As those who follow the rare-earths sector know, on March 13, 2012, the United States, the European Union and Japan (the complainants) filed simultaneous and near-identical complaints with the World Trade Organization (WTO), in which they requested consultations with China (the respondent) on the measures that it has in place related to restrictions on the export of rare earths, tungsten and molybdenum.
The following article presents an overview of the WTO dispute process, the specific details of the rare-earths-related complaints, and looks at how China might respond to the specific complaints made. It also looks at various criticisms of the complainants for filing the disputes. In addition, the article looks at the consequences of the various potential outcomes of the disputes, once they have been concluded, and looks at clues as to how things might actually turn out, gleaned from a similar WTO trade dispute.
The WTO Dispute Process
The precursor to the WTO (and later subsumed into it), the General Agreement on Tariffs and Trade (GATT), had a mechanism for dispute resolution, but it had significant limitations. The Marrakech Agreement (also known as the Uruguay Round agreement) in 1994 established the WTO itself, as well as the WTO's Dispute Settlement Body (DSB). The WTO describes the rationale for the process thus:
WTO members have agreed that if they believe fellow members are violating trade rules, they will use the multilateral system of settling disputes instead of taking action unilaterally. That means abiding by the agreed procedures, and respecting judgments.
Much of the recent commentary on the disputes has accused the complainants of cynical motives for their initiation (perhaps understandably so, depending on one's perspective). The fact remains, however, that the four parties involved are all members of the WTO, and have all formally agreed to the above process for dispute resolution. It is thus far from inappropriate for the complainants to use the legal mechanisms at their disposal in order to further their collective interests.
Under the normal rules of the DSB (which actually consists of all members of the WTO in general session), the first stage of any dispute is the consultation process, which may last up to 60 days. If these consultations fail, then the DSB will appoint a Dispute Panel, whose final report can only be rejected by the consensus of the DSB. Rejection is thus highly unlikely. This is the opposite of the old GATT approach, in which rulings could only be adopted by consensus, which meant that the objection of a single member (such as the respondent in the dispute) could block such a ruling.
Either side may appeal the findings of the Dispute Panel, primarily on the basis of the way that existing rules have been interpreted. No new evidence may be presented at that time. Such appeals are heard by a subset of the permanent Appellate Body, which can uphold, modify or reverse the findings of the Dispute Panel. The DSB is required to accept or reject the report of the Appellate Body within 30 days. Again, rejection of the findings requires full consensus of the DSB, so is highly unlikely.
Under normal circumstances, disputes are expected to be concluded within 12 months of initiation. Any appeals are expected to be concluded within a further three months, so that the whole process is supposed to be completed within 15 months of initiation. The process does allow for flexibility in these timelines, and in reality, disputes often take longer. A recent dispute (that we’ll come back to later in this article) initiated by Mexico, the European Union and the United States in August 2009, concerning the export of bauxite, coke, fluorspar and other materials from China, was finally deemed to have been settled in February 2012, some 30 months after initiation.
Details of the Recent Complaints
The complainants each filed near-identical requests for consultation with China, "with respect to China's restrictions on the export of various forms of rare earths, tungsten and molybdenum." The requests made reference to numerous harmonized system (HS) codes (used for classifying products, materials and services for international import and export) for specific rare earth, molybdenum and tungsten products and compounds. In the case of rare earths, forms referenced in the documents include (but are not limited to):
- Rare-earth ores;
- Thorium ores and concentrates (presumably by virtue of their rare-earth content?);
- Individual rare earth metals, including so-called “battery-grade” rare-earth metals;
- Individual and mixed rare earth oxides, carbonates, chlorides, fluorides and other compounds (including cerium hydroxide and cerium cyanide);
- Rare-earth-containing phosphorescent powders;
- Rare-earth-containing ferroalloys; and
- A variety of rare earth-containing magnetic powders and alloys.
Yttrium and scandium are included in the HS code classifications for rare earths, alongside the lanthanides.
With respect to "various forms of rare earths, tungsten and molybdenum," the complainants specifically alleged the following actions by China are not in line with current WTO trade provisions:
- The imposition of export duties;
- The imposition of export quotas and other quantitative restrictions;
- The imposition of other restrictions such as the right to export based on licenses, prior export experience, minimum capital requirements and "other conditions that appear to treat foreign invested entities differently from domestic entities;"
- The maintenance of minimum export prices, through the examination and approval of contracts and offered prices and through the administration and collection of the export duties, "in a manner that is not uniform, impartial, reasonable or transparent;"
- The imposition and administration of restrictions through unpublished measures.
The trade provisions with which the complainants allege that the aforementioned measures do not comply include:
- GATT Article VII: "Valuation for Customs Purposes;"
- GATT Article VIII: "Fees and Formalities connected with Importation and Exportation;"
- GATT Article X: "Publication and Administration of Trade Regulations;"
- GATT Article XI: "General Elimination of Quantitative Restrictions;"
- Various commitments within the Protocol on the Accession of the People’s Republic of China (including specifically Paragraph 11.3); and
- Various commitments within the Report of the Working Party on the Accession of China.
To summarize the proceedings then, the complainants allege unfair treatment of non-Chinese entities via export restrictions, discriminatory commercial operating rules within China, the setting of unofficial minimum export prices (what some might call price fixing) and an overall lack of transparency concerning the implementation of the measures in question.
The Chinese Response
These are early days for the disputes. At the time of writing, the Chinese delegation has not yet officially responded, through the WTO, to the request for consultations by the three complainants. There have, however, been some initial responses from official and unofficial Chinese sources outside of the WTO arena, with some having been published prior to the request for consultations, in anticipation of the WTO action. These responses mostly refer to allowable exceptions that are embodied within the GATT that, such sources contend, allow WTO members to put measures in place to control exports. Let’s take a look at some of the cited exceptions and other responses.
GATT Article XX: "General Exceptions" begins with the statement:
Subject to the requirement that such measures are not applied in a manner which would constitute a means of arbitrary or unjustifiable discrimination between countries where the same conditions prevail, or a disguised restriction on international trade, nothing in this Agreement shall be construed to prevent the adoption or enforcement by any contracting party of measures:
before going on to list a variety of the aforementioned measures, some of which are likely to be referenced in the Chinese response to the complaints. These include measures:
(b) necessary to protect human, animal or plant life of health;
This obviously relates to measures meant to protect the environment, and to mitigate pollution. Sources both Chinese and non-Chinese have frequently cited the environmental damage caused by rare earth mining and processing, as a justifiable reason for restricting the export of rare earths. There is certainly significant evidence to suggest that rare earth operations have previously caused widespread pollution and damage to local ecosystems, have contaminated water sources and have caused health problems in local populations, livestock and plant life.
However, it is difficult to see how controls on the ultimate destination of rare earth materials once out of the ground and processed, have any effect on the practices used to get them out of the ground and processed in the first place. Recent estimates indicate that approximately 65–70% of demand for rare earths comes from end users within China. A more persuasive argument could be made if overall production levels of rare earths were reduced, as a means of reducing the environmental impact of rare earth mining, instead of restricting their export. However, overall production levels of rare earth ores have remained steady or have actually increased in recent years.
There are indications that excess rare-earth processing capacity in China is being taken offline, with an emphasis on the closing of facilities that have the most egregious track records when it comes to pollution. New standards for pollution mitigation have also made a positive contributed here. Only the most skeptical of observers would deny that at least recently, China is taking the pollution problem associated with rare earths seriously.
There is no explicit language in this clause of article XX that relates to or requires the application of measures to domestic production or consumption, in order for them to be legitimately applied to exported materials as well. China may therefore be able to use this measure to successfully justify the export quotas and licensing processes, even if nondomestic customers are disadvantaged by them, if they can demonstrate that such actions are not a "disguised restriction on international trade," as stated in the preamble for Article XX.
(g) relating to the conservation of exhaustible natural resources if such measures are made effective in conjunction with restrictions on domestic production or consumption;
Another oft-cited argument for the implementation of rare earth export restriction relates to the disparity between the proportion of rare earth supply that originates in China (around 95% these days), and the proportion of global rare earth resources located within China (approximately 30–35% depending on who you talk to). Proponents of this argument say that this places an undue burden on China, which is unfairly expected to meet the demand for rare earths out of proportion with its resources, which are rapidly being depleted.
There are a number of issues with these arguments:
The first is that again, over two-thirds of overall demand is coming from end users located in China, and thus the comparison should perhaps be between proportion of supply (95%+) to proportion of demand (65–70%), rather than to proportion of resources (30–35%). Granted, a significant fraction of those end users are exporting end products back out of China to the rest of the world. Those end users would of course argue that they were "forced" to locate their operations in China in order to be competitive with Chinese market participants. We can also be pretty sure that the Chinese authorities didn’t resist the opportunity for the creation of jobs and tax revenues, when those foreign companies set up shop in their country.
The second issue relates again to the fact that it is difficult to see how controls on the ultimate destination of finished rare earth materials through export restrictions, have any effect on efforts to conserve China's rare earth resources, since overall rare earth production levels have not decreased in recent years, and numerous companies which previously received rare earths outside of China, have relocated operations to be within China.
The third issue relates to the question of whether or not the rare-earth resources in China can be deemed to be "exhaustible." Of course, any specific finite natural resource deposit that is removed from the ground, will at some point be exhausted. In the case of the rare earth deposits in northern China however, where the vast majority of the world's light rare earths come from, estimated mine lives in the hundreds of years are frequently quoted, with little disagreement.
In contrast, the ion-adsorption clays in the southern part of China, from where the world's heavy-rare earth supplies originate, are frequently referred to as being rapidly depleted, with mine lives estimated by the authorities to be in the order of anything from six to 20 years. While I am aware of more than one source that privately disputes these numbers, nevertheless, there would appear to be legitimate concern in China regarding potential exhaustion of the southern deposits.
This contrast in depletion rates between deposits in the north and south of the country, is perhaps one reason why this year, for the first time, the authorities in China divided the export quotas into separate allocations for light and for medium + heavy rare earths, in anticipation of the WTO trade dispute. Unlike for medium + heavy rare earths, significant new sources of light rare earths are expected to come on-stream in the next 12 months, from outside of China, and it is likely that the allocations by the Chinese for the export of light rare earths will be adjusted accordingly. In addition though, having a separate allocation for the rarer medium + heavy rare earths could well make for a strong fallback position for China, if it fails to make the "conservation of exhaustible natural resources" argument for the rare earths as a whole.
The fourth issue (and frankly the most problematic) relating to reliance on clause (g) above, is the explicit expectation that any measures taken with respect to foreign consumers, will only be deemed valid if those measures are also applied to domestic consumers as well. In my mind, this is the single biggest flaw in any attempt by the Chinese authorities to use the "conservation of exhaustible natural resources" argument to justify export restrictions, since by their very definition, they apply only to foreign consumers. It may smack of a technicality, but it's a pretty significant one, and frankly will undermine any attempt by China to use clause (g) to counteract the complaints filed.
(j) essential to the acquisition or distribution of products in general or local short supply; Provided that any such measures shall be consistent with the principle that all contracting parties are entitled to an equitable share of the international supply of such products, and that any such measures, which are inconsistent with the other provisions of the Agreement shall be discontinued as soon as the conditions giving rise to them have ceased to exist[. . .]
In some ways, this clause is a variation of the previously discussed clause (g) of Article XX. While it would not hold much water with respect to the northern light-rare-earth deposits, it is possible that it might be used with respect to the supply of heavy rare earths, although it would be a bit of a stretch to equate the future potential exhaustion of deposits, with "general or current local short supply." I therefore think that it is unlikely that China will use this clause in its arguments, and that such a claim is even more unlikely to stand up to scrutiny if it does.
In addition to Article XX of the GATT, Article XXI: "Security Exceptions" might, in theory, come into play as well. Commentators have noted that during the Rose Garden statement of March 13, 2012, to announce the request for consultations, President Obama did not make mention of the importance of rare earths to the defense supply chain (and, incidentally, did not mention tungsten or molybdenum at all). While it is true that the largest volumes of anticipated rare earth demand are likely to be in the green technology applications mentioned during the President's announcement, rare earths are deemed by many to be critical to a range of defense applications. This, despite a dominant group within the U.S. Department of Defense not agreeing with this assessment (or at least, declining to acknowledge that there is a risk of disruption to their supply, despite the best efforts of certain members of Congress to persuade them otherwise).
It is possible that these defense applications were deliberately not mentioned by the President, to avoid giving the Chinese WTO delegation an incentive to use part of Article XXI in a future response to the WTO action, specifically the subclause that states:
Nothing in this Agreement shall be construed [. . .] (b) to prevent any contracting party from taking any action which it considers necessary for the protection of its essential security interests [. . .] (ii) relating to the traffic in arms, ammunition and implements of war and to such traffic in other goods and materials as is carried on directly or indirectly for the purpose of supplying a military establishment;
This subclause is the (legitimate) basis for numerous countries placing restrictions on trade, where such trade could impact national security. In the U.S., a good example would be the restrictions on the export of dual-use technologies, as outlined in the Defense Federal Acquisition Regulation Supplement (DFARS). I’ve never heard anyone on the Chinese side use this as an argument for export restrictions on rare earths, and it is unlikely to start doing so. Still, we can be pretty sure that the U.S. in particular will avoid bringing the topic up during the subsequent consultations.
Criticisms of the Recent Complaints
In anticipation of a WTO trade dispute concerning rare earths and subsequent to its initiation, various commentators have criticized the complainants for taking such actions.
One common criticism is that the United States in particular, is trying to use the WTO action to "force" China to mine materials that it is not prepared to mine itself, because of the environmental problems that such mining can cause. The argument goes that the non-Chinese market for rare earths was happy to enjoy the low costs of these materials until relatively recently, but that such costs were only possible because of the lack of pollution mitigation in China.
While I can empathize with this latter viewpoint to an extent, I am not convinced that anyone is trying to "force" China to mine anything, since a positive finding for the complainants in this particular instance would not lead to such an outcome.
There is a range of other criticisms of the WTO action that would be similar to the anticipated responses from China, as detailed above. Such criticisms can get quite heated and emotional; however, they invariably fail to acknowledge that "rules are rules;" that at the end of the day, each of the parties involved voluntarily signed up to be held accountable to the rules and regulations of the WTO, and to be subject to its processes.
Moving away from criticisms that can be directly argued on the basis of some of the exceptions discussed above, an additional criticism is that the filing of these actions on behalf of downstream end users of rare earths, by the complainants (each a government entity), enables the continued shortsightedness and even belligerence of commercial end users who continue to value profit margins over the strategic concerns of the jurisdictions in which they operate.
The end users continuing to focus only on their own commercial goals, so the thinking goes, without acknowledging possible obligations beyond that, inhibits the potential growth of an upstream supply chain outside of China. After all, Adam Smith himself once stated that "defense is of much more importance than opulence," condoning preferential treatment for industries deemed to be of strategic importance, since, as he wrote in The Wealth of Nations:
[i]f any particular manufacture was necessary, indeed, for the defense of the society, it might not always be prudent to depend upon our neighbors for the supply; and if such manufacture could not otherwise be supported at home, it might not be unreasonable that all the other branches of industry should be taxed in order to support it.
The argument therefore goes that instead of filing WTO disputes on their behalf, the U.S. and other governments should instead be encouraging the rare earth sector to become independent of China, through the creation of an upstream industry.
Of course, these latter issues are only indirectly linked to the WTO action, and we should not try to infer too much from such actions. As stated above, regardless of what people think that companies and markets should or should not be doing from a commercial or even a strategic perspective, if one believes that governments should adhere to the agreements to which they sign up, then the WTO dispute process is a perfectly legitimate method of asserting the rights of individual members, independent of all other arguments.
One other point that gets raised in the context of the WTO dispute, is that since the Chinese authorities started to impose rare earth export quotas, there has not been a year where the official actual export numbers came close to meeting or exceeding the quotas set. However, the reduction in export quotas for 2010, by 40% compared to the previous year, caused a surge in price increases that did not abate until the summer of last year, regardless of the actual supply situation "on the ground."
The massive differences between domestic and export prices for rare earth materials in the latter half of 2010 and much of 2011, further exacerbated issues of competitiveness between enterprises located within China and those located without, and led to demand destruction. It would be one thing if these fluctuations were the result of normal market activities; such would be life in the commercial jungle. But if those price differences were caused by the imposition of unofficial minimum export prices, as alleged in the WTO complaint, then this is a whole other ball game, clearly in contravention of WTO rules and being played on anything but a level playing field.
Potential Outcomes of the Dispute
There are a number of possible permutations for the end result of the collective disputes. If we take the complaints collectively, we can speculate on the consequences of what those outcomes might be, should a dispute panel be formed, and the process comes to a conclusion. Let's look at some scenarios:
China is found to be in contravention of the WTO rules on all counts:
Tthere are a number of consequences to this ruling. China would be required to remove export restrictions, which would probably lead to a fall in export rare earth prices, and increased demand as a result. This would likely reduce the incentive for companies to relocate their operations to China if they have not done so to date. However, purely in commercial terms it would also reduce the need, for additional sources of supply outside of China, and could make it harder for the new non-Chinese sources of light rare earths to compete—but purely on (now fair) commercial terms.
An alternative action, that could happen instead of or in addition to the first, would be the enforced reduction in production levels of rare earths in China, such that both Chinese and non-Chinese end consumers get to "share the pain." This would lead to shortages of newly mined and produced rare earths, especially heavy rare earths, which could increase prices. This would further increase the incentive for the development of an upstream supply chain outside of China.
Which of these two alternatives would come to dominate, should they both be put into action, is hard to say at this point.
China is found to be in contravention of the WTO rules as they relate to light rare earths, but not heavy rare earths:
This would be an interesting outcome because although the previous points would apply to light-rare-earth production, the production of heavy rare earths would be exempt, and further restrictions would be possible. It would almost certainly lead to increased prices, and a further widening of the gap between export and internal prices for these materials. This would provide an incentive for end users of heavies to continue to relocate operations to China, but would simultaneously boost the case for the development of heavy-rare-earth projects outside of China. This is particularly the case if the overall demand for heavies continues to grow, especially within China.
China is found to be justified in its export restrictions, and the WTO finds in its favor:
If the WTO rules that China's export restrictions are justified, and does not require internal consumers to be subject to similar requirements as non-Chinese consumers, then the most obvious outcome would be a greater incentive for foreign end users to move operations to China, or to buy semifinished or finished products from China, since it is likely that the price differential between domestic and export rare earth materials will continue to be significant. Such a ruling would provide significant incentive to develop the external upstream supply chain. If China comes out on top with the disputes and if it really is running out of heavy rare earths, then it would still need to "play nice" with the complainants (although with the possible exceptions of the Norra Kärr project in Sweden and the Bokan project in Alaska, the leading potential new sources of heavy rare earths are not to be found in the jurisdictions of the initial complainants), since at some point in the future, China might become a net importer of heavies.
It should be noted that it is possible that despite the WTO finding against China, China could still refuse to change its export policies for rare earths, which would lead to the complainants being allowed, under WTO rules, to apply permanent retaliatory trade sanctions. The problem of course, is that such sanctions wouldn’t actually increase the amount of rare earths shipped from China, and could in fact reduce them, because of associated tariffs. . .
Looking at the Outcomes of Other Cases
It is reasonable to ask if the outcomes of previous WTO trade disputes can be used as precedents for the current set of complaints. The WTO makes it clear that each case is supposed to be considered on its merits, and on the evidence presented. However, if similar complaints have been made in the past, and similar evidence is presented, then it is not unreasonable to look to the outcomes of such disputes to give an indication of how the rare-earth case might turn out.
A particularly relevant case that recently concluded concerned export restrictions on "various forms of bauxite, coke, fluorspar, magnesium, manganese, silicon carbide, silicon metal, yellow phosphorus and zinc." The original complainants were Mexico, the European Union and the United States, who were subsequently joined by Argentina, Brazil, Canada, Chile, Colombia, Ecuador, India, Japan, South Korea, Norway, Saudi Arabia, Taiwan and Turkey.
Initiated in August 2009 and concluded February 2012, the complaint featured similar allegations to the present rare-earths case. According to the WTO summary of the case:
The complainants argued that the use of export restraints creates scarcity and causes higher prices of the raw materials in global markets. They also provide Chinese domestic industry with a significant advantage by way of a sufficient supply, and lower and more stable prices for the raw materials.
It went on to state that:
In one of its key findings, the Panel found that China's export duties were inconsistent with the commitments that China had agreed to in its Protocol of Accession. The Panel also found that export quotas imposed by China on some of the raw materials were inconsistent with WTO rules.
The Panel found that the wording of China's Protocol of Accession did not allow China to use the general exceptions in Article XX of the GATT 1994 to justify its WTO-inconsistent export duties. The Panel also considered that even if China were able to rely on certain exceptions available in the WTO rules to justify its export duties, it had not complied with the requirements of those exceptions.
In particular, China had argued in its defense that some of its export duties and quotas were justified because they related to the conservation of exhaustible natural resources for some of the raw materials. But China was not able to demonstrate that it imposed these restrictions in conjunction with restrictions on domestic production or consumption of the raw materials so as to conserve the raw materials. The Panel acknowledged, however, that China appears to be heading in the right direction in adopting a framework to justify its quotas under WTO rules, but that the framework is not yet WTO-consistent as it still has to be put into effect for domestic producers.
As for other of the raw materials, China had claimed that its export quotas and duties were necessary for the protection of the health of its citizens. China was unable to demonstrate that its export duties and quotas would lead to a reduction of pollution in the short- or long-term and therefore contribute towards improving the health of its people.
Regarding the administration and allocation of its export quotas, China successfully defended its practices in claims brought by the United States and Mexico whereas the European Union succeeded in its separate claim that it brought against China.
The Panel also found that certain aspects of China’s export licensing regime, applicable to several of the products at issue, restrict the export of the raw materials and so are inconsistent with WTO rules.
Not unexpectedly, China appealed against the findings of the Dispute Panel. Interestingly, the United States also filed appeals concerning certain aspects of the original findings. Some of the key findings of the Appellate Body's report:
The Appellate Body upheld the Panel's recommendation that China bring its export duty and export quota measures into conformity with its WTO obligations such that the "series of measures" do not operate to bring about a WTO-inconsistent result.
The Appellate Body upheld the Panel's finding that there is no basis in China’s Accession Protocol to allow the application of Article XX of the GATT 1994 to China’s obligations under Paragraph 11.3 of the Accession Protocol. In upholding the Panel's finding, the Appellate Body examined the text of Paragraph 11.3 and found that the provision does not suggest that China may have recourse to Article XX to justify a breach of its obligation to eliminate export duties.
The Appellate Body further upheld the Panel's conclusion that China did not demonstrate that its export quota on refractory-grade bauxite was "temporarily applied" to either prevent or relieve a "critical shortage," within the meaning of Article XI:2(a) of the GATT 1994. The Appellate Body found that an export prohibition or restriction applied "temporarily" in the sense of Article XI:2(a) is a measure applied in the interim, to provide relief in extraordinary conditions in order to bridge a passing need. The Appellate Body agreed with the Panel that such a restriction must be of a limited duration and not indefinite.
It can be seen then that China will have to do a better job of demonstrating the validity of its export restrictions on rare earths, than it did for bauxite, fluorspar and the other minerals and materials referenced in the recent dispute.
As previously stated, at the time of writing China's WTO delegation has yet to formally respond to the request for consultations, and the consultations are yet to take place. We’ll keep you informed as significant events occur in relation to the case— but it could be a while. . .
Gareth Hatch, Resource Investor