Lessons From TREM12 – Resource Investor

My more inquisitive readers may know that I was invited to be an expert panelist at the IAGS Technology and Rare Earth Metals Center “TREM12” conference this month in Washington, D.C. I never miss a chance to show off my knowledge and feed my ego.

I can’t recap the entire two-day knowledge fest but I’ll offer some highlights. Sen. Lisa Murkowski (R-Alaska) gave an impressive talk on Congress’ efforts to streamline permitting regulations for mining and the need for more aerial hyperspectral imaging surveys of unexplored properties in the US. David Sandalow, an Assistant Secretary at the US Department of Energy, acknowledged that the White House Office of Science and Technology Policy was the natural choice to lead the “whole of government” interagency effort on critical metal supply security. DOE’s Innovation Hubs are fully funded, but IMHO they should focus on business incubation and license out the tech they’re developing. One panelist said something ignorant about wind energy, that its cost is essentially free once you amortize away the initial capital costs (IMHO this is stupid because it ignores the cost of regular maintenance, inspections, blade failure, etc.).

The panel on automotive tech and grid storage made it clear that there will be no shortage of lithium to meet the world’s needs, which is one reason why the Li-Ion battery market is expected to consolidate into a smaller number of manufacturers. The automotive panel also emphasized that the US will need to update its transmission grid to accommodate a growing hybrid/electric vehicle market, and the demands of energy storage at grid level will help drive smart grid build-outs that will optimize charging times for vehicles. The graphite panel noted the many applications for this material but some have no synthetic alternative. Ambassador Ichiro Fujisaki of Japan discussed how Japan, the EU, and the US have coordinated their WTO complaint about China’s REE policy; they’ve learned lessons from past oil supply shocks and know that Japan’s increasing reliance on renewable energy (especially after the Fukushima meltdown) will make REEs critical.

The final speaker, Dr. Si Jinsong from the Chinese Embassy, restated the PRC’s official view on why they are curtailing rare earth exports. Environmental damage is IMHO a red herring. China can always dial back its domestic industrial use of REEs or get more aggressive about enforcing environmental regulations to mitigate damage from REE production. His claims that China has exported too much already and is facing resource exhaustion mean little to me. REEs are typically found in conjunction with base metals and China still has plenty of those. The real money quote came late in his presentation when he said the US and China should work together to expand high-value manufacturing. That is as transparent a statement of intent as the West will ever see from China. The PRC’s longstanding policy is to attract the onshoring of high-tech manufacturing supported by foreign direct investment so Chinese engineers can capture technical knowledge and Chinese industry can build a high-tech export base. US policymakers need a thorough education in China’s grand strategy, and they should start by reading Unrestricted Warfare to see recommendations straight from the People’s Liberation Army.

The fun part for me was my participation on the panel “Supply and Demand: In Balance or Imbalance?” moderated by Clint Cox of The Anchor House. We had some pretty lively discussions of the structure of the REE market, with Dr. Michael Berry contributing his macroeconomic perspective and Michael Silver from American Elements speaking as an operator within the sector. I’ll restate some of my own points from the panel below.

I led off with my assessment of the massive imbalance in the critical metal market and forecast for a future balanced market. Any market where 97% of supply and 100% of alloy processing must originate in China is the definition of a market far out of balance. I argue that a balanced market in strategic metals will eventually look like today’s energy market. A power plant doesn’t care if the feedstock is natural gas or coal because you don’t have to change a turbine’s physical structure to use either one. A transmission grid doesn’t care whether electrons come from hydropower, geothermal, solar, nuclear, or fossil fuels so long as those electrons can get to your home appliances. Eventually the metals markets will balance when diverse supply sources, efficient technologies, and synthetic substitutes can arbitrage away single sources of supply. US GDP has grown for the past several decades even though per capita energy use has declined. We can use the same energy metrics for the metals market.

I noted that Molycorp’s acquisition of Neo Materials changed the game for REE producers by creating a true vertical business model. The deal was cash-heavy rather than stock-heavy, which I thought odd given the strength of MCP shares trading at 23 times earnings. I wondered out loud whether Molycorp thought that the balance sheet risk of assuming a half billion dollars in debt outweighed the avoidance of shareholder dilution. Molycorp is the only REE producer than has the financial and operational strength to initiate M&A; all other REE producers are still young and are thus more likely to be bought themselves (like by an oil supermajor seeking lanthanum or cerium for fluid cracking) than to be buyers of alloy processors.

I threw several policy prescriptions at the audience, starting with a big one for federal government policy. Several other panelists had noted that DOD seemed to be the weak link in the interagency effort to secure critical metal supplies. I think I know why. DOD’s weapon system procurement program managers are selected from career warfighting officers, which makes sense if you want people who can dream up future capabilities for armored vehicles and fighter aircraft. The weakness of this approach is that warfighters don’t think like logisticians. They don’t know how to reach down three or four levels worth of subcontractors to find supply chain vulnerabilities. I would like to see DOD’s Defense Acquisition University incorporate supply chain security into its curriculum so program managers get the insight they need. I would also like those professional logisticians who do join the acquisition workforce to think more like intelligence officers when they screen contract sources for components and raw materials. The intelligence community has plenty of data on natural resource repositories in many countries; developing indicators and warnings of supply curtailments that procurement managers and logisticians can use should be a priority for the intelligence community.