by Leo Lewis – The Times – Published: August 27, 2010

The world will belong to the countries who control the resources, such as rare earth metals, which power the 21st century.

In the magnificent banqueting room of Seoul’s presidential Blue House, Evo Morales suspended his rabid socialism last night to enjoy South Korean capitalist hospitality at its most bountiful.

In the Bolivian President’s briefcase were two documents: a wildly generous memorandum of understanding from one of Asia’s foremost powers and an honorary doctorate from one of its best universities. Not a bad day’s work for a former llama shepherd who never finished school.

For 45 years, South Korea has ignored dirt-poor Bolivia, and certainly not entertained its leader at lavish expense. Mr Morales’s nation, however, has lots of lithium – and Seoul wants Samsung, Hyundai, LG and its other industrial giants to remain in business.

Not an ounce of the stuff has yet left Bolivia’s Salar de Uyuni, but the great salt lake holds enough lithium, according to some projections, to give whoever gains access to it future dominion over batteries for electric cars, laptops and mobile phones.

Mr Morales has also spotted sooner than most that the world has fundamentally changed: resource geopolitics has lurched far beyond oil. The impending clashes will concern almost-unknown minerals and the world’s consumer nations are realising this with some alarm. A series of recent reports warn that industries may no longer be viable even at the national level, forcing abrupt re-evaluations.

Countries like Japan, South Korea, Germany and other technology powerhouses may struggle to retain their positions. “We are at economic war,” Jack Lifton, an authority on rare minerals, told The Times.

“The world where you could get everything for a price is history. And the West has been sound asleep on this. The level of ignorance about the upstream of mineral supply … is just out of this world.”

Even in Asia, where growth is more visibly dependent on the minerals, the sense of dismay is recent. The South Korean government declared last week that it would draw cash from the national pension and sovereign funds to secure rare metals. It was coupled with a proposal that future aid should be focused on countries with rare metals.

The courting of Mr Morales is not an isolated incident: China, Japan, Russia and France have all tried similar ruses to win his heart. This is, however, just the start. Other land grabs in the “New Great Game”, warned a recent EU report, could erupt over the molybdenum used for cardiograms, cobalt for mobile phones, palladium for desalination plants, fluorspar, which is essential to chemical production, or the magnesium oxide vital to every oil refinery, cement factory and steel mill on Earth.

The EU lists 14 raw materials as “critical”.

The US Department of Defence will next month publish a report on how much its military relies on materials that, currently, can only be obtained from China.

In May, Britain’s Department for Transport and Department for Business received a report on rare earth resources which said it was likely that China would, by 2015, ban all exports of the metals – substances that underpin the digital revolution and without which most “green” technology cannot function.

Gal Luft, a director of the Washington-based Institute for the Analysis of Global Security, pointed to China’s 95 per cent control of global production of rare earth metals, predicting that foreign policies around the world would be shaped by the need for dysprosium, cobalt and platinum in the same way that oil defined geopolitics in the 20th century.

China’s ever-tightening restrictions on rare earth exports quotas will be slashed by 72 per cent by the end of this year – reflect a pattern that may soon be seen in other commodities. “When it comes to resources, there is no free market,” Mr Luft said. “The lesson for governments that want to stay in business is that you can’t source things you want from one place.”

Jaakko Kooroshy, a policy analyst at The Hague Centre for Strategic Studies, told The Times that the situation had exposed spectacular complacency among Western governments. “The West has woken up late to the idea that these metals have a strategic importance. In the supposed boom of the 1990s … mining was a non-issue and everyone wanted to diversify away from something seen as dirty and old. Suddenly it matters again.”

The mineral issues do not end with technology, with attention focused also on fundamental minerals. Control of world potash supply for crop fertiliser may become increasingly tormented by trade restrictions and politicised resource control.

Academics in the US and Australia have warned that phosphorus, the other mineral behind the 1960s “green revolution” in food, may be approaching physical limits, ushering in “the gravest natural resource shortage you’ve never heard of”.

Just as this resource vulnerability has not been lost on President Lee of South Korea, Japan’s leadership is at least unified on the need for panic. Supplies of lithium, tantalum, germanium, indium and the 17 rare earth metals are fundamental to things that Japan does best – consumer electronics, hybrid vehicles and precision technology.

The dominance of China in the supply of many of these has become a source of concern. Katsuya Okada, the Japanese Foreign Minister, has spent this year in a typhoon of trips. London, Paris, Berlin and even Beijing have not featured – instead it is South Africa, Vietnam, Tanzania, Mongolia, Kazakhstan and Australia that have featured.

The country is urgently talking to mineral-producing heads of state – before China and South Korea get their feet in the door.

“Until recently, the government took the attitude that this was something best left to market forces … but the world has changed dramatically and the Government cannot just sit back any more,” Mr Okada said.

‘Pricing at the margin’ is a phrase heard in the marketplace to indicate that a recorded price is not representative of the totality of transactions for that commodity, but instead was the result of perhaps as little as one transaction occurring at the margin (the edge) of the range of transactions. Pricing at the margin is not representative of market pricing.

Recent actions by Chinese governmental regulators, have caused some confusion in the rare earths market with regard to pricing, production, and inventory levels.

First, the Chinese government reduced the allocation of Chinese rare earth production in the form of individual rare earth raw materials for the export market for the rest of the year. There was no differentiation among the individual rare earths covered by this allocation reduction, so immediately the 28 officially licensed Chinese trading companies with ‘allocations’ moved to export only the highest priced of the rare earths, such as terbium, dysprosium, and europium that they had in stock, so as to maximize their transactional revenue.

These actions, of course, reduced the normal outflow of the more common rare earths such as cerium, lanthanum, neodymium and praseodymium.

After just a few transactions occurred at the margin of the market and a whispering campaign was started about China ‘cutting off exports’, the prices for all rare earths rose. Those familiar with Economics 101 concepts such as supply and demand, knew that a price increase of 500% for the most common of the rare earth metals, cerium, which is in oversupply now as it has been for decades, was an aberration caused by some glass polisher caught short of inventory at a critical moment.

In the same way the sharp increase noted in a few transactions for the most important of the rare earth metals, neodymium, was also an aberration probably caused by a panicked Japanese magnet producer or his trading company procurement department.

Chinese businessmen in Beijing during this period of price rises, said to me that non-Chinese buyers had not seemed to notice that there were no export reductions on rare earths contained in finished goods or components. Of course, when I relayed this to some junior mining executives, they responded that this also was a part of a larger ‘conspiracy’ to drive manufacturing jobs to China. In the West at least, when I was a corporate executive we called this a business model, not a conspiracy, as we demanded tariffs (import restrictions) against our foreign competitors along with anti-dumping legislation and lawsuits.

I was also told that non-Chinese alarmists also did not seem to have noticed that the previous quotas had not even been used up, so that there was in fact material available. I think the alarmists knew this all along.

In any case, I think that investors should be very wary of junior miners that immediately repriced their business models using the ‘new higher rare earth prices.’ First of all, those prices were not at all meant to pertain to the low valued, undifferentiated concentrates that junior miners’ pricing models  seem to think have the same value as 99.9% individual metals. Second of all, the prices will come down as soon as pricing at the margin is subsumed into realistic multi-transactional market pricing.

This is a very brief summary of the my analysis of recent Chinese domestic activity intended to consolidate the Chinese rare earth metals production industry. This consolidation is a prelude, I believe, to the restructuring of the entire global metals production industry, so as to insure for China its security of supply of all metals for its domestic economy.

As I have said before, this marks the end of both Western-owned or -operated metals production hegemony, and of Western metals supply hegemony.

China has taken recent action to consolidate production of all of its domestic metallic and mineral natural resources, under the aegis of its largest producers of base metals, with each one of the three chosen allocated a geographic and political, not a geological, region. In analyzing this, I noticed a pattern that, in of itself, explains these actions as a process to ensure Chinese security of supply of its domestic demand for metals in general and of the technology metals in particular, at least as far as China’s domestically produced natural resources are concerned.

The successful failure of the Western business model, to provide long term security of supply of technology metals for the American industrial manufacturing economy, at any level, seems imminent. I mean that America has been successful through the operation of market capitalism in securing supplies of critically needed technology metals for the mass manufacturing of technology-based consumer products, at the lowest cost for the American domestic market. But the very movements required to accomplish this short term goal, have now resulted in both the production of the technology metals and the mass production of the products critically dependent upon them, moving out of the United States and into a region where the domestic consumer economy is growing so rapidly, that it has become economically impossible to return to the status quo ever again.

America, in order to achieve the lowest prices for consumer goods, has simply been priced out of both the natural resources production and supply economy, and the consumer products production economy, of the Southeast Asian market. It seems to me to be only a matter of time, before the American consumer products market is subjected to pricing pressures that will end its built-in obsolescence (otherwise known as waste) model once and for all.

For Southeast Asian manufacturers to give priority to export markets in the future, it will be necessary for those markets to be much larger revenue generators than they are today. Thus rising prices for imported goods in, for example, the USA, will now be the norm. This includes the components for green technologies. Such components can no longer be made in the USA without imported technology metals, and those imports are becoming increasingly harder to acquire, as China gathers to itself the ownership and control of the majority of the world’s natural resources, of not only technology metals but of all metals.

For China, this means the ascendancy of its version of capitalism in one country, as the foundation for its growth into the world’s pre-eminent industrial manufacturing economy by, at the latest, another generation.

China’s cornering of the supply chain for those technology metals known as the rare earths over the last 25 years, has been, in my opinion, an introduction to the world metals production and demand economy of 2035.

By that year, at the very latest, global corporations, most likely Chinese-owned and -operated, will be focused on producing the useful forms of those metals in the specific places where they can be used most economically. China’s long term planners intend that place to be the manufacturing centers of the PRC. That is the explanation for all of their planning in the short term.

The television commentator and former Jesuit, John McLaughlin, used to make me laugh when he would tell a panelist of an opposing political view: “Once again you’ve stumbled upon the truth, even though you don’t know how you got there.”

The New York Times recently reported the facts of a story entitled, “China to Invest Billions in Electric and Hybrid Cars,” but failed to stumble upon the truth. So let me do that for the Times and for your benefit, dear readers:

China, as part of its national plan, a goal centrally set by those in overall charge of its economy, announced yesterday that its motor vehicle industry will be required to build one million electric and hybrid motor vehicles in the next few years. I believe that this means that the industry will be required to reach a production rate of one million electrifed motor vehicles, the size of passenger cars, per year.

This is part of an overall plan to marshal and deploy China’s natural resources and its resources of intellectual property for the benefit of its own people, first. How much more logical can it get than that as a reason to conserve precious natural resources such as the rare earths?

The New York Times points out in the above story:

“The announcement, analysts say, is another example of how China seeks to marshal resources and tackle industries and new markets. The plan also underlines what China describes as its growing commitment to combating pollution and reducing carbon emissions.”

When I was in Beijing in the first week of August, three weeks ago, one of the other (I was a speaker at the plenary session) speakers at the Chinese Society for Rare Earths 6th Annual Rare Earths’ Summit, stated that a goal of the next two five-year plans, to be completed in 2020, was to have 330 GW of wind-turbine-generated electricity installed by that time. The speaker pointed out that this would take 59,000 metric tonnes of neodymium, calculated as 28% of the rare earth permanent magnet alloy, neodymium-iron-boron, since each 1.5 MW wind turbine generator will require one tonne of rare earth permanent magnet alloy.

The same speaker who was from the Chinese rare earth permanent magnet manufacturing industry didn’t mention how much of the heavy rare earths would be required for the project. I will estimate that at most it would be one thousand tons of terbium and three thousand tons of dysprosium.

In any case the total requirements for these new (not replacement) uses for neodymium, would be the total production for three years at the most recently achieved high production rate of neodymium, and as much as five years of terbium and two to three years of dysprosium.

If the neodymium demand is to be met, and this means that China, AS THE SPEAKER SAID, decides to use only rare earth permanent magnets for its wind turbine electric generator program, then it would require that three years’ production of the contained neodymium, at the rate it was mined in China in 2008, among all the rare earths mines there, be reserved for Chinese domestic magnet and wind equipment manufacturers and be targeted for the Chinese domestic market!

I think that it is crystal clear, that China is not reducing the production of rare earths on a long term basis and is not reducing their export on a short term basis. It is in fact pausing to:

• physically clean up the rare earth mining sector;
• eliminate illegal mining and smuggling of this precious green resource;
• consolidate the rare earth mining industry under the largest state-owned base metal producers of iron, copper, and aluminum, to prepare to ramp up the Chinese domestic production of rare earths both to meet and to guarantee the success of its long-term green strategy.

This is called long term strategic planning for those in Washington and on Wall Street who don’t understand why the Chinese are ‘depriving us’ of this vital resource. This process is also called ‘conservation of domestic resources’, by the way.

As to electric and hybrid cars, they require neodymium, dysprosium, and terbium for the magnets in the rare earth permanent magnet electric motors – both that drive them and that power their accessories. Some or all may also use lanthanum in nickel metal hydride batteries, as all hybrids made today currently do. A. In any case, whether or not the Chinese electrified cars use NiMH batteries, they are being designed to use rare earth permanent magnet electric motors. A million such vehicles will probably require just one million kg (1,000 metric tonnes) a year. Oh, did I mention that they will need also 10-20 tonnes of terbium and up to 50 tonnes of dysprosium. All of this new demand will be added demand not replacement demand, by the way.

I have no doubt that China will remain the world’s largest producer of the rare earths indefinitely. In the near term, perhaps over the next 5-10 years, China will need to import the ‘light’ rare earths lanthanum and neodymium, to make up any shortfalls created by its proposed quantum leap in demand in the face of the temporary reduction of production, for environmental and reorganization reasons. If the non-Chinese light rare earth miners get their acts together in time so that they can produce light rare earths at a lower cost than their Chinese competitors are able to do, then both Molycorp and Lynas have a good chance of success even in the long term.

The real issue for the future of rare earth utilization and therefore of mining, is the continued growth of the use and need for the heavy rare earths, terbium and dysprosium.

These ‘heavy rare earths’ are believed by the Chinese to be in short supply domestically. China today is the world’s only producer of heavy rare earths, mostly from southern Chinese deposits known as ‘ionic clays’, although significant quantities are also produced from the Bayanobo region (even though they report in Bayanobo only in small quantities) due to the overall massive amounts of rare earths mined there. Nonetheless, China believes that its own domestic supply of the heavy rare earths has between 5 and 30 years remaining at present levels of use.

This means that the real supply opportunity in the non-Chinese rare earth mining sector, is for those deposits that have above average proportions of heavy rare earths, to be brought into production as quickly as possible.

It is a horse race among those non-Chinese juniors with commercially (i.e. economically) recoverable heavy rare earths.

They are:

Canada

1. Great Western Minerals Group
2. Avalon Rare Metals
3. Quest Rare Minerals

(Note: some of my colleagues have urged me to add other Canadian juniors to this list, such as Matamec Exploration, but I know little about that company and will reserve my judgement on them for a future time, when I have had time to study Matamec Exploration and to visit its site.)

USA

1. Ucore Rare Metals
2. Rare Element Resources (a light rare earth deposit but with significant europium only)

Republic of South Africa

1. Rareco (in conjunction with Great Western Minerals Group)
2. Frontier Rare Earths (private at this time)

The success or failure of any of the above, will depend on the quality of their deposits, the efficiency of their extractive metallurgy, the ability of the global rare earth refining industry to service them, and the growth of the Chinese, Japanese, Korean, and Indian domestic markets.

Disclosure: I own shares in Great Western Minerals Group, and I am a paid consultant in business development to Ucore Rare Metals and to Frontier Rare Earths.

It has now been reported in the Wall Street Journal that China is in the process of creating a unform governmental policy to export chemical engineering processing technologies so that the non-Chinese production of vital raw materials can be done economically by enabling foreign (to China) owned and located mining ventures to move up the supply and value chains far enough so that they can be profitable.

The Chinese rare earth processing industry, for example, is working with several foreign rare earth juniors to make their business models economical. In return the Chinese processors will get access to rare earth metals produced overseas, and hopes that once foreign local demands are satisfied there will be ample surplus material to be sold into the Chinese home market as needed.

The production of the heavy rare earths, it is hoped in China, will be enabled by chemical engineering technology exports of this type.

Apocalyptic predictions on the future of US military security and its civilian economy, if China cuts off the export of the rare earth elements (in which it currently has a production monopoly) are masking an even more important dilemma. What will happen to China, if it cannot produce or obtain sufficient rare earth elements to maintain its rate of domestic growth?

The rare earth supply ‘crisis’ can and will be solved when there is sufficient production of heavy rare earths outside of China, to resolve the impending shortage that the Chinese perceive as a serious threat to the massive growth that they have planned, primarily for their domestic green technology industry, among others.

The recent hubbub about reduced Chinese export quotas for the rare earth elements, seems to not address the point that the quotas may in fact only affect  the export of raw materials, and not the rare earth elements contained in finished or semi-finished goods. If it is just the raw materials forms (separated and purified chemical compounds) the export of which are being reduced, then it may not matter so much at all, because China has been reducing its export of ALL such raw materials since the beginning of the 21st century when it openly decided to require that Chinese raw materials not be exported unless as much value as possible had been added in China first. This was a program to create jobs in China, and to bring new technologies and manufacturers to China in search of secure supplies of raw materials. It worked and seems to have simply become state policy.

I have been saying for some time that the rare earth elements supply issue is just the tip of a rare metals supply issue, that will grow to monumental proportions in this decade if China’s domestic economy continues to grow as a consumption-driven economy. China is already far and away the all time largest producer in history of steel; it today produces some 50% of the world’s raw steel. This has resolved the issue of supplying the necessary structural metal to advance China to a world class industrial power.

Now it is the time for China to begin producing or acquiring all of the technology metals, such as the rare earths, so all of those buildings can be electrified, the roads can be filled with high tech vehicles, and the people can have cell phones, flat screen television, and personal computers.

To the one billion of us in the Americas, Europe, and Japan who already live in the Age of Technology, we must now try to add one and a third billion additional Chinese, and to do this, apparently, in just another generation. Even assuming that non-Chinese technology utilization grows at only a small rate, if at all, from where are we going to get the resources of minerals, energy, and water to more than double the production of technology metals?  The answer is that we will not be able to do it. The world will now move towards higher and higher prices for technology metals. This and the geographic and geological distribution of metals, minerals, energy, and water may well lead to a world of have and have not nations. It may well be that geology becomes destiny, and those that do not produce their domestic resources, may wind up ultimately only being financially able to be suppliers to the others. I am not talking only of African nations. I am speaking also of the United States.

Without ad hominem attacks on me or on my patriotism, tell me please how we avoid America’s economic decline without now and immediately producing and conserving our own resources, and without going out into the world to find resources to sustain our standard of living and quality of life?

Japan and Korea have already begun to do just that in order to survive as industrial nations. Have we decided not to continue as one?

The Wall Street Journal discovers the new old world of mining development and finance; and the natives of that new old world are smart, well financed, and decidedly unfriendly to competitors from the old new world.

Yesterday’s Wall Street Journal has an article buried on page A11 entitled “Chinese Firms Snap Up Mining Assets.” The article should be on the front page, but the WSJ’s editors do not seem to realize just how important this article is for predicting the future of the American industrial economy.

I have written frequently over the last several years of the growing global dominance of China in the production of metals. The WSJ has now discovered that China “already consumes one-third of the world’s copper and 40% of its base metals, and produces half of the world’s steel.” In actuality, a little research into the facts would have shown the WSJ’s reporters and fact-finding staff the following: China now produces not only (already) half of the world’s steel but also some 53% of all of the metals produced in the world. By 2012, China will produce more than 60% of the world’s steel, an amount that in 2012, is expected to exceed 700 million metric tonnes. That’s between 7 and 8 times as much steel as the USA is expected to produce in 2012!

Does anyone need to wonder why China is ‘snapping’ up mining assets around the globe?

And does anyone still think that this feverish resource acquisition, is a plot to control the prices or supplies of the world’s metals and minerals for any other reason than to feed, at the lowest cost, the gigantic and growing appetite of the Chinese domestic economy for raw materials?

As I keep pointing out, the rare earths monopoly enjoyed by China today is a direct result of the fact that China’s monumental growth in demand for raw materials to feed its domestic economy, began with those raw materials that the Chinese had in abundance. Materials such as the rare earths, iron ore, and tungsten. There is no mystery and no conspiracy to control prices; it is demand that is driving both Chinese acquisitions and its domestic growth of the production of industrial raw materials. It is the Chinese desire not to let others control the prices in China that is driving this raw material acquisition and development frenzy.

One more thing the WSJ did not notice, is that the Chinese are focusing on acquiring resources in countries that can produce more natural resources, than those countries can use internally. This avoids the problem of the Chinese creating their own competitors.

Rare earths are a perfect example of this. Chinese companies are investing in rare earth mining ventures in Australia, Canada, and Southern Africa. Not a single one of those places has a domestic supply chain for processing such ores, or for refining them for use in high tech devices, or for manufacturing those devices. The enormous cost of financing the development of a rare earth mine today makes it almost impossible for such an operation to be profitable at the ore concentrate stage – the most common stage at which a mining operation stops. Chinese investors can consolidate rare earth mines with existing Chinese ore processing and refining operations, and even with rare earth metal and alloy fabricators and end users in China. This way the mining overheads can be distributed among more comprehensive operations and the total operation can be made profitable in China.

This distributed cost is the hope of the forthcoming Molycorp IPO. The intention is to create a total mine-to-magnet supply chain with the profit coming from magnet production, not from the mining. I think that the Chinese recognize that there is a good chance that Molycorp’s plan could result in a competitor. Therefore they are concentrating on investing in countries rich in resources, but with much less population and wealth then the USA, so that there is no danger in those other countries of igniting competition to Chinese exports.

Those countries have neither the skills nor the domestic market that would encourage local investors to take the risk of creating an industry, that would only work with massive exports to China as a goal. The Chinese clearly plan to reverse several centuries of tradition by making China the 21st century’s pre-eminent industrial manufacturing center. The focus is on creating a flow of raw materials from lesser economies into China, and having the entire world as a well to soak up excess production (and thus stimulate Chinese growth.) Wasn’t that the exact system that the British Empire achieved in the nineteenth and early twentieth century? Didn’t that make Britain the richest and most powerful nation in the world for a while?

It looks like that system is working again, doesn’t it? Creating wealth beats consuming wealth without creating it every time.

In summary:

The WSJ’s reporters now know what everyone in the mining world already knows: the Chinese mining industry, in particular, and China’s natural resources sector in general, are aggressively pursuing the acquisition and development of natural resources around the world for the purpose of supplying the Chinese demand for these materials. American finance, looking only for short term gain, has completely ignored this and has, at this point, marginalized the USA as a global competitor for the resources needed by China.

The pattern I see in Chinese overseas resource development, is that China seeks resources and resource development in countries that do not and could not use all of the resources domestically. Thus China can pay for the development of the resources in ways that benefit the host country in general, such as infrastructure or the supply of goods and services not available in that country. This is a compensation scheme that is not possible in the USA, a country today with no defined purpose.

Already, the sun does not set on mining operations that feed the Chinese industrial economy.

There is a threshold of investor awareness and confidence that the rare earths have not yet passed; I don’t know if the rare earth sector will ever even achieve that threshold much less pass through it, but I do know why it hasn’t so far. There are indeed many critical uses for the rare earths and they, the rare earths as functional components, are pervasive in our technological culture. Understanding those uses  requires specialist education and/or technical skills. Explaining why, exactly, the rare earths are important to the general public, involves teaching skills far beyond that of the typical disgruntled or adventurous scientists and engineers, who have become analysts and publicists for the  financial firms servicing the high-tech sector of the stock markets.

The lithium battery sector has been better served by the educational and analyst establishment than the rare earth sector. I think this is because everyone with even a general higher education, thinks they understand at least the use of batteries. Thus the technical language of the battery sector of energy storage economics, seems to them to be at least familiar enough for them to be comfortable, that they understand it generally.

Between 2008 and 2009, the global production of lithium declined by 30%, entirely for economic reasons.  In fact, I created a definition for rare metals in 2009, in which I defined a rare metal in 2009 as one produced at a global rate of 25,000 metric tonnes per year or less. Lithium was my threshold rare metal in 2009 by this definition. In 2008 it was in fact produced at a rate of 25,000 t a year. When updating my rare metals chart earlier this year, to produce my list of the rare metals for 2009, I fully expected that lithium’s production would have increased to the point where it was no longer a rare metal by my definition. Instead, to my surprise, lithium tracked the recession. Its 2009 production was in fact 30% less than it had been in 2008; it was, in 2009, only 18,000 t for the year.

Like every other commodity metal besides gold, silver, or platinum, the production and price of lithium is dependent on the demand for the element in the global industrial marketplace and has no intrinsic value component at all. This demand in its turn is a direct function of the end use of lithium, in all of its chemical forms in mass produced devices, chemical catalysis, and pharmaceuticals. Therefore, instead of just being based on lithium metal production, a lithium ETF for a small investor is much better based on being indexed to not only actual production and demand but also to the probability of future demand and supply increases, due to technological breakthroughs. An indexed ETF that includes investments in technological breakthroughs that can drive future high demand, is the best bet for a small investor, providing that the companies indexed by the ETF are chosen for their ability to increase existing production of lithium, or to economically bring new production on line when called for, and/or for their ability to innovate uses for lithium and to commercialize those innovations profitably.

I don’t know who is choosing companies of both types, either lithium producers or present and future lithium users , for the new fund mentioned in the Wall Street Journal article noted below, but that individual or group of individuals will make all of the difference, among this new lithium ETF and any other lithium ETF that will be created now or ever. Before you invest in such a natural resource-based rare metal ETF, look carefully at its board of advisors and at its founders.

When I first encountered Euclidean geometry in junior high school 56 years ago, my understanding blossomed when the teacher ridiculed my answer to the question, ‘What is the reason that side A of the figure equals side A of the same figure? My answer was “it is obvious.” The very good teacher said “No, it is because they are congruent, and that is what is obvious, Mr. Lifton.” I realized at that moment, that nothing is obvious unless we all agree on the subject matter, the meaning of terms, and the rules of  logic.

Without further ado then, I give you the Magic World of rare metals-themed investing (drumroll, please and a cloud of non-toxic, non-irritating smoke – this type of smoke is called steam by the way; it is the visible output from nuclear reactors, for example, and is often mistaken for pollution…)

Yesterday’s Wall Street Journal had on the first page of its regular section called “Money & Investing”, a story I have been waiting for that I thought would come sooner, entitled “Lithium ETF Aims to Rev Obscure Part of the Market”.

Who benefits from an ETF based on rare metals such as lithium?

An ETF places in the hands of a group of experts, the role of advisor to small investors, on a sector that the majority of individuals find either too arcane or too technical to comprehend. There are, however, questions to ask these advisors – the answers for which are understandable by almost anyone without a specialized knowledge of the rare metal or metals (such as lithium) or its uses.

I am going to use lithium below in all of the questions and answers, but you can substitute any rare metal or metals generally ,and still need to answer the same questions:

Q: Is there today a shortage of lithium – is the current demand for it, greater than the current supply?

A: Unequivocally NO.

Q: Are there today sufficient existing producers of lithium, to meet foreseeable increases in near term demand (at least five years), by increasing output from existing proven resources?

A: Unequivocally YES.

Q: Is it possible for a new industry, such as, in the case of lithium, an automotive /transportation themed lithium battery industry, to use enough lithium to create a shortage if current production rates hold constant?

A: It is possible ,but highly unlikely until the second half of this decade at the earliest.

Q: Can current lithium battery chemistries (the principal end use) be mass produced economically enough for transportation uses, so that new producers of lithium would be required in the next decade?

A: NO and this is not due to the price of lithium, whose price in 2010 accounts for little more than 1% of the manufacturing cost of a storage battery for transportation use, in any of the chemistries being developed or tried in use.

Q: If there were to be a breakthrough in lithium battery chemistry, and in the manufacturing technology needed to mass produce it (two entirely different categories of problems and solutions), then which  manufacturing scheme for that technology, and which competent management to carry it through would be the best to invest in?

A: This is the reason that the makeup of an ETF’s board of advisors is the most critical aspect of the ETF. If such an ETF does not have people knowledgeable and experienced in real world mining, end use product development, and manufacturing management along with corporate finance, then the risk of the ETF’s failure to make proper choices is very high. This is my key objection to most of the schemes that have been proposed for rare metal themed ETFs; the advisors are all financial experts who know little or nothing of the real worlds of natural resource production, R&D management, manufacturing management, or end product marketing.

I find to my dismay that small investors think they are going to make money, while helping to fund the companies in the ETF’s index.

The purpose of an ETF is to first and foremost make money for its founders.

The function of the ETF (do not confuse purpose with function!) is to make it possible for small investors to reduce the risk inherent in betting on just one horse to win. It is a bet that if any one of them wins, you win i.e. a sure thing. The first problem is finding out if there is a race at all, and to find out which of the horses is likely to die of exhaustion, long before reaching the finish line.

The avowed function of the ETF is to allow ‘good’ companies, the ones chosen by the ETFs, to receive capital through the ETF’s purchase of their shares or of their metal. In practice this means that the ETF can participate in IPOs or private placements, or by choosing the stock for its portfolio, encourage institutional investors to buy into an IPO.

Note well that the only value a company gets from its issued shares trading in a market, is in the net worth of the company (its value) being maintained high enough to enable the company to get credit and financing for new projects as it needs them. I say this because it is not a trivial point for small investors, who somehow think that buying a share of stock in a company, after its IPO, is somehow money that goes directly to the company. I apologize to those who think, as I did, that this is an obvious error of judgment; but it is not.

For an ETF to make money for its investors, the net value of the ETF’s holdings must increase, so that new investors in the ETF will pay more for shares than those who bought them before.

The shares of the companies making up the ETF will only increase in value and maintain that value if those companies are doing well in their intended purpose. Whether or not that happens depends on the financial management, the manufacturing management, and the marketing management of the company as well as on the market fundamentals of the underlying rare metals, no matter which metals they are.

Judging the probability of the commercial success of a natural resource producer or end user, is a complex undertaking, requiring real world experience, and it is almost impossible for any single person or small group of persons to be successful at such judgment.

If you are a small investor in for the ‘action’ to make (or lose) a quick buck, who believes that the trend is your friend, and that a rising tide lifts all boats,. then invest in any rare metal ETF that comes along with a word in its name that you have heard a lot.

If you are a long term strategic investor, study the makeup of the fund’s personnel and then look at the choices they’ve made and then invest. The long term investors are the ones supporting our economy and letting it grow. That’s the trend to follow.

As reported in Part 1 of this series on “China’s Rare Earth Game Plan”, the first week of July 2010 saw an announcement from the authorities in China of a significant reduction in the total amount of rare earths that may be exported from China in the latter half of 2010.

In addition to that reduction, the authorities also announced that rare earth prices would be set and published by the central government on a monthly basis, through some form of unified pricing structure. There was also mention of a plan to eventually consolidate the numerous rare earth production companies in China, into 3-5 large conglomerates over a period of time, as well as discussion about a resource tax to funnel funds from the richer provinces to the poorer ones.

Rare Earth Pricing

It has been widely reported that the Chinese authorities plan to implement a “fully unified pricing mechanism” [per the China Daily] in order to control the price of rare earths throughout the country. This change could apparently be implemented as early as this month, ostensibly an attempt to prevent “cut-throat competition” between material producers. On closer inspection, the proposed mechanism seems to apply only to the Fujian, Guangdong, Hunan and Jiangxi provinces, and the Guangxi autonomous region, at this time.  These five jurisdictions are adjacent to one another in the southeast of China, an area whose elution-deposited / ion-absorbed clays are rich in the heavy rare earth elements. Inner Mongolia and other northern jurisdictions, which predominantly produce light rare earths, do not appear to be covered by the announcement. It would thus appear that the change is an attempt by the authorities to specifically control the prices of the more valuable heavy rare earths.

Some would argue that China is already well in control of rare earth pricing. Compared to news of the quota reductions, “I am less concerned with the Chinese openly stating that they will set pricing,” said Jon Hykawy, a clean technologies and materials analyst with Byron Capital Markets. “The fact of the matter is that world production of rare earths in 2009 was probably less than 100,000 tonnes of oxide,” he said, “but well under 10,000 tonnes of that amount came from countries other than China. With that market share, Chinese firms already control price.”

Are the Chinese looking to actively manipulate the price of rare earths? Dr. Hykawy doesn’t think so. “To assume that ‘the Chinese’, in some unified conspiracy, are working to throttle back rare earth supply and raise prices would be incorrect, in our view.” he said. “There are certainly some Chinese rare earth companies that recognize they will get the best pricing for material outside China, and would love to use their expertise to help establish operations outside China. This would allow these Chinese companies to more directly reap the benefit of worldwide demand.” said Dr. Hykawy. “We are already seeing direct evidence of a price discrepancy between the domestic Chinese and Asian market for rare earths, for example.”

Jack Lifton, my colleague and co-founder of Technology Metals Research, LLC, has also seen such price discrepancies. “As I have said before, a two-tiered pricing system – a China domestic price and a world price – has been a preferred solution in China up until now, to preserve jobs not only in the mining industry but in the value chain above it.” he said. “The problem for China is that it now actually seems to want to participate in the WTO, which doesn’t allow such a system.” Dudley Kingsnorth, Executive Director of IMCOA, agrees. ‘At the same time as the reduction in quotas, it appears that China is attempting to exercise some control over rare earth prices in some provinces in the South of China.” he said. “This could be contrary to WTO rules, which I believe to be a significant development. However, if there is adverse reaction, worldwide, the mechanism may be withdrawn or watered down to some form of guidance.”

Industry lobbyist Jeff Green, of J A Green and Company, noted that recent rumors regarding a WTO action on rare earths appear to be false. “The USTR plans to complete a materials case already underway before turning to the rare earth issue.” he said. He noted, however, that this unexpected and dramatic reduction in export quotas may result in them taking another look at the issue.

John Kaiser, editor and publisher of Kaiser Bottom-Fish Online, sees growing parallels between the rare earth industry in China, and the recent historical developments in the diamond industry. “China’s announcement that it intends to set rare earth oxide and metal prices on a monthly basis,” he said, “appears to be a step in the direction of establishing a cartel similar to the Central Selling Organization (CSO) operated by De Beers as a supply management system, before it lost control of the diamond market during the nineties. The CSO was effective,” said Mr. Kaiser, “because producers were forced to sell to a single buyer which monitored demand and sold rough diamonds to an elite group of ‘sightholders’.”

Mr Kaiser noted that there are similarities between the “value-add” segments of the supply chains of both the rare earth and diamond industries. There are of course some key differences. “Diamonds are a luxury good that exist as an end-product, whereas rare earths provide functionality as an incremental input to end-products whose form bears no relationship to the inputs.” said Mr Kaiser. “In addition, while diamond demand is largely a short term function of marketing and the business cycle, rare earth demand has a long term dimension, in that commercialization plans for products that require rare earth inputs have a long lead time. This constitutes a serious execution vulnerability, if ‘just-in-time’ procurement strategies are relied upon for critical inputs.”

What would be the consequences of such a cartel? “It would be a disaster,” said Mr. Kaiser, “reminiscent of the failed communist central planning systems which could never get demand and supply to match outside a free market price discovery system.” There would also be significant logistical issues, too. “For a monthly rare earth price fix to be meaningful, China would need to force all suppliers to deliver to a central warehouse, from which the operator would allocate supply to the next stages in the supply chain.” he said.

The critical question on everyone’s mind is this: will prices for rare earths, centrally fixed or otherwise, go up? Jack Lifton thinks so. “In order for the Chinese rare earth industry to be able to survive the costs of environmental remediation and restructuring,” he said, “and to take into account the realities of the unstoppable rise of costs in China of labor, energy, and water, it has been decided that prices must go up even within China. This means a consolidation of the industry, and the absolute elimination of rogue, unlicensed mining, because it is this wildcard that puts unfair competition onto the legal rare earth miners, to keep their prices down to their rare earth metal producers.” Mr. Lifton suggests that the Chinese need to look inwards on this. “The trouble in the pricing of Chinese rare earths, lies not in their stars, but in themselves.” he said.

China appears to have some work to do, in order to properly manage this situation. “China must ‘discover’ what it wants the long term price for rare earths to be,” said John Kaiser, “which is likely to be significantly higher than current levels. If the Chinese rare earth cartel miscalculates demand, in the absence of allowing a free market pricing system to resolve the implied shortage, the cartel will need to allocate the limited supply at its ‘fixed’ price. This rationing of supply when there is a supply-demand imbalance will likely serve a strategic domestic agenda.

Clearly then, there are significant implications for a unified pricing mechanism. What about in the longer term? “Within a few years, such a cartel will have become completely dysfunctional and foreign end-users will be simply out of luck.” said Mr. Kaiser. “The announcement that China will be adopting a monthly price fixing policy for rare earth oxides and metals will serve as a wakeup call to foreign end-users that they need to develop and secure their own rare earth inputs outside of China.”

This of course is the next question on the minds of many: in addition to the quota restrictions, what do price changes – up or down – mean for non-Chinese rare earth mining and exploration projects? “While we remain concerned about the profitability of non-Chinese rare earth mines,” said John Hykawy, “assuming we arrive at a point where the Chinese remove export restrictions on some elements such as lanthanum or cerium, we are less worried than in the past. Recent work we have done suggests that any operating rare earth company would remain profitable,” he said, “if only marginally, even if prices for lanthanum and cerium went to zero. It would take serious price cuts for all light rare earth elements to drive companies out of the market. Hypothetically, if the world is awash in light rare earths we probably don’t care if a few suppliers shrivel up and die.”

Dudley Kingsnorth notes that the time frame for future development, is critical. “I believe that collectively, the announcements [from China] give greater impetus to the development of rare earths outside China. There are only 2 projects,” he said, “that have all the necessary approvals in place to take advantage of this opportunity in the next 2-3 years. The other potential projects have a timeline of at least 5 years to production; so we are in for some interesting times.”

Jack Lifton has other concerns. “The serious problem for junior rare earth ventures outside of China,” he said, “centers on the value of ore concentrates – the end product of any rare earth mine. For many companies, there is likely insufficient value in the ore concentrates alone, to make stand-alone mining profitable at that stage. Even going further up the supply chain in the case of the rare earths, for example, will add more cost than benefit until a stage is reached in the value chain where the product sells for more than its total accumulated cost of production.” What might that stage be? “For the rare earths this is probably the ‘refined metals’ stage,” said Mr. Lifton, “which is a good ways down the value chain from the mine face, and the production of which has never before been attempted by a non-Chinese mining operation in a vertical integration. It is at this point that China will now report monthly prices, i.e., the producer prices.”

Mr. Lifton notes that price increases alone are not the only trigger required to kick start the production of rare earths in the West. “Settling on technologies to produce the metals, and then implementing them, is already under way in Japan,” he said, “and has actually been accomplished there, although I do not know at what level of volume. Toyota, having seen the problem already, has invested in the development of a mine outside of China to feed an existing value chain it has in operation at some level in Japan.”

Problems associated with future pricing of rare earths will affect different parts of the supply chain differently. “The actual value of the contained rare earths in a finished consumer product is very small.” said Mr. Lifton. “Therefore, even if rare earth prices doubled tomorrow, for one of the the largest end-user segments, the makers of rare earth permanent magnets, I doubt whether any increase in the price, for example, of the magnet for the vibrator function of a ‘silenced’ Blackberry, would cause the seller to raise the final retail price of the finished consumer device. Competition would intervene.”

The benefits of such competition would not be limited to the entities furthest downstream in the technology supply chain. “More mining outside China will increase competition and help to stabilize rare earth material pricing.” said John Ebert, US business manager for Yunsheng Hi-Tech Magnetics.  “Currently, many motor companies are hesitant to embrace the conversion of ferrite magnets to neodymium-based magnets, because of the perceived volatility of rare earth raw material prices.” Mr. Ebert is upbeat though, about the future prospects for the magnet industry outside of China, and in particular the USA. “With the opening of non-Chinese mines,” he said, “we should see a return of magnet production and knowledge to the USA.  A handful of specialist industries in plating, powder metallurgy, machining and injection moulding will find a new niche in refining, machining and assembling magnetic materials. This will revitalize a generation of magnetics specialists.”

Language included in the National Defense Authorization Act which passed the US House of Representatives in May, aims to help with that process. Amendments were successfully added which would require that efforts be made to re-establish a neodymium-based magnet supply chain in the USA, in addition to assistance for the revival of the rare earths industry in the country. Regeneration of the production of magnet materials in the US could have additional benefits. “With the growth of magnetics specialists in the USA,” said Mr. Ebert, “refining and machining the finished products outside of China will become economically viable.  The big tradeoff will be between faster lead times and higher quality (from producers in the USA) and lower prices (from producers in China).”

Mr. Ebert believe that even more positive changes for the US magnet industry are possible. “Chinese policymakers may just live to regret a decision that swings the magnetic manufacturing pendulum back the other way.” he said. “From being a leading magnetics manufacturer, China will likely transform into a major magnetics consumer, giving up their competitive edge to the rest of the world.” Whether such optimism is justified or not, remains to be seen.

Jeff Green believes that the US government is taking a close look at the speed with which the US. magnetic material production capacity could be brought online. “By focusing on obtaining raw materials on the open market now,” he said, “the government is examining stockpiling necessary materials while global rare earth production comes online. Concurrently, government investment in downstream, value-added processing is being considered as a means of more cost-effectively and quickly closing the rare earth gap from the top down.”

Industry participants at all stages of the technology supply chain remain watchful for signs of significant effects from the recent announcements from China, positive or negative. As various commentators have noted, the time frame in which critical decisions and initiatives need to be executed, in order to resolve the supply and demand requirements for rare earths outside of China, has long been upon us.

[this article can be downloaded in PDF format from here.]

In the first week of July 2010, the authorities in China announced a number of changes that affect the rare earths sector in China. These changes included:

• a reduction in the total amount of rare earths that may be exported from China in the latter half of 2010;
• the announcement that rare earth prices would be set and published by the central government on a monthly basis, through a unified pricing structure covering the main provinces responsible for rare earth production;
• the beginnings of a plan to eventually consolidate the disparate rare earth production companies into 3-5 large conglomerates over time.
• A resource tax to funnel funds from the richer provinces to the poorer ones.

So, taking the first of these changes, how will the reduction in export quotas, announced by China’s Ministry of Commerce [MOFCOM] affect buyers of rare earth oxides (REOs)?

Reduction In Export Quotas

“The export quotas for 2010 have been reduced by 40% compared with 2009.” said Dudley Kingsnorth, Executive Director of IMCOA. “This is a far greater reduction than forecast – along with others I had forecast that the reductions would be of the order of 6-7% in the coming years.” The impact of the change will have far reaching consequences, particularly outside of China. “Chinese rare earth export quotas for 2010 are now significantly less than rest of the world (ROW) consumption.” said Mr. Kingsnorth. “The quotas for 2010 total 30,250 t REO compared with ROW forecast demand of 50-55,000 t. Total ROW production capacity is currently 10-12,000 t at best, which indicates a shortfall this year 10-15,000 t at least.”

Mr. Kingsnorth believes that the reduction in export quotas has caused two crossover points. “First, the quotas are less than ROW demand this year, which I did not believe would occur until 2011 and to a lesser extent.” he said. “Second, if this trend continues, ROW supply will not be able to meet the shortfall for several years. In the near future, the shortfall will be met by a drawdown of stocks.” There is also one other consequence of significance. “I also believe that the resultant high prices it will make elimination of illegal mining in China more difficult.” said Mr Kingsnorth.

The level of existing stocks may be a key factor in how the news plays out. “In the short term, the end-users’ supply of rare earth metals and alloys from China will not be affected,” said Jack Lifton, my colleague and co-founder of Technology Metals Research, LLC, “because they have been building inventory in Japan, the majority direct user of rare earths outside of China, for several years. This ‘stockpiling’ by Japanese companies by every means possible, since perhaps 2005, has been in response to the reduction of exports that has been underway by China in this sector for the last decade.”

The reduction in export quotas directly affects the amount of rare earth elements exported from China, but not necessarily the components and downstream products produced from such materials in China, before being exported. “The quotas are designed to regulate the exports of rare earth materials,” said Constantine Karayannopoulos, President and CEO of Neo Material Technologies. “The processing of rare earths at facilities in China to produce precursor materials, downstream products and finished components for export, such as our Neo powders produced by our Magnequench Division and a good deal of our value-added rare earth materials produced by our Performance Materials Division, will not be directly affected by the changes to the quotas.” he said. “If anything, after a short-term period of volatility, as the industry is trying to find balance, the quotas could lead to an oversupply of certain rare earths domestically, potentially leading to price reductions inside China of metals such as cerium, lanthanum and neodymium.” Neo has facilities in Tianjin, southeast of Beijing, where its Magnequench division produces neodymium-based magnetic powders.

Jon Hykawy, a clean technologies and materials analyst with Byron Capital Markets, concurs with this analysis. “China is not imposing export quotas or contemplating banning ALL export of rare earth-containing products. Companies in Japan, Korea or the US may not be able to get pure neodymium metal from China to make magnets in their home nations, but they will still be able to export rare earth magnets, or the products containing them, from China. We had to get used to effectively all rare earths produced coming from China, and we may well have to get used to the idea, for at least a period of time, of all our rare earth-containing products coming from China.”

Industry lobbyist Jeff Green, of J A Green and Company, has a more dire view.  “This is exactly the situation we’ve been warning the US Government about for several years,” he said. “As worldwide availability of material decreases, more downstream, value-added processing migrates to China. This continues the erosion of the U.S. industrial base, which threatens our economic and national security, and will likely lead to a strong political response from the US over the next 12-24 months.”

There is also a growing school of thought that China is not actually able, at present, to use all of the materials allocated for domestic use only. “Out of a production level of perhaps 100,000 tonnes of total rare earth oxides in past years,” said Dr. Hykawy, “the bulk of that material has ended up being purchased by end-users in first-world nations.” Patrick Wong, chief investment officer at Dacha Capital, has also been tracking Chinese domestic usage of rare earths. “While the cut in export quotas is not a surprise,” said Mr. Wong, “the size and timing should be questioned. In 2009, industry experts noted that all of the export quotas issued in that year were not used and therefore left an opportunity for China to reconsider its quota policy and make adjustments. During the first half of 2010,” he said, “they left the quotas unchanged as compared to the 2nd half of 2009, and in my opinion conducted a very thorough analysis of the industry culminating in the drastic change recently announced.”

All of this puts additional pressure and demand on ‘value-add’ companies in China. Can they handle it? “In my view there is no certainty that the Chinese downstream industry has the physical capacity to take up the opportunity created by the potential ROW lack of output created by the reduction in quotas.” said Mr. Kingsnorth. “However, I believe that the ROW will rise to the task by drawing down on their stocks of rare earths, a greater part of which were built up over the past 18 months during the global financial crisis, when production exceeded demand and illegal mining and processing in China was not under attack as it is today.”

Still, the change in the quota appears not to have been a surprise to everyone. “With the benefit of hindsight,” said Mr. Kingsnorth, “looking at prices (e.g. at Metal Pages) over the past 6 weeks, it appears that many people recognised that the quotas would be reduced significantly, as prices have risen by 10-20%.” Mr. Wong concurs. “Our sources were indicating potentially large cuts in export quotas some time ago,” he said, “and so we believe that some within the industry have had some time to prepare, and that a period of overstocking may have occurred in the past few months which may impact volume statistics.”

A review of the specific allocations of export quotas given the various rare exporters in China shows that it is the foreign-invested companies that have been subject to the largest cuts, and indications are that this was not expected. Still, the restrictions affect the domestic-originated companies too. “The industry is up in arms about the allocations,” said Mr. Karayannopoulos. “Exporters such as China Minmetals have committed very significant sums of money to developing their rare earth businesses, with the export markets no doubt being a large part of their business models. To have the amount of rare earths that they can export reduced to such a degree, is going to be problematic for them.”

Bill Rigney, sales manager for China Minmetals’ US-based subsidiary, isn’t quite so pessimistic. “It’s too soon at this stage to know how the quota changes will affect the industry. Things will start to firm up on the next few weeks,” he said, “at which point we’ll know more. We’re confident that we will be able to continue to satisfy the needs of our customers. We also have access to potential additional quota, through our relationships with other rare earth companies in China, as needed.”

At first glance, there does not appear to be any granularity to the quotas that have been imposed, in terms of differentiation between the various individual rare earth elements. This further complicates the situation due to the varying availabilities and pricing for specific, separated oxides. “The Chinese producers will focus on the export of the higher value rare earths to get the maximum value from their quotas.” said Mr. Kingsnorth. “So, this should help Molycorp, Lynas etc. sell their light rare earths. Naturally it will also help the aspiring rare earths producers sell their output.” There may therefore be a disproportionate effect on non-Chinese purchasers of lower value rare earths such as lanthanum and cerium, and the products in which these rare earths are used.

Other factors may be at play though, some of which may not have been accounted for in the new quota. “There are several variables that will affect the elements that will mostly likely be affected most by the scarce quotas,” said Mr. Wong.  ”The factors they will not have been able to forecast are new sources of demand (for example, Dacha Capital) or the possibility of quota ‘abuse’.  This policy can lead to a ‘run on quotas’,” he said, “where any opportunistic trader may decide to export a large tonnage of low value product to induce a shortage of quotas that will create large differences in FOB markets for virtually all rare earth elements.  The effect that volume can have on one element can affect pricing for ALL rare earth elements.”

Since the announcement of the reduced export quotas last week, there have already been moves to try to reverse the announced changes. Japan’s Ministry of Economy, Trade and Industry was reportedly preparing to ask the Chinese government this week to review the new export quotas, during bilateral economic talks in China. “MOFCOM and China will come under pressure on this, as well as other international trade and investment areas,” said Mr. Karayannopoulos. “At a time when China is aggressively acquiring resource companies around the world, this decision by MOFCOM will likely make that process more difficult for China. It remains to be seen how the dust will settle”.

There has been much speculation in recent years on the reasons for the continued reduction in export quotas for Chines rare earths. John Ebert is US business manager for Yunsheng Hi-Tech Magnetics, a Chinese rare earth permanent magnet material producer. “China needs to protect a vast, but limited national resource,” he said. “This notion runs parallel with the attitude in the USA towards protecting its oil reserves – ensuring future supplies for its own burgeoning consumption.” The environment, too, is a factor. “China knows that it needs to provide stewardship of the environment in the Baotou mining regions.” said Mr. Ebert. “Tailings from mining are transforming Baotou into a toxic quagmire that will haunt future generations of Inner Mongolians.  Beijing already has plans to introduce less detrimental methods of extraction, recycle existing tailings and help recover the damaged environment.”

Dr. Hykawy is concerned that through this and other recent announcements, the Chinese are signaling reductions in fundamental supply. “The stated rationale is environmental protection, that illegal mining and certain smaller firms are disproportionately damaging the local environment.” said Dr. Hykawy. “It could be that the relevant ministries in China wish to preserve their resources and extract more money from Western end-users by reducing supply and watching prices rise. Either way, having less of the relevant rare earths available to us will make certain high technology products more expensive and less ubiquitous, and this may include hybrid or electric vehicles. Rare earth mines outside of Chinese governmental control would obviously help alleviate this concern.”

Mark Smith, CEO of Molycorp, Inc., would no doubt agree with the latter observation. “China is doing what it feels it must in order to maximize the value of their resources, improve product prices, improve their environmental practices and continue to create jobs in downstream manufacturing businesses in China, which have all been key policy goals of that nation.” said Mr. Smith. “They are clearly trying to leverage their > 97% supply position in rare earths to achieve that. Frankly, we hope the US will begin to emulate similar efforts as we get back to producing American rare earths in sufficient quantities to meet our own domestic demand.”

Clearly, if Molycorp and other companies with advanced mining and processing projects, such as Lynas, are up and running in two years, then the equation changes for end users of exported Chinese rare earths – at least as far as the light rare earth elements are concerned. But in the meantime? “These additional and very significant decreases in export quotas are clearly troubling,” said Mr. Smith, “given that it appears that rest of world demand will now exceed what China is willing to export.  We are very concerned that the rest of the world could face actual near-term shortages of rare earths. This shines an even brighter spotlight on the absolute necessity for the US to get to full-scale rare earth production sufficient to meet our own demand and to deploy a complete mining-to-magnets manufacturing supply chain as soon as possible. Molycorp is on track to deliver both of these by mid-2012.”

Keith Delaney, Executive Director of the Rare Earth Industry and Technology Association (REITA), notes that these changes don’t just affect the USA. “The implication to the developed countries of the world is that global stakeholders need to act in concert with one another,” he said, “to plan for and create the technical and commercial infrastructures necessary to meet the demand for clean energy and conventional rare earth applications.”

In Part 2 of this series on “China’s Rare Earth Game Plan”, we’ll look at the impact of the other recent announcements from China, on the rare earths sector, relating to fixed prices, consolidation and a proposed resource tax. In the meantime, this article can be downloaded in PDF format from here.