The idea is that supply chains are only as strong as their weakest link. The fact is that many thousands of technologies — electronics, aerospace, military, automotive, clean-tech and renewable energy, to name just a handful — rely on a small number of specialty metals, or what some call “technology metals.” These metals have obscure names, but in many cases, there are simply no substitutes.

United States of Windmills

Some so-called “technologies of the future” are destined to fail due to lack of critical metals with which to effect buildout. Take the rare earth, neodymium, for example. It’s a component of strong permanent magnets — which are made out of a mixture of neodymium, iron and boron.

Strong permanent magnets are critical to gaining efficiency in rotating power-generation units like, say, windmills. Y’know… we’re going to replace burning fossil fuels with windmills, right? Isn’t that the idea? We’re going to live in the United States of Windmills, right?

Except one fact of physics is that without strong permanent magnets, you can’t generate nearly as much power with each turn of the large blades. So neodymium — in the magnets — is critical to our windmill future. There’s NO substitute for neodymium, and believe me, people have tried to figure a way around it.

But with neodymium, as with a host of other relatively obscure substances from the periodic table, the global supply is precarious. In some cases, the supply chain is at great risk because there are but a few sources. For some of those sources, we see things like a major mine playing out due to depletion (Baotou, China, for rare earths) or shut down due to environmental issues (Mountain Pass, Calif., again for rare earths). With other metals, many mines are effectively off-limits due to political problems (in the Congo, for instance).

Looking Ahead with Critical Metals

Most of the strategic and critical metals are just plain “different” than other major industrial metals, like copper, aluminum, lead and even gold and silver.

From the standpoint of nuclear physics, for example, rare earths are not like the other elements. They are brilliant, stubborn and complex, and at the same chemically similar and uniquely individual. You take each rare earth atom the way it was formed in a nuclear reaction within some long-gone, exploded sun, billions of years past.

Another more mundane aspect of the critical metals is that few are exchange traded. For the most part, there’s no futures market, other public market or well-defined transparent price discovery mechanism. There has never been sufficient volume to build up a worldwide market for futures in these obscure elements. So most of the critical metals that get used in world commerce are sold under one-on-one, long-term contracts.

Lacking a forward market, industrial users can’t lock in future prices or deliveries through traditional hedging. They have to sign a contract and agree to pay for future product. It sounds straightforward, but the reality is different. The firms that use many specialty metals live in the worst of both worlds. There’s no futures market, but they are still vulnerable to supply interruptions, spot shortages and price squeezes in the market.

Dealing with Risk, and Virtual Hedging

One technique for users — as well as strategic-minded governments — is simply to pay upfront and stockpile material. This leads to issues with the costs of storage, ensuring physical security, the cost of money and the usual problems with inventory accounting and taxes. Also, with some metals, there are insurmountable storage problems with the rapid deterioration of product due to oxidation or other chemical deterioration.

In other words, in a world where supplies of critical metals are spotty, the traditional tools of costing and forecasting are unreliable. There’s just more risk in the critical metals biz, in some cases rising to “bet the company” levels.

The newest trend in the industry is what’s called “virtual hedging.” This is a term to describe a menu of techniques for developing forward prices and assured deliveries of critical raw materials. Firms use virtual hedging where a futures market does not traditionally exist.

One tool of virtual hedging is to make a direct investment in a mine and get payback via guaranteed metal deliveries (also called off-take agreements). Other kinds of virtual hedging are wide ranging, from stockpiling (for oneself or others), synthetic and/or over-the-counter hedges, material leasing, strategic reserves (i.e., get the government to do it for you) and closed-loop recycling.

Meanwhile, users are hard at work trying to work around issues of physical supply. There are aggressive efforts going on with traditional programs like critical material “thrifting” (use less and see what happens), material substitution, pricing index selection (gear the amount of input to the cost), flexible transfer pricing (charge the customer a surcharge for the extra costs of critical inputs) and in-house waste stream recoveries. The idea is to develop an overall strategy and methodology to mitigate price and supply risk of critical raw materials.

Similarly, producers and industrial processors may also employ these tools as a way to assure adequate income streams for debt retirement, more assured profitability and funding for future expansion and production. Virtual hedging truly has the ability to be the elusive win-win formula that most Western businessmen publicly promote, but are rarely able to employ.

Living Off Past Stockpiles

With one particular element — which I’ll decline to name just now — there’s already a severe supply crunch. This is an element that’s used in a wide variety of electronic products. The supply chain could run dry soon.

Thus, the industry that uses this item is “living off past stockpiles,” according to one inside player. Last year, the general estimate was that there’s enough product in the supply chain to last for two years. So the pipeline will be dry by 2012.

What happened? The problems originated with an unprecedented spike in the spot market price in 2000. In this thinly traded resource, supply fears caused many nervous dealers to sign long-term contracts and lock themselves into high market prices. Then when prices crashed for product off contract, across the user community, there were significant inventory write-downs, both current and future.

By 2006 and 2007, the industry returned to some semblance of normality. But with the crash of 2008, everything fell off a cliff as the economic meltdown jammed the brakes on consumer demand.

Meanwhile, the few companies that mine the substance suspended production. So now there’s a situation in which primary production of ore is all but shut down. There are stockpiles, and just a very limited amount of material coming out of a very small number of mines in faraway jurisdictions.

Thus, with this product, as with most other of the critical technology metals, the question to ask is what does is the downstream industry fear more? High prices for an essential, irreplaceable input? Or lack of physical supply from the mine and mill and widespread unavailability of any product at any price?

It’s a problem within the industry. And it’s just this kind of situation that gives us an entree into an opportunity for profit.

Until we meet again,
Byron King

October 30, 2009

Rare Earths and Other Critical Technology Metals was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Before we delve into the reasons behind all the publicity, here’s the basic skinny on REEs: One, they are rare, at least sort of. Two, they are indispensable to modern technology. Three, the number of active, dedicated producers is tiny, with more than 90% of the world’s supply coming from China.

If you took high school chemistry, you probably remember the periodic table of the elements. But if you’re like most of us, even if you pulled a 95 on the chem final, you may not recall many of the details today. And there’s a better than even chance you never bothered to memorize the names of the REEs. It’s time to get reacquainted.

They’re generally clustered in a separate grouping at the bottom of the table, are known collectively as the lanthanoids, and these are their names, in order of atomic number (57-70): lanthanum, cerium, praseodymium, neodymium, promethium, samarium, europium, gadolinium, terbium, dysprosium, holmium, erbium, thulium, and ytterbium. Yttrium (39) and lutetium (71) are also sometimes included.

Need to Know, Point 1: Rarity

Fact is, we begin with something of a misnomer. These elements are not, strictly speaking, rare. Earth’s crust is full of them. True, they’re not as common as iron, carbon, or silicon, but are about on a par with nickel, copper, and zinc. Even the scarcest is way more abundant than gold, platinum, or palladium.

What is rare about them is that they’re widely dispersed. Very seldom are they found in economically exploitable deposits. Complicating matters further is that there are so many of them, and they clump together. They have to be separated first from the ore and then from each other.

Thus REE production comes primarily from other mines’ byproducts. The miner strips off the metal he’s really after, then sends the REE clusters to a specialty refiner.

Need to Know, Point 2: Applications

It’s safe to say that life as we know it would be very different without the REEs. The more our technological accomplishments pile atop one another, the more crucial these metals become. Because of their unique properties, there are generally no substitutes for them.

Of all the REEs, the one people may have heard of is neodymium. Alloys containing it have revolutionized permanent magnet technology, allowing miniaturization of all sorts of electronic components in appliances, A/V equipment, computers, communication systems, and military gear. Your hard drive probably has neodymium in it. So does your DVD player.

Liquid crystal displays depend on europium. Fiber-optic cables can’t function without erbium. Virtually all specialty glass products, from mirrors to precision lenses, are polished with cerium oxide. Several REEs are essential constituents of both petroleum fluid cracking catalysts and auto emissions-control catalytic converters. Half a dozen REEs go into the manufacture of the energy-efficient fluorescent bulbs that will soon be mandatory. Lanthanum-nickel-hydride rechargeable batteries are replacing older ones based on lead or cadmium. And no REEs, no electric cars. Nor next-generation wind turbines.

That’s only a partial list. But what makes REEs an increasingly sensitive topic is their role in national defense. Here are a few small items that have become dependent on them: jet fighter engines, missile guidance systems, underwater mine detectors, range finders, space-based satellite power plants, and military communications systems.

Think the Pentagon is very, very interested in maintaining a steady REE supply?

Need to Know, Point 3: Supply

95% of the world’s REE production originates in China. If you’re looking for reasons why we’re so nice to the premier Communist power left standing, this is a biggie.

We weren’t always so dependent. Not long ago, mines such as Mountain Pass in California made us nearly self-sufficient in REEs. But in the early ‘90s, China flooded the market with cheaper product, until it had driven all of its competitors out of business.

Today, Mountain Pass is being revived, but the start-up of an old mine is a lengthy and costly process. There are also some from-scratch REE development projects under way in the U.S., as well as Canada and Australia. But for the moment, China holds the hand with all of the high cards in it.

Forget your hard drive. Forget 11th-grade chemistry experiments. This is a national security issue. The American government cannot afford to lose that supply source, period. Maybe someday, but not now.

And that’s what’s behind the recent furor over these obscure elements. Because China threatened just that, a cutoff. The one thing that really gets Washington’s knickers in a twist.

In August, the story broke in the mainstream press. Sources in China leaked news of a draft copy of a report from the Ministry of Industry and Information Technology. It allegedly calls for a total export ban on five of the rare earths, with the rest restricted to a combined export quota of 35,000 metric tons a year, far below annual global consumption of 125,000 tons, and rising fast.

This doesn’t look like a move they’d follow through on, if only because of the lost trade revenues. And it’s only a recommendation; final approval rests with China’s State Council. But consider it an opening shot across our bow, if you wish. Or perhaps they’re telling us they need their REEs for the domestic economy, and we’d best go find our own supplies. Either way, the scramble is on to find alternatives.

That could backfire. REE prices and demand were already dropping last fall as the recession deepened, and China maintains a decided competitive advantage beyond control of supply: lax environmental standards (many REEs are highly toxic). Thus the new companies could spend the fortunes required to come on line, only to find themselves victims of yet another market glut engineered by the Chinese. Still, these metals are so important, it wouldn’t surprise us if the U.S. government subsidized domestic production, rather than risk a squeeze.

The Market

The market took due notice of the China story, driving the stocks of Western REE producers, and would-be producers, nearly straight up. Since late August, Avalon Rare Metals has gained 120%, Arafura Resources is up 75%, Rare Element Resources has added 72%, and Lynas Corp. is 50% higher (China, ever the master strategist, exploited the credit crisis to grab 25% of Arafura and more than 50% of Lynas). Lurking in the background is Molycorp, the private company redeveloping Mountain Pass. It’s planning an IPO that may well come out of the gate red hot.

With market action this frantic, the sector is on the frothy side at the moment. The heady market caps being awarded to these companies are obviously not based on fundamentals, and a savvy investor takes care not to get caught on the wrong side of a bubble.

Even though the Chinese export ban may never materialize, the ever-growing need for REEs is dead serious. And while the current bubble may pop any day, the long-term prospects for successful miners are outstanding.

Regards,
Doug Hornig

October 5, 2009

Why All the Fuss Over Rare Earths? was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Much of Brazil’s South Atlantic development will require drilling wells in waters up to two miles deep, through four-five miles of rock beneath the seabed. The prize at the end will be oil deposits with reserves estimated in the tens of billions of barrels. With access to this offshore bounty, Brazil expects to take its place among the first ranks of energy-producing nations in the world.

Brazil’s state-controlled national oil company (NOC), Petroleo Brasileiro SA (Petrobras) plans to spend over $175 billion in the next five years just on offshore development. The immense investment involves buying and building dozens of new drill ships and seagoing platforms, along with many dozens more support and servicing vessels. Petrobras will lay thousands of miles of pipelines on the seafloor, connecting massive complexes of subsea equipment that will sit atop hundreds of oil wells.

To finance much of this development, Brazil has turned to China. With the active support of the Chinese government, many Chinese banks are lining up to extend loans to Brazil’s energy sector. Right now, there is an agreement for a Chinese consortium to lend Petrobras $10 billion. In exchange, Petrobras will eventually ship 200,000 barrels of oil per day to Chinese refineries. There are more such long-term finance supply deals in the works.

The Chinese government has established strategic guidelines for its national firms. That is, the Chinese government has set goals for Chinese firms to supply China’s long-term needs for energy and other natural resources. The Chinese are looking well ahead into the rest of this century, and even into the 22nd century. They want to ensure their future access to a diverse global supply chain, as well as win entrée into resource-rich regions of the world for Chinese industries and support firms.

Why are the Chinese receiving such a warm welcome in Brazil? According to Sergio Gabrielli, CEO of Petrobras, “The U.S. has a problem. There isn’t someone in the U.S. government that we can sit down with and have the kinds of discussions we’re having with the Chinese.”

In other words, there is a new geopolitics of oil at work. In the olden days, it would have been large international oil companies (IOCs) like Exxon Mobil, Shell and BP walking into a room to meet with the Brazilians. The IOCs were the only game in town. They controlled the financing and the technology for large developments.

But today, the biggest deals begin with a political understanding at the top, hammered out between the highest levels of the respective governments. This top-down political deal making cuts out the IOCs, except where they have technical expertise that can be hired on a contract basis.

In essence, we are witnessing the end of the post-World War II economic construct of the world’s financial system. That construct always had a Western bias. But the 2008 crash of the Western business and financial model has changed everything. It has left a barren worldwide financial landscape for large development projects. Most traditional Western financing is simply not available for large projects. And as French author Francois Rabelais (1494-1553) once noted, “Nature abhors a vacuum.”

Thus has the Western financial crisis handed well-capitalized, government-backed Chinese banks and industrial firms an unmatched competitive advantage. With the traditional credit markets dry, Chinese banks have transformed into key lenders for the resource developments that will fuel the next generation of humanity. Indeed, for now, the Chinese are the world’s ONLY lenders for large resource development projects. See Brazil, Exhibit 1.

China’s Rare Earths Monopoly – All But Insurmountable

China’s support for Brazilian energy development is not the only angle that the Chinese government is pursuing for its future gain. China’s large reserves of foreign exchange, as well as its national strategic focus, has enabled incomparable – even insurmountable – progress for the Middle Kingdom to corner the world supply of substances called rare earths. Here’s the production chart for the past half century. Obviously, something is going on here.

Now that we’ve seen this chart, the questions arise: What are rare earths? And why are they important?

Rare earths are the 15 elements within the lanthanide series of the periodic table, plus the elements yttrium and scandium. The best known are lanthanum, cerium, neodymium, praseodymium, gadolinium, europium and samarium.

Here’s why rare earths are important. They’re used in a wide range of industrial and electronic applications. For many years, large amounts of lanthanum and cerium have been used in petroleum refining, with the result of increasing yields from each barrel of oil by about 10% while extending the life of other expensive catalysts like platinum. And rare earths find their way into myriad other applications, from aerospace super-alloys to rechargeable cell phone batteries.

More recently, large volumes of rare earths (especially neodymium) have gone into magnets. In fact, rare earths are a key component in strong, permanent magnets. It’s not those cute little refrigerator magnets; your computer contains a number of tiny magnets in its hard drive. If there are no permanent magnets, there are no computers. Or DVDs or DVRs or iPods, etc. Say farewell to your wired way of life.

And then there are the giant 1-ton magnets used in large windmill assemblies. Each windmill magnet is about the size of a car engine and uses 560 pounds of neodymium. The implication is that if the U.S. wants to erect windmills to generate electricity, the nation is making a long-term commitment to buy and use unprecedented amounts of neodymium. And there are NO substitutes. For just this one “clean energy” application, large amounts of rare earths – and the ores and mines to produce them – are essential.

There are many other clean-energy applications for rare earths as well, particularly in the now forming electric car industry. Neodymium magnets are key components in electric motors and regenerative braking systems used in hybrid vehicles. Without these magnets, no electric cars will ever roll off an assembly line, let alone whiz down an American highway.

Another significant demand for rare earths will come from large rechargeable batteries for electric cars. Nickel-metal hydride (NiMH) rechargeable batteries, for example, contain cerium and lanthanum in a form called “mischmetal.” And right now, NiMH batteries are the battery of choice for many hybrid vehicles. Overall, a typical hybrid electric vehicle can use about 50 pounds of rare earths – between the rechargeable battery pack, the permanent magnet motor and regenerative braking system. (Plus other tiny magnets for the sound system, power windows, power seats, windshield wipers, etc.)

So clearly, demand for rare earths is set to skyrocket. Just clean energy applications will drive unheralded demand for metals of which most investors – let alone consumers – have never heard.

It’s also important to keep in mind that almost none of the rare earths used in large power systems (like windmills) or electric vehicles (such as with NiMH batteries) are currently being recycled. The long lifetimes of the magnets and batteries, coupled with the lack of recycling technologies and dedicated facilities, means that any increase in supply can only come from new mining.

Another factor is that there appears to be an official Chinese policy to slow down export of rare earths. Chinese exports have decreased by 8% or so each of the past three years. Chinese suppliers have placed foreign customers on allocation, at reduced quantities from years past. The Chinese explain that they have closed mines for environmental reasons. Yet the Chinese also promise adequate supplies of rare earths if foreign users will move their industrial facilities into China.

According to Yoichi Sato, head of the Rare Earths Department of Japan’s Mitsui Industries, China is displaying its long-term strategy toward these critical elements. Mr. Sato believes that China is playing a complex game with the world’s rare earth consumers.

First, China is restricting rare earths exports, to provide its own high-tech industries with the chance to flourish and gain a competitive edge over rivals in Asia, Europe and the U.S. And second, it will force many foreign firms to move their high-tech factories and research centers to China to circumvent quotas. China, to be sure, has a small army of highly capable scientists and engineers who focus on rare earths applications – over 15,000 Ph.D.-level individuals, by one count.

Mitsui’s Mr. Sato believes that China will use its existing monopoly status in rare earths production to crush any competition that emerges. While about 42% of worldwide rare earths resources are outside China, there are NO non-Chinese sites with any significant processing or refining capacity. In the game of rare earths, China holds almost all of the cards.

Mr. Sato has stated, “Many people are looking at establishing alternative refineries and sources outside China, but the investment is not necessarily a sound one because of the threat of price revenge by China. If new projects emerge, as they have recently in Malaysia and Australia, China could just drop its prices and force rivals out of business.”

And as if on cue, in April 2009, Chinese firms used their financial muscle to buy large stakes in potential foreign rivals in Malaysia and Australia.

I hope that you now understand the importance of rare earths to the 21st-century economy of the West, particularly to the energy future of the U.S. I’m following this situation very closely. There ARE some potential investment opportunities in rare earths, but only in very small, thinly capitalized firms.

Until we meet again,
Byron King

June 12, 2009

Brazil’s National Commitment to Energy – Bankrolled by China was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

This guy walks into a supply house and goes up to the clerk behind the counter. He says, “Excuse me, but could I buy some lanthanum?”

The clerk is busy smoking a cigarette. He looks the guy up and down and says, “We ain’t got no lanthanum.”

So the guy says, “What? You don’t have any lanthanum? OK, then how about some cerium? Or perhaps you could spare some yttrium? Do you have some cerium or yttrium that I can use?”

The clerk looks at him and shakes his head. “Sorry, pal. Not in stock.”

The guy begins to look a bit desperate. He says, “No? Well then, do you have any europium? Or is there any neodymium? While you are at it, can you please check for praseodymium or samarium? I don’t mean to trouble you, but do you have some gadolinium or dysprosium? And I need some terbium, holmium, erbium, thulium, ytterbium and lutetium.”

The clerk looks at him, shrugs and holds his cigarette out to flick some ash on the floor. “We’re fresh out,” says the clerk.

“Listen,” says the guy. “I hate to be a pest. But I can’t take no for an answer. I have to have these products. Without them, my whole economy shuts down. I’ll be ruined.”

The clerk looks at him and says, “Well, too bad for your economy. I guess you are just plain up the old creek, huh? Better grab a paddle.”

No Funny Punch Line to This Story

Well, dear reader, are you waiting for the funny punch line? Sorry, but there is no funny punch line on this one. This is no joke. I said at the beginning that I would tell you a good old story, not a funny story. And the investment recommendation makes for a good story, or maybe even a great one.

What were those strange-sounding things that the guy was requesting from the clerk? They are called “rare earths,” and for good reason. They are some of the most valuable, critical metals on the face of this planet or any other. Demand is soaring, and supply is…well, supply is not.

Meet the Lanthanides

In this issue of Whiskey I’m looking at an investment opportunity in 15 elements from the periodic table. In formal scientific nomenclature, they are called the lanthanides. More commonly, they are called rare earths.

None of these elements are famous like gold or sliver. None get shipped in giant ore freighters, like iron, aluminum or copper. You sure don’t learn much about these 15 elements in high-school chemistry class, unless maybe it’s the school that feeds lots of kids into MIT or Caltech.

In fact, the only people who really study these elements are master’s- and Ph.D.-level chemists and solid-state physicists. Oh, and national leaders in places like China. But without these elements, much of the modern economy will just plain shut down.

“Just plain shut down? C’mon,” you might say.

But yes, these elements are critical to the modern economy, and that is not hyperbole. We are addicted to rare earths as much as we are addicted to oil, except most people don’t know about the rare earth addiction. But I am going to explain it to.

Say Goodbye To TV Screens, Computer Hard Drives, GPS, and More…

These 15 elements are strategic. These elements play a critical role in petrochemicals, environmental protection, “clean” technology, electronics, automotive applications, optics, telecommunications, computing and defense. They are indispensable to a myriad of intermediate and end uses.

Really, without these 15 elements, you can say goodbye to much of modernity. There will be no more television screens and computer hard drives, fiber-optic cables, digital cameras and most medical imaging devices.

You can say farewell to space launches and the satellites that do everything from show you the weather to offer global positioning down to a few inches. And the world’s system for refining petroleum will break down, too. That’s pretty serious.

If you are curious about the details, I will discuss each of the 15 rare earth elements in greater detail at the end of this article. But this is not a technical paper on chemistry, no matter how interesting the subject might be from that angle.

What Are These 15 Elements?

These 15 elements are all metals, although usually one sees them in powdered form as oxides. They are called rare earths. But how rare are they? Well, they are scattered here and there in the Earth’s crust. But you won’t exactly trip over them as you stroll along the beach.

It is quite rare to find these elements in deposits that are economic to mine. So that is the investment lure.

Rare earths are usually found in rock bodies called carbonatites — for the most part non-geologists have never heard of them. And for our purposes today all we need to really know is that carbonatites are rare.

Once you find a deposit of rare earth elements in a carbonatite, it is still very difficult to mine and mill the rocks and minerals. The processing chain is long and complex. So we are dealing with rare earths in rare rock bodies that are difficult to mine, mill, and process.

Right now, almost all of the world’s supply of rare earths comes from China, which is why our investment opportunity is so appropriate. Unfortunately, I cannot let you know the specific investment opportunity I’m talking about. That simply wouldn’t be fair to the readers of my Energy and Scarcity newsletter. But now you at least know where to look.

Until we meet again…
Byron W. King
April 2, 2008

15 Rare and Valuable Metals was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.