Will China weaponise its dominance in rare Earths supply chains?

The US government has weaponized semiconductor supply chains in order to prosecute a technology cold war with China. US sanctions and export controls have severely hampered- at least in the near-term- China’s most important technology companies, including Huawei and SMIC.

As of September 2020, the US has choked off Huawei’s access to American microchip technology, a critical element within smart phone and 5G network infrastructure supply chains. Huawei, the world’s largest manufacturer of telecoms equipment, is currently burning through an emergency stockpile of microchips. Once this stockpile is expended, Huawei will lose the capability to service existing 5G contracts around the world, as well as build new networks. Huawei’s smart phone production capabilities have also taken a hit.
Washington also placed export restrictions on Manufacturing International Corp (SMIC), China’s most advanced micro-chip company. SMIC relies on US design software and manufacturing equipment to produce microchips.

All of this raises a frequently occurring question: Will China retaliate by weaponizing its rare earths supply chains?

China currently dominates the world’s rare earths industry, with state-owned Chinese companies having a virtual monopoly in 80 percent of global extraction and processing of oxides and metals, all of which are critical for producing today’s advanced technologies, including semiconductors.

Rare earths are comprised of the 15 lanthanide elements on the periodic table plus two other related elements, scandium and yttrium. They are classified into heavy and light categories by atomic weight. Many of these elements make up the so-called “critical minerals sector,” which, for example, includes dysprosium, an element that is vital for the production of magnets, which, in turn, are used in everything from smart phones, missile guidance systems and electric vehicles.

In retaliation for Washington’s targeting of Huawei and other Chinese tech companies, Beijing has threatened to sanction Lockheed Martin, the US defense contractor that manufactures America’s F-35 jet fighter aircraft. One F-35 aircraft requires more than 400 kilograms of rare earth elements, many of which are produced exclusively by Chinese companies.

In other commercial markets, China could prioritize the allocation of rare earths to its own national champions in, for example, the electronic and autonomous vehicles industry, effectively pushing competitors out of the market.

The US and its allies are rushing to preempt such moves from China. This new reality is accelerating strategic Western decoupling from China, even as Chinese technology companies double down on efforts to “de-Americanize” their own supply chains.

More broadly, the US-China technology cold war around both semiconductors and rare earths is accelerating the fragmentation and localization of global value chains.

China’s dominance in rare earth supply chains

In 1990, China controlled approximately 25 percent of the world’s rare earth market. At that time, however, under Jiang Zemin, the Chinese Communist Party (CCP) made rare earths a “leapfrog” priority, part of Beijing’s wider techno-nationalist agenda. Rare earths value chains are highly complex: once the elements are mined, they must be separated from host materials, processed and refined.

Until the 1980s, the US was the world’s largest producer of rare earths. In California’s Mojave Desert, the “Mountain Pass” mine, run by Molycorp, was the biggest rare earth operation on earth. But as US companies off-shored more and more production to China, and as Beijing seized the opportunity to modernize and up-scale its rare earths sector, the US quietly ceded dominance to China. Another reason the industry was off-shored: lower environmental standards in China, which lowered overall costs.

Today, China Rare Earth Holdings, China Minmetals Rare Earth Company and a handful of other state owned entities have a stranglehold on rare earth value chains. This has given Beijing, at least in the short term, a powerful geopolitical weapon.

In 2010, for example, China stopped exporting rare earths to Japan for two months following a territorial dispute over a group of islands located in the East China Sea. During this timeframe, the price of rare earths skyrocketed 50 percent.

More recently, in 2019, as the US-China tech cold war continued to heat up – in a precursor event to Beijing threatening to sanction Lockheed Martin- President Xi Jinping visited JL Mag Rare Earth, a specialty magnet producer in Jiangxi province, in a highly symbolic gesture to Washington and the world.

Rare Earth Decoupling & Re-shoring

The US and its allies, including the EU, Japan and Australia, are actively coalescing around new rare earths strategies. In 2019, for example, the US and Australia governments signed an agreement to work together with the aim of extracting, developing and processing rare earths within “safe” home environments. Some 15 different sites were identified throughout both the US and Australia for further development.

In addition to reopening the Mountain Pass mine in California, through a combination of private equity and Pentagon funding, the Department of Defense has signed a contract with Lynas, an Australian rare-earth company, to build a processing facility in Texas, along with with Blue Line, a joint venture partner. Together they will process dysprosium and terbium, two rare earths used to make leading edge-magnets, which, currently, only Chinese companies are able to process.

Other Australian companies such as Northern Minerals and Alkan Resources, with support from Canberra, are developing and building plants that will process various other rare earths required for metals, military-grade magnets and other high tech materials.

These developments have drawn the participation of Japanese and European interests. Germany’s ThyssenKrupp Materials Trading, has supply and extraction deals with Northern Minerals, an Australian company. Japanese corporate interests are keen to reduce their exposure to Chinese supply chains as well, and the Japanese holding company, Softbank- which is heavily invested in technology- is sinking money into both US and Australian rare earths projects.

Beyond US and Australian investment, the Japanese government is funding home grown projects. This has led to the discovery of possibly the world’s largest known rare earth reserves, off of Minamitori Island, about 1,150 miles (1,850 km) southeast of Tokyo. The site lies within Japan’s exclusive economic zone in the Pacific Ocean.
Mercantilism, Governments and Rare Earths

Private investment, alone, will not challenge China’s global monopoly in rare earths. The massive scale of China’s state-backed operations has created barriers to entry that no group of private enterprises can overcome.

Building a rare earths extraction and processing value chain requires ongoing investment in technological innovation as well as investment and development in highly specialized human capital. Building operations on a scale in the US and Australia that are large enough to satisfy current demand will take a decade to achieve and run into billions of dollars. These operations will likely not operate at a profit for years at a time, and must be treated as a public good and underwritten by governments.

China’s ability to control market pricing is another reason that governments have no choice but to fund rare earths operations. If these developments were left purely to private enterprise and market forces, China’s Ministry of Industry and Information Technology- the agency that sets rare earth production quotas for China’s state-owned companies- would simply dial up production thresholds and flood the global market with rare earths. This would drive down prices, and drive out “for-profit” enterprises. Contrary to its name, rare earths are not necessarily “rare.” They are abundant, but they are extremely difficult to mine, separate and process.

Rare earth supply chains are a microcosm of techno-nationalism: mercantilist-like behavior that links tech innovation and enterprise directly to the national security, economic prosperity and social stability of a nation.

More broadly, today’s geopolitical landscape reflects a paradigm shift away from a laissez-faire trading system toward a world of increased state activism and intervention in markets- a direct consequence of China’s mercantilist, state-centric model, which has effectively upended the post-World-War II liberal trading order.

The New Public Private Partnerships

Virtually all of the technologies named in Beijing’s Made in China 2025 (MIC 2025) initiative require rare earths. MIC 2025 calls for Chinese manufacturing dominance in 10 key industries, including: robotics, wireless technologies, advanced navigation systems,
electronic vehicles (EV) and autonomous vehicles (AV), among others.

Beijing aims to produce 50 percent of the world’s EVs and AVs by 2025. To meet these techno-nationalist objectives, Beijing would divert a large portion of rare earth allocation to Chinese AV and EV production, for magnets, lithium batteries and a myriad of other technologies found in the vehicles of the future.

This scenario, alone, will require the US, the EU and others to cut reliance on China for rare earths or risk being pushed out of competitive markets.

The response from the US and its allies, therefore, is inevitable: the formation of international public private partnerships not just to accelerate decoupling and reshoring but to promote a new “moonshot” innovation environment reminiscent of the space race between the US and the former Soviet Union. There is clear evidence that these innovation partnerships are already occurring.

This is a scenario is already under way. Much of the funding for these new partnerships will come from the US defense establishment, as was also the case in the 1980s and 1990s when the US semiconductor industry partnered with the US government to achieve a technological leapfrog over the Japanese semiconductor industry, which, at the time, was the world’s most advanced.

The Sino-US technology cold war will accelerate decoupling, re-shoring and ring-fencing, not only in semiconductors and rare earths, but in a host of other strategic global value chains. Collateral damage to existing supply chains is unavoidable: This new reality reflects not only a paradigm shift of historic proportions, but the primacy of geopolitics over business.