Is China really the Saudi Arabia of rare earths?

November 3rd, 2010

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It is no secret that China has a  stranglehold on rare earths. For those who are uninitiated, rare earth elements (REE) comprise 17 metallic elements with a variety of modern industrial and commercial applications ranging from petroleum refining to laptop computers to green energy applications to radar. It has been reported that China produces 95% of the world?s REE.

As a result of China?s monopoly in supplying the world?s REE, the recent alleged unofficial REE embargo against Japan had caused alarm among REE importer nations, of which Japan is the largest.

However, as investors, we have to understand clearly what China?s ?monopoly? on REE is and isn?t. Although it?s true that China has a commercial monopoly on rare earths, it does not mean that it is a real monopoly. To understand what we mean, consider this recent news article,

China has 30 percent of the world?s reserve of rare earths, but mines it cheaply and effectively. More than 90 percent of the world?s available supply is currently mined in China.

Basically, China has less than one-third of the world?s REE reserves but produces 95% of the world?s REE. Hence, do you see a problem?

REE are not as rare as their name suggests. There are plenty of REE scattered around the world. Before 1979, the US was the largest producer of REE. So, what happened? A recent report from Stratfor wrote,

The story of REE is not the story of cheap Chinese labor driving the global textile industry into the ground. Instead, it is a much more familiar story of the Chinese financial system having a global impact.

Unlike Western financial systems, where banks grant loans based on the likelihood that the loans will be repaid, the primary goal of loans in China is promoting social stability through full employment. As such, the REE industry ? like many other heavy or extractive industries ? was targeted with massive levels of subsidized loans in the mid-1980s. At the same time, local governments obtained more flexibility in encouraging growth. The result was a proliferation of small mining concerns specializing in REE. Production rates increased by an annual average of 40 percent in the 1980s. They doubled in the first half of the 1990s, and then doubled again with a big increase in output just as the world tipped into recession in 2000. Prices predictably plunged, by an average of 95 percent compared to their pre-China averages.

Most of these Chinese firms rarely turned a profit. Some industry analysts maintain that for a good portion of the 2000s, most of them never even recovered their operating costs. At the same time, an illegal REE mining industry ran rampant, earning meagre profits by disregarding worker safety and the environment and ruthlessly undercutting competing prices. With an endless supply of below-market loans, it did not matter if the legitimate mining concerns were financially viable. It was in the environment of continued Chinese production despite massive losses that nearly every other REE producer in the world closed down ? and that the information technology revolution took root.

In fact, if not for China?s massive overproduction, the technological revolution of the past 15 years would not have looked the same. In all likelihood, it would have been slowed considerably.

This is a classic predatory pricing. As we wrote in Chinese strategic plans: control of the supply of rare earth metals,

Predatory pricing is an anti-competitive practice by monopolies to bankrupt their competitors by slashing price so much that everyone makes a loss. Since the loss-making monopoly will eventually outlast their loss-making competitors, it is only a matter of time competition is eliminated and the monopoly can increase prices.

So, what this means is that China will only maintain its commercial monopoly on REE as long as prices remain uneconomically low.

Now, do you see a long term problem that China faces?

As we wrote earlier, China has less than one-third of the world?s REE reserves but produces 95% of the world?s REE. That means that they are supplying REE to the world by running down their REE reserves first before anyone else. Obviously, that will be problematic for them in the future because one day, the tables will turn against them as they start to run out of REE. From that perspective, it makes sense for them to curb REE exports to feed their own domestic needs first.

Of course, if China halt all exports of REE tomorrow, it will cause immediate big problems to the rest of the world because there are not many functioning REE mines (and expertise) outside of China. But in the long run (say more than 5 years later), as new production come online, the world?s dependence on China for REE will decline.

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  • Pete

    Great article CIJ!

    You have dispelled some of the REE myths, such as ‘scarcity’ and China’s control of them.

    I guess the question is what now? If a person was to jump in and invest in Lynas or Arafura right now for example, would there be any point? China could keep up it’s predatory pricing…and we don’t know when they will stop.

    So it becomes a matter of timing right? Is that time now?

    ‘China Denies Halting Rare-Earth Exports to Japan’
    http://online.wsj.com/article/SB10001424052748704062804575509640345070222.html

    (interestingly from the article you can see how the western media mis-reports or misunderstands those same myths that CIJ has dispelled in this article)

  • You know, price is falling consistently for electronic gadgets over the years. Portable computers and smart-phones are getting so cheap that they are increasingly being treated like disposable commodities.

    Maybe in the next decade, with more Chinese middle-class wanting more of them, maybe the era of cheap computers will be over?