Political Risk: The Case of Heavy Rare Earth Metals
Introduction
A myriad of risk sources amplify commodity price volatility, as discussed throughout this book. One specific case in point that we wish to elaborate more on concerns the influence of political risk. In today’s global supply chains, firms increasingly interact with supply chain members in countries such as China, Russia, and Brazil, which to a high degree are either state-owned1 or significantly influenced by national policy agendas.2 We will discuss this source of risk given the recent example and developments occurring with heavy rare earth metals (HREM).
Understanding the Heavy Rare Earth Metals Market
The sourcing of HREM from China provides a particularly information-rich setting for four reasons.3 First, the Western green-tech industry requires HREMs4 in general and four HREMs in particular (europium, terbium, dysprosium, and yttrium) as mandatory inputs to their sustainability-focused business models of offering green-tech products, such as electrical/hybrid vehicles, solar collectors/photovoltaic systems, and wind turbines.5 Second, the Western green-tech industry relies on Chinese HREM suppliers, which produce and control approximately 95 percent of the world’s HREM supply.6 Third, China’s objective of reducing the high environmental burden from its formerly often illegally operated domestic HREM mining and refining firms caused it to consolidate its HREM industry under the state-owned Baotou Iron and Steel Group.7 This consolidation effectively enabled China to control and eliminate the mining and refining capacity of illegally operated mines and refineries and to implement consistently higher environmental standards. Fourth, the state-owned Baotou Iron and Steel Group serves China as a vehicle to preserve its domestic green-tech industry, resulting in lower HREM mining and refining capacities.
Until 2009, the sourcing of HREMs posed few challenges to Western buying firms, and supply and price risks were not anticipated. This situation changed significantly in 2010 with the transition of China’s HREM strategy. China’s new domestic focus, combined with the reduced Chinese HREM export quotas and high export taxes, occurred at a time when world demand for rare earth metals rose in response to the growing demand for green-tech products.8 This led to price surges and concerns about the future supply of HREMs outside China;9 it also resulted in severe financial losses for the HREM-dependent Western green-tech industry as it sought to implement sustainability-focused business models.
How Firms Responded
These firms’ strategies helped only partially to reduce the negative consequences from politically driven supply risk. The firms also realized that these initiatives still did not address the full set of root causes of HREM risk. They became aware that addressing these causes might require them to engage in activities beyond the buyer–supplier relationship and to reach out to additional entities in their networks. Based on this shift, some firms pursued a combination of commercial and technical mitigation strategies together with current and new members of their HREM supply chains (so called network-centric commercial and technical mitigation). For instance, one wind turbine manufacturer and its battery component supplier invested in the capital-intensive development of a magnet joint venture (JV), together with an international mining firm (third party) as a means to develop a second source strategy for HREMs. As part of this JV, the mining firm contributes its technical HREM mining knowledge and guarantees that it will deliver all mined HREMs exclusively to the manufacturer and its supplier; the battery supplier contributes its technical knowledge of how to produce magnets from HREM powders; and the wind turbine manufacturer and its battery supplier commercially guarantee their purchase of magnets exclusively from the magnet JV (through a multi-year off-take agreement). This JV corresponds to backward vertical integration of the manufacturer and its supplier into the upstream mining sector and forward vertical integration of the international mining firm into the downstream manufacturing of magnets.
In another case, two component suppliers from the luminescence industry, together with several recycling firms, invested in a recycling program for luminescence products. As part of this cooperation, the recycling firms provided their technical capabilities in separating HREMs from returned luminescence products, and the two suppliers commercially guaranteed an HREM buyback quota at below-HREM market prices to the recycling firms. As a result, these firms could regain HREMs from recycled end products and therefore reduce their dependence on Chinese HREMs.
In addition, when Western green-tech firms fully realized that HREM price and availability uncertainties were, for the foreseeable future, significantly controlled by the national Chinese policy agenda, they also began putting the HREM issue on the agenda of political decision makers in their home countries. Although the firms were cognizant of the political causes of the HREM supply risk, many firms actively engaged in political agenda setting. Along the same lines, in some companies board members started discussing their industry’s rare earth metal dependence on China with the government and politicians, including an exchange with the national Ministry of Economics and Energy. Furthermore, firms joined cross-firm alliances to actively engage in political activities, such as bundling resource-related firm interests and connecting with influential politicians who can represent the allied firms’ and their own nations’ interests in the security of natural resources. Examples of such alliances include a U.S. alliance—Rare Earth Technology Alliance (RETA); a Japanese alliance—Japan Oil, Gas, and Metals National Corporation (JOGMEC); a French alliance—Comité pour les Métaux Stratégiques (COMES); and a German alliance—Allianz zur Rohstoffsicherung (ARC). Firms use these vehicles to garner political support to secure access to critical resources, such as HREMs, nonferrous metals (e.g., copper, aluminum), specialty metals (e.g., lithium, cobalt), coal, and graphite in foreign countries. One illustration of the potential influence of such alliances includes political visits to China, Mongolia, and Kazakhstan by German Chancellor Angela Merkel, during which she represented German firms’ resource interests, including HREMs.10 The multicountry-initiated World Trade Organization (WTO) dispute and associated ruling against China’s HREM export politics in early 201411 and the ending of the export quotas by China in early 201512 also illustrate how effective such alliances can be.
This shows that the basic assumption underlying today’s supply chains—namely, that the interaction in supply chains is among private firms coordinated through basic market mechanisms and supply chain members’ mutual commitment and trust13 is being challenged by contemporary supply chain realities. In addition to rare earth metals, other critical raw materials—such as specialty metals (e.g., lithium, antimony, cobalt, molybdenum, tungsten), nonferrous metals (e.g., copper, aluminum, zinc, tin, lead), and semimetal graphite—are mostly extracted and processed in geopolitically unstable regions and countries that follow state-promoted export policies.14 As North American and European countries increasingly import these critical raw materials, Western firms likely will encounter further politically motivated interests in international supply markets and the resulting structural imbalances, disruptions, or conflicts, in which state-owned suppliers have little motivation to withhold the exercise of their power.
Practical Approaches for Managing Political Risk
This has several important practical implications. First, existing supply market intelligence systems and models might need to be upgraded to more fully and quickly capture, for example, increasingly important political influences on supply chains and to simulate their effects. Second, supply managers who face political supply risk might consider active engagement in coalitions (e.g., the formation of alliances within and across supply chains) with other supply chain partners facing the same or similar risk. Managers need to be aware that actors—such as national governments enforcing state-promoted interests on international supply markets—might become more a norm than an exception. Third, to effectively mitigate political supply risk, managers might want to consider refining and expanding their existing repertoire of knowledge and skills. This need for such expansion seems particularly pronounced when risk is high—when the respective raw materials are both critical and scarce. Fourth, although the current networks of purchasing managers mainly target finding and exchanging commercial and technical best practices, the effective mitigation of political supply risk appears to require a broadened scope for related initiatives. Specifically, chief purchasing officers (CPOs) might therefore want to cast a wider net in terms of assessing politically induced risk and reaching out to partners in their mitigation efforts. Advancing and using both their business and political acumen should enable supply chain managers to strategically navigate increasingly complex supply chain contexts.
Both an extended coverage and reach of mitigation efforts and a quick shift from one mode of operation to another seem to be more feasible for firms when they are facilitated by an even stronger formal and informal strategic integration of the supply chain management (SCM)/ purchasing function. Top management should then ensure that SCM/purchasing has formal channels (i.e., representation on key committees) to access decision makers and to escalate any topics of strategic importance without delay. SCM/purchasing managers might also want to ensure open, informal, firm-internal channels. When the SCM/purchasing function has a strong internal reputation as a business partner for line management, its managers have easier access to the full range of strategic and general management functions when needed.
The HREM case also demonstrates that it is highly important for buying firms to be able to trace the provenance of their inputs at all stages of the supply chain. This is true not only for HREM. Traceability is a critical prerequisite for managing commodity price risk management and is the widely covered case of “conflict minerals” (CM)—tin, tantalum, tungsten, and gold—which are mined in the Democratic Republic of the Congo (DRC) and, after being smelted, are being used mainly in consumer electronics products, such as mobile phones and computers. Armed groups in the DRC earn large amounts of money by mining and trading CM, and in that process they continually violate the most basic human rights. To end the trade in CM, the U.S. Dodd-Frank Act (DFA) has recently forced listed companies to determine whether any of their products contain CM. Since individual firms are required to trace the provenance of the minerals, this regulation forces them to map their entire supply chain. Related to this example, recent allegations by consumers and nongovernmental organizations (NGOs) suggest that companies in the electronics and automobile sectors support child labor through their sourcing of raw materials or companies in the food and retail industries support slave labor in the fishing sector or the garment industry15 underscore the relevance of understanding traceability for addressing social issues.
Summary
Complex, global supply chains require companies (a) to trace the provenance of their inputs at all stages of the supply chain, and (b) to understand, anticipate, influence, and respond to political influences in their supply chains. HREMs provide one example of this risk. As we have discussed in the case of HREMs, commodity price volatility is one manifestation of political risk, with others including, but are not limited to, threats of supply disruptions, environmental and social sustainability effects. Supply chain professionals, in their management of global supply chains, need to be strategic, with the “buy-in” of other business functions and supply chain and industry partners, to holistically manage political risk. These efforts are critical for creating sustainable and resilient firms and supply chains in an ever-complex environment.