Workershandle neodymium ingots before they are crushed at Neo MaterialTechnologies Inc.'s Magnequench Tianjin Co. factory in Tianjin, China.Photographer: Doug Kanter/Bloomberg
April 14 (Bloomberg) -- The U.S. military depends on China for themetals required to build smart bombs, night-vision goggles and navalradar, according to a report from the Government Accountability Office.Bloomberg's Lindsey Arent reports. (Source: Bloomberg)
"Becauseexport quotas are limited, we basically can choose our clients; we areno longer compelled to sell to just about anybody who comes knocking,”said Bai Baosheng, who handles investor relations for Inner MongoliaBaotou Steel Rare-Earth Hi-Tech Co. Photographer: NelsonChing/Bloomberg
Annealedneodymium iron boron magnets sit in a barrel prior to being crushedinto powder at Neo Material Technologies Inc.'s Magnequench Tianjin Co.factory in Tianjin, China. Photographer: Doug Kanter/Bloomberg
The research facility at Inner Mongolia Baotou Steel Rare-Earth Hi-Tech Co. Photographer: Nelson Ching/Bloomberg
Samplesof various rare earth compounds are displayed in the showroom at InnerMongolia Baotou Steel Rare-Earth Hi-Tech Co. Photographer: NelsonChing/Bloomberg
Motorsin missiles like the JDAM might be three times as big without advancedmagnets. The JDAM has been used extensively in Iraq and Afghanistan.Photographer: Philip A. McDaniel/U.S. Navy via Bloomberg
Anopen pit mine in Nevada owned by Molycorp, which plans to mine almost20,000 tons of rare earths annually by late 2012 but doesn’t yet havethe capacity to refine the raw elements into metals. Photographer:Jacob Kepler/Bloomberg
KathyDeFries, co-owner of Excel Machine Technologies and owner of Coco'sCanine Cabana, attends to dogs in her doggie daycare facility inValparaiso, Indiana. The facility occupies a portion of an Excel plantthat used to make 80 percent of the rare earth magnets in laser-guidedU.S. smart bombs. Photographer: John Zich/Bloomberg
KathyDeFries, co-owner of Excel Machine Technologies Inc., next to drillpresses on Excel's shop floor in Valparaiso, Indiana. Photographer:John Zich/Bloomberg
Aquote by former Chinese President Deng Xiaopeng, which reads,"TheMiddle East has oil, China has rare earth minerals," on the wall atInner Mongolia Baotou Steel Rare-Earth Hi-Tech Co. in China.Photographer: Nelson Ching/Bloomberg
Samarium-cobaltmagnets of different strengths, left, and a defense component withmounted magnets are arranged for a photo at the Electron Energy Corp.factory in Landisville, Pennsylvania. Photographer: GopalRatnam/Bloomberg
A senior manager at a company thatchurns out metals routinely used in U.S. smart bombs pauses inmid-sentence when his phone rings: a Wall Street stockbrokerlooking for information. He makes a note to have an assistantcall back -- someone who is fluent in English, not just Chinese.
“It’s a seller’s market now,” says Bai Baosheng, 43,puffing a cigarette in his office in Baotou, China, where hiscompany sells bags of powder containing a metallic element knownas neodymium, vital in tiny magnets that direct the fins ofbombs dropped by U.S. Air Force jets in Afghanistan.
A generation after Chinese leader Deng Xiaoping mademastering neodymium and 16 other elements known as rare earths apriority, China dominates the market, with far-reaching effectsranging from global trade friction to U.S. job losses andthreats to national security.
The U.S. handed its main economic rival power to dictateaccess to these building blocks of modern weapons by cedingcontrol of prices and supply, according to dozens of interviewswith industry executives, congressional leaders and policyexperts. China in July reduced rare-earth export quotas for therest of the year by 72 percent, sending prices up more thansixfold for some elements.
Military officials are only now conducting an inventory ofwhere and how U.S. suppliers use the obscure but essentialsubstances -- including those that silence the whoosh of BoeingCo. helicopter blades, direct Raytheon Co. missiles and targetguns in General Dynamics Corp. tanks.
Warning Signs
“The Pentagon has been incredibly negligent,” said PeterLeitner, who was a senior strategic trade adviser at the DefenseDepartment from 1986 to 2007. “There are plenty of earlywarning signs that China will use its leverage over thesematerials as a weapon.”
China may already be flexing its muscles amid a diplomaticspat with its East Asian neighbor Japan. China last week imposeda “de facto” ban on exports to Japan of the metals used inliquid crystal displays and laptop computers, Japanese EconomyMinister Banri Kaieda said Sept. 28. That followed Japan’sdetention of a Chinese fishing boat captain whose ship collidedwith two Japanese Coast Guard vessels. Japan later released theman.
No such ban exists, China’s Ministry of Commerce spokesmanChen Rongkai said.
New Factor
“What it does, clearly, is bring a new factor into theconsideration of supply of critical materials,” said Dudley Kingsnorth, director of Industrial Minerals Co. of Australia, aforecaster in Perth.
The U.S. Congress’s investigative arm, the GovernmentAccountability Office, in April warned of “vulnerabilities”for the military because of the lack of domestic rare-earthsupplies. The House of Representatives Armed Services Committeewill hold a hearing in October, the same month a Pentagon reporton how to secure future supplies of the metals is due.
“The department has long recognized that rare-earthelements are important raw material inputs for many defensesystems and that many companies in our base have expressedconcern regarding the future availability of the refinedproducts of these elements,” Brett Lambert, director of thePentagon’s Office of Industrial Policy, said.
While two rare-earth projects are scheduled to ramp upproduction by the end of 2012 -- one owned by Molycorp Inc. inCalifornia and another by Lynas Corp. in Australia -- the GAOsays it may take 15 years to rebuild a U.S. manufacturing supplychain. China makes virtually all the metals refined from rareearths, the agency says. The elements are also needed forhybrid-electric cars and wind turbines, one reason supply mayfall short of demand in 2014 even with the new mines, accordingto Kingsnorth of Imcoa.
Doggy Day Care
Just how far U.S. manufacturing has waned is apparent at afactory in Valparaiso, Indiana, where dogs skitter across a bareconcrete shop floor, their nails clicking. This brick plant onElm Street once made 80 percent of the rare-earth magnets inlaser-guided U.S. smart bombs, according to U.S. Senator Evan Bayh, a Democrat from Indiana. In 2003, the plant’s ownershifted work to China, costing 230 jobs.
Now the plant houses Coco’s Canine Cabana, a doggy day carethe current tenants started to supplement sagging income fromtheir machine shop. On most days dogs outnumber the 15metalworkers, said Kathy DeFries, co-owner of Excel MachineTechnologies Inc.
“When things got slow for manufacturing, we had this bigempty shop floor,” said DeFries, nuzzling a floppy-eared puppy.“It’s a great stress reliever.”
Expensive to Mine
The rare earths are chemically similar elements, with namessuch as yttrium and dysprosium. China has the largest share ofworldwide reserves, about 36 percent, and the U.S. is second,with 13 percent, the U.S. Geological Survey says. While theelements aren’t rare, they’re less frequently found inprofitable concentrations, expensive for Western producers toextract and often laced with radioactive elements.
China produced 120,000 tons, or 97 percent, of the world’s124,000-ton supply last year, according to the GAO. Half of thatcame from Baotou, said Kingsnorth. The raw elements have manyapplications. Neodymium is used by Chinese companies includingmagnet makers, who sell to U.S. suppliers of defensecontractors.
Export Quotas
Export quotas and taxes for overseas buyers that the GAOsays can reach 25 percent are pushing up prices of elements evenin relatively large supply. For example, the cost of a kilogramof samarium powder, needed for the navigation system of GeneralDynamics’ M1A2 Abrams tank, jumped to $34 in early September,from $4.50 in June, according to U.K. researcher Metal PagesLtd.
The U.S. and the European Union consider Chineserestrictions on a range of raw goods part of a strategy to drawin higher-paying manufacturing jobs by making them cheaper tobuy inside China. The export taxes violate World TradeOrganization rules because China pledged to limit them to 84product categories when it joined the trade group in 2001, saidTerence Stewart, managing partner of Washington law firm Stewart& Stewart. In 2010, China had taxes on 329, he said.
The U.S. and the EU filed a WTO complaint over rawmaterials including bauxite and coke last year. China’s commerceminister, Chen Deming, said Aug. 28 that the policies complywith WTO rules.
Some manufacturers in China are lobbying the ministry toback off the latest quotas because a dispute will disrupt themarket, said Constantine Karayannopoulos, chief executiveofficer of Toronto-based Neo Material Technologies Inc., whichhas rare-earth production facilities in China.
Risk of Trade War
“It was very sudden and didn’t give the industry any timeto adjust,” he said. “This quota action could risk a tradewar.”
For Western companies, China’s policies are creating thereal “unobtanium,” the fictional mineral fought over in James Cameron’s 2009 film “Avatar.”
It’s taking as long as 10 weeks to get neodymium magnets,double the previous wait time, said Joe Schrantz, group supplychain manager at Moog Inc. in East Aurora, New York. He said thecompany buys hundreds of thousands of magnets a year to makemotors for cars, trucks and weapons including Raytheon’s AMRAAM-- or Advanced Medium-Range Air-to-Air Missile -- and Boeing’sJoint Direct Attack Munition, a tail fin kit for makingprecision-guided “smart” bombs out of ordinary weapons.
Rising Prices
Rising neodymium prices are forcing up the price ofmagnets, which typically cost between $2 and $30 apiece. That’shaving a “significant” effect on profit, and suppliers saycosts will keep going up, Schrantz said. The company isconsidering buying blocks of raw material and storing it.
“If everybody does that, then it’s going to get reallycrazy,” he said.
Neodymium, a silvery metal, is essential in a magneticalloy developed separately by engineers at General Motors Co. inDetroit and Sumitomo Special Metals Co. in Japan in the 1980s.The magnets are now in millions of stereo speakers, computerdisk drives and motors.
In missiles, they replace a hydraulic system of pumps andfluids that was costlier and heavier. Motors in weapons like theJDAM might be three times as big without advanced magnets, saidTodd Brewster, senior design engineer at Kollmorgen, a unit ofWashington-based Danaher Corp. The JDAM has been usedextensively in Iraq and Afghanistan.
Hybrid-Electric Motors
A Chinese supplier makes neodymium magnets for hybrid-electric motors the Navy is developing to cut fuel use ofArleigh Burke-class destroyers, according to the GAO. The agencyalso says Lockheed Martin Corp.’s SPY-1 radar on Aegisdestroyers contains samarium-cobalt magnets that will need to bereplaced over 35 years. China is virtually the only supplier ofyttrium needed for laser gun sights in the General DynamicsAbrams tank, the U.S. Geological Survey says.
“It’s amazing how this issue seems to have caught thecountry off guard,” said U.S. Representative Mike Coffman, aColorado Republican who was a U.S. Marine Corps infantryofficer. He noted that China’s capabilities have expandedsignificantly since 2001, when the U.S. Army canceled plans tobuy Chinese-made berets under pressure from Congress. “Howironic is that we were concerned about berets?”
Jon Kasle, a spokesman for Raytheon of Waltham,Massachusetts, said his company hasn’t experienced supplyshortages. Spokesmen for Bethesda, Maryland-based LockheedMartin; General Dynamics, of Falls Church, Virginia; andChicago-based Boeing declined to comment. “There is aparticular need to focus on rare-earth minerals,” said Alexis Allen, spokeswoman for the Aerospace Industries Association, anArlington, Virginia-based lobby group for defense contractors.“The Department of Defense should consider many alternatives toreliable access.”
Stockpile
One option is to stockpile the metals with allies. Since1994 the Pentagon has sold off excess raw materials for $7billion.
Another is subsidies of U.S. manufacturing. The U.S. Houseof Representatives approved yesterday a proposal byRepresentative Kathy Dahlkemper, a Pennsylvania Democrat, thatwould set up a research and development program at theDepartment of Energy to help U.S. rare-earth manufacturers suchas Molycorp with measures including loan guarantees. To becomelaw the bill, which cleared the House on a 325-98 vote, musthave a matching Senate version and be signed by the president.Currently there is no such measure.
While Molycorp plans to mine almost 20,000 tons of rareearths annually by late 2012, it doesn’t yet have the capacityto refine the raw elements into metals.
‘No Substitute’
Complicating matters is that even the Pentagon has beenunsure of its own needs. Stephen Luckowski, chief of materialsmanufacturing and prototype technology at the U.S. Army’sPicatinny Arsenal in New Jersey, told participants at a Februaryconference in Cleveland that it took him a month to learn thatrare-earth metals are in the nose of the Excalibur missile, andhe still wasn’t certain of the exact supply route. Luckowski, ametallurgist, was sure the Army needed the rare earths. “Thatmay be a case where you have no substitute,” he said.
China’s dominance in the materials comes as it scours theplanet for resources to feed its economy, which is expandingmore than 10 percent this year while the U.S. struggles with analmost 10 percent unemployment rate. The country has beensnapping up oilfields, buying copper mines and investing in windpower. China is also expanding its military, developing anaircraft carrier, nuclear-powered submarines and ballisticmissiles, the Pentagon said in an August report.
Deng’s Quotation
In the lobby of Bai’s company, a unit of state-owned BaotouIron & Steel Group Co., a now-famous 1992 quotation by Deng isemblazoned in pink marble. It reads: “The Middle East has oil,and China has rare earths.” A May interview with Bai isregularly interrupted by calls from stockbrokers, analysts andfund managers looking to learn more about the company.
“Because export quotas are limited, we basically canchoose our clients; we are no longer compelled to sell to justabout anybody who comes knocking,” said Bai, who handlesinvestor relations for Inner Mongolia Baotou Steel Rare-EarthHi-Tech Co. The shares have more than doubled in the past year,reaching 72.72 yuan on Sept. 29, giving the company a marketvalue of $8.8 billion.
The company is especially proud of the samarium-cobaltmagnets used in the Shenzhou 7 space capsule that lifted Chineseastronauts into space in 2008. They were developed at the nearbyBaotou Research Institute of Rare Earths.
Environmental Costs
The export restrictions compensate for the heavyenvironmental toll, said Zhang Anwen, vice secretary of theChinese Society of Rare Earths, a group of researchers inBeijing. “It’s unfair for the U.S. to be pointing fingers atChina now,” he said. “To undo the damage done to the earth, weneed to return the vegetation, increase water flow and treat theground. It’s an extremely costly repair.”
Deng set China on its path with a 1986 initiative whosegoals included acquisition of technology in “exotic materials”such as rare-earth metals, new energy compounds and high-capacity engineering plastics, according to a U.S. House ofRepresentatives committee report.
That year Zhu Weiheng, an electrical engineer at theChinese Academy of Sciences, wrote a report to Chinese officialssuggesting they control exports of rare-earth minerals becauseof their high value in manufacturing. Zhu had studied at theMassachusetts Institute of Technology in Cambridge,Massachusetts, and in 1965 designed a motor for China’s firstsatellite, the East is Red. Later he spent part of Chineseleader Mao Zedong’s Cultural Revolution under arrest as asuspected spy.
‘Real Revolution’
By the early 1980s, Zhu was testing samples of neodymiumiron boron, the alloy perfected by engineers at GM and Sumitomo.Two Chinese research institutes also developed it, said Zhu, 91.“It was a real revolution,” he said.
In 1990, Zhang Hong, the Chinese academy’s deputy directorof technology, visited Magnequench, a GM unit in Indiana thatused a spinning wheel to quench, or cool, the molten alloy intoflakes to make magnets. Five years later, a group including thenstate-owned San Huan New Materials and Hightech Inc. agreed tobuy Magnequench.
The Committee on Foreign Investment in the United States, across-agency board that reviews foreign takeover deals, allowedthe purchase partly because the partners agreed to keep openfacilities in the U.S.
Shipped to China
The company opened a new plant in Tianjin in 1998 and shuta former GM operation in Anderson, Indiana, four years later.Magnequench also purchased and later closed the factory inValparaiso, where Kathy DeFries now boards dogs for $5 an hour.That plant’s tools were shipped to three San Huan operations inChina, according to Shannon Song, a Beijing-based executive atMagnequench.
“What they were basically doing was replicating theproduction lines in China,” said Leitner, the former Pentagonofficial.
Indiana’s Bayh and Hillary Clinton, now U.S. secretary ofstate, both cited Magnequench as an example of the U.S. losingjobs and expertise to China. In the 1990s a dozen U.S.-basedsuppliers of magnets employed 6,000 people. Today there arefour, employing 500, said Ed Richardson, vice president ofThomas & Skinner Inc. in Indianapolis, one of the survivors.
Business Decision
The plant closures were a business decision after thetechnology bust in 2000 hurt sales, Song said. Most of theValparaiso factory’s business came from computer makers; defensewas a minor share, she said. In 2001, labor costs in Andersonaveraged $7.32 per kilogram of neodymium powder on top of $10.07in direct production overhead, she estimates. In 2003 inTianjin, labor costs were 16 cents and overhead $3.20.
“It was a question of letting the ship sink or doingsomething to cut the operating cost,” she said.
Toronto-based AMR Technologies Inc. bought Magnequench in2005 and renamed the merged company Neo. The company’s sharesrose to C$4.92 yesterday from as little as C$1.05 in early 2009.
San Huan, now known as Beijing Zhong Ke San Huan High-TechCo., went public in 2000. Sales have risen more than fourfold,from 371 million yuan that year to 1.6 billion yuan in 2009. Thestock has almost tripled in the past year, reaching 17.14 yuanon Sept. 29.
God and Magnets
“God created the universe from nothing and organized itwith the help of a magnet,” the company declares on itswebsite, in English and Chinese.
Shares of Aluminum Corp. of China Ltd. rose 18 percent overthe past two days in Shanghai trading after its parent announceda plan to invest at least 10 billion yuan ($1.5 billion) tobuild a rare earth production base in Jiangxi province with alocal partner.
A group of U.S. investors led by Denver-based privateequity firm Resource Capital Funds wants to challenge China’sdominance by restoring the fortunes of Molycorp, the largestsupplier of rare earths for much of the last century. Its mine,west of Las Vegas in California’s Mojave Desert, shut eightyears ago, under pressure from Chinese competitors andregulatory scrutiny of wastewater spills.
Molycorp, based near Denver, says it needs $511 million torefurbish and expand. It raised $379 million in its July sharesale, and has applied for a $280 million loan guarantee under aU.S. Department of Energy program for “innovativetechnologies.” The shares have almost doubled, closing at$26.73 yesterday from $14 in July.
Joshua Trees
Costs of environmental compliance will be steep, Molycorpwarns in a filing that says it spent $3 million last year alone.Beyond a 300-foot-deep open pit, John Benfield, manager ofquality assurance, points to a valley sheltering Joshua treeswhere slurry left after processing ore will be pumped and hardenlike concrete.
The trees, protected under California law, will be givennew homes after their precise positions are measured withcompasses. Their bark burns in the desert sun without the rightorientation. Even so, only 20 percent of replanted treessurvive, Benfield said.
The company will keep processing costs to $1.26 per pound,half the average in China, by recycling more water and using asingle acid to separate elements, said Mark Smith, Molycorp’sCEO. Molycorp is also negotiating with potential partners toalloy metals and turn them into neodymium magnets in the U.S.,creating as many as 900 jobs.
“It was a very, very strategic move that the Chinesemade,” he said. “They created a very, very large number ofjobs for the citizens of China. We ought to be looking atexecuting that exact same strategy here in this country.”
To contact the reporters on this story:Peter Robison in Seattle onrobison@bloomberg.netGopal Ratnam in Washington atgratnam1@bloomberg.net.
To contact the editor responsible for this story:Melissa Pozsgay in Paris atmpozsgay@bloomberg.netGary Putka in Boston ongputka@bloomberg.net.