Give Us Those Rocks, China

By Ross Marchand

            With climate change looming out to the horizon and up to the atmosphere, clean energy is likely to proliferate. Renewable Portfolio Standards (RPS), generous subsidies, feed-in tariffs, and other mandates are the government’s way of catapulting wind, solar, and electric vehicle technologies to majority market shares. But are taking everything into account in our promotion of fossil fuel alternatives?

We’re all too familiar with how fossil fuels are extracted and refined. But what about the alternatives? Here, rare earth elements (REEs) have a huge role to play. The US Department of Energy tells us that five such substances- dysprosium, neodymium, yttrium, terbium, and europium- are used extensively in creating our green products. Though lithium is not considered a part of the rare earth club, its supply is critical in making electric car batteries.

The vast majority (~95%) of these goodies hail from the People’s Republic of China, and that’s where the trouble begins. Minerals such as neodymium and terbium are, well, finite mined resources, and working with them causes terrible environmental by-products. The British Geological Society, spooked by the scarcity and geo-political problems of rare earth minerals, gives them an alarming “9.5/10” score on their 2012 supply risk table.

So, why are these dear Englishmen losing so much sleep over these rocks?  China’s geographical blessing gives it a near-monopoly on REM production, which allows their government to act anti-competitively. This problem reared its ugly head in 2010, when China slashed its REE export quota by 40%. Price levels shot through the roof, and depressed solar panel executives and weapons manufacturers drank away the pain at DC whisky bars. China’s rationale was that a) environmental degradation had to be reigned in; and b) resources levels had to be maintained.

The real reason was way simpler. Monopolist China could slash exports, watch the price rise, and make more profit at a lower output level.  And it didn’t have to deal with that pesky private sector- China’s production of REEs (along with most things) is heavily state-controlled and kept on a tight leash.

But the price boom in minerals didn’t last long. The bubble burst circa 2012, as companies purchasing REEs (mainly tech firms) made do with substitutes, kept inventories down, and went to China. Additionally, investors began to think that product demand was seriously over-estimated.

By the time the WTO invalidated the Chinese export quota in August 2014, REMX prices had fallen from $110/share in early 2011 to the mid $30s.  This was nothing spectacular; China will double-down by limiting exports in other ways.

You may be asking how clean technology fits into this ugly business. Well, I’d suggest examining the implications of the initial price bubble. When investors looked down the rabbit hole of scarcity, Chinese tactics, and more scarcity, they saw a worthwhile investment. While this proved a bit premature, clean technologies will be a huge demand driver in the coming years. And if the masses shop for solar panels and wind turbines, prices will surely skyrocket once again.

But will they fall back down to Earth? Normally, high prices would induce companies to dig harder and deeper to get those minerals. But if geographical and political considerations keep China as the only viable player and China continues its grip on the industry, renewables could have a major cost problem on their hands. And, just as many have feared “peak oil” over the years, there will be a “peak rare” even without China’s monopoly. Consider that dysprosium demand is projected by MIT to soar 2,600 percent in the next quarter-century. The mineral, integral to wind turbines and electric cars, is extremely difficult to mine outside of China. Even if the prices eventually shoot high enough to justify mining in remote areas of Greenland and Canada, mine development may take up to ten years.

Adding to this terrible inelasticity of supply, substitutes for REEs are hard to come by. A recent Yale study examining the substitution question found that the “big five” minerals for clean tech. have, “low to very low substitute potential.”

Without a doubt, policymakers trying to pave the way for renewables will have a tough time. Elected officials hoping to bring down the cost of these technologies will have to partner with China to open up the rare earth market. If 95% of production stays under the virtual control of one government, distorted prices will mean a less green future. But if the Chinese government pursues a laissez-faire approach and allows new suppliers to enter the market, clean energy can prosper. This admittedly involves wishful thinking, as it would require a comprehensive energy agreement between the US and China. That matter, though, is another subject that merits a separate posting.

Our policymakers can make the most difference in ceasing subsidization of “pet” green projects that they prefer. Picking winners from losers distorts price signals by interfering with resource allocation decisions. In responding to rising REE prices, clean tech. companies can increase market share by a) using less minerals; b) exploring low-cost substitutes; or c) a combination. Price competition also has to take land, and other scarcities into account (*cough* wind farms). But why focus on these pivotal resource decisions if the government can artificially boost your market share for you?

If we’re serious about curbing climate change, we need to halt our explicit and implicit subsidization of fossil fuels. The “fuel consumption bubble” touches everything from production to transportation to electricity generation. Only then will we be able to navigate the murky waters of rare earth markets. But with a free market in alternatives to our statist-quo of dirty fuels, our transition can be a smoother ride.

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