Saturday, March 24, 2012

The China-US rare earth games...

The China-US rare earth games...
By Peter Lee

The joint complaint by the United States, European Union (EU), and Japan filed against the People's Republic of China (PRC) before the World Trade Organization (WTO) for its restrictive rare earth export policies marks another satisfying act in President Barack Obama's contain-China political theater. It also provides some insight into where the world is headed, and Japan's attempts to maintain its economic and geopolitical relevance.

The handwriting is on the wall for the PRC to lose the rare earth case. It is a virtual carbon copy of the raw materials export restrictions case brought by the US, EU, and Mexico against the PRC. Beijing lost, both in the original adjudication and on appeal in January 2012. [1]

In the raw materials case, the WTO found that China's regime of export duties and quotas for bauxite and other materials created a two-tier system that favored domestically based traders and processors (including FDI entities), and discriminated against foreign purchasers. It rejected the PRC's defense that these measures were protected under GATT provisions permitting restrictions on exports for the purpose of conserving scarce resources and preventing environmental degradation, observing that price and quantity controls that primarily targeted foreign purchasers was not a plausible implementation of a conservation policy.

At the time, it was widely believed that a rare earth complaint would be next, and indeed the shoe dropped in high-profile remarks by Obama in the White House Rose Garden on March 13.

China-bashing makes for good politics in this election season, and his administration and the media did their best to paint the case as a victory for freedom and fair play against the Chinese menace, citing China's monopolistic 97% share of current rare earth production.

However, beyond the 97% number, the story gets a little thin. China only accounts for around 30% of world rare earth reserves, begging the question of how vital the WTO complaint is the protection of Western interests. After all, shouldn't Adam Smith's invisible handyman be busy knocking holes in the Chinese monopoly?

In fact, the market is responding pretty much as one would expect, with a certain, surprising, amount of help from China.

In addition to enforcement of the export quota system, China's widely reported measures to consolidate production, decrease pollution, and shut down the wildcatters and their inefficient, polluting mines have pushed up global rare earth prices.

In response, there are at least two major rare earth plays going ahead: the Mountain Pass mine in the United States and the Lynas project (mine & concentration in Australia; refining to metal powder in Malaysia).

Mountain Pass, in California's Mojave Desert, is the biggest rare earth mine in the world, once responsible for half of global output. It ceased operation in 2002, shuttered by a flood of inexpensive Chinese product. Now owned by Molycorp and flush with IPO money, the mine is reopening. It recently purchased Neo Materials Technologies, a Canadian rare earths processor, for $1.3 billion Canadian dollars.

In the requisite ironic counterpoint that seems to accompany almost every China sanctions story, a dismantling of Chinese duty and quota barriers would push down global prices and, perhaps, strangle these Western rare earth investments in the cradle.

As the Chinese government pointed out, only half of its 2011 rare earth export quota was subscribed, implying that there are limits to the pent-up global demand that can keep prices up to a level healthy to Molycorp and Lynas' investments.

Also, the Chinese government has openly welcomed development of new rare earth sources overseas in order to relieve pressure on Chinese suppliers to serve the export market instead of domestic users. In fact, Lynas' CEO, Nicholas Curtis, is a China resource insider with close ties to the PRC establishment; China Non-Ferrous Metals Mining Group would have funded the rare earth play but for Australian government opposition. The process technology for the Lynas processing plant in Malaysia is supplied by China. [2]

As for Mountain Pass, its chairman, Ross Bhappu, told reporters:
''It has been surprising, the Chinese are extremely supportive of us starting this mine, they have told us they don't want to be the world's sole supplier…They are concerned they are going to consume everything they produce internally and they won't have excess production to export." [3]
A study by Technology Metals concluded that every rare earth element will pass into permanent surplus by 2017 or earlier. [4]

The key issue is not access to the raw material, or even processing technology. The heart of the rare earth kerfuffle lies in Japan and its efforts to maintain its economic and diplomatic relevance as it is overshadowed by China as Asia's leading exporter and growth engine.

Rare earths attained their current geopolitical celebrity in 2010, when the PRC cracked down on rare earth shipments to Japan (perhaps one third of which are estimated to be smuggled material evading the export licensing system) during the spat over the detention of the crew of a Chinese fishing vessel near the Diaoyutai/Senkakyu Islands at the direction of Japan's ambitious, pro-US. defense minister at the time, Seiji Maehara. [5]

The PRC's attempts to fire a shot across Japan's bow backfired. Despite the fact that Japan had, by its own estimation, stockpiles of rare earths sufficient for six months (the Chinese suspect the figure is much higher) and no disruption to Japanese production occurred, rare earths became the useful symbol of overweening Chinese ambition in North Asia, just as the PRC's aggressive claims in the South China Sea have come to epitomize the Chinese threat in South Asia.

In an example of diplomatic and political synergy, the United States piggybacked its "return to Asia" on the back of Japan's rare earth woes.

The rare earth dispute provided a perfect showcase for alleged Chinese perfidy. Not only were rare earth elements declared to be at the core of Western defense technology; enjoyment of the green marvel of the Prius and the high tech wonder of the iPhone were tainted by the awareness that China, with its rare earth monopoly, could snatch them away at any time.

WTO proceedings against China appeared on the Japanese diplomatic agenda. In July 2011 Asahi Shimbun editorialized that Japan, "which has never filed a complaint against China" with the WTO, should do so over rare earths, drawing on the experience of the PRC's loss in the raw materials case. [6]

One can speculate that Japan cautiously held back on inclusion of rare earths in the original raw materials complaint so it could see how the case came out before taking the risky step of challenging China directly on the rare earths issue. Japan has not been a paragon of courage in the current rare earth case, either. Although the Japanese government has by far the biggest dog in the rare earth fight with China, it has let President Obama and the EU carry the China-bashing ball with high profile statements, while Tokyo has been conspicuously silent.

The universal complaint underlying criticism of China's two tier system is not so much the cost disadvantage to non-local purchasers; it is that the PRC has been using its temporary rare earth monopoly as bait to entice or compel downstream processors and fabricators to set up shop in China in order to gain access to raw material at preferential pricing.

China has been strikingly successful, and 25% of China's rare earth exports now pass through joint venture companies. As Keith Bradsher of the New York Times pointed out in August 2011:
For most industrial products that are manufactured in China using rare earths and then exported, China imposes no quotas or export taxes, and frequently no value-added taxes, either.

Companies do that math, and many decide it is more cost-effective to move to China to get cheaper access to the metals.

"When we export materials such as neodymium from China, we have to pay high tariffs," said Junichi Tagaki, a spokesman for Showa Denko, which announced last month that it would sharply expand its production of neodymium-based magnetic alloys, used in hybrid cars and computers, in southern China. The company saves money by manufacturing in China instead of Japan because the alloys are subject to no Chinese export taxes or value-added taxes, he said. [7]
An August 2011 Reuters article presents a picture of barely concealed Japanese panic:
But with no significant supply of rare earths expected outside China before 2013, analysts say the production move by Hitachi and Showa Denko could indicate the beginning of a mass exodus of technology manufacturers from Japan.

"If the differential between the export price and the domestic price continues as it is, I think we're going to see a lot more people following suit," said Asian Metal analyst Brandon Tirpak. "It's like the big fish, when it starts moving then all the others follow." …
Japan's rare earth market is expected to shrink by 30% in this year alone, due to the flight to China. The trend is expected to continue until prices outside China drop.

"Japanese production is moving to China faster than I've ever seen in the past," said Neo Material Chief Executive Constantine Karayannopoulos. "We may be witnessing a fundamental restructuring of the global rare earth supply chain." [8]
Beyond a $700 million government war chest to fund the strengthening of the domestic supply chain, Japan engaged in a flurry of rare-earth related activity: setting up a rare earth magnet recycling operation in Vietnam, inking an agreement with Kazakhstan, and touting the discovery of a trove of rare earths on the Pacific seabed.

Developments in the US gave Japan a desperately-needed lifeline.

In August 2011, Hitachi Metals, the world's largest producer of rare earth magnets, announced an agreement to source material from Molycorp's Mountain Pass facility; in December it announced it would invest 2 billion Japanese Yen to set up a neodymium magnet production line in North Carolina to serve the electric vehicle and hybrid vehicle market.

The plant was characterized as Hitachi's first overseas neodymium magnet investment, implying that a previously announced plan to put 20% of its production in South China is, perhaps, on hold.

Then came the simultaneous US/EU/Japanese rare earth complaint to the WTO.

And now there is the "Second Trilateral EU-Japan-US. Conference on Critical Materials", to be held in Tokyo March 22 "to explore ways to counter the unstable supply of critical materials such as rare earth elements." [9]

This all looks, walks, and quacks like rollback against China on rare earth materials, perhaps driven by a combination of economic realities and the recognition that the rare earth "crisis" is a heaven-sent rallying point for the US-Japanese alliance.

For its part, the Obama administration has happily joined the chorus of anti-Chinese rhetoric and welcomed the opportunity to help pound a wedge between Beijing and Tokyo on the rare earth issue, and discomfit China before the WTO.

However, beneath the harrumphing, the US appears to have a surprisingly relaxed attitude toward the rare earth issue.

This may be because the odds for China on the WTO case look very bad, and the raw materials precedent indicates that China will accept the WTO's nostrums (after a lengthy adjudication and appeals process that may take two years) in order to remain a member of good standing in the international trade fraternity, despite its current defiant chest-thumping.

China may also decide to relieve itself of its export-related embarrassment by following through on previously floated plans to build a major government rare earth stockpile of up to 200,000 tons on the grounds of national security, thereby substituting de facto rationing for the repudiated export quota system.

In any case, in a few years the dreaded Chinese rare earth monopoly will have collapsed, with the assistance of the Chinese themselves, and the free world can enjoy its hybrid vehicles, its smartphones, its Tomahawk missiles, and its night vision goggles free of the anxiety that China will make the rare earth world go dark.

The Obama administration's balanced overall approach to China policy (pairing a public kick in the behind with a discrete pat on the back) was also demonstrated in the rare earths matter. Just as President Obama issued his stern Rose Garden pronouncement on rare earth, the US government quietly assessed a remarkably temperate punitive tariffs of under 5% (instead of the expected 20-30%) in the case of another high profile Chinese infraction in the precious green industry sector: the solar panel dumping case.

This nuanced outlook apparently does not please certain members of the US rare earth fraternity, who rightly consider the evaporation of the US rare earth industry as a colossal failure of industrial policy and long for some kind of Manhattan Project-type government commitment to restoring America's previous eminence in the field of rare earths on the sacred grounds of national security.

An editor of the premier rare earths website, RareMetalBlog, wrote indignantly on March 15 that President Obama's announcement of the WTO rare earth complaint concentrated on mundane economic considerations with "no reference to what we all know and as eloquently summed up by a member in the audience: "...every frickin' defense platform uses rare earths."

He continued:
I just returned home from the TREM Critical Metals Summit [an industry confab sponsored by the Technology and Rare Earth Metals Center] about Washington's policy on rare earths and it was "leaked" that a DC report was forthcoming that would negate the need for creating self dependence on rare earth supply and would instead cite global interdependence and the benefits of Chinese economics in supplying cost effective REEs. [10]
After some teeth-gnashing came the dark conclusion:
What's the answer? One conclusion at the TREM event was that no conclusion would occur until after the Presidential election. So we challenge the Presidential candidates to add this relevant issue to their platform for debate. It is safe to say that in America's toxically partisan political atmosphere the worst venue for resolving any issue in a constructive manner is the Presidential campaign.
Events in Asia will probably outrun anger and opportunism in Washington and anxiety in Tokyo.

The money statistic in the August 2012 NY Times report cited above was the estimate by Constantine E Karayannopoulos, the CEO of Neo Material Technologies that by "the beginning of next year", ie now, China will represent 70% of global consumption.

Neo Material Technologies (NMT) is the company that was purchased by Molycorp, the company that operates Mountain Pass and will supply Hitachi Metals' US operation. NMT is also one of the largest processors of rare earths in China. Since the environmental and regulatory difficulties involved in processing rare earth oxides into metals in the US appear insuperable, it looks like NMT's China operations will be processing the Mountain Pass material and shipping it to Hitachi's plant in North Carolina.

Recently, Karaynnopoulos addressed advocates of a vertically-integrated, policy-driven American rare earths solution in an e-mail comment to RareMetalBlog and pointed out that global corporations crave global supply chain solutions, not nationalistic approaches to resource control that ignore economic realities. He wrote:
One of the things you and the rest of the commentators miss is the fact that the majority of the products we sell in China are shipped to Japanese, US and European manufacturers' plants in China. Any global RE producer would need to supply these global manufacturers everywhere they have a need for REs, including China. Otherwise, it would be extremely difficult, if not impossible, in my view for any RE producer to develop the critical mass and the necessary skill set to be a truly global RE player. [11]
In March of 2011, Molycorp predicted that China could likely become a net importer of rare earths by 2015 - including, one can safely assume, of Molycorp's rare earths - which will render the WTO export quota and duty issue moot. [12] If this happens, it would be an ironic twist on Deng Xiaoping's statement that China has rare earths "like the Middle East has oil," with the implication that China should husband and exploit its resource accordingly.

Instead, in an import scenario, China and Japan will be competing for the same rare earth resources…and the West will have the potential to squeeze China on the supply of another raw material.

And Obama, if he wins another term, can consider turning his attention to the most flagrant abuser of export quotas, one that distorts the international market for the most important resource on the planet, but a group that the United States has never mustered the will to confront: OPEC.

Notes: 1.
Appellate Body issues reports on raw materials disputes, WTO, Jan 30, 2012. 2. Lynas's Nick Curtis Builds Fortune With Bet on Rare Earths, Bloomberg, Mar 8, 2012. 3. The Money Man Behind America's Rare Earth Minerals, Forbes, Oct 18, 2010. 4. A Timeline For Eroding China's Rare Earth Chokehold, Wall Street Journal, Aug 17, 2011.
Japan spins anti-China merry-go-round, Asia Times Online, Oct 29, 2010.
Japan should ask WTO to resolve China rare earth problem, Asahi, Jul 19, 2011.
Chasing Rare Earths, Foreign Companies Expand in China, New York Times, Aug 24, 2011.
Japanese rare earth consumers set up shop in China, Reuters, Aug 12, 2011.
Japan, EU, US. to hold joint workshop on rare earths next week, Mainichi Daily, Mar 21, 2012.
Catalyst for Chinese Rare Earth Supply vs. US National Security Debate, RareMetalBlog, March 15, 2012.
China, Molycorp, and the Attempt to return to 1984, RareMetalBlog, Mar 18, 2012.
China could become net rare earth importer by 2015 -Molycorp, Reuters, Mar 10, 2011.

Peter Lee writes on East and South Asian affairs and their intersection with US foreign policy.

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