EDITOR: | October 30th, 2013 | 6 Comments

WTO’s verdict against Chinese Rare Earths export quotas underscores criticality of Sustainability

| October 30, 2013 | 6 Comments
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tdwtoIn March 2012, the United States of America, the European Union and Japan filed a compliant in the World Trade Organization (WTO) against China over its rare earth elements (REEs) trade practices. Last week it was announced that the WTO ruled against China (China is expected to appeal the WTO’s decision). China’s policies were a serious concern to the international allies. US President Barak Obama even took to making a formal announcement of the dispute in the White House Rose Garden to accuse China of breaking global trade rules. Why? Was China was flooding the market with tonnes of REEs at artificially low prices, bringing (much-needed) rest-of-world REE exploration and production to its knees? No. Just the opposite, in fact; China was restricting REE supply.

In 2007, the world’s ruling producer of rare earth metals quietly and unilaterally imposed taxes and annual tonnage limits (export restrictions/quotas) on its rare earth exports. It then gradually raised the taxes and lowered the tonnage limits in subsequent years, slowly strangling supplies to overseas manufacturers. However, the situation escalated in 2010 as Chinese quotas were cut by 40% to 30,300 tons in total. And, for a brief period of time (from October 18th to 28th of 2010), China effectuated an unannounced (and an officially unacknowledged) REE embargo. China had suspended shipments of REEs to the US, Europe and Japan. Although China had eventually allowed shipments of the minerals to resume to the US and Europe after the October interruption, deliveries to Japan had remained suspended. Not surprisingly, this really upset Japan (the world’s high-tech manufacturing leader that heavily relies on China’s REEs, vital to Japanese industry). But why did China initiate these measures? I’ll get to China’s ‘official’ justification shortly, but what’s the real reason behind China’s decision to cut off the REE supply chain? May I respectfully submit the following: a territorial dispute. Chinese customs officials abruptly halted the processing of paperwork for shipments bound for Japan on September 21, 2010. The shipments were halted during a (very) rancorous dispute over Japan’s detention of a Chinese fishing trawler that rammed two Japanese coast guard vessels on September 7, 2010, near islands controlled by Japan, but claimed by China (Japan promptly released the captain after China engaged in what Japanese officials described as “economic warfare”). As a result of the blocked Chinese shipments, some rare earths jumped in price as much 10+ times (this lead to significant illegal Chinese REE production and smuggling).

The WTO case against China by the US, the EU and Japan was viewed by some as the US and EU supporting ally Japan. Meaning, the real issue here was Japan’s inability to purchase rare earths from China from September to November 2010 and that the US and EU’s real interest in this matter was supportive. Some have raised the question: if Chinese export quotas were a legitimate concern that allies Japan, Europe and the US banded together to file a WTO case, where was Australia? Why wouldn’t one of the world’s most important countries (with essentially the same supposed interests and concerns as the other countries in this matter) join in bringing this action against China?

The official Chinese explanation contends that overproduction of rare earths will likely to lead to “environmental destruction and hinder sustainable development of the rare earth industry.” China has also said the export duties and rare earth export volume quotas are “reasonable from the perspective of protection of the environment and natural resources.” And that qualifies the country’s actions as being within WTO member guidelines. The US, the EU and Japan challenged China’s taxes and quotas at the WTO, on the basis that China has done little to limit rare earth consumption within its borders an operates a two-tier pricing strategy.

From my perspective, I would have thought that REE explorers looking to advance their projects from Australia to South Africa to Sweden to Canada to the United States — and to any other country outside of China that is developing (or is currently trying to develop) a REE mine — would have been pleased with China’s quotas. And that the resultant WTO verdict announced last week against China is counter-intuitive to the rare earth industry and its investors. It actually shifts the focus away from the critical issue at hand of securing alternative sources of supply (outside of China) for medium to heavy REEs (not just the light rare earths). The good news is the WTO’s ruling is “no surprise and [is] unlikely to change a thing in the industry,” according to the President and CEO of one of the most highly regarded REE junior exploration companies in the world (who wished to speak to me off the record). I also spoke to Toronto-based Euro Pacific Canada research Analyst Luisa Moreno, who echoed the same — almost verbatim. The truth is, even if the Chinese lose this case again on appeal, there will still be ample avenues at the country’s disposal to circumvent the WTO’s ruling and rules.

Rare earths are absolutely vital to numerous defense and clean-energy/sustainable-energy technologies, but if you’re a regular InvestorIntel reader, I’m not telling you anything you don’t already know. Furthermore, you probably also know that China controls (or ‘supplies’ might be a better word) 90% of global rare earths. This fact has piqued international interest in the how China governs the trade of its REEs. WTO members do not like export quotas. China argues that its policies are intended to promote Chinese environmental and economic sustainability (China has 23% of the world’s REE materials and at current production levels, it will exhaust its medium and heavy rare earth reserves) and has staunchly rejected a call for the establishment of a WTO panel. However, the US, EU and Japan claim that China’s REE export quotas violate trade rules that the country agreed to follow upon its entry into the WTO.

The basis for the tri-country case is the WTO’s support for free trade, and that China’s export restrictions are against WTO rules. However, many people in China feel that this case is quite ironic. These countries never complained to the WTO before about China previously dumping underpriced rare earth product on the international market, as they did with China’s export of low-priced steel and textiles. The truth is, these are the very same countries that urged China to sell them rare earths at a very low price, and denounced rare earth export restrictions from a liberal economic viewpoint. However, many feel that the decision to launch the case against China underscores just how essential rare earths are to the three countries’ respective economies. “The WTO win is far more likely to distract U.S. policymakers from the larger challenge of developing a strategic resource policy — and prolong U.S. resource dependencies to the detriment of our economic strength and national security,” explained InvestorIntel’s Daniel McGroarty. “As for exhaustible natural resources, the US and its co-complainants are actually making the case for China, in their statements on the critical importance of rare earth elements to economic, technological and even national security applications. So last week’s ruling notwithstanding, China is actually walking a well-marked line within the WTO’s logic to prevail in the current complaint.”

It is believed that the successful WTO verdict against China may force the country to terminate its dual-price system, but as China reduces production, there may not be excessive materials available on the market. China could also restructure its export quota system in line with WTO regulations to allow for the free trade of more prevalent, lighter rare earths that can be produced by Molycorp, Inc. in California and other areas, but could reduce the export of the more rare heavy elements. This could flood the market with material that would make US production less competitive and restrict the availability of materials that are critical to defense technologies – a possible unintended outcome.

But, as always, Jack Lifton said it best. “Ty, think about something. What happens if the Chinese say. ‘ok all REEs are going to be exported unrestricted’?” asked Lifton. “You can close up Molycorp the same day. Forget about the quotas on heavies. Think about the quotas on lights. This whole case came about without the universal acceptance of the junior mining community. This was a political response in support of our allies and not something pursed in our best interest. And it backfired.”

“Strengthening the regulations is intended to protect the environment and promote sustainable development,” explained Gao Yunhu, deputy chief of the Rare Earth Office under the Ministry of Industry and Information Technology of China. The Chinese government has announced production caps, stricter environmental standards and an export quota system for rare earth metals in recent years to protect the environment and preserve the exhaustible resources. “Despite export controls, China has met global market demand,” said Gao.

The aim of China’s restriction is to limit rare earth products or rare earth elements production enterprises with low standards of environmental protection, and not to limit the imports of the EU, United States or Japan. The country set an export quota of 30,200 tonnes for rare earth products in 2011, but actual exports totaled just 18,600 tonnes, meaning 40% of the quota was unused. If Japan, the EU, and the United States wished to buy more rare earth elements at the market price, they could have. So, according to the Chinese government, China did not limit REE purchases at all.

I believe China’s intention to limit REEs is a wake-up call for the rest of the world. The rest of the world has to stop having China do all of our heavy lifting when it comes to the REE industry. We let the Chinese control the REE industry because we were too cheap and too lazy (i.e. adhering to environmental protocols) to do it ourselves. If China wants to restrict REE exports, and can present a completely valid, linear and cogent argument (i.e. there is less than two decades of medium to heavy REEs left, environmental concerns, resource nationalization concerns) to justify its actions, I say let them. Perhaps China can force countries like the US and others to realize what they should have long ago – that it is significantly overdue to create a total rare earth supply chain outside of China. We have the deposits, we have the technology, we have the infrastructure, we have talent, and most important we have the need – and we will for the foreseeable future.


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Comments

  • Aat Oskam

    Ty, excellent analysis imo. Political victory, but shooting their own foot by not creating their own supply chain.

    October 30, 2013 - 5:11 PM

    • Ty Dinwoodie

      I could not agree with you more. I think it’s worth noting that Jack Lifton (one of the best minds in the REE industry, in my opinion) agrees wholeheartedly.

      November 4, 2013 - 12:11 PM

  • Tim Ainsworth

    Ty,
    IMO the fishing boat instance was simply a short term convenience for rhetoric. Look to the gradual reduction in export quotas from 2006 and the corresponding increase in tariffs, culminating in the 2010 40% cut THEN look at the spider graph, page 10: http://www.lynascorp.com/Presentations/2012/Roskill_Presentation_14_Nov_2012__FINAL.pdf
    Note the migration of ROW RE demand into China.
    Jack Lifton mentioned China’s 5 year plans recently and I’ll suggest Plan 1 was getting control of supply by exporting plentiful, cheap REO.
    Plan 2 was gradually reducing that supply and creating a two tier pricing structure thereby drawing in ROW tech & capital, usually in JV’s.
    Plan 3 is to capture far higher margins than simple REO export by controlling the middle supply chain and exporting value added componentry & end product.
    China did shoot itself in the foot by not anticipating the rampant price speculation following the 2010 squeeze that both stimulated smuggling and promoted thrifting & substitution, at a time of reduced global consumer demand.
    Most of their action since has been about getting their internal supply under control and as you suggest above, once in balance they won’t have too much difficulty in maintaining a two tier price structure but perhaps at a reduced margin.
    The fact that China has supplied 90+% of RE is no longer relevant but the fact that they control 80/90% of the higher value supply chain is. Catch us if you can.
    Begs the question re the current focus on HRE, even if the ROW wannabes can get to final separation who are they going to sell it to?

    October 31, 2013 - 12:00 PM

    • Ty Dinwoodie

      Tim — excellent analysis of the REE situation. Regarding your last point, wouldn’t the answer be domestically or to other end-users outside of China? I know there is a strong view of ‘once we build the create the marketplace, the market will come’ in the ROW HREE industry.

      November 4, 2013 - 12:36 PM

  • Tim Ainsworth

    Ty, I’m borrowing heavily from JL here but where is the ROW capacity? Go back to the Lynas spider graph and the one segment where ROW retains the means to turn REO into something useful is in relatively low value catalysts. China dominates all other segments but most particularly the high growth & value add sectors of Magnets/Batteries/Alloys.
    ROW has little capacity for final separation of SEG & HRE but even presuming that comes on stream in the next 2/3 years where is the middle supply chain to transform those oxides into metals, alloys, powders, etc, and then into useful components for end product? Sure, Neo, Hitachi and others have some capacity but: 1/ can they scale quickly, 2/ can they compete with the Chinese MSC sourcing ROW REO given the price differential?
    Classic chicken & egg scenario, and China have very neatly positioned whereby the ROW needs massive capital investment to catch up, and JL suggests we are way behind on the tech side as well.
    Turning to the macros, one of the disturbing stats coming out of the current stock market rally is the lack of revenue growth, profits are being driven by cost savings. In that scenario is GE or GM going to invest upstream in a MSC or are they going to continue sourcing their RE magnets, batteries, alloys, phosphors, etc as secondary materials or components from China? We know Toyota is investing with Matamec, Rhodia with Tantalus, perhaps Lynas, Siemens maybe with Lynas but internal difficulties have that on hold, but what of the big US manufacturers? Are they hooked on China? Where is the scale of investment & tech that is required to build a MSC that can compete with China? And even then that presumes the inputs are priced on a level playing field.
    Ty, it’s such a broad subject, and my view is superficial, really just joining JL’s dots with a few observations, but critical as to where is the CREO middle market, even once final separation is achieved?

    November 5, 2013 - 9:16 AM

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