Zig Lambo, The Critical Metals Report
Washington misses the point about rare earth element supply, says Jeffery Green, founder of J.A. Green & Co. With the Departments of Energy, United States Trade Representative and Department of Defense each approaching China’s near monopoly from different angles and Congress more divided than ever, it takes an expert like Green to illuminate the structure of this complex global market. In this exclusive interview with The Critical Metals Report, Green explains the fragmented policy developments in this space and pending WTO action, arguing that the U.S. needs to develop a domestic supply chain in order to remain competitive.
The Critical Metals Report: From your perspective as a Washington, D.C. consultant, does U.S. leadership consider China’s rare earth elements (REEs) quotas a threat to U.S. industry and security?
Jeffery Green: China continues to control 94% of world rare earth oxide production. Nearly all commercial metal production and the vast majority of permanent rare earth magnet production comes from China. Estimates today suggest that about 70% of REE consumption goes to European, U.S. and Japanese companies with operations and facilities in China.
Most of Washington misses the point that the U.S. does not have its own rare earth industry per se. The U.S. imports components and end products containing rare earths rather than the metals themselves in most industries. That produces misleading conclusions, like, “the U.S. can meet its own rare earth demand.” The reality is that U.S. demand appears low only because we’re importing the products that already contain them. We can meet our demand for the direct sales of some rare earths, like lanthanum and cerium, but we certainly can’t meet them for things like phosphors, metals and other magnets.
This has a big impact on industry and security. Rare earths consumers continue to migrate to China to obtain access to those raw material supplies. The U.S.’ inability to produce the end items containing these rare earths is really a pressing supply chain security issue, particularly when you consider the numerous defense applications for the materials.
TCMR: Is Washington largely unconcerned with the situation? There doesn’t appear to be any organized policy that addresses this situation.
JG: There are pockets of effort on the rare earth issue in Washington. I testified before the U.S.-China Commission in January that there is no single definition of strategic and critical materials. That leads to part of the problem: People are working in what we call, “stovepipes of activity.” The U.S. Trade Representative is working on a trade case that primarily focuses on consumers of the material rather than the producers. The U.S. Department of Energy is coming at it from the perspective of energy industry applications, so it’s very focused on research and development, recycling and substitution. The Defense Department, meanwhile, says, “We don’t use much of this material, therefore, we’re not that concerned about it. We think we can meet our own demand in an emergency.” So there’s no comprehensive policy.
Normally, it would be Congress’ role to set a comprehensive policy, but unfortunately, it’s a particularly difficult time for Congress to work together on any policy. Senator Lisa Murkowski has a bill that proposes to set a comprehensive policy on strategic and critical materials and advance the issue holistically. Unfortunately, the current political divide in Congress makes it very unlikely that the bill will move forward, simply because it mentions the word “permitting.” Although there’s no talk about significant permitting reform—merely establishing a working group to discuss the bottlenecks—permitting is a toxic issue right now that Congress doesn’t want to touch.
TCMR: What approach do you take to this issue when working with policymakers?
JG: When I speak to Congress, I try to start at the most upstream point of the supply chain and work back. I start with exploration companies trying to identify economically exploitable deposits that would support the establishment of a mine. At the mining level, these materials are then extracted and processed into saleable rare earth concentrates that would be further separated into oxides. Moving downstream, these go into metal production, alloy production and into the magnet market. That breaks up the rare earth supply chain into distinct phases. Most folks in Washington don’t realize that there are about four or five distinct industries at work in this space.
TCMR: It almost seems that we need the equivalent of a “rare earths czar” to oversee this issue.
JG: A large segment of the bureaucratic population in Washington believes that the free market will sort this supply chain out. They fail to look deeper at what that supply chain looks like. Even with new sources coming online, I don’t think Washington realizes that significant portions of that supply chain will still be relying on China for key processing technologies and intellectual property. Washington needs to realize that all roads lead to China.
It takes some kind of crisis to actually advance the issue in Washington. We saw a little bit of that back in 2010, the de facto embargo really brought this issue to the front pages. Since then, it’s settled down because, on the surface, it appears that a U.S. rare earth mine is coming online. The seeming urgency in this area has diminished to the point where many folks don’t feel that anything needs to be done.
TCMR: What will it take to get Congress to act on this issue?
JG: Unfortunately, this is an industry that is virtually nonexistent in the U.S. We don’t produce the metals, alloys or magnets in any great quantity. The constituency, which is the users of the products that contain rare earths, has largely been heard. A World Trade Organization (WTO) case has gone forward, and that group has a big constituency comprised of the companies that have to import rare earth products and that don’t like a two-tier pricing structure, not to mention the unreliability of the current supply chain. Its interests are being addressed by the WTO action, which seeks to establish a reliable supply of these materials.
What I think the government misses with the WTO case is that even if you theoretically win, there would still be no greater supply of materials. If China becomes a net importer by 2015, as predicted, there could still be no materials available for export.
TCMR: How large is the global market and production of these materials?
JG: Production in 2010 was estimated at about 120 thousand tons (Kt) rare earth oxide equivalent. That’s relevant because the estimated 2010 demand was around 160 Kt. Most folks in the industry believe that that 40 Kt supply chain gap will be closed by around 2013 with new sources of supply. That’s not really an apples-to-apples comparison because the new supply doesn’t directly correlate to unmet demand. The supply of materials like cerium and lanthanum may then be in excess, while heavy rare earth oxides like dysprosium and yttrium will be underrepresented. So overall production matching total demand in terms of tonnage alone doesn’t mean that supply and demand are equal for each of the 17 rare earths. The U.S. is estimated to increase capacity, not necessarily production, at approximately 40 Kt/year by 2012. Australia is slated to come online with 11 Kt in 2012, growing to 22 Kt in 2013.
TCMR: Considering China’s near monopoly on much of the supply and its future demand expectations, what are the implications for the rest of the industrial world?
JG: This is a big concern. First, the processors of metal will move to China to obtain the rare earth oxides required for production. Then alloy makers relocate to get the metal. Then magnet makers move to get the alloy. Over the last year or so, first-line processors or users of rare earth materials have moved production to build their components in China, where they have better access to those magnets. Eventually, assembly makers will move to get the components containing rare earths and, ultimately, end-product users will be forced to relocate to obtain access to these raw materials. The lighting industry exemplifies this trajectory; the vast majority of its production already takes place in China. Were this to unfold in the REE space, the U.S. and the rest of the world will lose economically. For the defense sector, where the stakes are much higher, this is an even greater concern. One of the other big concerns about this migration is the very real risk of intellectual property leakage.
TCMR: One could argue that this is the natural way business operates—the auto industry, for example, got concentrated in Detroit and the semiconductor industry in Silicon Valley. Isn’t it just a normal progression of events in any sort of a semi-capitalistic system?
JG: I think folks in Congress look at it from two perspectives. What’s happening may very well be normal market activity. If you have a free market and a level playing field, so be it. The concern in Washington is that the market in China has been manipulated to force the choice of China. I get very frustrated with policymakers who say we should accept a free-market solution. On the defense side, allowing that mentality to pervade government thinking is dangerous when the free market has picked a source of supply that has deliberately interrupted the flow of vital defense technologies in recent history.
TCMR: Where is this WTO case is at this point, and how do you see it unfolding?
JG: It’s still in the request-for-consultation stage, which could go on another few weeks or so. After that, the U.S., the EU and Japan will need to decide whether to bring a case forward, which is likely, based on a successful precedent in the previous raw materials case. It’s unlikely but possible that China would unexpectedly agree to change its current policies. What concerns me is that it is so focused on the consumer side of the equation. A successful WTO case might force China to drop its two-tier pricing system. But with China moving to an expected net-importer status by 2015, there may not be excess material available on the market to buy.
Even if the case is successful, China could reduce production, which it has already been doing, leaving less material available for export. It could restructure its export quota system to allow for the free trade of the more prevalent light rare earths, the ones set to be produced in California, but could restrict exports of the more scarce heavy rare earths. That could flood the market with materials that would make U.S. products less competitive and restrict the availability of materials that are critical for defense technologies.
China could also simply refuse to comply with the ruling. After all, there is no WTO police to enforce a strictly voluntary system. I think what’s missing in Washington is an appreciation that the WTO case is only one piece of the puzzle. The executive branch has done a lot of work on pressing the trade side of things. What it hasn’t focused on is ways to incentivize our own domestic production of the materials. Until that’s done, I believe we’ll remain critically vulnerable to supply disruptions that could impact our economic and national security.
TCMR: Can you further explain this two-tier pricing structure?
JG: It’s basically the inside vs. outside China price. The last estimate I heard was about a 25% differential on some materials. If you move to China, you are not only guaranteed access to the materials outside of its export quota system, but you will also benefit by paying the inside-China price.
TCMR: How does the WTO case seek to resolve this problem?
JG: It looks to eliminate that two-tier pricing structure, saying that it and the export quota system is outside of the General Agreement on Tariffs and Trade. China is relying on arguments that were previously unsuccessful—saying it’s doing this for preservation of its scarce natural resources. Many trade attorneys and trade folks in Washington look at this issue and say it seems to be exactly the same scenario as the earlier case and this should be a slam dunk in the WTO. I think China will have to counter that with some different strategies.
TCMR: Did the Chinese comply on the previous WTO case?
JG: We’re at the end of the appeal process on that one right now. We’re not at the enforcement or the compliance stage at this point. So that remains to be seen.
TCMR: What about prospects for domestic U.S. production? Molycorp Inc.’s (MCP:NYSE) Mountain Pass mine in California is the only current U.S. producer of rare earths. What’s going on with that project?
JG: I personally have a lot of unanswered questions about that project. Last month Molycorp. announced the acquisition of Neo Material Technologies (NEM:TSX) and one of its divisions, Magnequench, a Canadian-based company with processing plants in China. Part of Molycorp’s supply chain now is inherently tied to some of the intellectual property and production facilities in China. It would be very interesting to know just how much of its phase 2 Mountain Pass production will be exported to China. I think it indicated that 7–12% of its production capacity is going to be exported, but I don’t think it has stated what percentage of its actual production it will export. The less of the capacity it uses, the higher percentage of the material it will actually export out of the U.S.
There’s also the question about its ability to import material into China and get it back for use in the U.S. or allied countries. China changes its export quotas yearly, so it would be very interesting to know if Molycorp has any long-term assurances from China on the ability to get those U.S. natural resources back after this year’s export quotas expire.
Lastly, there is a lot of talk about Molycorp’s magnet production plans in cooperation with Daito Steel (private) and Mitsubishi Corporation (MSBSHY:OTCPK) in Japan. It was recently asked how its new magnet facility would produce materials with technology different from Hitachi Metals Ltd.’s (5468:TKY; HMTLF:OTCPK) patented technology, what the patent numbers are and how they differ significantly from Hitachi’s neodymium-iron-boron magnets. Hitachi owns all the intellectual property on these neodymium-iron-boron magnets and has not licensed any additional producers in several years. This is a material that we can’t produce in the U.S. today and Molycorp is trying to find a work-around.
So there are a lot of questions about how this project will unfold and what it will bring to the market in the next few years at each step of the supply chain.
TCMR: You aren’t directly involved in the investment business, but from your perspective, what sort of prospects do you see for smaller potential producers of rare earths here in North America?
JG: There is certainly no shortage in companies interested in producing rare earths. At last count, there were more than 400 publicly traded or publicly stated rare earth companies. Clearly, there isn’t room in the market for anywhere near that number of producers. One of the perverse effects of a successful WTO trade case is that it actually could be a disincentive to production. The reason that we see 400 companies trying to get into the rare earth space is that the prices have appreciated to the level where many of these deposits are now economically viable. A WTO case that drives material pricing back down would probably make many of these projects uneconomic.
In the U.S., there are companies interested in all segments of the supply chain, from exploration to novel separation technologies, to producers of metal, alloy and magnets. Because the U.S. doesn’t use a whole lot of this material, there’s no really stable demand for rare earths. Until demand for rare earth magnets, metals and alloys returns to companies that actually buy that material in the U.S., rather than as a component containing rare earths, it’s going to be a very slow process to bring this industry back. To successfully reestablish a rare earth industry, we have to capture each stage of the supply chain, working back incrementally.
I’m optimistic that the U.S. government will eventually see the need for a secure domestic or allied-nation supply chain that severs our complete dependence on China, but that may take another trigger event like the 2010 embargo. It could be in the form of retaliation over the WTO case or something that no one foresees. Whatever it is, the U.S. government will finally realize that the current dependence on China is ultimately unsustainable.
TCMR: No matter what happens, it’s a multiyear process at best.
JG: Yes. I don’t think this will be resolved any time in the near future. We could have a bit of a wild ride ahead of us until companies are online outside of China and producing at each step of the supply chain.
TCMR: It will be interesting to see how this all plays out. Thanks for speaking with us today.
JG: Thank you.