Chinese strategic plans: control of the supply of rare earth metals

June 16th, 2009

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Our long time readers will know that we keep a watchful eye on big picture secular trends. One of the big-picture secular trend is the rise of China. As we wrote before in Example of a secular trend- commodities and the upcoming rise of a potential superpower,

It has been said that today?s 21st century will see the secular rise of China. During the 20th century, China endured non-stop revolutions, civil wars, invasions, social upheavals, ideological experiments (e.g. Cultural Revolution, Great Leap Forward). It was the last couple of decades of the 20th century that China began to slowly emerge from her self-imposed shackles to catch up with the West.

As we observe China, it becomes clear that the Chinese government has a deliberate and long-term plan for the nation. Unlike its democratic Western counter-part, it does not have to worry about winning elections every few years. Since winning elections involves some level of populism, the short-term interests of the ballot vote can clash with the strategic long-term goals of the nation. By the way, please don’t get us wrong- we are not praising China here and political ideology is not our cup of tea. Our goal is to observe in the context of becoming a better investor.

So, for today’s article we will look at one aspect of China’s long-term strategic plan- the monopolisation of the rare earth supply.

First, what are rare earths? As this article explains,

Rare earths are the 15 elements within the lanthanide series of the periodic table, plus the elements yttrium and scandium. The best known are lanthanum, cerium, neodymium, praseodymium, gadolinium, europium and samarium.

Rare earths have a lot of vital industrial and electronic applications. Without them, many of the modern way of life that we enjoy today will not exist. The fact is, there are no substitutes for rare earths in some of these applications. Here are some examples:

  1. Petroleum refining- large amounts of lanthanum and cerium have been used here, “with the result of increasing yields from each barrel of oil by about 10% while extending the life of other expensive catalysts like platinum.”
  2. Aerospace super-alloys
  3. Rechargeable batteries (NiMH).
  4. Powerful permanent magnets in information technology products (e.g. hard disks, DVD, DVR, iPods, smart phones, computers), giant windmill assemblies, hybrid vehicles (a typical one consumes 50 pounds of rare earths).

Rare earths are particularly vital in the clean energy applications. Without them, there can be no clean energy industry. Also,

It?s also important to keep in mind that almost none of the rare earths used in large power systems (like windmills) or electric vehicles (such as with NiMH batteries) are currently being recycled. The long lifetimes of the magnets and batteries, coupled with the lack of recycling technologies and dedicated facilities, means that any increase in supply can only come from new mining.

Now, here comes the focus on China. China is the largest producer of rare earths. In fact, it is said that China is the Saudi Arabia of rare earths. This graphs shows the rare earth production over the past half-century:

Global rare earth metal oxide production

The Chinese are in the process of cornering the supply of rare earths,

Another factor is that there appears to be an official Chinese policy to slow down export of rare earths. Chinese exports have decreased by 8% or so each of the past three years. Chinese suppliers have placed foreign customers on allocation, at reduced quantities from years past. The Chinese explain that they have closed mines for environmental reasons. Yet the Chinese also promise adequate supplies of rare earths if foreign users will move their industrial facilities into China.

By encouraging foreigners to move their industrial facilities, high teach factories and research centres to China in order to gain access to rare earths, there will be technology transfer to China.

Furthermore,

While about 42% of worldwide rare earths resources are outside China, there are NO non-Chinese sites with any significant processing or refining capacity.

Mr. Sato has stated, ?Many people are looking at establishing alternative refineries and sources outside China, but the investment is not necessarily a sound one because of the threat of price revenge by China. If new projects emerge, as they have recently in Malaysia and Australia, China could just drop its prices and force rivals out of business.?

In other words, the Chinese are engaging in predatory pricing. 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. Anti-competitive practices are illegal under the anti-trust laws. Though this law can be enforced on individual corporations, it is not possible to do so against a nation.

As for investors, this is a tricky investment theme. The rare earth mining company that you are investing in can be a victim of predatory pricing!

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  • Mihai Radu

    You hit it. Extremelly good article. Exceptional. Bravo.

  • Mihai Radu

    You hit it. Extremelly good article. Exceptional. Bravo.