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My colleague Michael Komesaroff, principal of Urandaline Investments,  a consultancy specializing in China?s capital intensive industries, and executive in residence at the School of International Affairs, Pennsylvania State University, has written an  excellent analysis of a recent aspect of China's implementation of its natural resources policies.  It is particularly interesting as evidence of the seamless amalgamation of political and economic policy toward state directed goals.  Mr. Komesaroff has 30 year?s experience of Asia?s mineral industries of which nearly 20 years was with Rio Tinto. His last two roles in Rio Tinto were as President Rio Tinto Japan and Vice-President Strategy for the aluminium business group. In 1997 Mr. Komesaroff was recruited by an arm of China National Nonferrous Metals Corporation to work in China. Returning to Australia in 1999, Mr. Komesaroff established Urandaline which has now provided services to many or the world?s largest mining companies as well as investment banks and government agencies.  

His essay, "Precious Earth", which appeared in the March 2010 issue of China Economic Quarterly (pp. 12-14) follows:

How much should the world worry about China?s near-monopoly of global rare-earth production? Fears that China has the power to cut off supply of essential ingredients for a wide range of military and green technologies resurfaced in February, when Beijing threatened sanctions against US companies selling military equipment to Taiwan. The 17 metallic elements known as ?rare-earth? elements are used in precision-guided munitions and cruise missiles, as well as high-efficiency light bulbs, wind generators and electric vehicles. The fact that China accounts for 93% of the world?s output of rare earths means that the West in general and the US in particular are beholden to China for materials critical to their national defense.

Despite their name, rare earths are not particularly rare in nature: many are more common than tin or molybdenum, and cerium is more abundant than copper or lead. Rare earths are so called because they were only isolated as oxides from their minerals in the early 19th century ? much later than most other elements. Because they could only be produced in small quantities under laboratory conditions they remained a curiosity until after World War II, when scientists finally developed processes to produce them in industrial quantities. One of the first commercial applications was in color television sets, where europium was used as a red phosphor activator. Global demand for rare-earth oxides is roughly 130,000 tons per annum, valued at around US$1.5 bn.

The dirty underbelly of clean tech

Until the mid-1980s, most of the world?s rare earths were mined at Mountain Pass in California. But a combination of escalating environmental regulations and falling prices, driven down in part by cheaper production in China, forced the operation to close. Over the past 20 years China has taken over as the dominant force in the global rare-earth market, while the US is now totally dependent on imports. Aside from leading the world in production, China is number one for reserves, consumption and exports. China has 59% of the world?s total reserves; consumes four times as many rare earths (60,000 tons) as the US (15,000 tons); and exports 40% of its output, of which 50% goes to Japan and 25% to the US. China accounts for almost all the global production of terbium and dysprosium, two elements crucial for manufacturing electric cars.

Unsurprisingly, the weak spot in China?s global dominance is environmental standards. Many small, illegal mines use crude processing techniques which result in large tracts of land being contaminated by toxic tailings laced with radioactive waste. Even China?s largest rare-earth mine, Bayan Obo in Inner Mongolia, has severe environmental problems. Because it extracts rare earths as a by-product from a much larger iron ore operation, Bayan Obo is a very low cost producer. But the processes used to refine the ore use high-temperature sulfuric acid and other hazardous chemicals, which exposes the local environment and workers to toxic pollutants. Plans to consolidate the industry around larger operations than the small mines that currently dominate production should help cut pollution. But, for the moment at least, the world?s green technologies will remain dependent on resources mined in China using processes that cause serious environmental damage.

Far more worrying for foreign governments and technology companies, however, is Beijing?s long-term objective to tighten its control over the global supply of rare earths. The Ministry of Industry and Information Technology plans to create a rare metals reserve in 2011, while the Ministry of Commerce has already begun to reduce export quotas and is considering an outright ban on exports of dysprosium, terbium and ytterbium. Policy makers hope this will force foreign consumers of rare earths to relocate their manufacturing facilities to China, thereby boosting employment and transferring technology. Around three quarters of rare-earth finished products are already fabricated in factories located in China, and tighter export controls mean this proportion is set to grow. State-owned holding company Jiangsu Eastern China Non-Ferrous Metals Investment?s 2009 purchase of a 25% stake in Aafura Resources, an Australian mining firm with rare-earth operations in the Northern Territory, only heightened international fears that China is seeking to monopolize the industry.

Incentives for smuggling

To be fair, Beijing?s motives are not entirely sinister. As the world?s biggest manufacturing base for rare-earth intensive gadgets such as cell phones and iPods, China has a rising domestic demand for these materials and consequently less room to export. By 2012, some analysts predict that China?s own demand will have increased to such an extent that it will no longer export any rare-earth material. But the commercial impact of further reductions of rare-earth exports could be enormous. Around 25% of Japan?s rare-earth imports come from illegal sources, thanks to a lack of legitimate Chinese exports. The shortage is so acute that Japan has begun to stockpile critical rare earths and is looking for alternative supply sources, including new mines in Vietnam.

Yet the greatest pain is probably felt in the US, once the world?s dominant rare-earth producer and the pioneer of many of today?s fabricating technologies. General Motors, in conjunction with the Pentagon, perfected the manufacture of the cheap rare-earth magnets used in Toyota?s Prius back in 1982. But seeing no further value in the technology, GM sold it to a Chinese group that dismantled the manufacturing plant and shipped it  back to China. Not only did the US lose its rare-earth production capacity; it also threw away its technological lead.

The onus now is on the US and other countries with significant rare-earth deposits, notably Australia and Canada, to develop new mines. The problem is that low market prices mean there is little financial incentive for purely commercial operators, while new entrants to the industry have to overcome significant technical barriers. Because of their relative novelty, technologies for processing rare earths are not commercially available and need to be tailored to specific deposits. Even if foreign governments decide to subsidize the funding shortfall, it will take decades for Western or Japanese engineers to bridge the technology gap with their Chinese competitors. And as more foreign manufacturers transfer their operations to China to be closer to global end-users, China?s grip on the rare-earth industry is set to tighten. The US and China?s other global competitors have only themselves to blame ? but they are right to be worried.

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