The Post-China Price: What Beijing’s Green Revolution Means for Rest of Us
c.2011, Sean Daly
Living in a liquidity-driven economy for the past decade, US pundits can be excused for seeing yet another mania in “rare earths” miner start-ups like Molycorp (MCP), Ucore Rare Minerals (UURAF.PK), and Rare Element Resources (REE), all of which now sport rich valuations and skeletal operations. But when you really look deeply into the historical pricing circumstances of the rare earth elements (REE) industry, you don’t see a bubble. You see the exact opposite.
In a recent report, the strategic consultancy firm STRATFOR analyzed the pricing of rare earths over the past three decades and concluded that the West has been quite oblivious to how abnormally cheap the metals were made during the last twenty years due to China’s unregulated mining. Yes, total disregard for occupational safety and environmental impact allowed for low-cost REEs (rare earth elements) worldwide. Pictures of Baotao miners often show them caked in yellow mud laced with thorium and uranium. Apparently their untimely deaths have been giving the world’s consumers cheap MRI machines for the past two decades.
But the report makes another very interesting point, one never discussed. It suggests that Chinese state loans to mining operations -- which were focused on “social stability through full employment” and not profitability -- gave the world decades of supply:
The REE industry — like many other heavy or extractive industries — was targeted with massive levels of subsidized loans in the mid-1980s... Production rates increased by an annual average of 40 percent in the 1980s. They doubled in the first half of the 1990s, and then doubled again with a big increase in output just as the world tipped into recession in 2000.
World prices predictably plunged, by an average of 95% compared to their pre-China averages. The consultancy firm computes that if world prices were to go back to 1980s levels (and a non-Chinese supply), the developed world would be seeing a very different cost structure for many now pervasive products –including computer drives, compact fluorescent bulbs, electric cars, even those Apple (AAPL) ibuds.
Take, for example, the 13.5 kilograms of REEs in the Toyota (TM) Prius battery system. That material was responsible for a mere .9% of the car’s cost in 2009. That percentage has now risen this year to 2.9% due to higher lanthanum costs this year. But that cost would be 15.2% of the cost if pre-China prices were applied. Likewise, the typical GM (GM) catalytic converter will probably go up, as its REE component cost would quintuple from today’s 3.4% of total product cost to around 17%. A manufacturer can not be expected to eat all that cost...
Now, of course, you will ask: why would we ever have to go back to “Pre-China Prices?” The short answer: we have no choice. China is initiating a massive modernization effort and it needs the fruits of its own labor to provide for it. Sorry Grasshopper, the Ant can’t spare a square...
A recent incident is instructive: On October 19, one day after an important Chinese Communist Party plenary session had meted out the nation’s trajectory for the next five years, the Ministry of Commerce leaked that export quotas for rare earth elements (REEs) will be 30% lower in 2011. The Ministry report also mentioned that all exports might be outlawed entirely in the coming decade. How this outlawing of exports (or even the quotas themselves) squares with the WTO precepts signed by Beijing in its 2000 accession agreement was not discussed. The story was picked up the Associated Press and the leak was denied the next day, but the fact that it emerged following a pivotal CCP meeting on future energy security is suggestive.
Indeed, such a reduction doesn’t deviate from the trend: foreign exports have been tightening for seven years. China just slashed its late 2010 export quota by 72% in July, arguing the country needed to protect its supplies for the future. As the state-mouthpiece People’s Daily made clear in discussing the leaked report:
"No one is entitled to criticize China over this because this is an affair absolutely within China’s sovereignty."
Attended by the PRC’s political elite, the recent plenary session hammered out an ambitious plan. It offers up a tough new energy plan for the country, with 15-20% reductions in energy intensity over five years and a 40-45% reduction in carbon emissions by 2020. Such a plan can only be met with a massive investment in “green” technology. This relates to rare earth metals because of their extensive use in the latest wind turbines and in electric cars. Traditional wind turbines have gearboxes that were prone to breakdown. The new rare earth-based permanent magnet generators have no moving parts and are therefore far less costly in servicing in their often extreme, offshore locations. They are quickly becoming the turbine of choice for companies like Vestas (VWDRY.PK), GE (GE), and Siemens (SI).
Likewise, each Prius uses 2.2 pounds of neodymium in its electric motor magnets, and 20-30 pounds of lanthanum in its batteries. And those amounts will only go up as the car’s powertrain continues to evolve for more efficiency.
Earlier this year, China declared an ambitious national plan to reach a production rate of one million electric cars per year. Metal expert Jack Lifton has suggested that this plan would require at least 10 tons of terbium, 50 tons of dysprosium, and a staggering one thousand metric tons of lanthanum per year. This followed a Beijing plan for 330 Gig watts of wind turbine energy by 2020. Lifton suggests this ten year project -– if completed as spec-ed -- will absorb a total of 59,000 metric tons of neodymium, 1,000 tons of terbium and 3000 tons of dysprosium.
Collectively, these national plans create a very “tall order.” Producing all those green products is going to soak up a lot of rare earths. That is why on October 18, the Secretary General of the Chinese rare earths industry association suggested that domestic Chinese demand for REEs is likely to soar. He wasn’t trying to “scare the West.” He was simply recognizing what this new plan meant for his industry. He sees in-China use rising from 75,000 tons per year today to 130,000 tons in five years. Domestic demand for terbium and dysprosium -- the far rarer “heavy rare earths" -- will be huge. This is why foreign export -- though presently 40% of 2009 levels -- will be reduced further. This is why -- leak denials aside -- exports might be outlawed in 2011.
An New Era
It appears that the developing world is being asked to source its own rare earths. Many of its products -- wind turbines, MRI machines, and electric cars -- will be adversely affected in the interim two or three years before the new mines produce.
This brings me to the individual names. For the sake of brevity, I will focus on Molycorp and Ucore, the two companies that offer the federal government a set of core US-located assets that best solve its national security issues if properly subsidized. (A US-blessed buyout of Ucore by Molycorp is not out of the question.) How will Molycorp fare? The company has high ambitions for itself as a stand alone, high volume, and vertically integrated provider. It has many things going for it. Its Mountain Pass mine is well-located and its refurbishment might move smoothly. A recent debt facility arrangement with BNP Paribas (BNPQY.PK) and its $379 million IPO suggests the money is there to get its supply chain up and running.
The question remains, though, just how well a large American “standalone” will work against Japan and Korea’s more corporatist model. Though less directly statist than China, these nations use a “guided market” approach which will subsidize the mining and refining processes, shouldering its cost across the zaibatsu / chaebol framework. One example: Japan has recently drawn up a $78 million rare earths strategy, working with Toyota on a task force. Toyota’s trading arm, Toyota Tsusho Corp (TYHOF.PK), which absorbed rare earth importer Wako Bussan a year ago, quickly formed a joint venture with Sojitz Corp. (SZHFF.PK) and a Vietnamese state-run miner. A direct line can now be drawn from oxide to finished product, and that helps assure that that the capital intensive mines are not buffeted by boom-bust profitability issues.
Molycorp has suggested that its new refining processes will create magnets that are half the price offered by China. This is certainly an attractive proposition. It will also have a cerium-based water filtration product in addition to its magnet business. But GE is apparently working on a nanotech solution that cuts REE usage for its electro-magnetic motors, as have the Japanese. And a Republican victory might slow the whole wind turbine “green infrastructure” initiative in the US. The question remains whether Molycorp can grow to a large scale as a “light rare earths” (LREE) provider. The LREEs are far more common and their oxides will likely be ubiquitous in a few years when every Vietnamese or Indian miner with pluck starts producing. Japan just cut a deal with New Delhi on this over the weekend.
At present, the rare earth metal market is only a $1.5 billion market globally. As I have shown, the market may triple in three years based on China’s doubling of use and a reversion to higher, more appropriate pricing in the West. Molycorp clearly has an opportunity to dominate the US and European sphere. But one can make a strong argument that –- for a North American producer -- only a smaller, “right-sized” miner focused on the truly rare “heavy rare earths” will thrive. The heavy rare earths are those elements above 62, starting with Europium 63. Of the four metals most critical for permanent magnets, neodymium and praseodymium are light REEs while terbium and dysprosium are heavy REEs. Full access to elements like terbium and dysprosium are what the Defense Department needs for its drones, guided missiles, quiet helicopters, and sonar equipment. Securing those sources within US legal jurisdiction is perhaps the best use of the RESTART Act.
An American HREE Play
This brings me to Ucore Rare Earth Metals -- the only company in possession of a HREE-rich property within the US. How “core” will Ucore be to the American defense act that recently passed the House? It really depends on how you define the word “RESTART.” An acronym for “The Rare Earths Supply-Chain Technology and Resources Transformation Act of 2010,” the RESTART Act is really the foundation stone for all viable US REE mining.
The Act passed the House in September and has three stated missions. After creating an Assistant Secretary-level “Agent,” the US government will:
1. Re-establish a competitive domestic rare earths supply chain.
2. Create a national stockpile.
3. Buy rare earths from the People’s Republic of China to meet national security and economic needs.
A literal reading of “restart” emphasizes tenet 1 -- that we “reestablish” domestic suppliers, employing properties or companies that will be within the US legal jurisdiction. This avoids the issues of trade dependence or the vicissitudes of foreign company ownership. Will the Aussies “go to the mat” for us when Lynas (LYSCF.PK) gets bought up by Chinalco five years from now? Wasn’t that recent Businessweek article “Red Star over Australia” a glimpse at a new economically-induced alignment?
Of course creating a “national US stockpile” designed to maintain demand for these miners would be a real plus for Molycorp or Ucore, keeping them from boom-bust cycles. But creating a national stockpile that opportunistically buys rare earths from China or its smugglers, leaving the two begging, doesn’t help. In many ways Ucore is a call option on a geologic fact meeting a geopolitical imperative. The Canadian company that trades in the pennies but it has a few impressive things going for it. The company reminds me of the old Mark Twain adage about investments: “Buy real estate. They’ve stopped making it.”
Though the US is a large country blessed with enormous resources, from coal to timber to uranium, there is only one place in the US that offers high heavy rare earth content that is accessible to existing transport. That is Ucore’s Bokan Mountain site. The Bokan-Dotson Ridge is about 50 miles southwest of Ketchikan, AL with its main mining site complete with pre-existing roads. Terbium, dysprosium, and samarium have been found in high grades in the area.
Like Molycorp’s Mountain Pass mine, Ucore’s Bokan was a focus of US Cold War-related scrutiny and procurement. In 1989, the area was studied by the US Bureau of Mines for its heavy rare earths content. The study -- which proceeded NI 43-101 compliance -- estimated 37.8 million tons grading at .50 TREO, tilted highly to HREEs. This summer the US Geological Society sent a team to Bokan, following the July 10th Chinese state intervention in its rare earths industry. The field work was completed by September, analyzing vein-type REE deposits throughout a number of areas including Sunday Lake, which apparently yielded the highest HREEs on record for a North American location.
The company’s own May 2010 drilling for two specific areas -- Dotson and I&L -- also suggest an impressive yield. The revised model generates 3.5 to 6.5 million tons with a grade ranging from .76% to 1.42% total rare earth oxides, 40% of which is heavy rare earth content. One distinguished geologist has voiced concerns about the selective mining methods necessary at the site, but the increasing rarity of HREEs, the US location and the political nature of US federal subsidies are likely to make this less important.
On October 16, China’s Ministry of Commerce voiced fears that the country will “run out” of its heavy rare earths within 15 years at the present rate of production. As I mentioned earlier, domestic demand for terbium and dysprosium -- the far rarer “heavy rare earths" -- will be huge in China in the coming decade and production is ramping up sharply. The price of Dysprosium FOB China has gone from $50.00 in 2005 to $290.00 in Oct. 2010, with that number often double outside the mainland.
Thus, in the strangest of reversals, Ucore could conceivably be exporting HREEs to China in 10 years. This would only apply to the “heavies” not the LREEs, though they too have seen depletion. According to Professor Xu Guangxian of Peking University:
China used to have about 43 per cent of rare earth reserves worldwide, but this may have fallen to about 30 per cent now.
Another plus for Ucore: Alaskan legislators had a hand in writing the RESTART Act and will lobby hard for it. And I’m fine with that. If large loan guarantees and subsidies are to come from the US government, it would preferable to have them go to the construction of US-located facilities, US jobs, and affiliated development.
On Friday, China ended its “informal” rare earths embargo of the West, with shipments resuming to Japan, the US, and Europe after a speech by the Secretary of State Clinton appeared to raise the diplomatic stakes. Meeting with Japanese officials in Honolulu on October 28, she called the embargo a “wake-up call”:
This served as a wake-up call (about) being so dependent on only one source... The entire world has to seek additional supplies in order to protect the important production needs that these materials serve.
For “stealth heavy” Ucore -- a call option on geology meeting geopolitics -- this is precisely the kind of upper-level executive branch rhetoric you want to see.
 STRATFOR Special Report: “China and the Future of Rare Earth Elements,” October 12, 2010
 What does it mean for the average American? Higher costs and the knowledge that all those cutting-edge gadgets that telegraph “ain’t it cool” individuality and “off the grid” independence source back to some stodgy People’s Republic committee. The ghost of F. E. Hayek would not be pleased.
 As the People’s Daily is officially sponsored and supervised by the PRC, all “leaks” are assumed to have government sanction.
 China denied this development in a later statement.