Global Dependence on China’s Rare Earths

Beijing’s Black Gold?

In late September, reports emerged that the Chinese government planned to implement restrictions on the export of so-called “rare earths” – elements and metals that are integral components of advanced technologies, such as computers, communications devices, advanced weapons systems, and green technologies. Currently, China produces some 97% of the world’s rare earths, and consumes 60% of them. Some observers view the Chinese government’s move as a step toward cornering the world’s rare earths market – a fulfillment of Deng Xiaoping’s proclamation that rare earths would be for China what oil is for Saudi Arabia. Others see it as sensible policy that has fallen victim to sensational reporting. They believe that non-Chinese producers – whose mines had lain dormant through a period of abundant supply – will now resume mining operations.

While the motivations for China’s decision are open to debate, the fact remains that the move could have radically disruptive implications not only for high technology industries but for geopolitics as well.

Insights from the Ergo Network

To examine how China’s move will impact the profits and growth of these industries, Ergo engaged four experts to help determine the far-reaching consequences of this trend.

• Expert 1: Former senior intelligence officer focusing on China

  “The Chinese are stockpiling everything – whether it’s rare earths, commodities, everything – and they’re paying over the market price. They’ve got the forex to do it. They just bribed an Afghan official with $30 million to gain access to a copper mine. The Chinese have nervous anxiety about an inability to continue manufacturing. They decided a long time ago that they weren’t going to trust the spot market, so now they’re trying to control access to the resources they need to continue their economic growth.”

• Expert 2: President of a technology consulting company and a leading authority on rare earths

  “When the news reports about China hoarding rare earths came out, the guys who put out the reports were interpreting some internal discussions – it was not an actual policy that would be going on anytime soon. This group must have had stocks or something to benefit from this news leak. I actually heard that this was personally beneficial to them. Like any thinly traded market you can go through enormous swings in the market with a small shift in demand. Companies that don’t have long-term relationships with suppliers could face significant difficulties. There will be a lot of opportunities for R&D, for companies to identify how to get by with less material, and to get more performance out of a system. Another thing is substitution; there are all kinds of technologies sitting on shelves that could become price competitive in an environment with tight supplies of rare earths.”

• Expert 3: Vice President of Market Development at a rare earths exploration and development company

  “Are the Chinese cornering the rare earths market? No. That has a negative connotation; I would argue they had a long-term vision decades ago, and now they provide the rest of the world with 95% of the rare earths supply. It’s a small field of companies that both understand and can develop rare earths. I’m not suggesting that many of the companies out there are snake oil salesmen, but there is a lot of promotion going on out there without any substance. What’s not spoken about is that we need R&D, manufacturing, etc. and we’re not going to get an immediate return the next quarter/year. Getting new raw material sources requires five years. This requires a vision change for industry. I don’t think any one company will be able to do it – it’s the whole supply chain that requires a collaborative effort. That’s not in our culture – it takes a broader thought process and more collaboration, from universities to industry to government. There will be tremendous opportunities for companies and investors that are able to take a long-term perspective and get beyond the dividend culture.”

• Expert 4: Leading U.S. Government mineral scientist specializing in rare earths

  “Generally the Chinese have added an export tax and put quotas on companies to limit the supply of rare earths that are put on the market. The bottom line is that they want more value for their production – either by increasing the price of the basic compounds and metals, or by moving up the value chain. By encouraging people to move their plants to China, they can attract foreign technology and IP in exchange for raw materials. It’s not just U.S. companies [that will suffer from these moves]; the rest of the world is going to suffer. With the Chinese having control over resources and production, they can distort the price by taking off the export controls and tariffs; and they need these things to keep their economy growing. They’re aggressively purchasing deposits and production elsewhere. People don’t think about it but these rare earths go into things ranging from catalytic converters to oil refineries. At one point people tried to take rare earths out of the refineries and they found that they got half of the yield out of it. The biggest story is that this is a market controlled by one country, and the biggest problem is that investors are scarce.”

Looking Ahead

In order to compete in a rare earths market increasingly dominated by China, companies and governments must urgently diversify their supply chains. While some companies may find it beneficial to move their manufacturing base to China to obtain secure supplies of rare earths, others may want to invest in rare earths production and manufacturing outside of China. Foreign producers, however, must be able to sustain operations in a market where China could drive down rare earths prices very quickly, making production uneconomical.

Limited rare earths supply will have an impact on the research and development of next generation technologies. China produces almost all of the world’s rare earths, but rare earths innovation is coming from the United States, Europe, and Japan. This construct may prove to be unsustainable. The most promising R&D activities require both a supply of the materials and a reinforcing manufacturing capacity. China’s weak protections for intellectual property discourage firms from moving their R&D and innovation businesses to the rare earths source, and its dominance in rare earths production will constrain American, European, and Japanese innovation due to an insecure supply of materials.

One way for rare earths manufacturers, producers, and investors to hedge their risks and reduce exposure to sudden price swings is to leverage securitized products based on the commodity. While no such financial instruments currently exist, the development of derivatives and ETFs linked to rare earths, if conceived of and executed correctly, could help stabilize the market in the face of growing Chinese dominance.

Rare earths are not as well known as other more widely traded commodities, but they are vital to economic growth and development. A new age of mercantilism may be upon us, as countries and companies scour the earth to secure access to the materials that will drive the 21st century’s economy. The future of the rare earths industry has tremendous implications for governments, investors, innovators, and corporations. Those who move quickly to seize opportunities stand to benefit for decades.

Ergo is the market leader for deep research in China. Ergo has conducted numerous studies on natural resources and investment opportunities in China, specialized technologies, and supply chain vulnerabilities.