"No More Selling Gold for the Price of Potatoes"
The President has recently taken his case to the media in order to prepare for a complaint filed at the World Trade Organization over Chinese export restrictions on rare earth materials, a group of 17 elements that are vital for manufacturing an array of high-tech products, including cell phones, wind turbines, electric car batteries and missiles. China has fired back in the media declaring that they are doing what they need to in order to fix the environment and that under WTO rules they have a sovereign right to not export these materials.
For those at home keeping score who may be a bit confused, we want China to export less, except for Rare Earth materials, of which they should export more.
China put the U.S. out of rare earth production ten years ago and today they dominate rare earth production with a 95% market share. However, the China of today no longer wants to dominate this sector as it has left behind environmental destruction in its wake and they hope to keep their reserves of these key materials for the future. The U.S., Japan, and the EU demand they keep shipping.
How Did Rare Earths End Up Selling for Less Than Pork?
The year was 1992, China was dirt poor with one of the lowest GDP per capita on the planet. By now many people are familiar with the quote by China’s premier Deng Xiao Ping about rare earth material when he said “Saudi Arabia has oil but China has rare earth”. This quote has been thrown around so much I was not sure of its origin so I searched it in Chinese on Bai Du. As it turns out, the premier did in fact make those comments, however, the context has not been understood. In 1992, as the rare earth sector in China was starting to open up, many government officials in China were opposed to exporting rare earths at all as they deemed it a strategic material. It was then Deng Xiaoping who stepped in and made the now famous quotation. The context however, was not to try and control the rare earth market for any type of geopolitical gain but just to earn money for China. Get rich like Saudi Arabia so to speak.
The rare earth material market developed in China not unlike other industries. Provinces with rare earth materials competed against each other to gain market share driving the prices lower and lower. Loss-making companies were backed with local provincial government money and support. There were absolutely zero environmental or safety regulations. There were even reports of entire villages of farmers working mines and selling “dirt” to rare earth material companies. The farmers had no idea why they wanted to buy “rocks and dirt” and did not know the value of the materials this special “dirt” contained but they were happy to work the mines and sell their product.
It wasn’t until 2009, that the Chinese government started to take notice of the market and were baffled by how pork was selling at $4.00/kg and Cerium Oxide was being exported at $3.88/kg with domestic prices being even lower. Rare earth elements must be mined, which leaves behind a radioactive footprint, and then they must also be processed in a foundry using a lot of electricity and processing technology. After all of that, it was selling for prices that were lower than the cost of pork.
There was obviously something wrong here. This was not free market capitalism. Government money found its way into the pockets of directors of these companies while the companies were selling the materials at far below costs. These costs were not capturing the actual cost of mining and production not to mention the environmental damage with radioactive fields of waste left behind in its wake. In fact, over exploitation of the metals has not only impeded local economic development, but also posed a threat to drinking water safety in some provinces.
Clearly, had the Central government exerted control of planning and production of the rare earth industry they would not have allowed this to happen. The reality is that what happens in China locally can most of the time not be controlled by Beijing. As they say in China, "Heaven is high, and the emperor is far away."
By 2009, this phenomenon came to be known in China as “selling gold for the price of potatoes”. The Chinese government then stepped in to get control of the industry. Export quotas and environmental regulations were put in place to ensure extraction methods did not destroy the environment. China also directed several large Chinese producers to consolidate the industry.
By 2010, panic buying of rare earth set in as shortages of the material developed outside of China due to the export quotas. Japanese imports of rare earth from China were up 400% in 2009, they were clearly trying to store as much inventory of the material as they could before China could get control of the industry. The infamous Chinese fishing trawler incident occurred at the same time. A Chinese fishing trawler was captured for ramming a Japanese coast guard vessel and the captain was detained. Rare earth exports to Japan stopped at that time. Many people linked the two incidents believing that China used rare earth as a political weapon against Japan. There is no real evidence to corroborate that and it is our opinion that the two events are not correlated.
U.S. Gets Back Into the Rare Earth Game as Prices Rise
Due to the quota system out of China and a general shortage of the material, the prices of rare earths have skyrocketed. That Cerium Oxide that was selling for $3.88/kg went as high as $118/kg but has since collapsed to $29/kg. Prices have stabilized but could rebound as buyers have come back into the market after exhausting inventories that were built up in 2010. Indeed, China’s largest rare earth company, Baotou steel, is up almost 100% in 2012 based on increasing optimism.
At current prices, the door has now opened to the U.S. getting back into rare earth mining. The U.S. has recently re-established a rare earth juggernaut named Molycorp which is about to restart mass production at the previous mine in Mountain pass, California. Molycorp has built and acquired itself into a one-stop shop for rare earth mines and magnets. They have some the best reserves and technology on the planet.
The time for the U.S. to intervene into the market was from 1992-2002 when rare earth prices were impossibly low. China was distorting global markets with unfair trade and no environmental regulations. The price continued to drop until for almost a decade even after the last U.S. producer was put out of business. Since 2009, China has ramped up export controls and stopped distorting the global market. The free market has corrected and allowed the U.S. back into this business which is creating American jobs and export surpluses. And now here comes the government, trying to force China to continue exporting to provide competition for America’s newest and only producing rare earth company.
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