This insight forms Part 3 of a series on the recent wave of critical mineral strategies in advanced economies to reduce dependency on China and their likely impact on global supply chains and market structures.
In this insight, we will discuss the appropriate set of policy measures required to support governments in their efforts. This clearly depends on the country/jurisdiction and the mineral in question. We conclude by assessing how realistic it is for governments to achieve their stated objectives.
In Part 1 and Part 2 of this series, we provided an overview on the recent critical mineral strategies globally. Critical minerals policy measures can broadly be divided into financial and non-financial incentives. For strategies to be successful, governments need to pursue the right mix of these policy measures.
This policy mix will vary across critical minerals, depending on the level of government intervention required and the scale of the associated risk. Supply chain risk refers to the probability of events that could disrupt the availability, cost, quality or delivery of goods and services.
The appropriate mix of policy support depends on the specific commodity market
As more commodities are designated as critical, determining the appropriate balance of policy measures is becoming increasingly complex:
- Distinct market characteristics: The appropriate combination of financial and non-financial incentives must reflect the specific characteristics and challenges of each market.
- Risk of resource misallocation: Not all designated critical minerals require immediate substantial government support. Treating them equally or applying measures universally could obscure the markets facing the greatest risks and lead to misallocation of public resources. We discussed the need to narrow the critical minerals investment focus in a previous insight.
To identify the most appropriate intervention, CRU has developed a critical minerals risk matrix. The matrix groups commodities into four quadrants based on two dimensions specific to each industry – the cost of government intervention and the level of supply chain risk.
In this instance, the cost of government intervention refers to the financial cost for the government to participate as a producer or an investor to mitigate supply chain risks. It excludes non-financial impacts such as environmental and social costs. The scale of supply chain risk depends on several factors, including concentration and the criticality of end uses.
For instance, disruption of supply in metals used in defence, energy transition and AI will have severe economic and geostrategic implications. Based on these two dimensions, metals can be positioned across the matrix’s four quadrants, helping determine the most appropriate policy mix for each commodity.
Low supply chain risk and low intervention cost: These markets do not require government intervention and are unlikely to feature in critical minerals lists.
Low supply chain risk and high intervention cost: Given the limited supply chain risk, these markets do not require government intervention. For example, iron ore is widely available, and its demand is not expected to grow significantly over the long term because infrastructure investment in China – the world’s largest consumer of iron ore – is slowing down. However, because the iron ore sector is large, significant government resources would be needed to intervene in the market.
High supply chain risk and low intervention cost: These markets are likely to require greater emphasis on clearly focussed financial incentives. Despite the requirement for new supply, private investors may remain wary of entering such markets. In particular, markets characterised by low volumes and low barriers to entry may be pushed into oversupply by a few capacity additions, thereby affecting long-term profitability. Governments may therefore need to identify industry champions and directly support selected producers.
An example of a market is this category is gallium. CRU estimates that if gallium were recovered as a by-product from all alumina refineries, annual production could exceed 20,000 t Ga, compared to a total market size of just under 1,000 t Ga contained.
High supply chain risk and high intervention cost: These markets will generally require a combination of strong financial incentives and substantial non-financial support. Although financial assistance will be needed to encourage production and support sustained production, it is unlikely to be sufficient on its own. Given the large size of such markets, governments are unlikely to fund a large share of the required investment directly. Strong non-financial measures are therefore needed to encourage private-sector participation. This will also allow much needed ‘hidden’ champions in these markets to emerge.
Policy interventions are working in the rare earths market
Rare earths are characterised by a relatively low cost of government intervention and high supply chain risk. Investments in the sector have increased significantly over the past year, following China’s trade restrictions on rare earths. Due to the nature of geopolitics at play, these investments have mostly been driven by the US government through a combination of loans and equity partnerships.
For example, the US government has taken an equity stake in MP Materials, a US-based rare earths producer, while also providing generous loans to other domestic producers in the rare earths value chain. In another recent example, the US Department of War, formerly the Department of Defense, announced a $620 M loan to Vulcan Elements to support NdFeB (Neodymium Iron Boron) permanent magnet production. As a result of such investments, global supply of rare earths outside China is forecast to grow at an accelerated pace by 2030. This will lead to a declining market share for Chinese supply over time (see Figure 3).
This momentum has been driven largely by strong financial incentives, such as equity partnerships, price floors and favourable debt financing. These are complemented by several non-financial measures, including multilateral agreements and accelerated permitting.
One of the most notable policy measures in the rare earths sector is the use of price floors by the US government to support MP Material and USA Rare Earth, two key US-based producers. Historically, investors have been sceptical of investing in the rare earth market because of the risk that oversupply from China could depress prices sharply, creating significant investment uncertainty.
Given the rare earth industry’s positioning in the matrix shown in Figure 2, the current combination of financial and non-financial incentives by advanced economies represents an impactful mix. Figure 4 below shows how Arafura, an Australian mining company, has secured project financing for a rare earths project, which is expected to start production towards the end of the decade.
Resolving supply concentration in high-cost midstream commodity markets is more complex
High-cost industries are too large to support only with direct financial intervention. For example, China is forecast to remain the dominant supplier of copper and lithium refining in 2030, both of which are essential to the energy transition and increased electrification. Although policymakers and industry participants can draw inspirations from the rare earths sector, the incentive mix will need to be different. Well-chosen non-financial measures will need to be blended with financial measures in larger markets for diversification to be a success.
Midstream capacity is particularly challenging, and copper refining provides a useful example. Treatment and refining charges (TC/RCs) are currently close to record lows, revenue from by-products such as gold and sulphuric acid is highly volatile, and profitability remains under pressure in the developed world, due to higher operating costs (partly linked to the need to meet stricter environmental standards).
Addressing this challenge will likely require a combination of non-financial incentives, such as bilateral agreements with lower-cost emerging economies, and financial incentives, including equity partnerships, backed by advanced economies with more financial resources and strong motivation to diversify supply.
Completely decoupling the supply chains is unlikely, particularly given the inter-connected nature of global production and processing networks. Assessing the probability of success therefore requires understanding the relative effectiveness of different types of incentives.
- Financial incentives: These typically have an immediate impact on the supply chains because they provide direct capital, accelerating investment across the supply chain.
- Non-financial incentives: Their impact may take longer to materialise because they generally rely on attracting and mobilising private-sector capital, which is generally slow to move.
Figure 6 illustrates the potential for success of these policy measures.
- High supply chain risk and low intervention cost: As mentioned earlier, these markets need to see a greater degree of direct financial support across the value chain. As a result, supply chain risks are likely to be reduced substantially over the long term. However, because new plants require time to build, configure and qualify for strategic end-uses, meaningful progress in the short to medium term is possible but less certain.
- High supply chain risk and high intervention cost: Given the larger scale of these markets, medium-term success is unlikely. Supply chain risks can be reduced over the long term, but this depends on mobilising sufficient capital. Sustained private sector participation (incentivised by non-financial incentives) is essential.
A policy framework based on recommended matrix does not mean certain success. Other conditions must also be in place, such as sustained private sector interest in developing alternative supply chains and establishment of a durable premium for supply produced outside China.
As supply chain risks increase, developing effective policies is becoming a growing priority for governments worldwide. In a rapidly evolving policy environment, companies must also identify and assess the incentives most relevant to their operations and investment decisions. CRU provides ready-made intelligence and tailored research to help governments and organisations navigate critical minerals markets. To learn how CRU can support your strategy, please get in touch here.
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