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Wednesday, November 24, 2010

Rare Earth Elements: Stockpile or Markets?

Quick, what do you know about lanthanum, praseodymium, neodymium, or dysprosium? If you said they are chemical elements, you are right: numbers 57, 59, 60, and 66, to be exact. They and their neighbors on the periodic table, collectively “rare earths,” were once mere curiosities tucked in between barium and tungsten. Now they’re having their day in the sun, thanks to new technology, as did uranium and plutonium when atomic energy was developed. The military may begin stockpiling them.

Good idea or not?

My first encounter with these elements was a project that developed high-tech shock absorbers to protect a replacement camera for the Hubble telescope during the camera’s rough ride to orbit. These devices, called M-Struts, pioneered the use of permanent magnets for shock mitigation. The only material our team found that would provide sufficient magnetic flux density (a measure of the strength of a magnetic field at a given point) was a rare earth alloy, NdFeB (neodymium-iron-boron). This material could only be procured from China.

M-Struts were a one-off project that had no discernible effect on the demand curve for neodymium. But now the demand curve is crowding up against the supply curve largely because of rare earth applications in “green” energy devices such as wind turbines (extra points if you knew that).

Engineers build things that work right most of the time, and as a result the public remains largely ignorant of how devices and systems work or how they are designed, manufactured, built, and maintained. For every blowout preventer that enters the limelight, thousands of other more or less critical devices just keep on working. Consider wind turbines, which have been a common sight along the freeway near my home for some years now and are popping up in other windy parts of the country. They may look simple from a distance, but they definitely are not. They are complex machines designed and built under stringent safety, efficiency, reliability, and durability constraints. Great care must be taken to ensure that they work consistently and safely under normal circumstances and can survive worst-case earthquakes and wind storms. Maintenance and repair work on a turbine 30 meters above the ground is an expensive and hazardous undertaking.

The turbines are encased in aerodynamic nacelles, which hide the complexity of the machinery inside. There is a gear train that steps up the slow rotation of the blades and drives an output shaft connected to a generator. Bearings, lubrication systems, control systems, brakes, and gears must be carefully designed for efficiency, reliability, longevity, and quiet operation. Weight minimization is an important design goal, meaning wind turbines, like M-Struts, must employ permanent magnets with very high flux density, which only rare earths can provide. A generator of moderate size (three megawatts) uses about a ton of these super magnets, of which roughly 700 pounds are neodymium. Multiply those figures by thousands of current and projected wind generators and you get an enormous demand for neodymium.

Wind turbines aren’t the only new use for rare earths. A typical hybrid car employs about 25 pounds consisting of lanthanum in the battery and neodymium in the drive motor. Lithium, also a chemical element but not a rare earth, is another key element used in current battery designs. Compact fluorescent bulbs, which the government will force us all to use by 2014, include a phosphor coating of rare earths. Other applications include water treatment, precision-guided munitions, DVD players, optical lenses, and MRI scanners, to name just a few.

Why Stockpile?

Rare earth oxides are mined. At one time a single mine in a remote part of California called Mountain Pass accounted for the majority of world production. But in the early 1990s imports from China began cutting into the mine’s market share and prices began a steady decline. At the same time, environmental problems raised production costs at Mountain Pass. Consequently, production ceased for about five years. In 2008 Chevron Corp. sold the mine to a private group that intends to restart it. The group formed a company called Molycorp, which had an initial public stock offering last July. Analysts estimate the owners reaped substantially more in that offering of 25–35 percent of the company than they paid for the whole operation. Molycorp management claims to have resolved production problems and hopes to restart production next year.

A free-market success story in the making? Not exactly. This being the age of crony capitalism, Molycorp management expects and will likely receive, as the company website puts it, “appropriate federal assistance for research, development and capital costs.” In other words, some of the risk is imposed on taxpayers while all the profits go to private parties.

Ninety percent of current rare earth production comes from China, though this may change if Mountain Pass comes online. Given the high demand for rare earths and export restrictions imposed by the Chinese government, it comes as no surprise that that the U.S. government, specifically the Department of Defense, intends to begin stockpiling these materials.

Past Stockpiling Fiascoes

U.S. government stockpiling began after World War I, though the basic idea is ancient and mentioned in the Book of Genesis. The War Industries Board, which encountered shortages during the war, suggested that future problems be ameliorated by stockpiling: a reasonable-sounding idea that did not quite work out as planned. In 1922 a bureau was established in the War Department that got busy compiling a list of 42 strategic materials to be acquired. But the government took its time acting on the list. It was only in 1938, with another war looking ever more likely, that Congress passed the Naval Appropriations Act, authorizing $100 million for purchases of materials. Unfortunately, when war did come in 1941, only about half of the authorized acquisitions had been completed. Consequently, most strategic materials had to be imported during the war. Only three of the 15 materials in the wartime stockpile came from domestic sources.

Following World War II there was a great deal of debate about what should be stockpiled and who should be in charge. Compromise legislation established an unwieldy bureaucracy led by the Army/Navy Munitions Board, with participants from the departments of State, Treasury, Agriculture, and Commerce. It was left largely to the bureaucracy to decide what materials should be stockpiled, where, and in what quantities. By 1948 a list of 51 materials valued at about $2.1 billion had been compiled, and by 1950 $1.6 billion worth of materials was on hand with half a billion more on order—this of course being a time when a billion dollars was real money. As always, those in charge took care to spread the work over as many congressional districts as possible: By 1953 the stuff could be found at 71 military depots, nine General Services Administration depots, four government-owned vaults, six commercial vaults, 165 commercial warehouses, 34 commercial tank farms, seven open-air commercial sites, four open-air government sites, and 18 industrial plants. One wonders how much was lost, stolen, or simply forgotten.

In 1962 President John Kennedy said he was “astonished to find that the stockpiling program had accumulated $7.7 billion worth of materials, an amount nearly $3.4 billion greater than estimated wartime needs.” By 1965 a disposal program was in full swing, but in 1981 another upswing began as part of the Reagan defense buildup. “It is widely recognized that our nation is vulnerable to sudden shortages in basic raw materials that are necessary to our defense production base,” President Ronald Reagan warned. The next downturn came in 1992 with the demise of the Soviet Union along with candidate Ross Perot’s harping on deficits in that presidential election year. Eighty-four individual materials were on hand then, worth an estimated $7.7 billion. Between 1993 and 2005 some $5.9 billion worth of materials were sold, while minor acquisitions continued. By 2008 a mere $1.6 billion stockpile remained, and that may turn out to be another cyclical low. In that year the military suspended or limited sales of 13 commodities whose stockpile levels had previously been considered excessive.

Another Cyclical Upswing

A new turning point may now be at hand in the form of the Pentagon’s proposed Strategic Materials Security Program, which among other things would grant the military greater discretion in deciding what to buy and from whom. One wonders about the likelihood that Congress will give up an option to steer major amounts of spending and jobs to their constituencies.

In any event, in 2009 several rare earths were added to the list of materials that the military might stockpile. So now we have one branch of the government attempting to mitigate a problem caused largely by other branches. Observe: Except in special circumstances, electricity cannot be generated economically by wind or solar devices, absent government subsidies. Hybrid or all-electric cars are likely uneconomical as well at present. Thus the increased demand for rare earths is largely due to government subsidies. By the very nature of such subsidies, all these technologies divert scarce resources away from other projects that would better serve consumer needs.

But wait. If not presently economical, won’t these devices soon become economical, and isn’t it a smart idea for government to hasten a good thing that is surely coming? No. Even if we concede the inevitability of these “green” alternatives, the unhampered market will tend toward not only the optimal uses of present resources but also the timing with which new technologies are deployed. Scarcity of saved capital is always the limiting factor in investment and production, not technological knowledge, as Murray Rothbard pointed out in Man, Economy, and State.

What Are the Alternatives?

Returning to stockpiling, we now ask why governments stockpile strategic materials at all and whether there are better alternatives.

If we are to have a military at all, it must consume materials. Just as manufacturing firms try to stockpile the right amounts of materials and parts—too much ties up scarce capital while too little risks shutdowns—we might expect the military to follow similar practices. But this comparison is superficial. To begin with, the aforementioned tendency of members of Congress to pursue their narrow interest is always at work, which is also why base closings are so difficult. Second, Pentagon planners have a hard time foreseeing what might actually be needed. (When it became apparent that Humvee military vehicles were vulnerable to roadside bombs in Iraq, the DoD had to scramble to find supplies of a special hardened steel alloy to retrofit the vehicles. It had stockpiled many materials, but not that alloy.) And of course, unlike loss-fearing private businesses, government officials lack any strong motivation to economize.

What Is Unseen

In evaluating the economics of stockpiling, we must follow Frédéric Bastiat’s insistence on considering what is unseen as well as what is seen. DLA Strategic Materials (DLASM)—what the Defense National Stockpile Center was called until July 2010—assures us, via its website, that the “stockpile acts like an insurance policy with an outlay return of many-folds [sic] over the original costs should the stockpile be used, and yet until used, it retains indefinite value (at current market value).” A win-win situation, free of costs, it would seem. The DLASM site makes no mention of the costs of acquisition, transportation, storage, safeguarding, accounting, or deterioration. Nor does it consider higher prices paid by civilian consumers of stockpiled materials.

DLASM stockpiling is not motivated solely by military needs. In fact, the website specifically states that the stockpile “is not solely a military element, but rather, it is intended for all essential civilian and military uses in times of emergencies.” Who decides what is essential and what is an emergency? Blank-out, as Ayn Rand liked to say. The laissez-faire notion of strictly separating government activities from private interests, if it ever existed at all, is not what we have today, not by a long shot.

So if stockpiling is problematic, what is the alternative? Private speculation. Uranium is difficult to store because it is radioactive, and yet the Uranium Participation Corporation is a private Canadian firm which does just that. It offers operators of nuclear power plants a steady source of supply and speculators an opportunity to seek profits. In addition, uranium futures are traded on the New York Mercantile Exchange. Although rare earths can be difficult to store, they are not radioactive. Given the long list of materials that are now traded in spot and futures markets, it would not be surprising to see rare earths joining their number, thereby harnessing the efforts of speculators for the benefit of military or commercial users. Markets offer the opportunity for all users to harness the profit-driven foresight of speculators.

But what if somebody cornered the market for neodymium? Could they hold the entire military or even the entire civilian economy hostage? No. Cornering (purchasing almost all available stocks in an effort to exact monopoly prices) is almost impossible to achieve, as Nelson Bunker Hunt found out when he tried to corner silver in 1980 and lost his shirt. Should a cornering effort be detected, the military or another major user could easily front-run it with above-market bids.

Stockpiling, in short, is a practice with major political problems and a historical record of wild swings. We would do better to let markets husband scarce resources.

  • Warren Gibson teaches engineering at Santa Clara University and economics at San Jose State University.