China's rare earth grip
BY PETER KOVEN, FINANCIAL POSTNOVEMBER 20, 2010
Constantine Karayannopoulos still finds all the attention hard to believe.
In the grand scheme of things, his industry is microscopic. The entire sector is not worth
much more than US$1-billion. Maybe US$2-billion.
Yet the rare earth industry seems to be dominating political discourse around the world, and
was recently at the centre of a major diplomatic stand-off between China and Japan. Now,
with China taking outrageous measures to control supply, an ugly trade war with the West
could loom on the horizon.
The idea that China would instigate a trade war over an industry as tiny as rare earths seems
absurd, and it is certainly not something Mr. Karayannopoulos ever thought he would see.
But in 1993, the CEO of Toronto-based Neo Material Technologies Inc. did realize one thing
that took the world much longer to figure out. That call has made his shareholders a lot of
money.
“You can’t fight nature, and nature has given China by far the best rare earth deposits in the
world,” he says. “We knew it was only a matter of time before they dominated the space.”
China has done just that. Ever since former leader Deng Xiaoping allegedly said “There is oil
in the Middle East; there are rare earths in China,” the industry has become a mantra for the
Chinese people.
The rare earth elements go by nearly unpronounceable names such as neodymium,
dysprosium, ytterbium and gadolinium. While total production of these 17 metals amounts to
a paltry 120,000 tonnes a year, they are needed in a huge variety of applications: consumer
electronics, automotive components, green energy technology, cruise missiles and many
others. There are no known substitutes.
In Zibo, a gritty industrial city in China’s Shandong province, Neo Material takes the raw
material from Chinese mines and separates the elements into individual chlorides through a
solvent extraction process. It then creates high-purity light rare earth products for export,
particularly cerium and neodymium, used in catalytic converters in cars.
While the technology is straightforward, it has also proved impossible to replicate. China is
not exactly known for its intellectual property protection, and there have been numerous
attempts to steal and copy Neo Material’s processes. “All the Chinese producers look at what
we do and then they try to do it. It’s inevitable that they figure it out. But by the time they
figure it out, we’re onto the next thing,” Mr. Karayannopoulos says.
Neo Material, which has three facilities in China and one in Thailand, was started by former
investment banker Peter Gundy, who was approached by the Chinese about setting up a
trading company to sell rare earths to the West out of a factory in China.
At the time, the quality of rare earth products coming out of China was awful. Mr. Gundy
decided the only way to make it work was to control the entire supply chain, including the
production in China, in order to make products that could meet the needs of customers. He
sent his right-hand man, former Toronto mayoral candidate Rocco Rossi, and Mr.
Karayannopoulos to China to close the first deal in 1993.
China was not yet a dominant player in rare earths, but the Neo Material founders had no
doubt it would happen. What they realized is that China’s production costs were going to be
so low that nobody else could possibly compete.
Gradually, other producers would disappear and China would control the market. Getting in
early only made sense.
That is exactly what happened. Today, China produces roughly 95% of the world’s rare earth
supply.
Media reports have often pegged China’s rare earth cost advantage on poor environmental
standards, which are a problem in the chaotic mining operations in Southern China. But the
truth, according to experts, is that China’s largest source of rare earths does not even come
from a rare earth mine. Rather, it comes out of the tailings (or waste material) from the giant
Baotou iron ore mine in the province of Inner Mongolia in Northern China.
The vast majority of the tailings from Baotou goes to the tailings pond, where it is disposed
of. The rest gets taken away and processed into light rare earths. Because the rare earths
are being recovered from waste material, the production cost is microscopic.“To put it in
perspective, they have historically wasted three times the amount of rare earths that they
have been recovering, although this may be changing,” Mr. Karayannopoulos says.
Southern China is also home to low-grade rare earth clay deposits. A cheap processing
method is used to covert them into high-purity product.
As production from these sources continued to ramp up in the 1990s, there was massive
overcapacity built in China, and prices collapsed. The Chinese government introduced the
first export quotas in 1999.
There was still more than enough supply reaching other markets to keep everyone happy.
And there was no real talk of a problem in the sector until the past couple of years, when
growing global demand for rare earths highlighted the fact that China had put everyone else
out of business. Comments from Chinese government officials started to suggest that they
view the industry as more strategic than ever before, and were intent on securing more
supply for domestic use. They started taking measures to consolidate domestic supply and
reduce smuggling.
Then on July 8, the government dropped the bomb: rare earth export quotas would be
immediately reduced by a staggering 72% for the second half of 2010, capping them at
7,976 tonnes. Chinese officials have also suggested that further cuts are coming next year.
It’s no surprise export prices have quickly moved up.
The response from the international community has been furious. U.S., Japanese and
European officials have mused about filing a case against China with the World Trade
Organization. The U.S. House of Representatives also passed an act to find and develop
substitutions for Chinese rare earths. In Japan, the impact is even more immediate. Shortly
after Japan detained a Chinese fishing boat that collided with Japanese boats in disputed
waters in September, China’s exports of rare earths to Japan ground to a virtual halt. They
picked up again only this week, according to reports.
The export quota crisis is entirely of China’s making, and thus raises an obvious question:
What was the government thinking? “It’s not a particularly big business in the big picture.
And why the Chinese would take that risk [of a trade war] over it, I don’t know,” says Don
Bubar, chief executive of Toronto-based Avalon Rare Metals Inc.
The most obvious answer seems to be that China wants to force foreign companies to
consolidate supply chains in-country, moving jobs into China and away from everywhere
else. By locating in China, U.S. and Japanese companies would never have to worry about
rare earth supply again, and China would get access to more of their technological
innovations. That brings new meaning to the term “strategic resource.”
This process is already happening, and the result is stronger demand from within China.
Today, more than half of Neo Material’s production stays in China; in the 1990s, at least 90%
of it was exported.
There is another theory behind the export quotas that, as far-fetched as it sounds, is gaining
traction: that this entire dispute is about the U.S. military, which China wants to keep
contained.
Military applications make up less than 1% of total rare earth demand, according to experts.
Yet in the United States, fear-mongering media reports have suggested China controls the
fate of the U.S. military, theories that have been perpetuated both by U.S. military hawks and
by junior mining companies trying to justify questionable rare earth deposits scattered around
North America.
Even the most bullish rare earth commentators will acknowledge the rhetoric has become
overheated. Yet it has served one good purpose: it has forced the rest of the world to get its
act together.
While there is no rare earth source that can match the Baotou tailings dump, these deposits
can be found all over the world. China’s actions have put this issue firmly on the radar screen
and countries are getting serious about developing new sources. Two of the most promising
are in Canada: Avalon’s Thor Lake project in the Northwest Territories, and Montreal-based
Quest Rare Minerals Ltd.’s Strange Lake project in Quebec.
Even Mr. Karayannopoulos, as big a believer in China’s rare earths as anyone, knows the
future lies outside China as well. Neo Material recently struck a framework agreement with
Molycorp Inc., which is re-starting an old rare earth mine in California, and is working with a
firm in Brazil to capture rare earths from the tailings of a tin mine.
Yet it remains a China-dominated industry, and thanks to China’s superior deposits, it always
will be. “It’s difficult not to conclude that our future in North America and Europe is
inextricably related to what goes on in that part of the world,” says Mr. Karayannopoulos.
Financial Post
pkoven@nationalpost.com
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