As discussed in my previous post, restoring the functionality of free markets is particularly important with respect to the rare earths industry. By subsidizing and disguising their true costs of production and through other means, the Chinese government has enabled Chinese companies to achieve a near monopoly over rare earth mining activities and in many downstream industries. Initially, this led to artificially low prices that could not be matched by competitors, forcing most of the non-Chinese rare earth mining companies out of the market. Now, prices are soaring and access to these critically important materials outside of China is a growing concern due to Chinese export duties and export quotas. Mining industry executives and others believe that restoring properly functioning markets could take several years due in part to excessive permitting delays and overly burdensome taxes and regulations here in the US.
The Plot Thickens
Unfortunately, the factors leading to the demise of the Valparaiso, Indiana manufacturing operations of Magnequench, which was once among the largest manufacturers of neodymium iron boron magnets in the world, are less clear. According to a Feb 18, 2003 Insight on the News article by Scott L. Wheeler titled "Missile technology sent to China;" the manufacturer, originally a subsidiary of General Motors known as UGIMAG, held the Department of Defense contract to produce the high-tech motors for precision-guided JDAM missiles. A cloud of controversy still shrouds the events and motives that led GM to sell this division in 1995 to an investment consortium headed by Archibald Cox Jr. (son of the illustrious Watergate prosecutor) acting in concert with two Chinese state-owned metals firms, San Huan New Material and China Nonferrous Metals Import and Export Company (CNNMIEC), which had been pestering to sell Magnequench since 1993. According to WebMemo No. 1913 published by The Heritage Foundation on May 2, 2008, there were reports that the Chinese government pressured GM into selling Magnequench to Chinese interests as a condition for approving GM's bid to open an automotive production line in Shanghai. After a series of corporate reorganizations the remnants of this company eventually became owned by the Canadian company Neo Material Technologies (NEM.TO, NEMFF.PK) which still operates this division under the name Magnequench. It is said to control 80% of the global supply of bonded neodymium magnets, primarily through joint venture agreements with a number of companies located primarily in China, although the Company has reported that a key patent is scheduled to expire in 2014.
Two Long and Winding Roads
However, for the rare earth mining companies themselves and other new entrants into related downstream industries, the path back to functioning free markets, characterized by a natural state of equilibrium between the forces of supply and demand, will require:
· a restoration of non-Chinese-government-dominated sources of supply, possibly including improved recycling efforts, as well the development of potential substitutes, a process that could take years, if it is even possible; and
· actions leading to more equitable, market-oriented behavior on the part of China which would alleviate concerns regarding potential disruptions in supply that would facilitate even greater market distorting activities that could pose more serious risks to our national defense and the health of the global economy.
As indicated in a comment that I attached to my previous post, many of these concerns are described in a paper co-authored by the attorneys Terence P. Stewart, Elizabeth J. Drake, Amy S. Dwyer, and Ping Gong, titled "Rare Earths, An Update: A Fresh look at the Supplier(s), the Buyers, and the Trade Rules" which was presented to a Colloqium of the Global Business Dialogue, Inc. and the Trans-Atlantic Business Dialogue on June 9, 2011. Terence Stewart is the Managing Partner of the Law Offices of Stewart and Stewart, and he was a speaker at the TREM ’11 Conference held in Washington, DC on March 22 and 23, 2011.
This paper provides an excellent summary of issues related to both of the remedial courses of action described above, but in this article, I would like to highlight and then comment upon what I believe to be the key passages from this publication dealing only with the latter course of action. I urge you to read the publication in its entirety, including the citations to many other sources of valuable information regarding the rare earths, but for now let’s focus on the following dealing with China and the WTO.
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The United Steelworkers union, with the Law Offices of Stewart and Stewart as outside counsel, filed a section 301 petition with the U.S. Trade Representative in September of 2010 seeking to have a number of China’s practices affecting trade and investment in green technology goods brought into compliance with China’s WTO commitments, includings its export restraints on rare earths. …The U.S. has not yet filed a WTO case challenging China’s restrictions on exports of rare earths. (page 1)
Policymakers in the U.S., Europe, and elsewhere have a number of options for addressing the crisis in rare earths, including a challenge to China’s policies at the WTO, but time is of the essence in order to ensure that vital, emerging high-tech and defense industries will have access to these critical materials. (page 2)
II. China’s Export Restraints on Rare Earths
China has been able to take advantage of its dominance of rare earth mining to become a leader in downstream processing of rare earths through a variety of means, including restraints on exports of rare earth ores and oxides. While these export restraints take a variety of forms, including export licensing requirements and, potentially, price guidance, this section focuses on the two most basic means of restraining exports: export duties and export quotas. …While export duties on the elements were originally set at ten percent, they have continued to increase over time and, in 2011, the duties range from 15 to 25 percent. …A translated excerpt of China’s 2011 export duty schedule is attached at Exhibit 1. (page 7)
These export duties are a clear violation of China’s obligations under its protocol of accession, in which China agreed to eliminate export duties on all but a select list of 84 items. Imposition of export duties on these items is thus a direct violation of paragraph 11.3 of China’s protocol of accession to the WTO. (page 8)
In addition to export duties, China also applies quotas to limit the volume of rare earth exports since at least 2000. These export quotas have been reduced each year since 2005 as China’s domestic demand for rare earths has grown. …China allocates its quotas among domestic rare-earth producers and Chinese-foreign joint venture producers, and issues the quotas in two batches, one for each half of the year. (page 8)
Foreign-invested enterprises have seen their quota allocation cut more sharply than the volume of quota available to domestic Chinese enterprises. …As a result of this disparate treatment, foreign invested enterprises only received a quarter of the quota allocated in the first half of 2011, down from more than a third of the quota allocated in 2009. (page 9)
In addition to applying these global export restraints, there are reports indicating that China may be applying the restraints differently to different export destination, exerting its leverage over access to the materials to support foreign policy goals. (page 10)
These export quotas are a direct violation of the obligation in Article XI:I of the GATT 1994, which prohibits the imposition of export quotas. China specifically committed to abide by this obligation by eliminating export quotas when it joined the WTO. The quotas are thus a facial violation of China’s WTO commitments. In addition, to the extent that China is administering the quotas in a manner that treats some nations less favorably than others or discriminating against foreign enterprises in the allocation of export quotas, these may constitute additional violations of national treatment and most-favored nation obligations in WTO rules and in China’s protocol of accession. (pages 10, 11)
The U.S., Europe, and Mexico challenged a similar set of export restraints, including duties, quotas, and other measures, imposed by China on a subset of raw materials at the WTO in June and August of 2009. That case did not address the export restraints on rare earths. ...The panel report is likely to become public sometime in July of this year, at which point any of the parties will have 60 days to appeal the findings to the Appellate Body. (page 11)
In the panel phase of the current export restraints case, China argued that its export restrictions were justified by certain exception to WTO rules, including the exception for measures that relate to the conservation of natural resources. Those exceptions are based on the principles of even-handedness and non-discrimination. While it remains to be seen how the WTO dispute settlement panel treated those claims in the pending dispute, the required “even-handed” treatment is not evident in China’s measures on rare earths. (pages 11, 12)
While China has identified environmental protection and resource conservation as motivations for its rare earths regulations, Chinese company officials and provincial and local authorities have stated that the policies also serve to secure relatively abundant and low-dost supplies at home while restricting the quantity and raising the price of supplies available abroad, creating an incentive for producers of value-added, downstream products such as rare earth magnets to shift production to China. (page 13)
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In July, a WTO legal panel dismissed China’s claim that its system of export duties and quotas on raw materials served to protect its environment and scarce resources. That ruling was considered to be a victory for the US, the EU, and Mexico. According to an August 24, 2011 article in the International Business Times titled “China Vows to Appeal Raw Materials Ruling by WTO,” US and EU officials have speculated about filing a WTO complaint against China regarding its similar restrictions on its exports rare earths and rare earths based materials, and some experts have suggested they may be waiting on the raw materials appeal to run its course before relying upon it as a precedent.
However, last Wednesday, August 24, China vowed to appeal the WTO legal panel’s July ruling. According to the same International Business Times article referenced above, Chinese Ministry of Commerce spokesman Shen Danyang told reporters at a press briefing, “First, we will make an appeal. Second, we still think Chinese practice and policies do not violate WTO rules.” But, according to Chin Leng Lim, a professor of law at the University of Hong Kong, “If you are going to argue on environmental grounds, you would have to have been even-handed in the past and applied the same constraints at home. If you haven’t done that, well then you can’t change it.”
That may be true, but arguing cases before WTO legal panels is a slow process about as efficient as the mine permitting process in the US, and even the not so elderly among us may shrink an inch in height before it is completed. In the meantime, the status quo could likewise cause the rest of us to lose some stature.