Rare Earths Diplomacy
By Sean Daly | November 12, 2010
China ended its rare earths embargo of the West last week, with shipments resuming to Japan, the United States, and Europe after a speech by Secretary of State Clinton raised the diplomatic stakes. The ban ended as it began, quietly and without official notification. The question now is whether the resumption of trade will lull the developed world back into dependence, or whether the whole affair really was, as Clinton described, a "wake-up call."
In many ways the embargo itself was a sideshow for two larger disputes—the long-simmering maritime feud between China and Japan, and a newer, fresher conflict that seems to be emerging with the developed world over high-tech employment.
Beijing's use of its rare earths as a diplomatic cudgel was an absurdly flawed tactic, but it brings this new conflict into clearer definition. China's true challenge to the West—indeed, its winning strategy—can be found in its ambitious modernization goals this coming decade. Set out in obscure committee directives and benign national policy choices, these are its best-laid plans.
The following incident, unrelated to the embargo firestorm, is instructive on this larger issue. On October 19, one day after an important Chinese Communist Party plenary session had meted out the nation's trajectory for the next five years, a leak from the Ministry of Commerce indicated that export quotas for rare earth elements (REEs) would be 30 percent lower in 2011. The Ministry report also mentioned that exports might be outlawed entirely in the coming decade.
How this outlawing of exports (or even the quotas themselves) squares with the WTO precepts signed by Beijing in its 2000 accession agreement was not discussed. Because China controls 95 percent of all REE mining, the ban would hit Western manufacturers hard. The story was picked up by the Associated Press. The leak was then immediately denied the next day, but the fact that it emerged the day after the United States launched a probe into Chinese subsidies of its green industry and following a pivotal CCP meeting on future energy security is suggestive.
Indeed, such a reduction doesn't deviate from the trend: Foreign exports have been tightening for seven years. China in July slashed its late 2010 export quota by 72 percent, arguing the country needs to protect its supplies for the future. Shipments would be capped at 8,000 metric tons, down from nearly 28,500 tons for the same period in 2009. As the state-sponsored People's Daily made clear in discussing the leaked report: "No one is entitled to criticize China over this because this is an affair absolutely within China's sovereignty."
Long the topic of metal speculators, the rare earths issue has received copious press lately precisely because it intersects so many of the great debates, anxieties, and aspirations of our time. As Beijing seeks to cut off the world with a series of stringent quotas, those cherished notions about free trade and an employment-enhancing "green economy" are facing the tough reality of mercantilism, sourcing monopolies, and an obscure world of technology metals that are rather hard to mine cleanly.
There is a growing recognition that an emerging China might not simply need a dignified "place at the table" and then always be a progressive player on global agendas. In fact, as I wrote earlier this year, China might behave more like the United States—a hungry, solipsistic nation, capable of fierce unilateralist tendencies.
Threading through various PRC policy discussions and governmental white papers, a general consensus appears: The next decade offers China a historic "window of opportunity" to focus on solving its big domestic needs while also lifting the nation to technological parity with the West. Beijing's obsession with its own modernization will likely shock the developed world in the coming years, as all calls for free trade and "fair play" are met with indifference or suspicion.
The recent rare earth embargoes of Japan and United States appear to confirm this point.
The "Informal" Embargo
The world certainly got a bit less "Friedman flat" last month when Beijing swung to hot, coercive diplomacy following the September 7 arrest of one of its fishing boat captains near the Senkaku Islands.
Some flare up of nationalist sensitivities was to be expected, yet it is still astonishing how quickly the crisis cascaded into every aspect of Sino-Japanese relations. Following the arrest by the Japanese coast guard, China canceled cultural exchanges, dropped tourism, and tabled all energy plans. It arrested four Japanese nationals on trumped-up spying charges. It spoke ominously of economic consequences, and within a week all exports of rare earth elements to Japan mysteriously ceased. Ordered by Chinese customs officials, this "informal" embargo of neodymium and other metals aimed to wobble the Nikkei's high-tech manufacturers.
Faced with questions at a conference on October 3, Wen Jiabao pointed to the overzealous patriotism of individual exporters and declared that shipments would quickly resume. But they did not.
Indeed, the unspoken halt to all shipments spread to other developed markets within two weeks. On October 19, the New York Times reported that Chinese customs officials imposed restrictions on REEs bound for the United States and Europe hours after a top Chinese official denounced an American probe into Chinese subsidies. The restrictions are explained now as a policy of heightened diligence. As Chinese embassy spokesperson Wang Baodong described in a recent email:
With stricter export mechanism gradually in place, outbound shipments to other countries might understandably begin to feel the effect. But I don't see any link between China's reasonable rare earth export control policy and the irrational U.S. decision of protectionist nature to investigate China's clean energy industries.
Despite Wen's comments on October 3, the Japanese embargo stayed in place for 26 more days, ending without any official acknowledgment on October 29. Shipments to the United States and Europe also resumed that day.
Whereas the developed world saw these trade bans as retaliatory, Beijing soon presented them as a healthy approach to smuggling problems amid necessary industry consolidation. The argument was that many of the exporters had simply exhausted their quotas for the year and that the lax environmental regulation that had allowed for pell-mell increases in mining had to be curbed.
Ultimately both sides are right. The bans were clearly retaliatory; China is concerned about its supply. But the rift in perspectives on the issue suggests a new era may be taking shape: a bumpy "deglobalizing" period when the developed world must question the wisdom of trade dependence on China and cope with its inward focus.
Grand Plans for a Green China
The October CCP plenary session hammered out an ambitious plan. It offers up a tough new energy agenda for the country, with a 15–20 percent reduction in energy intensity over five years and a 40–45 percent reduction in carbon emissions by 2020. It is a plan that can only be met with a massive investment in "green" technology, which now often depends on rare earth elements.
Rare earth metals are used extensively in the latest wind turbines and electric cars. Traditional wind turbines have gearboxes that are prone to break down. The new neodymium-iron-boron magnet generators have far fewer moving parts and are therefore less costly to service in extreme offshore locations. They are quickly becoming the turbine of choice.
Similarly, each Toyota Prius hybrid uses 1 kilogram of neodymium in its electric motor magnets, and about 10 kilograms of lanthanum in its batteries. Those amounts will only go up as the car's power train evolves for more efficiency.
Earlier this year, China declared a national goal of reaching an annual production rate of 1 million electric cars. Metals expert Jack Lifton estimates that this feat will require a staggering 1,000 metric tons of lanthanum per year. Beijing is also aiming for 330 GW of wind turbine energy by 2020. Lifton suggests that this ten-year project will absorb some 59,000 metric tons of neodymium, 1,000 tons of terbium, and 3,000 tons of dysprosium.
Producing all those green products is going to require a lot of rare earths.
The "Win-Win" Scenario
How will China maintain decent prices for the domestic companies it has tapped to build its green future? It will control prices, curb exports, and combat illegal mining. On July 10, 2010, China's Ministry of Commerce declared full state intervention in the industry:
- All REE prices will be set by the central government, with a national price set each month.
- All REE mining companies will be consolidated by the state into 3–5 conglomerates.
- Exports for 2010 were to drop to 40 percent of 2009 levels.
Prices spiked for all rare earths following this action, with neodymium outside of China quadrupling to $80,000 per ton. It sells at half that inside the country.
On October 18, the Secretary General of the Chinese rare earths industry association suggested that in-China use will soar from 75,000 tons per year today to 130,000 tons in five years. This is why foreign exports may be reduced further and—denials aside—exports of the "rarer" rare earth elements might be outlawed altogether.
Developed countries were already squirming under recent Chinese development strategies. Beijing started to reduce export quotas as early as 2003. Though actual Chinese REE production climbed 60 percent from 2003 to 2008, its exports to other countries during that period dropped 50 percent.
Why reduce exports, especially when they fetch higher prices for the miners? China appears to be implementing a nationalist agenda that does several things simultaneously. By pressuring foreign companies to relocate factories, with lower in-China sourcing costs as the lure, Beijing hopes to absorb innovation and expand into those attractive industries. The move also strengthens China's high-tech "national champions," which can produce at even lower input costs than their Asian neighbors and mop up domestic demand. China thus leverages its REE monopoly to climb up the manufacturing chain, creating the magnets and value-added technologies that require rare earths.
These "national champions" in the green and high-tech fields will enhance employment at home, and their products will reduce pollution and energy usage within China. They will also sell well in emerging economies, further marginalizing the developed world's high-tech manufacturers. The strategy produces a "guided market" virtuous circle.
The End of an Era
So how should the developed world react to reduced exports? These new controls will draw down existing stockpiles and ultimately affect high-tech pricing. According to Dudley Kingsnorth, executive director of Industrial Minerals Company of Australia:
First, the quotas are less than "rest of the world" demand this year, which I did not believe would occur until 2011. … Second, if this trend continues, world supply will not be able to meet the shortfall for several years. In the near future, the shortfall will be met by a drawdown of stockpiles.
Prices are already up significantly this year for most rare earths. Lanthanum has doubled since July following China's intervention. The price of dysprosium in China has gone from $50 per kilogram in 2005 to $290 per kilogram this October, with that number often double outside the country.
The West is being asked to source its own rare earths. But it might not yet understand just how much higher those prices will go, having historically experienced a pricing environment that can only be understood as an anomaly. In a recent report, the strategic consultancy firm STRATFOR analyzed the pricing of rare earths over the past three decades and concluded that the West has been quite oblivious to how abnormally cheap the metals were during the last 20 years due to China's unregulated mining.
Yes, total disregard for occupational safety and environmental impact allowed for low-cost REEs worldwide. Pictures of Baotou miners often show them caked in mud laced with thorium and uranium.
But the STRATFOR report makes another very interesting point, one rarely discussed. It suggests that Chinese state loans to mining operations—which were focused on "social stability through full employment" and not profitability—gave the world decades of supply:
The REE industry—like many other heavy or extractive industries—was targeted with massive levels of subsidized loans in the mid-1980s. … Production rates increased by an annual average of 40 percent in the 1980s. They doubled in the first half of the 1990s, and then doubled again with a big increase in output just as the world tipped into recession in 2000.
World prices predictably plunged, by an average of 95 percent compared to their pre-China averages. The consultancy firm computes that if world prices were to go back to 1980s levels (and a non-Chinese supply), the developed world would be seeing a vastly different cost structure for many now pervasive products—including computer drives, compact fluorescent bulbs, even those Apple earphones.
Take, for example, the Toyota Prius battery system. Its rare earths components were responsible for a mere 0.9 percent of the car's cost in 2009. That percentage has increased to 2.9 percent due to higher lanthanum costs this year, and that cost would increase further still to 15.2 percent if pre-China prices were applied.
Manage and Control
Last week, in a sign of growing concern, a collection of 35 business groups from the United States, Europe, and Asia sent an open letter asking officials at the G-20 meeting in Seoul to try to resolve the issue of rare earths exports and their free trade. Unfortunately, it is unclear what kind of real leverage over Beijing there is on this issue. Tellingly, on the same day, the chemical giant W. R. Grace bid to secure non-Chinese supplies. It tapped a new U.S. miner ramping up initial processing in California, promising to buy 75 percent of all lanthanum produced.
At the Asia-Europe Summit in Brussels last month, Wen Jiabao made a statement on rare earths: "What we are pursuing is the sustainable development of rare earths, which is necessary to meet our national needs—and also the needs of the world." Wen, a trained geologist, went on to say that it was "necessary" to "manage and control" the rare earths market.
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