On Rare-Earths, Quotas And Embargoes

As we approach the end of October 2010, initial news coverage of disruptions in the Chinese supply of rare earths to Japan, has given way to news of similar disruptions to the USA and to Europe. The majority of coverage accuses China of imposing an embargo on its rare-earth exports, in retaliation for specific actions taken by various countries. Such actions apparently include the arrest of a Chinese fishing-vessel captain close to disputed islands in the East China Sea; criticism by the USA of China’s currency policies; allegations of illegal subsidies to its domestic renewable-energy industry; and a wide-ranging formal complaint against China, filed by a US steelworkers’ union, with the US Trade Representative.

Chinese officials as senior as the country’s premier, Wen Jiabao, have publicly denied that there is any such official embargo, and that China would not use its dominance in the production of rare earths as a bargaining chip when dealing with other nations. To complicate matters further, however, there are now stories circulating that the authorities in China have plans to further reduce the semi-annual export-quota numbers by 30%, though such initial reports were swiftly denied by the authorities.

It is thus rather challenging to figure out just what exactly is going on in this space at the moment. Certainly it is possible that there really is an official embargo in place, despite denials from the Chinese authorities, but there are also a number of other more plausible explanations, which, either individually or in combination, may well explain what has happened.

Before getting to those possibilities, let’s look at what we do know – some facts that few people will likely dispute:

1. Rare earths are not listed on a metals exchange; thus there is no “official” price for rare-earth elements or their compounds, and the buying and selling of these materials occurs on a company-to-company basis. This might involve intermediary traders, but essentially they are traded one deal at a time, with a variety of pricing and delivery mechanisms used to conclude the transactions;
2. The authorities in China have issued official export quotas on the rare earths for the last six years, including 2010;
3. The total quotas are made up of export limits that are allocated to individual companies within China. It is difficult to determine on what basis specific limits are given to specific companies; the allocations appear at first glance to be arbitrary, and Chinese-owned companies as a group are given significantly higher allocations than foreign-owned companies [though the actual number of companies that fall into each of these groups may be a factor here];
4. The export quotas allocated to these companies are monolithic – i.e. they do not differentiate between specific rare-earth elements, in either metallic or compound form. The quota levels relate to total exports of all rare earths collectively;
5. The export quotas are allocated to raw rare-earth materials only. They do not apply to semi-finished or finished alloys, compounds or components that contain rare earths; they do not apply to devices and systems that contain such components. In other words, companies in China, be they foreign-owned or otherwise, at present have no restrictions on the amount of such goods that they can export, on the basis of rare-earth content alone;
6. If we compare the annual quota numbers officially issued by China for the past six years, to the estimated demand outside of China for those years, based on official numbers, we see that in each year prior to 2010, this demand did not exceed the official quota level that was issued;
7. Even if we factor in the demand outside of China that was satisfied through the export of uncontrolled or illegally mined rare earths in China [estimated by some to satisfy around 20-30% of the actual total demand outside of China], and then factor in the demand that was supplied by sources outside of China [perhaps 10-15% of total demand outside of China, produced in Russia, India and the USA] we can see that the official Chinese quota numbers have been in the vicinity of actual “rest of the world” [ROW] demand.

This latter point is better illustrated in the following chart [click on the image or here to enlarge], where the “Official ROW Demand From China” data points represent the “official” numbers [overall ROW demand minus the rare earths supplied from sources outside of China] whereas the “Actual ROW Demand From China” also factors in an estimated uncontrolled / illegal supply equal to 25% of official numbers for overall ROW demand:

Note that the basic demand data was obtained from IMCOA, who allocates a 15% margin of error on those numbers. What this chart also shows us is just how sensitive the overall supply situation is, to the uncontrolled and illegal sources in China at present.

So, with all of that said, let’s turn back to the current issue of supply disruption. Note that I am not an expert on the import / export of commodities; however, just a little thinking on this subject, coupled with the “facts” listed above, yields a surprising number of possible explanations – some or all of which may be in play here. Here are seven HYPOTHETICAL possibilities to start with:

1. There is an official embargo in place on the export of rare-earth materials to countries outside of China, and the authorities have been untruthful when denying that such an embargo exists;
2. Individual companies outside of China [ROW companies] are trying to do business with individual trading companies based in China [Chinese companies], whose quota allocations are running out. Such companies have decided to refuse to export certain rare earths to those external customers, because they want to reserve the rest of their dwindling quota allocation, for the export of rare earths of higher value than those being requested;
3. ROW companies are trying to do business with Chinese companies, whose quota allocations have already run out, and such companies are declining any further exports of rare earths as a result;
4. ROW companies have done business [unwittingly or otherwise] with Chinese companies whose quota allocations have already run out, but the Chinese companies attempted to ship product to their customers anyway. The shipments were delayed or stopped altogether because Chinese customs officials did routine inspections, and found that the shipments were in contravention of the quota allocation given to those individual companies;
5. Having encountered the situation outlined in scenario 4, an official memo was sent out to all Chinese customs officials to carefully scrutinize all exports of rare-earth materials from some or all of the traders permitted to make such exports, because transgressions have been detected – leading to further detections, delays and prevention of shipments;
6. A variation on scenarios 3-5 occurs in cases where ROW companies have been buying rare earths [unwittingly or otherwise] from unlicensed or illegal sources in China, and where such exports have been detected by the Chinese authorities.
7. ROW companies who do not interact directly with Chinese companies, are dealing with intermediaries who are. Such intermediaries [unwitting or otherwise] have been caught up in any or all of the above scenarios, and have either been truthful with their ROW customers, or less than truthful, on the real issues concerning delays in supply.

So those are seven possibilities for a start. I am sure there are others. Combinations of the above, together with a lack of effective communication that is frequently encountered between ROW and Chinese companies, make for a complex set of possible reasons for the current supply disruption, a complexity not well-understood or reported on in the recent press coverage.

This latter issue of communication is especially aggravating, given the common practice of Chinese companies to neglect to provide updates and information on production or other logistical issues, even in the best of times. There are differences in business culture here that in my opinion, have been significantly under-estimated as a secondary factor in making a difficult situation worse. The Chinese authorities, too, have also done a pretty ineffective job of properly explaining their own point of view, on the actual root causes of the supply disruptions.

So let’s come back to the topic of the export quotas for a moment. It is entirely possible that future export quotas will be allocated to specific companies in a more granular fashion i.e. allocations will be determined based on individual rare earths, or groups of rare earths [such as lights or heavies]. Given recent comments from the Chinese authorities over concerns of dwindling supplies of heavy rare earths, such a move would be a logical way of streamlining the quota process and to make it more discriminating.

In addition, it is clear that many outside of China are not convinced by China’s principal argument for reducing exports of rare earths – specifically that it is required in order to clean up the environmental mess that has been created, as a result of unregulated, full-bore production to date. This argument would be strengthened considerably if the Chinese authorities used quotas to either restrict the overall production of rare earths within China [regardless of the destination of those rare earths] or to restrict the total quantity of rare earths to be sold by each Chinese trader, instead of just the amount to be exported. Either or both of these changes, would allow the Chinese authorities to still achieve their stated aims of clean-up and consolidation within the industry, without falling afoul of accusations that the export quotas are simply a way to control the rest of the world. They would also effectively counter criticism that the Chinese are simply running up prices for those exports, making it even more difficult for rare-earth users outside of China to compete with those inside the country, than it already is.

This growing disparity in export vs. domestic pricing for rare earths is clearly beginning to erode the confidence of those outside of China who bought into China’s original explanations for the quotas in the first place. It is clearly reasonable for China to want to do what it needs to do in order to clean up the environmental damage caused by production in the past, and to generally want to conserve its natural resources for future use. Making the quotas fairer would give significant weight to these explanations.

Finally, speaking of environmental issues, the West could stand to do some self-scrutiny of its own. The excessive paperwork and bureaucracy associated with the permitting of new rare-earth and other rare-metals projects, in certain Western jurisdictions, has had a significantly negative impact on the progress and viability of such projects. Safeguarding the health and safety of people, and taking care of the environment should of course always be top priorities, but it appears that some jurisdictions fail to see the wood for the trees with these processes. As my colleague Jack Lifton likes to say, the road to the green economy starts in the black earth, i.e. the metals that go into components and devices vital for sustainable technologies, have to be mined and processed somewhere.

It is perhaps a little ironic then, that it is a growing awareness of the importance of these two priorities – taking care of the people and their environment – that is the key driver, ostensibly at least, in the imposition of China’s export quotas on rare earths in the first place.