China's Leverage on Renewable Energy Increases

Last month's announcement that China was cutting its export quota for rare earth elements by 72% for the second half of 2010 didn't seem to attract wide attention, but now that the other half of its strategy has been revealed, that might change. Today's Wall St. Journal reported overtures from Chinese officials to firms interested in accessing these materials, which are critical for the production of some components of renewable energy technology and advanced vehicles. The apparent deal: invest in rare earth processing in China to obtain access, with the output from new facilities incorporated into products for the rapidly-growing internal market or export. Not only would this practice compound the difficulties faced by US and other foreign renewable energy firms seeking to market their products in China, it could also make it much more expensive to produce them outside the People's Republic.

For some time I've been intrigued by growing concerns about access to rare earths and scarce metals. These include the true "rare earths" from the periodic table of the elements, as well as other scarce elements such as Indium, Gallium and Tellurium. Their uses include solar panels, wind turbines, hybrid car motors and batteries, and other "clean energy" devices, along with many non-energy applications. As the Journal noted, China accounts for over 90% of global production of the rare earths and is among the top producers of the other scarce materials. And although China doesn't have a natural monopoly on them, it currently enjoys an effective one, as plans to resume or ramp up production in North America, Australia, South Africa and elsewhere will require both time and significant capital.

This development poses an unwelcome challenge to a variety of renewable energy firms. At a minimum, it could significantly raise their production costs, just as they are trying to move down the experience curve in order better to compete with conventional energy--including newly-abundant natural gas--and at the same time that governments around the world are being forced to cut back on subsidies, due to fiscal imbalances and the weak economy. Any company that depends on a stable, let alone expanding supply of these ingredients must either be looking seriously at relocating production to China or making potentially fundamental changes in their technology to switch to more abundant raw materials. Green jobs, perhaps, but where?

China's efforts to capture higher returns and more of the value-added for these scarce materials shouldn't surprise anyone; it's basic economics. OPEC tried this strategy in the 1980s, when it built export refineries in the Middle East and bought existing ones elsewhere. This didn't work out very well, because it contributed to a persistent glut of global refining capacity that, with the exception of a few standout years, generally benefited consumers more than producers. China could experience something similar in rare earths, once new, non-Chinese sources are brought online--assuming they are. Mining and processing such deposits entails large capital costs that, once invested, can set up a classic boom-and-bust commodity cycle. Unfortunately, the prospect of a future rare earth glut will be of little comfort to makers of wind turbines, advanced car batteries, and thin-film solar cells for the next several years, at least.