Let Them Compete! Solving the Rare Earth Dilemma

June 15, 2011
Allowing for greater competition among rare earth producers would result in China's rare earth prices being determined by global market conditions ultimately fostering global innovation.

American Industry cannot exist without rare earths; 15 exotic elements residing at the bottom of the Periodic Table. However, essentially 100% of the annual global production of these metals comes from one source, China. This has serious economic and political implications for both the U.S. and China. This rare earths dilemma has been widely reported in the news lately. But much of the coverage is inaccurate. It is critical to understand the actual facts so the U.S., China and the rest of the industrialized world can ensure a steady flow at fair prices allowing for the long-term growth of all nations.

Want to build a car? Can't without rare earths. Cerium is a basic ingredient in catalytic converters and keeps windshields from yellowing. Yttrium is required to produce spark plugs. Neodymium magnets drive the many small electric motors in modern cars. Europium phosphors light up TV and computer screens. Cell phones, solar energy panels, fuel cells, and wind turbines all require at least one rare earth.

For decades the world was happily unaware of the importance of rare earths because they're typically used in minute quantities. Then last year Japan decided to test China's claim to a small outcropping of islands in the South China Sea by detaining a Chinese fishing vessel and jailing its captain. China warned Japan they would suffer dire consequences if he was not released. Japan refused. Did China recall its diplomats? Restrict importation of Japanese goods? No, it simply stopped shipping rare earths. In less than 24 hours, Japan buckled, released the captain, China resumed shipments and the world woke up. But how did we get here?

Historically two companies controlled the global rare earth supply chain. The French company Rhone-Poulenc (now Rhodia soon to be a division of Solvay) built a base of operations in China, and Unocal's Molycorp division (acquired by Chevron Mining then spun off and taken public last year) owned a mine in California. Prices were maintained artificially high as a result.

In 1998, I flew to Inner Mongolia (a semi-autonomous region of China similar to Tibet and base of operations for China's rare earths industry) with the intent of breaking this duopoly. My company became one of the first Americans to supply direct from China. Within a year the Molycorp mine was shuttered and Rhodia closed its sole U.S. rare earth facility in the face of competition and significantly lower prices.

Until two years ago prices remained reasonable due to healthy competition among Chinese producers and the governments thirst for foreign currency. In 2005, Chinese policy leaders experimented with ways to raise prices through export quotas and tariffs. Hundreds of producers were denied quota and closed.

But prices remained stubbornly low so the government implemented a plan last year to absorb remaining large private producers into a single state-owned enterprise ("SOE"). Independent owners swapped their stock for shares in the new enterprise. Export offices now review shipments and deny export licenses to ones deemed sold too cheap. Global prices skyrocketed and continue to do so.

As a result, the world has begun a desperate search for alternative sources. Molycorp is scheduled to re-open. Other major projects are being developed in Canada (Great Western Minerals), Australia (Lynas) and elsewhere. Conventional wisdom is that it's just a matter of time before these operations come on line and prices drop to 2008 levels (Goldman Sachs even projects a glut in 2015.) But Goldman Sachs is wrong. This will not happen. Recent articles on the subject claiming "rare earths are in fact not all that rare" are grossly naive.

Inner Mongolia's Baogang deposit is immense, essentially a mountain range of easily extractable high quality bastnaesite (rare earth) ore and only one of several deposits in China. While the Chinese are making in-roads in environmentally-sensitive mining techniques, costs drive decision making. Molycorp, the most promising and only previously operated major deposit outside of China, is a single, narrow (and narrowing) pit mine that has been exploited since the 1940s and is situated in the Mojave Desert District; a federally protected area heavily regulated by the CalEPA, the U.S. EPA and the Bureau of Land Management. Not a recipe for cheap extraction costs.

If a country controls the lion's share of a metal, it essentially has a "soft monopoly" on that commodity. Imagine the entire Middle East as one country. That country would be in the same position with oil as China is with rare earths. If China were to freeze exports, Molycorp plus all other mines on the drawing board combined could never meet world demand. Add to this China's drastically lower operating costs and the largest domestic manufacturing base in the world and you have the first country in history that both controls a commodity and has the means to fully exploit all of it into every finished good requiring the commodity.

China could greatly restrict exports driving up world prices given both demand and the high operating costs of alternative sources and make them available domestically at materially lower costs. Simply push this national advantage up the supply chain to its manufacturers of products requiring rare earths. But would this strategy be in China's long term best interest? I believe not.

The numerous applications for rare earths developed over the last 50 years were primarily invented in the U.S. and secondarily Europe and Japan; few in China. As the dominate producer of rare earths, China only benefits from allowing the great R&D facilities throughout the world to continue to spend their research budgets inventing next generation products based on rare earths. As a result of how China handled the Japanese dispute, U.S. researchers are now being funded to do just the opposite; search for alternative materials and technologies. American Elements worked with General Electric to develop its Reveal light bulb. I believe GE would never have launched the bulb if it thought it would have trouble sourcing neodymium.

Next, the world is not stupid. If it becomes increasingly apparent that China is using its raw materials advantage to render cars, televisions and computers produced by those outside its borders uncompetitive, trade wars are inevitable. Global political pushback would certainly stifle China's "Go Global" strategy; such as its massive investment in Africa and its goals in South America and Afghanistan. If China were willing to pursue this strategy with rare earths, why not tantalum in Africa, lithium in Bolivia, etc.?

Finally, artificially reducing the risk of failure of its fledgling industries by providing an easy road to lower costs will foster a generation of managers lacking innovation and entrepreneurial skills. China need only look to Japan and its "keiretstu" approach to corporate interrelationships to see how a promising economy can be rendered risk adverse when government paternalism and too great an emphasis on cooperation prevents the development of a generation of true entrepreneurs. As Tom Peters said, to succeed companies must "Fail, Forward, Fast."

The U.S. and the rest of the world must understand that rare earths put China in a position to produce many important products at prices lower than foreign competitors. How this is managed may create a world wary of innovating new technologies reliant on rare earths. Perhaps allowing for greater competition among its rare earth producers would assure the world that China's rare earth prices are determined by global market conditions. I believe this would foster a wealth of global innovation that will foremost benefit China. In turn, the world cannot blame China for their very good fortune to have had just the right space rocks drop on their turf.

Michael Silver is the president and chairman of the board of American Elements, a global advanced materials and rare earth elements manufacturer with corporate headquarters in Los Angeles, California.

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