China Tangled In Trade Disputes (Part 2) (FXI, REMX, GEX, TAN, XLK)

China Tangled In Trade Disputes: Solar Panels and Rare Earths (Part 2 of 2)

Note: This article is the second of a two-part series. Click here to read part one.

In the case of rare earths (NYSEARCA:REMX), China (NYSEARCA:FXI) has been criticized for its export restrictions and production quotas, which have prompted many foreign firms to relocate their manufacturing operations to China in order to buy raw materials at competitive prices. But China has not always wielded a monopoly over rare earth production. From the 1960s to the 1980s, a Mojave Desert mine in California was the world’s largest supplier of rare earths. During the 1990s, however, China’s entrance into the world market lowered global prices; at the same time, the Mojave mine experienced expensive pipeline accident and radioactive fluid leak, threatening a nearby town. Facing these economic and environmental challenges, the mine closed in 2002. Hence China’s 90 to 97 percent market share in rare earth supplies over the last several years.

Japan, a country lacking domestic reserves of rare earths, has relied on China for imports to sustain its production of high-tech products (NYSEARCA:XLK), such as the metallic components used in hybrid and electric cars, energy-efficient appliances, and magnets for wind turbines. To hedge its bets, the Japanese private sector has stockpiled six months to a year’s worth of rare earth supplies and has agreed with the Australian mining firm Lynus Corp to import modest amounts of rare earths beginning in 2013. For the moment, however, Japan’s supply chains face constant insecurity due to China’s production quotas.

US firms are also heavily dependent on Chinese rare earths (NYSEARCA:REMX), prompting concerns within government and industry. In a December 2011 report, the US Department of Energy called for a diversification of global supply chains and reengagement in domestic production of rare earths. The Critical Materials Strategy notes that manufactures of wind turbine generators and electric vehicle motors “are currently making decisions on future system design, trading off the performance benefits of neodymium and dysprosium against the vulnerability to potential supply shortages.” Moreover, the report warns that “as lighting energy efficiency standards are implemented globally, heavy rare earths used in lighting phosphors may be in short supply.”

Given their vulnerable dependency on China’s rare earths, the US, European Union, and Japan have combined forces to launch a WTO case against China’s export quotas. In their defense, Chinese officials have argued that the quotas are justified because the government is cracking down on illegal rare earth mines and must control environmental damage. Furthermore, they contend that it is unfair and unreasonable to expect China, a country with only 36 percent of the world’s rare earth reserves, to bear the environmental costs and resource depletion necessary to fuel the economies of developed countries. Opponents would respond, however, by arguing that China’s sale of irrationally cheap rare earths led to the closure of mines in other countries, leaving China as a one-nation OPEC for rare earths (NYSEARCA:REMX)

Despite the political sense of urgency, the WTO case opened this month is expected to take months to years to resolve, which has prompted scientists worldwide to research alternative technologies that circumvent China, making clean tech industries (NYSEARCA:GEX) independent of rare earth supplies. The US Department of Energy has commissioned the Advanced Research Projects Agency-Energy (ARPA-E) to invent ways around the US’s dependence on China’s rare earths. Among other projects, scientists at ARPA-E are experimenting with substitutes for neodymium, the rare earth element found in the permanent magnets of modern wind turbines and in the batteries of electric vehicles. However, the research is far from commercially applicable, as one scientist of the team explains: “Each of us has [to have] at least one miracle scenario to be successful.”

In the transition to cleaner energy sources (NYSEARCA:GEX), it is important to consider the reality that many economies may be trading a fossil fuel addiction for a dependence on rare earth metals. Even as the US applies tariffs to Chinese solar panels (NYSEARCA:TAN) and seeks to strengthen domestic industry, more advanced solar technologies (NSYEARCA:TAN), such as thin-film solar panels, require indium—another rare earth metal, 100 percent of which is produced in China. Though the US mining company Molycorp has bought and plans to reopen the Mojave Desert rare earth mine, the promises of robust production by mid-2012 seem unlikely.

So, what do these complex and politically charged trade disputes mean for the future of the clean tech industry? First, it is important to recognize that China has a huge volume of its capital assets invested in the US and Europe and is therefore unlikely to risk a trade war. Second, just as tech companies in developed countries are dependent on Chinese raw materials, the Chinese economy is dependent on the consumption of its exports in developed countries; therefore, Chinese politicians have little incentive to threaten the stability of this interdependence. Moreover, with the slow yet promising growth of diversified rare earth supplies (NYSEARCA:GEMX) and rare earth-independent technologies, the US and Chinese clean energy industries (NYSEARCA:GEX) are preparing a path of balanced and sustained growth. Given these conditions, this short term bickering will likely pass and give way to the broader energy trends already in motion, a waning of fossil fuels and the increasing profitability and application of renewable energy (NYSEARCA:GEX).

Note: This article is the second of a two-part series. Click here to read part one.

Ryan Landon Swanson is an associate writer for Wall Street Sector Selector. His chief research focus is on the political economy of China’s energy sector, but he also enjoys writing on the political economy of Latin America. He fluently speaks, reads, and writes Spanish and Mandarin Chinese. Ryan has substantial experience living, studying, and working in both China and Argentina. He earned a B.A. from the University of California, Berkeley in Interdisciplinary Studies with a focus on international relations and energy.