Volatility cuts both ways

Lest we be lulled into the assumption that commodity prices are on a one-way trip to infinity:

In just the last couple weeks corn prices have fallen from nearly $8/bushel to about $6.15. All of that is due to a rather small amount of information about the progress of this year's crop. Yes, there were reports of flooding and late plantings, but that kind of thing rarely has much effect on the overall crop production. The late plantings just set up even more volatility going forward, since the plants will be susceptible to extreme heat in July and August.

That's Michael Roberts, who concludes that

this volatility does provide a teachable moment: it shows how sensitive prices are to small quantity changes.

True, but I think we are collectively more attuned to the downside factors (climate change, growing demand) than the potential upsides (e.g., a sudden removal of biofuels mandates, or a restoration over several years of typical buffer stock levels). A 25% fall in a matter of weeks is huge, and a reminder that high food prices and food price volatility are not the same thing (a huge pet peeve of mine).

This can also be true for seemingly exhaustible physical resources, as yesterday's announced discovery of "vast deposits of rare earth metals" on small plots of Pacific Ocean seabed show us.

estimated rare earths contained in the deposits amounted to 80 to 100 billion metric tons, compared to global reserves currently confirmed by the U.S. Geological Survey of just 110 million tonnes that have been found mainly in China, Russia and other former Soviet countries, and the United States.

(don't sleep on the B vs. M - that is 800-1,000x current confirmed reserves)

I am pondering a longer post on what this means for commodities as an asset class (namely that over decades, they will not provide attractive real returns, although they may have some value as a hedge against inflation).

China's rare earth monopoly: long-term and short-term

In the wake of China's alarming decision to block rare earth exports to Japan, FP Passport published a longer and richer than usual post on whether China is making a rare earth power play, which is a helpful update on the latest global scenario.

As usual, some of the most insightful and prescient commentary came from Geoff Styles, a month ago already:

China's efforts to capture higher returns and more of the value-added for these scarce materials shouldn't surprise anyone; it's basic economics. OPEC tried this strategy in the 1980s, when it built export refineries in the Middle East and bought existing ones elsewhere. This didn't work out very well, because it contributed to a persistent glut of global refining capacity that, with the exception of a few standout years, generally benefited consumers more than producers. China could experience something similar in rare earths, once new, non-Chinese sources are brought online--assuming they are. Mining and processing such deposits entails large capital costs that, once invested, can set up a classic boom-and-bust commodity cycle. Unfortunately, the prospect of a future rare earth glut will be of little comfort to makers of wind turbines, advanced car batteries, and thin-film solar cells for the next several years, at least.

The OPEC comparison is interesting and relevant for the long-term view on rare earths, which are physically not that rare, just difficult and expensive to process. But Geoff is also right that in the short term, China may have a genuine squeeze. And if you believe this report (referenced by FP) that rebuilding the U.S. domestic industry would take 15 years, the short term doesn't look that short after all.

Moon shots and electric vehicles

Thomas Friedman on "moon shots":

China is doing moon shots. Yes, that’s plural. When I say “moon shots” I mean big, multibillion-dollar, 25-year-horizon, game-changing investments. China has at least four going now: one is building a network of ultramodern airports; another is building a web of high-speed trains connecting major cities; a third is in bioscience…; and, finally, Beijing just announced that it was providing $15 billion in seed money for the country’s leading auto and battery companies to create an electric car industry...

Not to worry. America today also has its own multibillion-dollar, 25-year-horizon, game-changing moon shot: fixing Afghanistan.

I'm not the biggest Friedman fan - he too often glances over important nuances - but he has a gift for stating core ideas in powerful ways, like the above. He devolves into simplicity here too:

The country that replaces gasoline-powered vehicles with electric-powered vehicles — in an age of steadily rising oil prices and steadily falling battery prices — will have a huge cost advantage and independence from imported oil.

If the economics were such a home run, it wouldn't take so much publicly funded start-up R&D to get this going - in fact, while I agree the prices of oil and batteries are moving in different directions, they're starting from such divergent places that they may well not cross any time soon. Batteries currently cost ~3x what they'd need to to be competitive, and Exxon - not the world's likeliest electric car revolutionary - has the world's best technology for the thin-film plastic separators that are the main components.

Especially given China's latest rare earths antics, we should also be worried about trading strategic energy dependency on one commodity (oil) for dependency on others.

That said, I believe Friedman's overall point on moon shots is spot on. My father (a scientist) and I disagree over the extent to which publicly funded basic science research enabled the technological boom of recent decades (think computers, the Internet, cell phones, biotechnology, etc.), but it certainly played some part, and skimping on this type of investment is a short-term decision with unpleasant long-term implications.

Hat tip Chris Blattman.

Does the rare earths market lie?

There is a lot of press about the scarcity of rare earths, but what is the market saying, and does it really lie? Compare these three points of view. First, America (and by the way MolyCorp is the only rare earths company in the U.S.):

“The pricing of the rare earths doesn’t make sense — they’ve been way too low for way too long,” grumbled John Benfield, the square-jawed senior chemical engineer at the [currently non-operational] Mountain Pass mine.

Then China:

Low prices for rare earth elements from China contributed to cuts at the Mountain Pass mine before it closed in 2002. They also discouraged most entrants to the industry until the last two years, when prices began to climb because of strong demand.

Then financial investors:

The Kaiser Bottom-Fish Online Index of share prices of rare earth companies soared eightfold last year, and has kept most of its gains. That has encouraged worries about a possible bubble.

“Most of them will get nice share prices for a while and then what goes up, comes down,” said Judith Chegwidden, a managing director and longtime rare earth specialist at Roskill Consulting Group in London.

I recognize that mines like these have long lead times, but when financial investors are worried about a bubble and prices are still not high enough to make American production viable, the worries start sounding to me more like supply chain security concerns (particularly for sensitive applications like defense) than commercial concerns about an aggregate supply shortfall. Also, if the rare elements are extremely valuable in minute quantities, they would be much easier to store than oil, for example (in which large-scale physical speculation has recently occurred), so why aren't savvy investors or countries doing this already?

While I'm critiquing, I also don’t really agree with this analysis:

With each start-up typically raising $10 million to $30 million and signing up one or two long-term customers, the ventures are fragmenting the market’s search for reliable supply sources beyond China. A result could be that few mines actually open outside China, which would remain the dominant supplier.

“The customers and the industry are not being discerning enough, and we’re going to end up with 70 rare earth companies employing geologists and rare earth directors and no more than five new mines by 2020,” predicted Dudley J. Kingsnorth, the best-known consultant in the industry and an adviser to some of the start-ups.

I would characterize that not as fragmentation, but as “competition”, which is generally believed to have positive effects in bringing supply to market in an economically efficient way, and without conceding rents to dominant suppliers.

Some other fascinating tidbits are that Molycorp was owned by Unocal when CNOOC made its famous and ultimately unsuccessful bid (farsightedness only now detected?), and its currently owned by a PE consortium, of which Goldman was a member but has recently sold its participation.

Turning Oil Into Salt (6): Batteries are the crux

Anyone plugging PHEVs has to address the issue of vehicle cost, and the authors own up to the fact that the battery is currently the critical bottleneck. They cite Ford that a lithium ion battery for a PHEV costs $8,000-15,000 (~$1,000 kWh), a number which needs to come down to ~$300/kWh for PHEVs to be cost-competitive.

One very interesting fact I did not know before was that the most costly element of a lithium ion battery is not the lithium or rare earth metals that get so much press, but rather “hair thin sheets of plastic called separators.” It turns out Exxon has the world’s best separator technology, and the authors hope a prize can inspire others to match it. I wish they had broken out in one place the cost of a battery by its different components, since without that it’s tough to infer more.

All the same, the question of raw material availability looms. The authors cite the well-known predominance of Bolivia’s lithium reserves and China’s rare earth metals reserves and point out known reserves elsewhere in the world. They also cite recycling and extending battery life as mitigating strategies for the West. But while they squarely name this challenge and address it head-on, I come away unconvinced that an electric car revolution wouldn’t be trading strategic energy dependency on one commodity (oil) for dependency on a host of others.

Ultimately, the authors also have the right, open attitude toward technology and avoid the “picking winners” trap:

As the backdrop of all of the above activities, it is important to remain open-minded about other battery chemistries and realize that advanced battery technology is only at the beginning of its upward trajectory. While significant progress is made toward mass production of advanced LiIon batteries, it would be imprudent for the government to crown one battery chemistry “the winner,” particularly in light of its questionable track record of picking R&D winners. With all their potential, the race is not over.

Yet despite that attitude and the optimism it engenders, in the end they do not illuminate a line of sight to the day that PHEVs will be cost-competitive with normal cars. And without that, their OFS story is basically a biofuels (or other hydrocarbon-to-liquids fuels) story... and is that really that revolutionary?

Electric cars and rare earths

This is a bit hysterical.

If in fact the massive onset of electrical vehicles will lead to some sort of apocalypse, Colorado’s monster ~$42,000 tax break isn’t helping.

Not yet beyond anti-trust regulation's reach

An Australian regulator has foiled what seems to be a thinly-veiled attempt to tighten China's already-strong grip on the world market for rare earth metals.

A Chinese company has abandoned plans to take control of the rare-earths explorer Lynas Corporation Ltd after Australian regulators demanded it reduce the scope of the planned transaction.

Market observers say the deal was an example of China's bid to tighten its grip on the rare earths market.

Almost all of the world's rare earths are produced in China.

This reminds me of the time that Russia tried to buy all of Libya's oil and gas. That wouldn't have been good news for Europe. This is a good reminder that there is no infallible anti-trust regulator of last resort in world capitalism.

Hungry China

China's voracious appetite for resources continues unabated: securing a $41bn natural gas deal in Australia, restarting oil exploration in São Tome and Principe off the West African coast, and apparently even hoarding rare earth metals.

Update: Apparently the China doesn't have a complete monopoly on rare earth metals, as the linked article suggested - a California mine appears to be reopening and other potential sites and Canada and Australia are being investigated.