story deeply disturbing, both for what it says about China and what it says about us. On one side, the affair highlights the fecklessness of U.S. policy makers, who did nothing while an unreliable regime acquired a stranglehold on key materials. On the other side, the incident shows a Chinese government that is dangerously trigger-happy, willing to wage economic warfare on the slightest provocation.”

My colleague Tom Barnett sees the same circumstances surrounding rare earths as Krugman; but he is not quite as alarmist over their long-term consequences. In a recent post on the subject entitled China’s alleged control of the rare earth materials, Tom wrote:

“[The Financial Times published a] story on how [the] ‘US is scrambling to resume production of raw materials vital for defence equipment and green technology in response to rising fears about Chinese domination of the sector.’ The point to be clear on: China dominates current production of rare earths (95-plus percent) but in no way has a dominant supply/reserve position. The world has simply allowed China to achieve its dominant production position by abandoning their own mining efforts. Why? Very expensive and very environmentally damaging. Rare earths are a collection of 17 metallic elements with similar chemical make-up. They present unique magnetic and optical properties that make them highly useful for miniaturization, lasers and energy efficiency. There are considered strategic because of their applications in high-tech industries, to include weaponry. No one much cared about China’s domination of production, until the South China Sea dust-up with Japan led China to allegedly slow exports to Japan (not entirely clear what happen[ed], but impressions were made). China has also recently signaled that it will cutback on exports to make sure it has enough for its own burgeoning domestic demand. Now, according to the article, we’ve got people in Congress dreaming of US self-sufficiency on this score, which will be–like most things in this globalized economy–virtually impossible to achieve. Long ago, the US was the dominant global producer, but we abandoned the effort due to environmental and cost realities. [The] article says the last US mine closed in 2002 and is looking for $500m to reopen. Those guys should send a thank-you letter to Beijing, because I’m betting they’ll get their investment soon. Obviously, if the material is considered strategic, there’s good logic for mining at multiple sources. I would consider this a reasonable space for cooperation with long-time allies so that we’re not all doing this in the most expensive manner possible.”

Krugman notes that “until the mid-1980s the United States dominated production” of rare earths. Then in the early 1990s, “Deng Xiaoping, the architect of China’s economic transformation,” declared, “There is oil in the Middle East; there is rare earth in China.” He then set China on a course to exploit those resources. Krugman reports that “China has about a third of the world’s rare earth deposits.” That is a significant amount; but, as Tom points out, hardly a monopoly. Krugman continues:

“This relative abundance, combined with low extraction and processing costs — reflecting both low wages and weak environmental standards — allowed China’s producers to undercut the U.S. industry. … Policy makers simply stood by as the U.S. rare earth industry shut down. In at least one case, in 2003 — a time when, if you believed the Bush administration, considerations of national security governed every aspect of U.S. policy — the Chinese literally packed up all the equipment in a U.S. production facility and shipped it to China. The result was a monopoly position exceeding the wildest dreams of Middle Eastern oil-fueled tyrants.”

Krugman agrees with Tom that efforts to break China’s monopolistic position need to be global and coordinated. He recommends:

“The world needs to develop non-Chinese sources of these materials. There are extensive rare earth deposits in the United States and elsewhere. However, developing these deposits and the facilities to process the raw materials will take both time and financial support. So will a prominent alternative: ‘urban mining,’ a k a recycling of rare earths and other materials from used electronic devices.”

A U.S. House of Representatives defense panel is pushing for legislation that would provide $70 million to the Department of Defense for research into how the United States could reestablish rare earth production over the next five years [“Bill Allots $70M for R&D on Rare Earth Mineral Production,” by John T. Bennett, Defense News, 27 September 2010]. In commenting on the push to reestablish U.S. production, Daniel Dombrey reports that the Department of Energy is supposed work closely with the Department of Defense [“‘Rare earths’ fears spur US review,” Financial Times, 26 September 2010]. Dombrey reports:

“The Department of Energy is to set out a strategy to increase US production, find substitute materials and use rare earths more efficiently. The Pentagon will complete a study of the US military’s dependency on the materials. … The challenges are steep. A report by the Government Accountability Office said in April that rebuilding the US’s supply chain for rare earths could take up to 15 years and would require patents held by foreign companies. … ‘Diverse global supply chains are important for any critical materials, including rare earths – recent incidents underscore this,’ said David Sandalow, the assistant secretary at the energy department who outlined the push for a new US strategy. Brett Lambert, an industrial policy director at the Pentagon, added that his department had a dedicated team working on rare earths and planned to issue a comprehensive review in October. He said the US remained confident that its forces ‘have access to any and all materials necessary’, while recognising ‘the importance some of these elements have for both our supply chain and certain military systems’. Although rare earths are not in fact rare, their extraction is difficult and can often be environmentally hazardous.”

The U.S. company that looks poised to benefit most from China’s actions is Molycorp Inc., whose “New York Stock Exchange-listed shares have surged from the $14 IPO price in August, to $34.26 on [19 October].” [“U.S. Rare-Earth Miner Downplays China Worries,” by James T. Areddy, Wall Street Journal, 21 October 2010]. Areddy reports:

“The chief executive of Molycorp Inc., the primary U.S. rare-earth producer, played down worries that Beijing is abusing its near monopoly in the global supply of the metals, but said that China’s strategy of limiting exports underscores the need for alternative suppliers. … Mark A. Smith, chief executive officer of Colorado-based Molycorp—whose stock price has more than doubled since an August initial public offering amid the concerns around supply shortages—said in an interview … he sees China taking commendable steps to reorganize an industry that supplies high-technology companies with critical elements. For several years, he said, China has systematically reduced exports in recognition of its own growing demand and to regulate sometimes chaotic production and trading. ‘I really admire what they are trying to do to correct the industry as a whole,’ Mr. Smith said, also citing Beijing’s crackdowns on smuggling and measures in recent years to close some of the most polluting producers.”

I’m not surprised that Molycorp’s CEO finds China’s actions commendable. As long as China continues to reduce exports, his company’s valuation should continue to climb. As Areddy notes, “Molycorp is ramping up again and hopes to begin mining next year to produce 20,000 metric tons of rare-earth oxides by late 2012. In fact, Molycorp expects to emerge as one of China’s largest competitors.” Mr. Smith’s comments followed on the heels of a new Chinese announcement that is going “to cut rare earths export quotas next year by up to 30 percent to conserve supplies.” [“China to reduce rare earths exports,” Associated Press, Washington Post, 19 October 2010]. Areddy continues:

“In recent weeks, Molycorp’s Mr. Smith said he has heard from some Japan-based buyers of difficulty importing rare earth. He said Molycorp, which also distributes, has so far had no trouble importing from China but intends to step up its monitoring of the trade. The current environment, Mr. Smith said, provides ‘a lot of short-term benefits,’ but said that based on his almost 25 years in the industry, he believes that sustainability of the rare-earth industry might depend on coordination between policy makers and producers in the U.S., Japan, Australia and China.”

Japan has reacted to China’s latest threats by stating it will fund research leading to the development of “substitutes for [rare earth] use in high-technology products.” [“Japan reacts to China’s ban on rare earth,” by Mure Dickie, Financial Times, 29 September 2010]. Dickie continues:

“Banri Kaieda, [Japan’s] minister of state, … noted that Japan had been ill-prepared for what he called the ‘surprise attack’ of Chinese export curbs. ‘[It seems] there’s a need to put effort into developing substitute products,’ that could play the same role as rare earths in high-tech products, he added. Tokyo would also look to develop alternative sources of supply for rare earths, Mr Kaieda said. … Mr Kaieda’s comments highlight the risk for China that international views it is willing to use exports as leverage in a diplomatic dispute could end up undermining its dominance of the rare earth market.”

Japan is also looking to capitalize on “urban mining” by recycling metals found in scrap electronics [“Japan Recycles Minerals From Used Electronics,” by Hiroko Tabuchi, New York Times, 4 October 2010]. Tabuchi reports:

“Two decades after global competition drove the mines in this corner of Japan to extinction, Kosaka is again abuzz with talk of new riches. The treasures are not copper or coal. They are rare-earth elements and other minerals that are crucial to many Japanese technologies and have so far come almost exclusively from China, the global leader in rare earth mining. … This town’s hopes for a mining comeback lie not underground, but in what Japan refers to as urban mining — recycling the valuable metals and minerals from the country’s huge stockpiles of used electronics like cellphones and computers.”

Concern over China’s monopoly may prove to be a big boon for electronics recycling. Until now, much of that recycling has been done under dangerous conditions in developing countries. Tabuchi continues:

“In Kosaka, Dowa Holdings, the company that mined here for over a century, has built a recycling plant whose 200-foot-tall furnace renders old electronics parts into a molten stew from which valuable metals and other minerals can be extracted. The salvaged parts come from around Japan and overseas, including the United States. Besides gold, Dowa’s subsidiary, Kosaka Smelting and Refining, has so far successfully reclaimed rare metals like indium, used in liquid-crystal display screens, and antimony, used in silicon wafers for semiconductors. The company is trying to develop ways to reclaim the harder-to-mine minerals included among the rare earths — like neodymium, a vital element in industrial batteries used in electric motors, and dysprosium, used in laser materials.”

Tabuchi indicates that “used electronics in Japan hold an estimated 300,000 tons of rare earths.” I daresay that most developed countries have a stockpile of used electronics that contain similar amounts of rare earths. China has recently backed off of its tough stand. In early October while on a visit to Europe, Chinese Premier Wen Jiabao stated that China would not use its monopoly on rare earths as a bargaining chip [“Premier: China won’t block rare earth exports,” by Elaine Kurtenbach, Washington Post, 8 October 2010]. Unfortunately for Chinese leaders and businessmen, past actions speak a lot louder than promising words. Kurtenbach reports:

“Japan’s Cabinet … approved new funding for securing rare earths as part of 5.05 trillion yen ($61 billion) in new economic stimulus. Concerns over the issue are prompting a resumption of some projects in the U.S. and Australia that had been postponed for years due to competition from cheap Chinese suppliers.”

Kurtenbach also reported that a new find of rare earth reserves has been found in China’s Henan province. Even with this new discovery, it is estimated that China’s rare earth reserves will only last 15 to 20 years at current production levels. As Tom pointed out in his post, 70 percent of the globe’s rare earth reserves are found outside of China. The fact that China monopolizes production still provides China with an economic edge it is trying to exploit [“China Dangles Rare-Earth Resources to Lure Investment,” by Yajun Zhang, Wall Street Journal, 15 August 2010]. Zhang reports:

“China is cautiously using rare-earth resources as bait for foreign investment that could bring in sophisticated technologies that it needs. Industry and government officials have begun talking about a Chinese government plan to offer access to its rare-earth resources … to get companies including electronics manufacturers and auto makers to set up rare-earth-processing plants in China. … China bans foreign companies from investing in rare-earth mining, but has allowed foreigners to enter processing joint ventures with Chinese businesses.”

China is not backing down on the actions it is taking. Earlier this week, China “denied that it is violating World Trade Organisation rules in its strongest statement since the US announced an investigation last week into Beijing’s rare earths and green technology policies.” [“China defends policy on rare earths,” by Leslie Hook and Mure Dickie, Financial Times, 20 October 2010] Hook and Dickie continue:

“The New York Times reported on Wednesday that China had halted rare earths shipments to Europe and the US. China’s exports of rare earths oxides to the US are extremely small as the US has no capacity for rare earths refining but nonetheless the New York Times article about halted shipments is certain to raise the temperature in Washington.”

In the long run, aggressive Chinese actions concerning access to rare earths will probably hurt China more than its competitors. In the short-term, however, China looks to obtain the greatest possible benefit it can from its rare earth reserves. Supply chain analyst Adrian Gonzalez warns that there is “a very real supply chain risk for high-tech and other companies that depend on these materials for their products.” [“Supply Chain Risks: China Rare Earth Minerals and Currency Wars,” Logistics Viewpoints, 20 October 2010]. He continues:

“China is to rare earths as Saudi Arabia is to oil, and several wars have been fought over the latter. And as with oil, the only way to effectively reduce this risk is to develop alternate sources of supply—preferably domestic—and to eliminate the use of these minerals from products, which would require scientific breakthroughs and innovations in materials science and product design. Unfortunately, both of these approaches are very long term solutions, so we’re left with politicians and diplomats to resolve this issue and prevent it from escalating.”

Although I don’t see a rare earth conflict emerging any time soon, Gonzalez is correct to point out supply chain risks exist whenever there is a monopoly that controls the supply of any resource. The search for substitutes for rare earths is likely to continue, but information age technologies will ensure that suppliers of rare earth minerals will have a ready market for decades to come. That is why I agree with Tom that “there’s good logic for mining at multiple sources” and that there is “reasonable space for cooperation with long-time allies so that we’re not [creating new sources of supply] in the most expensive manner possible.” Rare earths may not be all that rare, but sensible policies often are.

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