Rare Earths, Major Headache

The tsunami that struck Japan March 11, 2011, and the subsequent nuclear emergency at Fukushima Daiichi nuclear power plant offered the world a dramatic lesson in how vulnerable complex manufacturing supply chains can be. But supply chain risks don't only come from natural emergencies. What if a country could unleash a supply chain storm by restricting access to critical elements for a host of applications ranging from refining oil to polishing glass to building tablet computers and M1A2 Abrams tanks?

Critics say that is just what China did in 2010 when it started cutting back on exports of rare earths and even imposed a brief, unofficial embargo. Chinese officials said they were taking this step in order to improve environmental conditions at Chinese mines and to shut down illegal operations. Some analysts, though, believe China's newfound concern about the environment is a ruse to control prices of rare earths and to move up the value chain, from simply mining the minerals to processing them and then producing products.

For many minerals, the Chinese move would have been an inconvenience. But since the early 1990s, China has virtually cornered the market on rare earths, the collective label for 17 minerals that are not only critical to many emerging commercial applications such as wind turbines, but which are employed in a host of national defense products as well. For the past two decades, China has dominated the production and processing of rare earths, driving U.S. producers out of the market.

It didn't take long for the effects of the Chinese announcement to impact the market. For example, one rare earth, dysprosium, cost about $250 per kilogram in 2004, notes Chris Berry, founder of House Mountain Partners. In the first seven months of 2011, the price of dysprosium shot up to $2,500 per kilogram. Even now, this rare earth still costs about $1,400.

At Molycorp's innovative paste tailings facility, most of the water from mine tailings is removed for recycling, and creates tailings with the consistency of "paste," which allows for environmentally superior, long-term storage.

On March 13, President Obama raised the profile of the rare earths dispute when he announced the United States would be joining the European Union and Japan in bringing a complaint against China to the World Trade Organization. Noting that rare earths are used in products ranging from hybrid cars to cell phones, Obama says U.S. manufacturers need to have access to rare earths to produce those products in the United States. China's current policies, he says, "are preventing that from happening."

"Being able to manufacture advanced batteries and hybrid cars in America is too important for us to stand by and do nothing," says Obama. "We've got to take control of our energy future, and we can't let that energy industry take root in some other country because they were allowed to break the rules."

EU Trade Commissioner Karel De Gucht charges that China had not changed its policies despite a previous WTO ruling in January that China was not providing required access to raw materials.

"China imposes a set of export restrictions, including export quotas, export duties and additional requirements that limit access to these products for companies outside China," according to an EU statement. "These measures significantly distort the market and favor Chinese industry at the expense of companies and consumers in the EU."

Mixed Reaction from Business

Business reaction to the move was mixed. American Iron and Steel Institute President Thomas Gibson says his industry is pleased to see the United States "tackle China's attempts to use export restrictions on raw materials to force foreign companies to shift industrial production and technology to China."

Scott Paul, executive director of the Alliance for American Manufacturing, calls the administration's shift to more aggressive enforcement "welcome news for America's workers and businesses as they face both subsidized Chinese competition in America and restricted access to China's marketplace."

But economist Alan Tonelson of the U.S. Business and Industry Council, which represents 2,000 domestic manufacturers, says the trade complaints had "zero potential" to help domestic industries in the foreseeable future.

"As just illustrated by its new Boeing-Airbus ruling, the World Trade Organization procedures he plans to use work painfully slowly, and genuine enforcement of decisions is excruciatingly difficult," Tonelson says.

Calling the WTO dispute a "distraction," Derek Scissors of The Heritage Foundation wrote on the think tank's blog "The Foundry" that what the United States really should complain about is not the rare earths quotas but rather "anti-competitive Chinese behavior in rare earths both in the global market and in China itself."

Scissors wrote that the "heart of the matter is that China subsidizes its firms so they can outcompete everyone else's internationally but uses regulations to prohibit competition at home. It's a win-win: China wins at home and China wins overseas."

No Quick Fix

If the rare earths crisis seemed to arrive with startling speed, one thing that is clear is that there will be no quick fix.

"We are still under the best of circumstances five to 10 years away from having our own legitimate, self-sufficient supply chain for rare earth elements in this country," says Berry. The West needs to not only mine new sources but to develop processing capacity. Experts says it also needs to rebuild its metallurgical intellectual capital.

Still, the Chinese actions have set off a flurry of exploration around the world. Gareth Hatch, a founding principal with Technology Metals Research who covers the technology minerals market, is tracking more than 400 projects trying to find and develop sources of rare earths.

Hatch points out that perhaps a dozen of these projects were underway five years ago. That was because exploration firms recognized there would be increasing demand for rare earths due to their unique properties. These firms knew that China had a virtual monopoly on the supply of rare earths, with an estimated 97% of the market.

Molycorp Mine in Production

Farthest along in the United States is the Molycorp mine at Mountain Pass, Calif. The mine had been shut down for 10 years because it was cheaper to buy rare earths from China. The mine is now back in production, and the company has made a series of acquisitions in pursuit of a "mine to magnet" vertical-integration strategy.

Manufacturers using rare earths have reacted to the sharp rise in rises by trying to reformulate products and processes so they use less rare earths or eliminate them entirely. They are also seeking alternative sources of rare earths, so they are not completely dependent on China. For example, Toyota Tsusho, the trading company of the Toyota Motor Group, has signed a memorandum of understanding with Matamec Explorations Inc. to speed up production from Matamec's Kipawa heavy rare earths deposit.

When China started to tighten its quotas for rare earths in the fall of 2010, Grace Catalysts Technologies soon felt the impact. Grace uses the rare earth lanthanum in the manufacture of fluid catalytic cracking catalysts and additives. Shawn Abrams, president of the W.R. Grace & Co. division, says the company was forced to institute a rare earth surcharge as local supplies of rare earths dried up and the company had to order directly from China. "Pricing started to accelerate rapidly, almost on a per week basis, from Q3 to the latter part of 2011," Abrams recalls.

Grace took a number of steps to secure its supply chain and shield customers from pricing volatility. In November 2011, Grace signed a contract with Molycorp which could supply Grace with more than 75% of the lanthanum production from Molycorp's Mountain Pass mine.

Grace is also pursuing products that use either reduced or no rare earths. Last June, Grace introduced eight fluid catalytic cracking catalysts -- five in a Replacer family of catalysts with zero or low rare-earth content and a ResidUltra catalyst with 40% lower rare earth content than in comparable products.

Abrams says the low rare-earth catalysts are performing well compared to the products with rare earths and are saving customers up to $2,000 of rare-earth surcharge.

"Customers have reduced the amount of rare earths in their catalysts virtually across the board," Abrams says.

While acknowledging "many unknowns" in the situation, he says he is comfortable Grace has a "portfolio of products that will allow us to go in whatever direction rare earth goes. If prices spike back up, our customers know we have the low-no formulations. If prices were to stabilize back where they were before, our customers can consider if they want to go back into more rare earths in their product."

Rare earths make up anywhere from 0% to 35% of the glass products produced by Schott Advanced Optics. The company uses rare earths in glass products for night vision lenses, lasers and filter materials. Schott also uses cerium oxide in the polishing of glass.

"We really can't replace them in our formulations," says Heather Rayle, vice president and general manager for the Schott North America business unit. "The materials are key to obtaining the physical properties our customers require in some different refractive index and even how well the glass transmits. We have talked to a few customers about requalifying new glasses that have slightly less rare earths but in general we are stuck with the situation as it is."

The major rare earth Schott uses is lanthanum oxide. "In 2009, our average price for lanthanum oxide was $13 a kilogram," recalls Rayle. "In June 2011, it was $208 per kilogram."

As prices rapidly rose, Schott was forced to pass along price increases. "We literally shared our invoices and quotes with customers to show them that all we were doing was passing along the costs that we were bearing," says Rayle. "In the peak of the summer when everybody was in a panic to procure materials, you would literally get quotes that were good for 24 hours because prices were changing so fast."

At Significant Risk

Schott has secured a second source of rare earths in Asia, but Rayle says the company remains at "significant risk of another spike." While the company has adequate supplies of the minerals now, she says the question remains, "What will the Chinese government do in the future? Will they reduce the quotas further to the point you may not be able to get the materials?"

At a House subcommittee hearing last September, Christine Parthemore said the rare earths dispute should have been "predictable." Parthemore, a fellow with the Center for a New American Security, said: "In previous disruptions of minerals critical to defense assets and private sector demand -- rhenium, uranium and cobalt, for example -- supplier concentration appears to be a consistent and strong warning sign that exporting countries are likely to use their mineral supplies for geopolitical leverage. The global trends leading to China's dominance in supplying rare earths exports have been clear for years."

Given the Chinese government's concern about social stability, Parthemore testified, it was a "safe assumption that it would eventually focus greater attention on reducing the environmental impacts of rare earths production. It is also predictable that the Chinese government would act to wield the political power and strategic advantage its corner on rare earths supplies has created."