The WTO Panel Report On Chinese Rare Earth Exports

by Gareth Hatch on April 3, 2014 · 20 comments

in China, Legislation, News Analysis, Rare Earths

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Introduction

On March 26, 2014, the World Trade Organization (WTO) issued its long-awaited findings in response to formal complaints made by the United States (USA), the European Union (EU) and Japan (collectively the Complainants), concerning China’s approach to the exports of rare-earth elements (REEs), tungsten (W) and molybdenum (Mo).

The 257-page document, combining the individual sets of findings for each Complainant (the Report), was completed by a three-person Panel of the WTO’s Dispute Settlement Body (DSB). It is an exhaustive evaluation of the measures that China has put in place to regulate the export of these materials, and follows a two-year investigation by the WTO into the complaints made.

My March 2012 article on the initiation of the WTO actions, reviewed the details of the initial complaints, and the mechanism behind the WTO dispute process, including the DSB. In it I suggested the potential arguments that China might make to defend its export measures, using certain exceptions to the WTO rules, and the potential consequences of various outcomes.

In the following article, I will review the main findings of the DSB Panel, the basis for their determinations, and the key takeaway points from the Report. We’ll also look at what China’s next moves might be, and the potential consequences for REE supply and pricing. I’ll also highlight the ongoing key advantage that the Chinese downstream REE supply chain has over other countries, even in light of the recent WTO findings.

The Complaints

Since the initial request for the formation of a DSB Panel to review the issues at hand, the specific complaints were refined. They focused specifically on measures relating to export duties, export quotas and the limitations placed on companies that are permitted to export these materials. The Complainants alleged that these measures are inconsistent with China’s obligations under its Accession Protocol – the document that codifies China’s acceptance into the WTO. They also alleged that the measures were inconsistent with the 1994 General Agreement on Tariffs and Trade (GATT) – specifically Article XI on the General Elimination of Quantitative Restrictions.

Initial claims relating to “an alleged lack of uniform, impartial, or reasonable administration of the export quotas” were dropped soon after the process began.

China responded by claiming that the country’s export-related measures were permitted, by virtue of Article XX of the 1994 GATT, related to General Exceptions. China pointed specifically to Article XX(b) relating to measures “necessary to protect human, animal or plant life or health” and Article XX(g) relating to measures for the conservation of “exhaustible natural resources“.

Process Timeline

  • The process started on March 13, 2012, when the Complainants each requested consultations with China, under WTO rules, with respect to the initial measures and claims that were detailed in my previous article;
  • Consultations were held during April 25-26, 2012. These consultations did not resolve the dispute between China and the Complainants (collectively the Parties);
  • On June 27, 2012, the Complainants each requested that a DSB Panel be established;
  • On July 23, 2012, the DSB established a single Panel to hear the cases presented by the Complainants;
  • On September 12, 2012, the Complainants requested that the Director-General determine determine the specific membership of the Panel;
  • On September 24, 2012, the Director-General appointed Mr. Nacer Benjelloun-Touimi to chair the Panel, and Mr. Hugo Cayrús
 and Mr Darlington Mwape as the additional members;
  • The Panel adopted a set of Working Procedures and a timetable on October 18, 2012;
  • The first substantive meeting of the Panel with the Parties took place during February 26-28, 2013, during which an additional session with interested third parties also took place;
  • A second substantive meetings of the Panel and the Parties was held during June 18-19, 2013;
  • The Panel sent questions to the Parties on February 13, 2013, March 1, 2013, April 11, 2013, May 30, 2013 and June 21, 2013;
  • The Panel issued the descriptive part of its Reports to the Parties on July 31, 2013;
  • The Interim Reports were issued to the Parties on October 23, 2013; and
  • The Panel issued its Final Reports to the Parties on December 13, 2013.

Summary of the Panel’s Findings

The final combined Report from the Panel went into painstaking, exhaustive detail on every aspect of each specific complaint, and China’s responses to those complaints. In summary, the DSB Panel found that:

  • Because its Accession Protocol does not form part of the permanent ‘framework’ of the 1994 GATT, China could not claim the benefit of the exceptions noted in Article XX of the 1994 GATT for the imposition of export duties or export quotas, or for imposing certain restrictions on the activities of companies that export REEs, W and Mo, which otherwise contravene the provisions of its Accession Protocol;
  • Even if Article XX was available to China as a justification for export duties, those duties were not “necessary to protect human, animal, or plant life or health“, as required under Article XX(b), and thus the imposition of export duties was “inconsistent with China’s WTO obligations”;
  • China’s export quotas “were designed to achieve industrial policy goals rather than conservation”, thus negating China’s ability to use Article XX(g) to justify the imposition of export quotas. The Panel further found that these measures did not work together with other measures imposed on domestic Chinese use of REEs, W and Mo, as also required by Article XX (g); and
  • Although Article XX did allow for “restrictions on the rights of enterprises to export” REEs and Mo, China did not demonstrate how such restrictions on the basis of Article XX(g) specifically, were justified. The Panel found that these “trading rights restrictions breach its WTO obligations“.

Analysis

Having reviewed the Panel Report in its entirety, there are three overarching themes to take away from it:

1) The negative environmental impact of mining and processing in China is undisputed
During the WTO process, China strongly asserted that the mining and production of REEs and other metals in China has caused significant harm to its environment, and to the health of people, animals and plants in the country. China presented extensive evidence on the environmental risks associated with the REE supply chain, including reference to the toxicity of mine tailings and the challenge of air and water pollution. The Report included China’s statement that:

[T]he risks to human, animal or plant life or health and the costs of controlling such risks are key reasons why rare earth production was shut down outside China. In this regard, China submits that companies outside of China that were producing, or had the capability to produce, rare earths were not ready to bear the high costs of implementing technology that would tackle environmental harm and meet national regulatory environmental requirements.

The EU and the USA did not dispute China’s assertion with respect to environmental damage; Japan indicated that it deferred to the Panel’s judgment on this particular issue.

After reviewing the evidence, the Panel stated in the Report that it considers that “China has demonstrated that the mining and production of rare earths, tungsten, and molybdenum have caused grave harm to the environment and to the life and health of humans, animals, and plants in China“.

The initial announcement of the Panel’s findings at the end of March met with significant criticism from entities within China, the implication being that the WTO had not considered the environmental impact of the REE industry in China, in its findings. On the contrary, the Panel made it crystal clear that it did in fact recognize that such harm had occurred. The Panel insisted however, that the existence of such damage “does not suffice to demonstrate that export duties are necessary to protect human, animal or plant life or health“.

2) China did not demonstrate that export duties have a material effect on environmental protection
In response to the complaints made, China insisted that its export duties on REEs, W and Mo were “an integral part of a comprehensive policy that has the goal to reduce pollution and protect the health of China’s population, its animals and plants“.

The Panel noted that it was not sufficient to simply state that the imposition of export duties was part of a wider “comprehensive policy for environmental protection” in China. In fact, the Panel found that no part of the comprehensive environmental policy that China cited, showed a link between export duties and “a pollution reduction objective“. There was no evidence to suggest that putting export duties in place would have or had had any material effect on the stated goal of pollution control. This was a similar finding to a previous WTO dispute involving China.

This assertion of a connection was always going to be a problem for China to prove, since the final destination of a resource (i.e. outside of China) really has no bearing on the way that it was produced in the first place.

3) China did not demonstrate evenhandedness with measures associated with resource management
The Panel noted that export duties increase the price of REE products that are exported for use outside China. China failed to demonstrated that there were any corresponding measures that increase the price of REE products that are intended for use inside China.

The discussion on export quotas centered on China’s insistence that it was allowed per Article XX(g) to impose such quotas on the basis of “the conservation of exhaustible natural resources“. However, this exception also requires that “such measures are made effective in conjunction with restrictions on domestic production or consumption“. The Panel acknowledged that each member of the WTO has permanent sovereignty over its natural resources, and that member countries may adopt “conservation measures should they wish to do so, in the light of their own objectives and policy goals, including economic and sustainable development“.

However, the Panel noted that:

no WTO Member has, under WTO law, the right to dictate or control the allocation or distribution of rare earth resources to achieve an economic objective. WTO Members’ right to adopt conservation programmes is not a right to control the international markets in which extracted products are bought and sold.

The Panel found that China had not demonstrated evenhandedness in its approach to domestic and foreign entities, with respect to access to REEs, and thus the imposition of export quotas was not made in conjunction with other measures that would affect the domestic supply chain. There was significant discussion on the role of production and separation quotas, but the Panel was not convinced that the impact of the measures was anything other than discriminatory against foreign entities.

What’s Next?

China has up to 60 days from the date of the Report’s publication, to decide if it will appeal against the Panel’s findings. If it does not, or if it does and the findings are upheld, then it is likely that China would be required to drop its export duties and export quotas on REEs.

The export duties on individual REE products varies from 15-25%; in addition, since the price spike of 2010-2011 there have been additional costs associated with ‘quota surcharges’ on individual REE products. In the absence of other measures, the elimination of China’s REE export measures would have the effect of reducing the export prices for REEs to those currently enjoyed in China, for use in China.

While this is great news for end users of REEs, it is not particularly good news for the operators of existing REE mines outside of China, or the developers of new REE projects. Many developers have for some time been using erroneous price assumptions when reviewing the economics of their projects, since they have assumed that they could sell intermediate concentrates into China, at discounts to FOB / export prices. The reality is that such sales would have to be competitive to internally sourced concentrates, and so the correct approach is to discount in relation to domestic, not FOB / export prices. If the prices converge as a result of the elimination of export controls, then the ambiguity goes away, and we are left with similar prices regardless of the destination of the products.

That said, there have already been discussions within the industry in China, concerning the imposition of across-the-board resource taxes on REE products, which would elevate the prices above the current domestic levels, presumably to some point below current FOB prices. If China is genuinely concerned about controlling the environmental impact of REE production, and in protecting its resources from exhaustion, then the imposition of such taxes, as well as a reduction in the overall production quotas, and the imposition of pollution taxes, could be effective measures – measures which do not discriminate against foreign entities, thus conforming with the WTO rules.

It should be noted that regardless of the outcome of the WTO dispute, downstream users of REE products in China, that incorporate these materials into components and other goods that are then exported from China, will still have a distinct advantage over downstream users outside of China. Apart from labor costs, exports of finished goods are eligible for a rebate on the 16% VAT paid on the original raw REE materials, a rebate that has not been given on exported raw materials since 2007.

We will keep an eye on the appeals process for this WTO case, and will of course share what we discover, when we have more to report.

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1 Alan Levy April 3, 2014 at 6:02 pm

Gareth, this is a really super piece of work. The metals’ community is indebted to you for collating this information.

I understand that the LnO piece of the WTO case has been the main driver, but since the case also involved W and Mo, I was wondering if you could comment on these elements as well.

2 Gareth Hatch April 3, 2014 at 6:19 pm

@Alan Levy: thanks for the comments. With respect to W and Mo, where each of these elements was subject to restrictions, the Panel came to the same conclusions.

3 David Edmonds April 3, 2014 at 7:39 pm

Gareth, we appreciate the clarity and thoroughness of your analysis.
As a modest investor in the development of the Australian rare earths industry for the last “interesting” 8 years, such analysis is very helpful.

4 Sara April 3, 2014 at 8:04 pm

Really great, thanks so much. Appreciate the link to the whole findings document, too.

5 Matt S April 3, 2014 at 9:34 pm

Thanks for this Gareth.

6 Ron R April 3, 2014 at 10:56 pm

Sara –start at the first link in the original article and click on Panel Reports. After reading a few dozen or so pages, you will realize how well Gareth summarized the original documents. And yes, I always appreciate the original links.

7 gb April 4, 2014 at 1:07 am

If you’re reporting on the WTO thing, it doesn’t take 15 lines as the summary.
Please do not succumb to the US ethic of “more lines, more credible”.

8 Gareth Hatch April 4, 2014 at 1:11 am

@David Edmonds, Sara, Matt S and Ron R – thank you for your comments.

@gb – if it’s over simplistic, facile sound bites that you’re after, there are plenty of other places online that you can get your information ;-)

9 Stephen Maguire April 4, 2014 at 8:18 am

Great Job Garret. I learn from your in-depth analysis. I don’t want sound bites. I like detail. Keep it up please.

10 MANAMOHAN PURANDHAR April 4, 2014 at 10:47 am

Dear Mr Gareth Hatch.
Noted the informative Panel Report.
Keep us informed on the reaction or its appeal against the Panel’s findings.
Good work
with warm regards

M.Purandhar

11 DJ Christian April 4, 2014 at 2:35 pm

Excellent report ! Very informative.

12 Gennady April 4, 2014 at 3:15 pm

Dear Mr Gareth Hatch.
I can start searching for yttrium, cerium, and others.$299000 a year.
Example : 220000sq km, 1 (32) samples, (max/min):
Cu (791), Y(512), Pb (255), Zn (274), Mn (258), Fe (211), Ti (125), Ce (120), Ni (161), Mo (116), Ba (131), Na (110), Al (107), Sr (83),Li (67), Au (47), Co (49), Ca (50), As (30), Mg (48), V (30), Cr (53),
P (30), Rb (33), Zr (37), Ga (32), Sb (18), Th (14), Ag (18), La (11), Cs (48), Nb (9), K (90), Cd (10),
Hf (4.6), Sn (4), U(3), Bi (2.5), Sc (33), Tl (1), Be (1), B (2), Hg (3), Te (1),
(W-S-Se-Ge-Ta-In-Re-Pd- Pt)-?
Highlighted elements deposits and occurrences are already known.
Analysis revealed Mineral deposit: Gibraltar(Cu, Mo), Highland Valley (Cu, Mo), Endako (Mo), Mount Polley (Cu, Au, Ag),
Bralorne MINE- Au(130?/18?/?): +(Fe, S, As, Hg, Cu, Pb, Zn,Ag,W), 4 placer (Au, Pt )- Fraser River, Thompson, Cariboo, Omineca.
Recommendation: The search for new deposits Cu,Y,Pb,Zn,Mn,Fe,Ti,Ce

13 Sara April 4, 2014 at 9:06 pm

Thanks, Ron R. I was told it might be difficult to find the original document, complex organizations and all, so it was a terrific help to have it hand delivered by Garth! I will be diving into the doc soon.

14 Mike Holt April 4, 2014 at 11:09 pm

Thanks Gareth. This is an excellent summary of the WTO’s findings and their underlying rationale, as well as a well balanced analysis of the implications for:

– rare earths mining companies inside and outside of China;

– producers of rare-earths-based components in downstream industries inside and outside of China; and

– Chinese and non-Chinese end users of products containing rare-earths-based components.

Next, it would be interesting to learn what, if any, actions are being taken to develop downstream industries outside China capable of producing rare-earths based components critical to many high tech applications, and whether any end users manufacturing products reliant upon rare earths will acquire upstream businesses in order to ensure access to the rare earths based components required for their products to remain competitive in the global marketplace.

Even though the market for rare earths is relatively small, and competition from Chinese producers of rare earths and rare-earths-based components will further limit the potential size of profits that can be generated from sales of rare earths and generic rare-earths-based components, the profit margins on end products benefitting from the unique qualities imparted by rare earths can be very significant. As such, this would seem to create an incentive for manufacturers of higher-margin end products to take steps to ensure access to these critical components even if the relatively small cost of those components was modestly higher relative to their costs if they were purchased from less reliable sources.

For example, paying $0.15 rather than $0.10 for a component that will result in much higher sales volumes of products generating profits of well over $100.00 per unit should be recognized as a sound investment, even if China does decide to abide by WTO rulings, for now.

15 Dr Allan Branch April 5, 2014 at 1:34 am

Well done Gareth, Allan.

16 Simon Schillebeeckx April 5, 2014 at 4:52 am

Dear Gareth,

Thanks a lot for your article, very interesting. I’d be interested in your views on the blogpost I wrote following reading your account.
You can find it here:
http://imperial-business-blog.com/2014/04/05/after-the-wto-ruling-can-china-appeal-successfully/

17 Marcello Eusani April 6, 2014 at 8:51 am

“China should strengthen the end applications of the rare earth industry, focusing on developing key technologies that can create higher added value to reverse the current trend of just selling rare earth materials abroad for a cheap price, experts said.”

18 Gareth Hatch April 6, 2014 at 6:45 pm

Thanks folks, for your comments.

@MANAMOHAN PURANDHAR – will post more as soon as we hear the outcome of the expected appeal.

@Gennady – given that there 55+ projects which have defined mineral resources, I’m not sure that finding new deposits of REEs is the problem…

@Mike Holt: tying into my last comment – I completely agree that the issue for the REE sector outside of China is the downstream value-add portion that also predominately exists in China. The good thing is that unlike the REE deposits themselves, we can move that part of the supply chain fairly easily….

@Simon Schillebeeckx – interesting piece that you wrote. I don’t think that REE prices are so meticulously set I’m in the way that you describe (social marginal cost / marginal cost etc). It is also likely (though not definite) that any appeal will be on the basis of the facts previously presented, and since China did not, to my knowledge, mention Article XXXVII in its responses to the WTO Panel, it’s unlikely that it’ll come up now. BUT – you never know, and it’s certainly an interesting avenue.

19 Dan April 7, 2014 at 1:52 pm

Gareth, Thanks for bringing light to the issue. I am particularly interested in the Tungsten aspect of this. The decades long Chinese lockdown on Tungsten has caused a considerable price escalation and any news of a policy change will create a significant correction in all things Tungsten. I also welcome any news on policy changes.

20 KenB May 22, 2014 at 10:46 pm

Any appeal will be decided on the proper application of the law. If there was no legal fault in the judgement and the decision the decision will stand. It is rare to have a WTO decision over turned. The next decision will be up to China when their appeal is denied.

If they then decide to flood the market with LRE it will all but eliminate the nascent industry outside of China. If they choose to ignore the ruling what risk do they run in the world economic community when they (like the Arabs during the oil crisis) have us over a barrel.

The value added piece is critical, the raw and processed material is incidental. The intermediate products like magnets, optics, etc. and developing larger assemblies is where the money is and China controls most of that as well.

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