July 30, 2017
Maybe Not So Rare After All
As the long term prognosis for the rare-earths business shows, the administration should move carefully in “strengthening supply chain resiliency.”
By James Hasik
On 18 June, Dennis Berman of the Wall Street Journal asked Commerce Secretary Wilbur Ross a general question about “buying American.” Ross quickly noted that the Buy America(n) Act(s) applied only to federal contracting. We might hope that this signaled at least a reticence for any general assault on free trade, in the name of making it “fair.” The rest of his answer, however, provided an interesting view of what the secretary thinks that industry should do on its own accord:
But I think people ought to think about short term versus long term. If I were an importer, I would beware of what happened already in the rare-earths [metals industry]. China is a very big supplier of rare earths, which are quite essential to many electronic products. They drove everybody in this country out of business by dumping, dumping, dumping, dumping. And guess what happened once they did? Prices suddenly went way up. And when they get angry with a country, they cut off the supplies. So long term, it seems to me, the interests of American businesses and of the president’s policy are totally consistent because there are no free lunches.
The episode to which Ross was referring was illustrated in an August 2011 briefing by long-time lighting manufacturer Osram Sylvania, which shows the drastic rise in prices of rare earths in 2010 and 2011. Sylvania rather pioneered the use of rare earth phosphors in lighting in the 1960s, when cerium oxide was discovered as an effective source of red in color televisions. Six years ago, the company was scrambling to find substitutes for cerium oxide as the price increased 35-fold in ten months. The proximate cause seems to have been Chinese export restrictions, following a maritime border dispute in September 2010 with Japan, the world’s largest importer of rare-earths. The secondary cause was fear of supply chain disruptions, which led to hoarding by both manufacturers and speculators, and sharp increases in prices.
At this point, it’s worth reviewing a little metallurgy. The rare earths constitute seventeen elements in the periodic table: the fifteen lanthanides (atomic numbers 57 through 71), plus scandium (21) and yttrium (39), which frequently occur in the same mineral deposits, and have some similar physical and chemical properties. Excepting promethium, these elements are actually fairly plentiful in the Earth’s crust. It’s their commercial extractability that’s rare, because those chemical properties cause them to be highly dispersed amongst other substances. Fortunately, little is needed for most applications. As such, single mines often produce a vast proportion of the quantities demanded globally. Four of the rare earths are named for a single quarry in Ytterby, Sweden, and the names of another three are drawn from their discovery there. For decades, almost all American production was from a single open-pit mine in Mountain Pass, California.
From there, the history gains some drama. In the opening of his 2014 study for the Council on Foreign Relations, Rare Earth Elements and National Security, Eugene Gholz (then of the University of Texas at Austin) summarized the situation neatly:
Until the 1990s, the United States was the dominant rare earths producer and China produced almost none. But Chinese companies enjoyed a combination of lower labor costs and relatively lax environmental regulations. Moreover, China’s biggest rare earth mine also produces iron ore, providing another revenue stream to help cover the mine’s fixed costs. By contrast, in 2002, the major U.S. mine shut down in the wake of complaints about environmental damage; the mine and associated processing plant needed capital investment and an arduous round of permit applications, and the owners (then Unocal) decided not to carry on. Meanwhile, Chinese production soared.
Gholz’s introduction leaves open the technical point of whether Chinese firms acquired market share, as Ross asserted, by actually dumping. According to the World Trade Organization’s rules, this is “bringing a product onto the market of another country at a price less than the normal value of that product.” The WTO discourages that, but does not prohibit it, and defines it without strong logic. Normal is taken in the first instance to mean the price at which the product is sold at home—i.e., in China. Where that number isn’t available—say, because the Chinese government treats basic economic statistics as national secrets—the WTO allows calling “normal” the export prices to other countries, or a price floor based on a calculation of the producers’ total average unit costs. Again, Chinese economic obscurantism makes these difficult to obtain too, so there is a whole section of people at the Commerce Department—the Antidumping and Countervailing Duty Operations Unit—concerned with estimating those costs. The logical problem remains: in theory, export prices could still be lower than domestic prices if domestic competition or buyer power is less intense than that in other countries. By that measure, plenty of American pharmaceutical exports would be dumping. It’s just that no one abroad laments low drug prices.
Regardless of any administrative finding, this relatively sudden shift in rare-earths supply meant a sudden import dependence for the United States. Gradually taking note of the issue, the federal government conducted several studies from 2009 through 2015, and concluded that small quantities of 7 to 15 of these elements may be “critical” to various military applications, including precision guidance and night-vision. However, as the Government Accountability Office noted last year, that range of numbers remains: the Pentgon’s Manufacturing and Industrial Base Policy (M&IBP) Office and the Defense Logistics Agency disagree considerably over which are critical, and by just how much. The range of findings has also evolved over time, as the actual degree of the long-term problem has become more clear.
Consider the study Remaking American Security, written in 2013 for the House of Representatives by reitred Brigadier General John Adams, and subtitled “Supply Chain Vulnerabilities and National Security Risks across the US Defense Industrial Base.” The monograph covered a wide range of issues, but the third chapter on “Specialty Metals” sounded an alarm on rare earths and other largely imported metals. The problem with Adams’ study was that its validity lasted less than a year: the “resource boom” in prices that he lamented as benefitting China and harming the US was quickly becoming a resource bust. The next year, Gholz (who is moving this coming semester to Notre Dame) wrote of how concern was even then overblown:
China’s advantages in the rare earths market were already slipping away as early as 2010 due to normal market behavior—particularly increases in non-Chinese production and processing capacity, as well as innovations that have helped to reduce demand for some of the most crucial [rare earth elements].
Gholz cited Joseph Sternberg’s January 2014 article in the Wall Street Journal, “How the Great Rare-Earth Metals Crisis Vanished,” which concluded that “China's attempt to control the market for materials essential to the tech industry is turning to dust.” Sternberg adds substitution and recycling as additional factors limiting the efficacy of any “dastardly plan” Beijing might concoct. In his study, Gholz further noted that Chinese mining and processing firms actively evaded the export restrictions by exploiting loopholes in its enforcement. But not everyone was getting the message. In his 2015 interview with Ali Velshi on the now-departed Al-Jazeera America, Gholz needed to reiterate that the world was awash with rare earths, with big suppliers like the American Molycorp entering bankruptcy due to steep declines in prices.
The same day that the WSJ published its interview with Commerce Secretary Ross, it also reviewed Victoria Bruce’s new book on the rare earths business—Sellout: How Washington Gave Away America's Technological Soul, and One Man's Fight to Bring It Home (Bloomsbury, 2017). If that sounds dramatic, her presentation in June at bookstore Politics & Prose—with Jim Kennedy, the “one man” of her title—was no less breathless. Kennedy has spent years trying to sell Washington on the idea of mining thorium at Mountain Pass, in an effort to restart the nuclear power industry, just with an untried technology. By that plan, the American mine would thus gain the other revenue stream that iron ore provides the Chinese. During the pitch, Bruce asserted that “you can’t make anything, you can’t bring back manufacturing of high-tech products, unless we have some kind of control here in the US.” This is nonsense. Plenty of countries with manufacturing capacity and expertise—e.g., Singapore, Japan, Germany—have little access to domestic deposits of rare earths, and yet aren’t panicking. Perhaps that’s because they’re lived with import dependence for decades, and perhaps because yet more adaptation has been afoot.
Molycorp was purchased out of that bankruptcy in 2015 by creditor Oaktree Capital Management, the world’s largest investor in distressed debt. The firm was reorganized as Neo Performance Materials, and now owns a rare-earths processing plant in Estonia. Its old Mountain Pass mine was separately purchased earlier this month for just $20.5 million by MP Mine Operations LLC, a consortium led by investment firms JHL Capital and QVT Financial. Their bid was half a million more than that of the competing consortium, composed of another American distressed debt investor, a Swiss private equity firm, and the Australian rare-earth mining company Peak Resources. The winning group, however, included rare-earths mining firm Shenghe Resources. Presumably someone needed to bring relevant expertise in mining what Americans haven’t much mined in fifteen years, so the Chinese firm got just under a ten percent stake.
In mid-July, Michael Silver, CEO of American Elements Corporation, told Bloomberg Politics that he had recently met at the White House with Steve Bannon, Sebastian Gorka, and the outgoing Reince Priebus to ask them to ask Donald Trump to nationalize Mountain Pass, to effectively create an in-ground stockpile of rare earths, rather akin to the National Petroleum Reserve in northwestern Alaska. Perhaps Silver is annoyed at the Chinese influence; he may more practically lament how the mine has remained closed for the past two years as JHL and QVT have fought with Oaktree for control of the operation. Those winning bidders were lower-ranked debt-holders, but they now own the mineral rights. Oaktree still owns most of the important mining equipment at the site. Perhaps negotiations are proceeding, but investors with a long view may feel no urgency to complete a deal. Meanwhile, American Elements would appreciate a domestic source of supply for the many chemical products it markets.
This latest chapter should induce three observations. First, plenty of Americans with money think that rare-earths mining is a good long-term investment—so good, they’re bickering over who will get paid how much. After all, any defense-minded industrialist can cheer a federal assessment of the industrial base and its supply chain resiliency. These happy few, however, have already started marching.
Second, American rare-earths mining appears a sufficiently enticing investment that a Chinese firm is sending its expertise to California. The economic nationalists allied with the administration often reflexively oppose the reverse, such as Boeing’s construction of an aircraft interiors factory in China. But if export of American expertise is bad, then how is JHL and QVT’s strategy to bring Chinese know-how here not good?
Third, the government isn’t always a passive observer of its supply chains. Sometimes it should at least feign disinterest; as some former Pentagon industrial policy chiefs have told me, there’s often a procession of industrialists in the M&IBP office begging favors to stave off some imminent collapse. The remedial actions are almost always, and with great success, left to industry to manage. In this case, it is possible that Silver’s call for the federal exercise of eminent domain will just provide the shadow of the law needed to hasten the deal. For his part, Jim Kennedy has been lamenting the federal government’s unwillingness to override the environmental regulations that have made rare-earths mining unprofitable in California. But Kennedy is a Missourian, and as such, he might remember the state motto: salus populi suprema lex. Though sometimes remembered as potum populi cerevisias rex, it means that the safety of the people shall be the highest law. Or as Cicero put it, inter arma enim silent leges: in war, laws fall silent. In the event of actual, high-intensity shooting of some duration, we can guarantee that Mountain Pass would be reopening.
Yet even so, as Warren C. Gibson of Santa Clara and San Jose State Universities wrote for the Foundation for Economic Education way back in 2010, stockpiling is problematic. Without market signals, it’s hard to know how much of what to hoard, and whether it will matter. In the 1960s and the 1990s, the federal government went through two rounds of surplus sales from stockpiles that looked silly in retrospect. For as the Defense Department learned again during the Iraq War, one can easily stockpile the wrong stuff. All those Humvees and MRAPs needed specialty steel for blast-resistance, but none had actually been bought in advance. Shopping abroad turned up plenty in Sweden and Israel, though the Swedes needed to be asked to divert their production from Chinese cellphone towers into American armored plate. And it’s not as though the National Petroleum Reserve or any policies out of the Energy Department have in any way been responsible for the rejuvenation of domestic oil production of late. That’s entirely the result of fracking, dreamt up by Texans, and put to use first in the Barnett Shale.
In contrast, when rare-earths prices were climbing in 2010, buyers were doing just what industrial policy would hope they’d do—stockpiling to prepare for further political disruptions in supply. Those people were weighing the long term against the short term, just as Ross asked, putting their own money in, and taking the risks themselves. Past administrations have complained plenty that industry doesn’t take risks when participating in the business of national defense. This administration shouldn’t discourage their enterprise by attempting to do too much of their work for them.
James Hasik is a senior fellow at the Brent Scowcroft Center on International Security.