In Paris Innovation Review, 14 05 2012
The global market for commodities has profoundly evolved over the last ten years. The dynamics between large producers and consumers have shifted and new factors have been added to an already complex equation. Within this context, both governments and large industrial firms are being forced to rapidly redefine their current strategies with some moving more swiftly than others.
Paris Innovation Review – As globalization accelerated in the 1990s the assumption was that newly opened markets would provide improved access to raw materials and policymakers in the developed world should focus their attention elsewhere. In fact, this has not been the case: in recent years the. Is this merely a blip or are we witnessing something more durable at the structural level?
Didier Julienne – In the 1990s numerous commentators were hailing the “peace dividend” brought on by the collapse of the Soviet bloc and the spread of democracy. Vanishing frontiers were to usher in a new era of prosperity, increasingly efficient markets would provide commodities. At a theoretical level this may be true but in reality the market for raw materials behaves rather differently than others, due to a number of its own specificities.
First, the market for raw materials, and notably metals and minerals, is fragmented, opaque, and based on evolving strategic partnerships. One must also factor in the existence of hidden stocks, as well as a lack of transparency and reliable figures across the supply chain. Classical economics are of little assistance and the actual reality can only be understood through hard-won experience on the ground while accepting a variety of less quantifiable factors that include politics, structural realities, geostrategic imperatives, or simple human factors. Theories fall short of explaining these intangibles, not least in a market as complex as that for raw materials, which makes it all the more frustrating to see the strategies of large firms and States guided by such theories.
Secondly, raw materials are not just another factor in the industrial cycle but are the pillar on which all other processes rely. Access to raw materials (exploration, exploitation, transformation) is a necessary precondition for manufacturing. Without guaranteed access the entire cycle is threatened, which explains why restrictions are often spoken of in terms of economic warfare.
To these structural challenges must be added a third dynamic that may be considered cyclical in nature were it not for the fact that it has endured for at least the last decade and has made forecasting problematic. The intrusion of financial actors has upset the more traditional producer-consumer relationship and they now manage 60 times more of the value in raw materials than was the case a mere decade ago. We have witnessed a sharp increase in financial vehicles aimed exclusively at investment in strategic materials which has placed upward pressure on price and is creating distortions in the supply chain for industrial firms.
Whether mere speculators or not, the arrival of these new actors is having an impact on pricing mechanisms which are no longer based on the fundamentals (supply, demand, stock, production costs) but must now include the behavior of investors. Prices are not only higher but are suffering increased volatility when compared to the past. The arrival of high-frequency trading (using computerized algorithms to effect high-volume transactions) has only served to amplify these basic trends.
Blaming price volatility on the increasing financialization of the commodities markets tells only part of the story however and it would be wise to return to the simple rediscovery that markets alone are unsuited to price stability and reliable supplies of raw materials. A volatile yo-yo effect ensures that certain sectors of the economy suffer when the raw materials on which they depend skyrocket in price. One need only cast a glance at the airline industry and their melting profits whenever a barrel of oil becomes costly or the crisis in the automobile industry brought on by the rising cost of steel over the last decade.
If questions over securing adequate supplies of raw materials have moved to the forefront of the policy agenda, are decision makers taking adequate steps to confront the problem?
In the industrial sector steps are being taken and we will return to this subject later. As for the political figures, it’s another story. In Europe especially, public authorities have been rather less agile in their response as has the wider public opinion, which is characterized by a degree of short-termism. To take an example, it is common knowledge that the price of oil will not be dropping anytime soon, not least because the emerging economies continue to demand more and more of the resource. Solutions such as electric vehicles, solar panels, and wind turbines can all help reduce dependence on uranium, coal, oil, and gas. But in creating new solutions we may also be creating new problems such as increased dependence on lithium, indium, gallium, “rare earths”, etc.
This new set of raw materials is more poorly understood than their predecessors and throws up a number of unknowns. It is highly likely that new shocks to the supply chain, similar to the 1970s oil crisis, will arise and a new generation of decision makers will have to grapple with a market in which transparency is in rather short supply and real world experience even less so. To meet the task more market intelligence is required. New challenges require more refined approaches and new tools. In short: new strategies.
Among developed world countries has Europe been more naïve than her contemporaries?
The European political climate of the 1990s was underpinned by a dominant faith in free and fair markets which fit in naturally with the undergirding principles of the EU and made these beliefs the alpha and omega of economic policymaking. Fortunately, some countries, which we will return to later, were more reticent and felt a stronger need to guard an industrial vision based on a less naïve view toward securing raw materials.
But one must search outside Europe’s frontiers to identify global strategies. A major component of America’s foreign policy is centered on securing adequate petroleum supplies. In terms of minerals and metals the United States, as well as South Korea, Japan, and China have long lists of materials that are considered of strategic interest. In no particular order these materials are: copper, nickel, iron, platinum, palladium, rhodium, rhenium, antimony, beryllium, cobalt, gallium, germanium, graphite, indium, magnesium, niobium, “rare earths”, tantalum, tungsten, lithium, tellurium … and the list is non-exhaustive.
Should a distinction be made between raw materials of vital interest to a particular industrial sector and those of interest for an entire country?
Yes but framing it in slightly different terms than you suggest we can make a distinction between raw materials that are critical and strategic. This distinction is capital as it defines the terms in which State actors can maneuver and make public interventions.
A critical resource is one for which no replacement is possible creating heightened risks for industry in the event of a shortfall of supply. What we define as critical can vary across industries as well as across national frontiers and the situation is constantly evolving and changing. The variable nature of demand for raw materials makes it difficult to define what is critical on a permanent basis because the market is always changing. For example, in automotive catalysis the critical materials are platinum, palladium, and rhodium. As more electric vehicles are rolled out priorities will shift and the critical raw materials will undergo a change of complexion to include metalloids and minor metals.
Strategic resources remain the prerogative of the State and its role as the guardian of national security. The stakes are different and include issues of national sovereignty and the ability to conduct national developmental policy. Yet the same logic is just as useful when applied to enterprise and could make the difference in access to essential raw materials. Development would be based less on compromises over lack of resources than on strategic planning to ensure that no shortfall ever arrives.
One raw material might be considered strategic in one country but not in another and the terrain shifts and evolves over time. To illustrate the point, the two principal materials for the production of steel, iron-ore and coal, are of strategic importance in the Far East as they form a key component of government policies for rapid urbanization whereas in the West they have long since passed their zenith. In another example, copper no longer occupies a strategic role in those countries where electricity-powered transportation has reached a mature stage of development. Yet tides can shift as has been the case in Germany with the necessary construction of a new generation of high-voltage power lines to relay electricity generated by off-shore wind farms in the North Sea to the industrial heartland in the Ruhr and Bavaria.
It should also be observed that strategic resources are not always synonymous with scarcity. Iron and coal are not rare and if they become so it is often the result of a temporary imbalance between supply and demand.
Making a distinction between strategic and critical resources is useful when there is a temporary shortfall in supplies and when disparate players enter into competition to secure necessary raw materials. On occasion the distinction between strategic and critical resources no longer serves when overlapping strategies (state-driven or industrial) run into procurement problems. When this happens the buyers are placed at a disadvantage and the producers play a more dominant role in managing the flow of raw materials, whether according to pricing criteria or the role of State policy in producer countries.
What accounts for delay between demand for critical metals and their eventual supply?
The principle reason is industrial. When production forecasts are delivered a simplistic approach is taken toward geological resources in which a simple measure of the quantity of given raw material which can be extracted from the earth is taken without taking into account the actual removal cost or any secondary processes. These factors are non-negligible. It should be known, too, that while many of these metals are not rare they are often combined with others (major metals) meaning production hinges on the dynamics of the major metal.
If fact, the existing mines for major metals are often insufficient or are reaching the end of their productive life and a lack of adequate planning means new sources are somewhat thin on the ground either because of a lack of exploratory work or because future sources have yet to be found. Lest we forget, it can take years of investment before mines become productive. The so-called “rare earths”, for instance, are actually not particularly rare. The problem is that there is a disconnect between cycles of exploration and production and the existence of industrial demand. It is a case of one had acting without the other.
Recycling metals appears promising at first glance but again the time these projects would take to become operational could extend over several decades. Moreover, actual recyclable material could be extremely negligible due to a combination of complex alloys and low concentrations of usable metal. Additionally, we have yet to develop sufficient methods to surmount these significant technological hurdles and produce usable materials.
This combination of factors explains the low elasticity of the current market.
Which industries are the primary consumers of these metals?
You touch upon the crux of the problem as almost all industries are concerned and the demand is simultaneous: electric vehicles, next-generation aircraft, light-emitting diodes, electronics, smart phones, solar panels, wind turbines, fuel cells, steel, optics, lasers, petrochemicals, etc. The scale has evolved as have the rules of the game with price competition from multiple sectors. It should come as little surprise given the current conditions that prices have skyrocketed. Furthermore, lines have become blurred between economic fundamentals and the shadow role played by the State in managing flows of resources. Classical solutions such as a reduction of unit quantities or leveraging substitution methods are certainly valid approaches but not to the reality of the current conditions.
The role of rare earths in the production of permanent magnets provides an ideal illustration of both rising consumption and the ways in which the industrial stakes have been altered. Rare earths comprise only a few grams in the construction of computers, but an electric bicycle requires some 200 grams. One electric vehicle requires some one to two kilograms whereas a direct drive wind turbine requires a massive 200 kg/MW.
Given these conditions it has become a strategic imperative to secure supplies as the Chinese have demonstrated with their decision to limit the export of rare earths. Not only is the decision rational but it demonstrates a desire to create a quasi-monopoly on the production of permanent magnets with consequences for industrial actors further downstream. They have a short window of opportunity as sooner or later the country will be transformed into a net importer of rare earths as operations go online in places as diverse as Canada, California, Australia, and Sweden. It is too soon to tell whether the policies will bear fruit and whether China’s current monopoly on raw materials will give it the edge in creating a world beating industry and a de facto monopoly in the market for permanent magnets.
The real question for other industrialized countries is not only how to obtain necessary resources but to maintain and develop their capacities in industries that rely on access to rare earths. The challenge is enormous and has not been made any easier by the fact that policymakers neglected to provide the necessary political impetus to address this problem of access to resources earlier.
A shift in perspective is required that recognizes when it comes to raw materials we are no longer operating purely according to markets but more in terms of balance of power relationships where strategy, as conducted by very capable actors, plays an important role and where firm steps are taken toward fixed objectives. To anticipate as well as manage access to raw materials therefore, it has become a necessity to both acknowledge and formulate policy based on competing state doctrines of strategic interest.
Taking into account these operating conditions are more robust public policies necessary in order to improve the competitiveness of enterprises?
Yes, if only because they would allow industrial actors to focus on improved cooperation and development of their core strategies. States and economic cooperation zones (such as Europe) will need to play catch up and elaborate a coherent policy on commodities and raw materials as they are facing competitors who have already taken considerable strides along this path. Make no mistake, what we are facing are bit players but producers that are guided by strategies and policies that form an integral part of state doctrine and governments that are willing to step up and defend strategic policymaking.
As a starting point, a global perspective is required and an acknowledgement must be made of the economic dynamics at play in emerging economies and how they differ from those in the developed world. Next, an effort must be made to understand the underlying strategies of both public and private actors.
Beginning with economics the indicators are easy enough to read. In the developed world consumption of raw materials, notably energy and metals, is stable or falling whereas in the emerging economies the opposite is true with raw materials providing the basic fuel for economic development and rising growth. Without exception these countries depend either directly or indirectly on rising consumption of what have already been identified as strategic metals and minerals.
A second group of indicators highlights two distinct trends linked directly to national sovereignty: the power of producers and the influence of consumers. The confluence of the two is leading to greater inflationary pressure on prices. In geostrategic terms we are observing a split between developed countries/emerging economies and producer countries/consumer countries and the looming specter of what by all appearances are preconditions for a form of economic warfare.
A third complicating element must also be considered and will add even more complexity to already existing tensions over natural resources: the game between strategic alliances and open competition. On one hand, greater cooperation between consumers of raw materials would encourage more investment in production. On the other hand, competition between these very same actors could lead to commercial disputes over how resources are distributed across various industries.
Within this context cooperation between industrial leaders and governments is essential if any consensus is to be achieved on strategy toward raw materials.
What approaches might be taken by governments?
It is only natural that in net exporting countries such as Australia and Canada investment will be encouraged in order to maximize profit. The question is more complex in countries that rely on imports. The principal levers at the disposal of States in the latter category are strategic alliances between producer and consumer countries, creation of reserves, development and maintenance of domestic production, as well as the creation of trading companies. Yet, perhaps the most promising avenue would be to develop and reinvigorate the mining and energy sector of certain European countries on national soil. The development of shale gas provides a case for greater clarity.
In the Far East policymakers have adopted a more forward-thinking approach in the metal, mineral, and energy sectors. Japan and South Korea have a long-standing policy to guarantee stable supplies of raw materials and both are characterized by the willingness of both state and industrial actors to work together toward achieving this aim. China has created a three-pronged approach that seeks to maintain stable domestic supplies through a centralized bureaucracy, consolidation of the industry, and the fight against contraband.
The United States has taken a pioneering role in developing its strategic metal reserves through diversification of supplies and actively promoting the use of substitution and recycling for industrial uses. Rapid expansion of the country’s shale gas resources has completely reshaped the global flow of energy creating new connections between opposing sides of the Pacific Ocean and diverting attention away from the Persian Gulf and Russia…
As for the rest of the globe many states have taken a wait-and-see approach in which policies are applied ad hoc and with a lack of forward planning. Europe was smart enough for developing the CAP and has long debated a similar policy towards energy. As for metals and minerals we have fallen behind our rivals and there rests considerable ground to make up.
And for enterprises…?
They are often a reflection of their country of origin. In Asia for example, and in Japan, South Korea, and China in particular the trend is toward a high degree of centralization. Firms are quick to identify risk factors and seek to move up the value chain. Elsewhere around the world, faith is placed in the power of the market and extrapolating outward the banking sector. As discussed previously however this model is demonstrating its shortcomings and many industrial actors are creating their own solutions in the face of inaction from State actors. A number of enterprises have elaborated their own individual policies toward the procurement of essential resources through alliances and strategic partnerships.
We are witnessing a reemergence of tighter vertical integration in a number of large firms. Some examples include steelmakers Severstal, Novolipetsk, Evraz and ArcelorMittal who have all made investments in coal and iron mines, or Posco (ferro-nickel in New Caledonia). Other examples are Outokumpu (chrome mines) or Vallourec, a specialist in seamless tube production who now mines their own iron and coal in the Brazilian state of Minas Gerais. We can also cite Alcoa and Norsk-Hydro who possess their own bauxite mining operations or indeed the numerous investments being made by Russian, Chinese, and South Korean electronics firms in uranium mining concerns. The German-owned RWE has invested in a lignite mine, while Toyota Tsucho has entered the rare earths sector, and South Korea’s IMC has entered into a joint-venture to ensure tungsten supplies…
Can governments encourage these trends, or even participate?
Yes indeed. Germany has taken a leading role in responding to the need for unhampered access to critical materials, through the creation of a commodity advisory agency in 2011 composed of some of the country’s largest industrial concerns, in an effort to reduce any shortfalls that could compromise the success of its firms. The idea is to act cooperatively to ensure that access is made possible for all without creating destabilizing volatility as firms compete for scarce resources. The first remit is to both discover and obtain guarantees on future supplies of three critical resources: rare earths, tungsten, and coking coal. It may come as something of surprise to find coal among this list but this is merely a reflection of German preoccupations following revisions to the country’s national energy policy.
Will the agency be confronted with the problem of protectionism and nationalism in the countries where it searches to secure contracts? Unfortunately, this is an unavoidable question in a world where consumer countries are in a race against each other to secure access in regions across the globe including Africa, central Asia, Australia, and South America. Additionally, producers are inclined to introduce restrictive controls as can be witnessed in different forms in South America, Russia, the United States, and Australia as well as more recently in Argentina with the nationalization of YFP.
This takes us back to a topic already discussed concerning mutually beneficial partnerships between producer and consumer countries. How can these be constructed?
Producers remain sovereign both on their soil and underground. They are becoming more assertive in terms of controls and more restrictive in terms of contractual obligations on profit sharing. Australia has taken a democratic approach toward fiscal policy and the mining regime whereas the Brazilian government maintains a partial stake in its two leading energy and mining concerns (while loosening the strings on actual operations in more recent times). Guinea is expected to maintain its participation in any mining concessions whereas Russia has recently opened its petroleum sector to foreign investment. The example of China illustrates the exercise of sovereign power to favor national industrial development through a quid pro quo arrangement with the centralized economic and political bureaucracy. As a final example of nationalism in the distribution of raw materials a decision was taken in Indonesia at the beginning of March to uphold a 2009 law forbidding the export of unprocessed raw materials and came into effect as of 6 May 2012.
Still, the policies of state decision makers will come to naught in the absence of a mature industrial sector and enterprises are the centerpiece of any successful strategy. They possess the financial muscle, the knowledge base, the networks, and the jobs. In my experience the most successful and harmonious exercise in the creation of a just equilibrium has been the South African model where the government and PGM mining concerns worked together to create a local catalytic converter industry suitable for export operations.
Consumer countries have a major advantage because of their networks of mature industries and the bargaining power this brings to the negotiating table. Yes, we need to move beyond the “customer is king” approach that prevailed in the 1990s, but consumer countries still possess a number of inherent strengths.
It is from this base that we can envision a number of possibilities for successful partnerships, all the more so as according to current trends producer countries will begin to export less of their commodities and consume more. Saudi Arabia has advanced considerably in the rankings for the world’s consumers of petroleum products due to the simple fact that local needs, both domestic and industrial, have risen considerably. Yet while producer countries can be expected to use up a larger chunk of their existing commodities, especially in those African countries undergoing rapid demographic growth, there are others, such as Russia, where the population is stable and with whom Europe should be creating and reinforcing long-term partnerships.
For consumer countries does the possibility of strategic reserves represent a serious option?
Yes and no. Yes in the sense that they provide a stopgap solution to short term volatility in the market but no as a replacement for political engagement. China, Japan, South Korea, and the United States all have policies that promote strategic reserves for metals and minerals. In the parts of the Middle East and Asia the focus is on stockpiling foodstuffs while IEA countries promote the storage of hydrocarbons…
As a solution these policies are inherently fragile for a number of reasons. They provide only short-term solutions and are resistant to a coordination of resources leading to considerable up-front costs and the need for a permanent dialogue between policymakers and enterprises. They are designed for the long-term but their management is subject to the vagaries of the market in which investors will always have the upper hand. The expertise required to negotiate these tensions is considerable. France once held strategic metal reserves but sold them off in the 1990s. Coincidentally, this was at the precise moment when political will initiated anti-pollution measures auguring an explosion in the demand for catalytic converters in the automotive sector.
What conclusions can be drawn from the current state of affairs?
European countries have become somewhat habituated to the flow of raw materials from south to north or from east to west, placing their confidence in the power of the market. This situation is in many ways the consequence of a lack of a common European industrial policy and has led to a weakening of the position of individual States and industries. In stark contrast, the Far East has followed a different path placing doctrines toward raw materials at the heart of strategic planning to ensure a steady supply for its industries despite a lack of local resources. Central planning and a methodical approach to increased access has led to an international network of strategic partnerships the results of which are world-beating mining operations and firms that are international leaders in the trade of physical goods. Strategic reserves have also played a role and we can conclude that when it comes to the market for raw materials some players are more equal than others, largely due to the existence, or lack of, a coherent strategy.