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While U.S. Dependence on China is virtually unchanged The Wall Street Journal, Pentagon and Congressional Research Service Get It Wrong - Again.
Joseph Sternberg with the WSJ recently opined that the rare earth crisis is over (see How the Great Rare-Earth Metals Crisis Vanished ). The WSJ article appears to be based on deeply flawed analysis taken from a recent Pentagon report "Annual Industrial Capabilities Report" that is saturated with "free market" jargon (the Pentagon's report reads like talking points from the outsourcing department of a multi-national corporation - that can't be good) and mirrors conclusions within the recently released Congressional Research Service (CRS) report "Rare Earth Elements - Global Supply Chain".
The following analysis suggests that something close to 100% of the world's "high value rare earths (rare earths minus Cerium and Lanthanum)" must originate or pass through China's vast value chain under the current market configuration. This is not good news for new technology companies looking to make 'green products', advanced sensors & electronics, advanced materials, high efficiency motors, standard, electric or hybrid automotive components or just about anything with a display screen.
Regarding U.S. national security and defense, China in fact, can control the procurement and production for much of our Nations rare earth dependent weapons and communications systems as well. The recent disclosure that the F-35 fighter uses rare earth magnets from China is just the tip of a very large iceberg. My analysis suggests that the problem is ubiquitous and omnipresent.
Major media outlets, Wall Street analysts, the CRS and Pentagon suggest that U.S. sustainability is now well in hand through Molycorp's Mountain Pass mining operation in California. However, in reviewing Molycorp's IPO documents and more recent USGS data on the Mountain Pass deposit (See: USGS Data page 7, Table-2) it appears that this is questionable. Nearly 83%* of Molycorp's production appears to be low-value lanthanum and cerium.
Cerium and lanthanum oxides, which are typically sold into industries such as glass polishing and petroleum cracking; are not critical materials utilized for high technology or DoD weapons applications.
It is my understanding that Molycorp sells most of its lanthanum to W.R. Grace for use in the chemical catalyst and petroleum industry, not to the DoD. Molycorp recently disclosed to shareholders that much of its cerium production cannot be sold, indicating that materials like cerium are in oversupply.
The Good Stuff Goes to China: The remaining 17%* of 'high value' rare earths that Molycorp produces from their Mountain Pass deposit appears to be sent to China for refining and value adding. This is based on my understanding of the acquisition agreement between Neo Material Technologies Inc. (aka Magnequench) and Molycorp and various press accounts of the transaction which you may access to make your own conclusions.
Adjusting for the production and transfer of high value 'technology resources' -- nothing has changed Current total annualized production for Lynas (OTCQX:LYSDY) and Molycorp combined is less than 18,000* tons per year. Of that production, over 80%* is cerium and lanthanum, non-critical materials that are already in oversupply, resulting in roughly 3,600* tons per year in high value 'technology resources' at current run rates. Of that, Molycorp will send about 3,000* tons per year to China for further processing into value added metals, magnets and components.
Lynas Corp.'s distribution of cerium and lanthanum is not quite as high as Molycorp's based on the distribution of rare earths in the Mount Wield deposit (See: USGS Data page 7, Table-2). However, unlike Molycorp, Lynas has non-Chinese off-take agreements for all of its production.
After adjustments, the total amount of high value 'technology resources' for DoD and high-tech applications, mostly from Lynas, may be as high as 600 tons per year. The maximum production of heavy rare earths, also mostly from Lynas, would be less than 100 tons per year.
Molycorp's contribution towards these technology resources for 'western' consumption and value adding appears to be zero. If, as various reports and documents appear to demonstrate*, Molycorp is now just one more supplier to China, where is the upside in that?
Death Spiral: Due to the natural distribution of rare earths within their ore deposits, Lynas and Molycorp in particular, contribute to the overproduction of cerium and lanthanum (See: USGS data page 7, Table-2), impacting market prices; oversupply results in reduced prices and lowers profits for light rare earths across the board. Simultaneously, one should note that Molycorp has not demonstrated that it has commercially recoverable heavy rare earths to offset its losses (U.S. EPA Rare Earth Elements December 2012).
This is, in my professional opinion, contributing to a death spiral in pricing* for Lynas and Molycorp. Based on the natural rare earth distributions for these types of deposits, more production will only increase operating losses and put additional downward pressure on pricing for all light rare earths.
Recently Lynas' Chief Executive Officer Eric Noyrez said that its operating cost are 25% above market prices and Molycorp (October 2013) disclosed that it cannot sell its cerium due to oversupply. Cerium, which makes up nearly 50% of Molycorp's rare earths (See: USGS Data page 7, Table-2), was specifically cited in J.P. Morgan's downgrade later that month.
So what of Molycorp's plans to increase production to 40,000 tons per year? That equates to 33,000 tons of cerium and lanthanum, equal to a 40% increase in global supply. That cannot be good for pricing. As for the remaining 7,000 tons off high value rare earths, they would pass through China for value adding.
The take-away is that as Molycorp and Lynas ramp up production they undercut pricing for all light rare earths. While this disproportionately effects Molycorp (+99.9% light rare earths) and Lynas (99.3% light rare earths), pricing on China's virtual monopoly over all heavy rare earths is largely unaffected.
What is Normal: Molycorp and Lynas are always quick to say that their fortunes will improve when pricing returns to 'normal levels'. But many would argue that 'normal levels' are based on the recent pricing bubble that China created by announcing a string of export quota reductions (that were never fully utilized) and a dispute with Japan that resulted in a temporary halt in rare earth shipments. Unfortunately for Molycorp and Lynas, current pricing is in line with historical trends: cerium and lanthanum have historically sold at or below production cost.
Wall Street analysts, the CRS and Pentagon assume that China's rare earth industry acts under 'free market' principles; like the U.S. and other nations currently do. If that were true China would allow unlimited production and price competition within its borders. That is not happening. Today China is operating at about 1/3rd its officially installed capacity - this does not include the so-called black market producers.
Evidence suggests that China's stockpile program is helping to maintain prices at current levels. China has been aggressively developing a strategic stockpile that is equal to 3 years of global demand. What happens when this buying spree ends?
All evidence demonstrates that China manages its economy under Mercantile principles, that includes maintaining its monopoly in rare earths as a means of capturing and aggregating global IP, and leveraging its control over corporations and nations.
The high drama of Molycorp and Lynas amount to distraction - or even misdirection: U.S. rare earth production is meaningless unless the U.S. is able to refine these resources domestically into something that industry and the DoD can use. China continues to retain a global monopoly on all refining, metallurgical, alloy and component technologies forcing U.S., Japanese, Korean and European businesses to relocate inside China for guaranteed access to these materials and components, including those used for National Defense.
China continues to strengthen its hand as host, or hostage taker, to most of the world's refining, metal, alloy, magnet, component, OEM end-users and material science research facilities. For instance, in 2013, GM established a new Technology Science Laboratory in China; or what about the Chinese corporation that won approval to purchase the assets of A123 battery corporation?, remember that A123 was the centerpiece of the Obama Administrations push for electric vehicles; and the fact that GE moved the last of its medical imaging division to China. The loss of GE's imaging division is not an exception, it is the rule. Over the last decade nearly every major multinational utilizing rare earths has moved manufacturing facilities to China or has established subsidiaries or suppliers inside China for access to these materials. The continued drain of technology and jobs to China is quickly undermining our economic future.
Why does any of this matter? The total economic value of the entire rare earth market is only about $3 billion (mines to metals). The big money is in the value adding and that is what China is after. Through its monopoly China now controls the future of nearly $5 trillion in rare earth dependent, value added goods and services. And through this monopoly China is stripping the rest of the world of its remaining IP and high technology jobs.
According to the "Dominating the World" report China is currently situated to capitalize on all new advances in rare earth technologies, regardless of who develops them.
Translation: All global rare earth IP goes to China and this conclusion is inescapable as long as the 'west' continues to allow China to maintain the only fully integrated rare earth value chain in the world.
How did it get this bad: It wasn't always this way. China's near -universal dominance in all things rare earth reflects the enormity of the past and current analysis failures that helped shape what is now institutionalized policy failures evident in the recent CRS and Pentagon reports and echoed by the WSJ and other media outlets.
Policy failure has its price as the "Dominating the World" report makes all too clear. Before the acquisition of Magnequench, China's role in rare earths was limited to being a supplier of raw and semi-refined rare earth resources. The U.S., Japan and France firmly controlled all value-added services too: including metallurgy, alloy, magnets and components.
High level Chinese government involvement in the acquisition of Magnequench and ownership interests in Neo Materials is well documented (National Institute of Avanced Sudies- See page 28). Despite this and under protest from members of Congress, the sale was allowed to go through.
If not for this and decades of ineffectual analysis on many levels the USA would still be playing a leading role in the development and commercial production of rare earth dependent technologies.
Conclusion: The WSJ, Pentagon, CRS and Wall Street analysts have got it wrong on this issue again and again. And at what cost? U.S. vulnerability and economic regression in all things requiring rare earths (basically all technology markets) has had the effect of a self-inflicted 'scorched earth policy' on jobs, manufacturing and national security.
Unlike the investment banks who manage IPOs, analysts who tout stocks or pension funds and day traders looking for an easy buck, China is not in it for the money. China is in it to capture and control global IP and everything that goes with it.
Part of that everything is our collective economic futures. The U.S. needs to re-take this field.
(*Numbers indicated above are based on my understanding of public documents and corporate news releases.)
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.