China and the US each seek an edge

China and the US are engaged in a global competition for strategic dominance as the world reverts once again to a bipolar environment. While the US still seemingly retains dominance in the technology sphere (semiconductors, AI, etc.), a key focus of this struggle is resources: specifically, energy and rare earth elements (REEs).

Energy is necessary for the increasing power needs of the modern world: in data centers for AI, for modernization of the grid, and for electric vehicles. Equally, rare earths are vital for most cutting-edge technologies. Together, they serve as examples of the constraints facing the US, and the West more broadly, as it navigates its relationship with China. And they may explain why the US bargaining position has eroded in the past decade.

Energy competition

First, secure, low-cost energy has always provided nations with an edge, attracting investment and allowing companies to undercut foreign competitors. Currently and historically, the US has possessed a domestic resource advantage offering attractive power prices, thanks to its domestic oil reserves, access to other nations with oil, and the fracking revolution. America now faces challenges, however, as its power grid ages and its AI power needs jump exponentially.

For years, China has focused on battery storage technology and on increasing its power capacity across the energy spectrum: coal, renewables, and nuclear. For example, it is constructing 34 nuclear plants (with another 200 of them on the drawing board) while almost no new nuclear plants have opened in the US for decades. This has allowed China, whose chips for AI generation are slower and require more energy, to overcome its technology deficit in semiconductors, using its energy advantage to catch up with the US. Data centers in China pay an average of three cents per kilowatt hour, versus seven cents or more in the US.

Consequently, while US electricity production has been flat this century, Chinese capacity has soared. The ironic result is that China, which is generally resource poor, is becoming the leading, global power producer as it pushes battery storage innovation and subsidizes energy prices to increase electrification across its economy.

All of this means that China now has an energy surplus to meet future demand. By contrast, the US faces a 44-gigawatt shortfall in the next three years. To keep up, the US and its allies will need to develop more and better sources of power – and quickly. Any Western company involved in raising energy production and modernizing the power grid will likely benefit.

Ever-rarer earths

Second, the reliance on China for magnetic rare earths highlights the limited leverage the West and the US have on China – most recently demonstrated by the US climb-down in tariff negotiations. In the past, the US could use semiconductor chip restrictions as a reliable and powerful bargaining chip.  That era is over.  Rare earth elements (REEs) made a return to the news recently when China moved to restrict supply and exert export controls. The matter has been resolved for the time being, with China agreeing to hold off on these restrictions for one year – but it also sets the clock ticking.

Why is this important? These minerals are crucial for many of the cutting-edge products of modern life. Smartphones, electric vehicles, wind turbines, and robots all depend to one degree or another on REEs. The US military is particularly keen to maintain access to them.

Not surprisingly, then, rare earths represent a significant potential choke point for the economy, with China having cornered the market for decades as part of its long-term industrial policy to control the lion’s share of global supply. Refining dominance is really what separates China from the rest of the world. China has roughly a third of the world’s REE reserves, yet it produces much more than four-fifths of supply. There are several countries, including the US, that can extract rare earths, but due to a monopoly on the technology, only China can presently process them in quantity. It’s a question of monopolistic price setting, environmental considerations, and cost structure.  

Rare earths have figured in President Trump’s policy initiatives in Greenland and also in Ukraine. In October, the US signed a deal with Australia with both countries pledging billions of investments to build up capacity. Currently, Australia is the second-largest producer of rare earth elements after China but it still lags far behind.  China will continue to leverage its mineral processing capabilities and advantage as the US looks to negotiate a trade deal.

Where we end up from here is anyone’s guess. The two largest economies need each other to continue to prosper but are still looking at ways to disengage.

Implications for investors

We expect energy stocks—particularly those involved in the electrification of energy—to be strong beneficiaries of this trend. Growing energy production and increasing innovation in the space, rebuilding and modernizing the electric grid, and securing new rare earths processing technology will be high priorities, requiring significant support from the government.

As things stand, rare earths are a less-certain investment thesis. For now, the technology behind such processing is pretty much owned by China. Does the West have the stomach to invest for the long term to catch up? Factoring in the environmental impact – which would be considerable – we believe this is still an open question.