The Rare Earth Crisis of 2009 – Part 2: The Green Wind Blows From China

The immediate consequences of total import reliance
DETROIT, Nov 8, 2009 — U.S. Senator Charles (Chuck) Schumer (D-NY) is up in arms about the fact that a wind power “farm” to be erected in Texas, would be made up of components entirely constructed in China, and would create in the USA only the temporary jobs needed to erect them and a few permanent jobs to maintain them – while providing work for more than a thousand Chinese. He is questioning why such a project should receive public money. I am amazed to find myself in total agreement with the Senator. The projects should not receive any public money, but this will entail, for the present, that they not be built. If the USA is to embark “On The Green Road” it must first establish a balance between environmental activism and economic necessity.

The real question to be addressed is why are the components being made in China? Can we do anything to cause them to be made in the USA?

The companies that mine rare earth metals in China are not public nor are they audited by independent third parties. There is no way of telling if they make a profit or what their cost structures are. Therefore, the prices for the rare earth metals are set and the price “discovery mechanisms” for the rare earths, are simply the prices for the metals “set” by the producers or the trading companies that export the metals from China. Is this why we cannot get rare earth mines financed in the West? How can we determine the long term value of their products? What is the value to be added for strategic necessity or criticality? Is there a green value to be added to the rare earths?

The hot air over the Texas wind farm is instructive if the larger issues are examined.

For any and all wind turbine generators designed to use rare earth based permanent magnets, with a handful of minor exceptions it is today necessary to have the magnets made in the People’s Republic of China (PRC). The growth of modern manufacturing technology and engineering in China, just since 1989, along with the – for the time being – lower cost of skilled labor in the PRC, also makes it economically beneficial to produce all of the components of permanent magnet type wind turbine generators in the PRC! One of Europe’s major producers of electric generators, Siemens, has, in fact, already begun construction of a world class wind turbine generator manufacturing facility in Inner Mongolia for the express purpose of serving the Chinese domestic market. America’s General Electric has been subcontracting the construction of any and all wind energy components, using rare earth based permanent magnets, to its partner companies in the PRC for most of the twenty-first century.

These are the current consequences of the non-production of any but trivial amounts of the rare earths outside of China, combined with the economic thinking of America’s business and government elites; the former want to maximize profit at any cost, the latter want revenue from the taxes on those profits. The economic future of the United States as an industrial manufacturing economy producing goods for both the domestic and export economies (one of only two ways to create wealth – the other being the production of natural resources to supply the industrial economy) does not seem to be of any interest to America’s business or government leaders.

In the 12th century Mongol military geniuses Kublai and Genghis Khan conquered China. When the new Mongol emperor turned his attention to the large island nation near China’s coast known then, dimly, to Europeans as Cipango, and now as Japan, he ordered an invasion fleet be constructed to ferry his Mongol warriors to an easy conquest. But, as the Japanese tell the story, the gods intervened and a “divine wind,” a kamikaze in the Japanese language was sent by the gods to blow the Mongol ships back to China, and it scattered and destroyed the Khan’s ships and drowned his soldiers. Japan was saved from the Mongols.

Ironically, miracles based on wind are turning out quite differently today. Now the wind from Inner Mongolia, today a Chinese province that produces essentially all of the world’s rare earths, is blowing strongly towards and across Japan – so strongly. in fact. that it has had noticeable effects as far away as the American “Lone Star” state, Texas.

Please take a moment to read the story in the Sunday, November 8, 2009 edition of the New York Times, which is entitled “Schumer Seeks to Block Stimulus Funds for Chinese Backed Texas Wind Farm.” Senator Schumer, a multiply elected senior (and therefore powerful) member of the United States Senate, has noticed that going green in America, through the erection of wind turbines to generate electricity sustainably without the need to burn fossil fuels, can and may well in fact create jobs – green jobs, I guess, but the majority of those jobs are to be created in the People’s Republic of China. Ironically, most of the jobs created or “maintained” in China by the proposed wind farm in Texas, will be in Mongolia – talk about a divine wind.

In my article “The Rare Earth Crisis of 2009 – Part 1” [available for free download to subscribers – just fill out the form in the top right of this page] as if the rare earth story was unique. In thinking further about this topic, I have come to realize that the looming “crisis” is only symbolized by and, due to some perhaps precipitous Chinese “trial balloon” announcements, actualized by the current situation in which the Chinese have a monopoly on the “production” of rare earths. This is in addition to their refining, the production of metals and their alloys, and the production of end-use products critically dependent on the properties of the rare earths. Keep in mind that the Chinese today monopolize the entire supply chain for the rare earth metals. Note well that this means that they also control the benefits accruing from the value chain, for the production of rare earth based technologies. Controlling the value chain means that the added money value of the mining, refining, fabricating, and assembly of components and devices based on the rare earths, translates into jobs for Chinese workers, directly in China. This is called “wealth creation”, for those of you who think that consuming is the paramount economic activity.

Chinese businessmen with whom I have spoken, typically evince disbelief when I tell them that Americans, especially the business leaders, do not understand the core value of maintaining high employment in China as a driver for many so-called “mysterious” or “sinister” Chinese actions in the natural resource acquisition and utilization fields. They think that I am crazy when I tell them that American business and government leaders mistake the value that the Chinese put on full employment, for the productivity gains that in America allow a manufacturing company to contain costs and maintain prices. They, the Chinese, think it is obvious that they put as great a value on employment, as the so-called free market economies put on “profitability.”

Institutional investors have been so far reluctant to finance the development of rare earth mining in the non-Chinese world, because they and the governments under which they function are myopic.

If you examine the costs of putting a mine, any mine, into production you will find that for the hard-rock mining of metals it typically takes 5-7 years before any revenue can begin to flow from the mine. Even this relatively short time – in mining terms – requires that infrastructure be present or cheap and fast to build. Before mining starts, there must be adequate supplies of skilled and unskilled labor, water, electricity, and heavy transportation.

As if the very long wait for the return on investment for hard rock mining wasn’t enough, there is also the question of calculating whether or not there could even be a profitable return, or any return at all! This involves being able to predict both the price and the demand for the metal(s) to be mined, at the time in the future when production and delivery begin and during the life thereafter of the mine. The twenty-first century has been anomalous for mining promotion finance. The “new” economy of cheap money and high risk was a bonanza for mining stock promoters. All they had to do was incorporate a buzz-word into their prospectuses and someone would underwrite an office in Toronto or Vancouver as well as small mining camp and some drilling and chemical analysis. Thereafter announcements of the findings of high grade pebbles were clothed as findings of potentially large ore bodies. and money continued to be raised for offices, overhead, and public relations by junior miners always telling investors that they were in negotiation with a “major” miner to develop the property.

Institutional investors do not have the luxury of infinite time to value mining opportunities, and so they tend to be conservative. They have a difficult time separating the wheat from the chaff or the noise from the information.

Institutional investors interested in mining are not financial engineers. They have mostly missed the importance of the supply and value chains as a metric for the long term valuation of mining opportunities. Nowhere is this truer than in the rare earth space.

Rare earth mining did not begin in the USA, but it reached its first high point here at Mountain Pass, California, where in the early 1980s production levels of contained rare earths in concentrates reached more than 20,000 metric tons per year. This is a level that has not yet been surpassed by any one mine working from a single ore body. Yet, due to the rise of Chinese predominance in rare earth production today – which I have discussed elsewhere in great detail – the Mountain Pass operations of Molycorp today function solely by separating and refining above ground concentrates produced last in 2002, when low pricing from China forced the shutdown of rare earth mining operations.

While Mountain Pass was fighting to hold on to market share against intense Chinese competition over the last twenty-five years, the supply chain for end use products based on the properties of rare earth metals, simply abandoned the United States and removed itself mostly to China with a small amount going to Japan. China’s strategy was simple: if you wanted a secure supply of the rare earths for your product(s) then all you needed to do was to locate in, or re-locate to, China where your raw materials could be obtained, obtained for less, and your products produced by lower cost labor. This process worked so well that it can be viewed now as a paradigm, a model, for the Chinese process of improving a country’s domestic economy. One could say that the Chinese system is today “corner the natural resources and the world will come to you for its needs. Then you can cherry-pick what technologies and production you need domestically, and then, and only then, sell some of those raw materials to obtain the technologies and the manufacturing engineering. When you are secure and self sufficient simply cut off the supplies other than for exports you can spare.”

America has vast resources of rare earths, as does Canada. Ironically, China is now worried about running out of the heavy rare earths for its own domestic needs within 30 years -imagine that, an economy that worries about more than the share price, an economy that has a national long term strategy! Chinese and Japanese companies are now looking at these North American resources for the benefits of the economies of their home countries. They can only do this so long as North America does not any longer have a domestic supply chain to refine, produce metals and alloys, produce components, and assemble those components into end use products. North America has today remaining from its only recently complete rare earth supply and value chains, just two manufacturers of rare earth permanent magnets. Both buy the high purity rare earth metal, samarium, from Chinese suppliers, and both import cobalt from overseas. The main use of the products of these two suppliers is in critical military applications.

There is a movement in the US Congress called RESTART for the purpose of restarting the North American rare earth production and utilization industry as a closed loop supply and value chain. The Defense Appropriations Act for Fiscal Year 2010 requires that an immediate (due April 2010) assessment of the rare earth supply and demand situation be prepared for the Secretary of Defense. This is a very good start, but we must now devise a financial strategy, for private equity to allow an investment in a rare earth mining project to take into account the total end-use-product value, to determine the value of the mining project. This requires what the mining analyst John Kaiser calls strategic logic, as well as economic logic. And that requires government action in the form of guarantees or off-takes from mines not yet in production. Until such action is undertaken the wind from China will only get stronger.