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Nick Cunningham is an independent journalist, covering oil and gas, energy and environmental policy, and international politics. He is based in Portland, Oregon. 

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Will China Cutoff Rare Earth Exports?

Oil prices sank once again on heighted fears of the U.S.-China trade war, this time because China has threatened to step up its response.

China threatened to cut off exports of rare earth elements to the U.S., a move that would intensify the trade standoff. The materials are used in a wide variety of electronics, including iPhones, electric vehicles, wind turbines, LED lights and even weapons systems.

Hu Xijin, editor-in-chief of the Chinese tabloid Global Times said that the government was “seriously considering” curtailing exports to the United States. But as traders and analysts told CNBC, the statement is murky because it is not necessarily an official threat from the Chinese government.

Still, the Trump administration continues to ratchet up pressure on Beijing, which increases the odds of a response. The U.S. has basically outlawed Chinese tech giant Huawei from doing business with American companies, and has explored additional sanctions on other Chinese companies.

Rare earths would add another complex layer to the trade battle between the two countries. “With the rare earths headline, I think investors are realizing that this is more than just about a trade war,” Michael Katz, partner at Seven Points Capital, told CNBC. In dollar terms, the rare earths trade is rather small. The U.S. has tariffs on $200 billion worth of Chinese imports, while the U.S. only bought about $160 million-worth of rare earths last year, according to Bloomberg. But rare earths’ importance vastly outstrip their dollar value because of the critical role they play in so many different technologies, as well as the lack of alternatives to them.  Related: Why EVs Can’t Do Without Oil

The U.S. depends on China for about 80 percent of its rare earth imports. Rare earth minerals are not exactly rare, but they are costly to produce and have environmental challenges associated with them, which makes setting up a mine difficult. As a result, China controls the vast majority – 71 percent in 2018 – of the global supply.

The possibility of a cutoff sank financial markets. The Dow Jones Industrial Average dropped 200 points when it opened on Wednesday. Crude oil was down more than 2 percent in early trading. “Oil prices are under pressure amid the further escalation of the trade conflict between the U.S. and China,” said Carsten Fritsch, an analyst at Commerzbank AG in Frankfurt.

The move comes a few weeks after President Xi Jingping made what appeared to be a calculated visit to a rare earths processing facility during a domestic tour. But on May 29, the rhetoric escalated. China’s People’s Daily wrote that the U.S. should not underestimate China’s willingness to fight back in the trade war, and used a tough sounding phrase meaning “don’t say I didn’t warn you,” according to Bloomberg, which has historical overtones that analysts understood as a serious threat.

However, there are challenges for China if it decides to go down this path. In 2010, China cut off rare earths exports to Japan over a standoff over the detention of a fishing trawler. The aggressive move drove up prices and sparked interest in alternatives sources of rare earths. China backed off after only a few weeks and resumed shipments. Related: The Next LNG Boom Will Dwarf The Last One

In the U.S., a bipartisan group of Senators are proposing legislation that would ease permitting requirements on setting up new mines aimed at rare earths. The Senators view the issue as a national security concern. The legislation would no doubt receive a boost if China decides to move forward on weaponizing its rare earth exports.

The trade war and the heightened risk of an economic slowdown is now dominating the narrative in the oil market. WTI has sunk to roughly $57 and Brent is down to $67.

Meanwhile, the fundamentals of the oil market still look rather tight, at least in the near term. Brent futures are in a steep state of backwardation on the front end of the curve. “The backwardation of the Brent forward curve is becoming increasingly pronounced. The price gap between the front-month and the following forward contract (July vs. August) has meanwhile reached $1.5.,” Commerzbank wrote in a note. “The last time it was any higher in this segment was in September 2013. That market participants are prepared to pay such a premium for oil that can be delivered at short notice points to tight oil supply.”

By Nick Cunningham of Oilprice.com

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