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Rare earths alert: How the US forfeited its lead, and a framework to win it back


Growing tensions between the United States and China have highlighted the West's increasing dependence on China for rare earth metals.

The group of 16 metallic elements are used in the manufacture of a wide range of consumer and industrial products, but also are indispensable for many defense applications as well as new green technologies, particularly electric vehicles.

China accounts for more than 90 percent of the world's output of rare earths, and the fact that the West in general and the U.S. in particular are beholden to China for such strategically important metals creates some remarkable ironies.

First, it is ironic that the West's green technologies depend on ore supplied from high-polluting Chinese mines where workers are exposed to toxic pollutants such that the incidence of cancer is very much higher than elsewhere in China. Second, the West is developing electric vehicles as a means of reducing its dependence on foreign oil, but the chosen route makes it even more dependent on China, a country some consider hostile. The third and possibly biggest irony is that U.S. defense is dependent on components that can only be produced in China with Chinese raw materials, but with technologies developed in the U.S. and funded by the Pentagon.

These ironies have not been lost on China's neighbors, Japan and South Korea, where their governments have announced strategies for ensuring uninterrupted supplies of rare earths. Their concerns have been raised by China's policy of using export quotas to systematically reduce the volume of rare earth shipments. China's decision to limit its rare earth exports is consistent with its long-standing policy of consolidating its industries around fewer but larger players that are financially more viable and environmentally more sustainable than the many small players that characterize much of its industry. This is especially so in rare earths.

A consequence of China's decision to restrict exports is that it encourages foreign consumers of rare earths to relocate their manufacturing facilities to China, where they believe they will have an uninterrupted supply of raw materials. For the Chinese, this migration creates much-needed employment as well as transferring value-adding technologies not currently available in China. The United States has been hit particularly hard by the relocation of its high-performance magnet production to China.

Rare earths are critical ingredients in the manufacture of the high-performance magnets at the heart of many U.S. defense systems, and the loss of a domestic magnet capability has led to calls for Washington to take action to avert a perceived looming rare earths supply crisis. While hopes run high that some strategic priority will be accorded to the rare earths sector, analysts are well aware that it was government inaction in the past that enabled the nation's high-performance magnet capability to be bundled up and shipped off to China.

In the early 1990s the United States was the dominant producer of rare earth magnets and the industry was based on technologies pioneered by the Pentagon. The leading producer, Magnequench, a General Motors Corp. subsidiary, saw no value in further development so it sold its technology and associated manufacturing operations to a Chinese group that subsequently dismantled the plant and bundled it off to China.

The White House could have used the Exon-Florio Amendment to the U.S. Defense Production Act to prevent the transfer of Magnequench's facility to China. Exon-Florio permits the President to block any investment deemed a threat to national security. Similarly, the Berry Amendment requires that specialty metals, and specifically high-performance magnets, incorporated into products delivered under Defense contracts be melted in the United States or a "qualifying nation." China, which at the time had been described by President George W. Bush as a "strategic competitor," is not classified as a "qualifying nation."

Contemporary reports imply that influential groups lobbied Bush to withhold his veto, and with no opposition from the government the plant was dismantled and shipped to China while 450 skilled U.S. workers lost their jobs in a modern high-tech industry where America was the clear global leader.

U.S. dependence on China for rare earths has encouraged the emergence of a vocal group lobbying for preferential treatment for local rare earth producers and consumers. The risk is that such committed constituencies—an alliance of so-called "panda bashers" who fear China's growing influence and investors petitioning government assistance—could sway policy in the wrong direction. Policy makers should be cautious as such partisan groups could do as much harm as the free-market devotees who lobbied in support of Magnequench's sale.

In formulating their response, policy makers need to be aware that China's monopoly on rare earths is not geologically predetermined as there are significant deposits elsewhere, including in the United States but particularly in Canada and Australia. Most of these deposits are owned by publicly traded companies, but because of sustained low prices there has been no incentive for investors to develop the properties.

Understanding that with a stronger price for concentrates the rare earths supply constraint is a downstream manufacturing problem and not an upstream resource issue is fundamental to developing appropriate support polices. Funding new mines will not improve the rare earths supply chain, whereas encouragement of downstream fabricators will. Fabrication is more about manufacturing than mining, and the sustained erosion of U.S. manufacturing capabilities since the time of President Reagan demonstrates that governments of all persuasions have yet to devise strategies that can successfully stem the manufacturing migration to China.

Policy makers also need to be aware that output from new non-Chinese mines would need to be shipped to China, where almost all of the world's rare earth products are now manufactured. Complicating the policy process are situations like Magnequench, where equipment and core technologies have relocated to China, making it difficult to challenge its dominance. This challenge will only get harder as more manufacturers migrate to China, giving local rare earth producers even greater opportunity to collaborate with global end-users in the development of the applications that will sustain ever-growing demand for rare earths.

With these constraints, how should policy makers react? First, it is clear that it is in the nation's interest to have a viable rare earths industry, and if this is to happen then there is a need for some government support. Second, because of the geological abundance of rare earths there is no need to encourage new mines so public money should be directed downstream to foster fabrication and assembly capabilities. And finally, because governments are notoriously poor at picking winners, the development of national champions will require innovative policies. Indeed, the challenge for policy makers is to be as innovative as the entrepreneurs they should be sponsoring.

A possible solution to the policy dilemma is for the government to purchase rare earths concentrate and toll it through a refiner or fabricator. A tender to supply concentrate to the government should be attractive to potential investors in new mines as the winning supplier could use the supply agreement to support finance for the mine's construction. This approach also would help the downstream sector, which is handicapped because it currently does not have a reliable supply of rare earths.

While U.S. policy needs to encompass other aspects, especially encouragement for further research, the concept of tolling government-purchased concentrate has the necessary elements of a sustainable industry policy.

Michael Komesaroff is founder of Urandaline Investment, an independent consulting company specializing in capital-intensive commodity businesses. He also is Executive in Residence at the School of International Affairs at Pennsylvania State University.

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