Back to the futures
Learning from China’s iron ore futures to secure USD pricing power in rare earths
The United States is in a bind. China, our main geopolitical rival, controls rare-earth refining and processing and is actively pushing to ensure rare-earth metals are priced and settled in Chinese renminbi. What’s a superpower to do? What America does best: financialization.
Last week, Reuters reported that the world’s largest derivatives exchange, Chicago-based CME Group, is developing plans to launch the first-ever futures contract for rare-earth elements — specifically a contract for neodymium and praseodymium oxide (NdPr), the primary rare earths used in permanent magnets for electric vehicles, wind turbines, and drones. Assuming you’d like to be competitive in the future of manufacturing, warfare, or energy, these are essential inputs.
If launched, the CME contract could become a widely-recognized, dollar-based (we love this), standardized price that:
Creates a reliable reference for pricing decisions and contract negotiations
Lets market participants financially hedge against extreme price swings caused by Chinese dominance in rare earths
Helps the U.S. take some pricing power from China, if paired with the right policies
What is a futures contract? A standardized, exchange-traded contract to buy or sell an underlying asset (e.g. oil, gold, or metals) at a fixed price on a future date. They are traded on exchanges like the Chicago Mercantile Exchange or London Metals Exchange (LME).
Why do we need them? The OG reason is that producers, consumers, and businesses use futures to lock in prices and protect against adverse price swings. Southwest Airlines saved about $3.5 billion on jet fuel costs over a decade because they loaded up on crude oil futures in 1998 at ~$11 per barrel (simpler times). Futures markets get producers, consumers, and speculators on the same platform to gauge future supply and demand expectations. They were the original prediction market except you’re betting on wheat prices instead of whether, I don’t know, Jesus will return in 2027.
How do they enforce USD dominance? Most major global commodity futures are priced and settled in USD, which means participants around the world must acquire dollars to trade, post margin, or settle contracts. This creates persistent, structural demand for USD, reinforcing the dollar’s central role in global commerce.
A rare-earth hegemon
China controls refining (70%) and processing (90%) of rare earths, which allows them to largely dictate pricing in this small, thinly-traded, and opaque market. Unlike widely-traded metals like gold, prices for rare earths have been set through negotiations between Chinese producers and global buyers (Raytheon, GM, companies that need rare earths to make things), and influenced by Chinese government export and production quotas.
In 2014, China established the Baotou Rare Earth Products Exchange. Baotou is a city the size of Chicago in Inner Mongolia, surrounded by 80% of China’s rare-earth reserves. By centralizing trading on the exchange, China made prices for companies across the rare-earth supply chain more transparent, though foreign participants typically have to access the market through intermediaries. All trades are spot trades (i.e. purchases for immediate delivery… if you hit “buy” you better have somewhere to put all that neodymium you are about to get delivered) and trades are settled in Chinese renminbi (RMB).
The exchange also just launched a rare-earth price index to give participants a benchmark to track daily prices. As China tries to direct more transactions through the exchange, global buyers are forced to settle in RMB (and therefore manage both price swings and currency exposure), positioning the renminbi as the primary, if not sole, currency for global rare-earth transactions — a stated ambition of the Baotou exchange chairman.
Futures contracts are not allowed on the Baotou exchange. This is ostensibly to limit speculation by retail traders, which is something of a pastime in China: Bloomberg recently reported on Merry Chen, a 42-year old homemaker in Hangzhou who “with no prior experience in derivatives . . . opened a futures account last Monday on the advice of friends” and blew 750,000 yuan trading gold futures.
But the futures ban could also have a strategic purpose: without a way to hedge against price volatility, rare-earth projects in the West struggle to secure financing from banks. The CFO of MP Materials recently complained:
“What good is it to invest billions of dollars if the second you turn your refinery on, prices go from US$170 to US$45?”
Banks require predictable cash flows to underwrite projects, but volatility in rare-earth prices with no way to hedge makes financial projections highly speculative. Perhaps for this very reason, Chinese exchanges have signaled an intent but announced no concrete timelines to offer rare-earth futures. This financing gap in the West could explain why major rare-earth projects frequently rely on backing from the U.S. government. Only Uncle Sam has the risk tolerance for the geopolitical premium that comes with China controlling pricing in rare earths.
So what can the U.S. do to take back some control of pricing in rare earths? In the 2010s, China actually faced a similar problem in the iron ore market, including a few dominant suppliers, many fragmented buyers, opaque pricing, and limited hedging tools. They attempted to solve their situation with futures.
Lessons from China’s iron ore futures
The largest buyer of a commodity doesn’t automatically get to call the shots on prices of that commodity. China learned this the hard way with iron ore (which is used to make steel for bridges, railroads, factories, etc.). In 2013, China imported over 70% of shipped iron ore, an incredibly dominant market share that translated into zero price-setting power because Chinese demand came from 7,300+ fragmented steel mills, while supply came from three coordinated mining giants (BHP, Rio Tinto, Vale).
Before 2010, these three mining companies would get in a room every year to negotiate regional prices with Japanese, Korean, and Chinese steelmakers, though the Japanese had the most influence. In 2010, the miners abandoned the annual negotiations, which had locked in prices for a year, because explosive demand from China kept pushing ore prices in spot markets higher (leaving billions on the table for miners). The miners instead tied their contracts to dollar-denominated spot market price indices like Platts.
China, by now the largest importer, still bemoaned their lack of pricing power. To rectify the situation, the Dalian Commodity Exchange (based in Dalian, a port city the size of Houston) launched an iron ore futures contract in 2013, which importantly included physical delivery and settlement in RMB. The other widely-traded iron ore contracts in Singapore and Chicago were cash-settled (did not include physical delivery) and priced in USD.
Physical delivery means that when the futures contract expires, you don’t just get or owe cash. You get the actual commodity. The physical thing. In this case: actual iron ore, showing up at an actual warehouse, requiring actual trucks to move it. I will never forget being a newly minted derivatives trader on the floor of the Chicago Board of Trade. At 6:30 AM and out of nowhere I heard a string of the most colorful expletives I’d ever heard in my life. The trader a few desks down had forgotten to close out his crude oil futures before the contract expired, and the clearing house was calling him to ask where he would like his 50,000 barrels of oil delivered. He had to scramble to find some warehouse in Louisiana willing to take delivery so he could sell the crude to someone who actually wanted it. Awkward.
Anyway! Physical delivery had some useful properties for China. First, it gave Chinese steel mills guaranteed access to physical iron ore at locked-in prices, protecting them from both price volatility and the more troublesome problem of not being able to buy iron ore when supply gets tight. Cash-settled futures hedge your financial exposure but don’t give you anything to throw in the blast furnace. Second, physical delivery created an independent Chinese price benchmark based on real transactions. Actual iron ore changing hands at actual Chinese ports drove Chinese prices, instead of Western price assessments, which industry observers believed were more favorable to (and preferred by) the mining giants.
The Dalian Commodity Exchange’s iron ore futures became the world’s largest iron ore derivatives market by volume. In 2018, China opened the contract to foreign traders, which boosted liquidity. By 2019, major international trading companies like Cargill and even Vale started using Dalian iron ore futures prices as the basis for some spot contracts with Chinese buyers, even settling transactions in RMB. Academic research showed the futures market was useful: it contributed 60–70% of price discovery, meaning futures prices were doing most of the work to figure out what iron ore should cost. Chinese importers now had a RMB-based tool to hedge and lock in prices.
Futures can only take you so far
The Dalian iron ore futures contract gave Chinese steel mills some useful things: renminbi hedging, huge trading volumes, and regional price influence. But it failed to give China truly global pricing power in iron ore for a couple reasons:
Despite China’s status as top importer, the market was still a fragmented group of steel producers reliant on supply from the mining giants who preferred the dollar-denominated benchmarks, like Platts, that they adopted in 2010.
While physical delivery was great for Chinese buyers, the Dalian futures required delivery at a Chinese port and that is not so convenient if you are literally anywhere else.
The Dalian Commodity Exchange became wildly popular with Chinese retail speculators, creating volatility unrelated to actual iron ore fundamentals, which made foreign participants nervous about using it for serious pricing.
So while futures gave China a foundation to improve conditions for steelmakers, they weren’t enough. Beyond diversifying iron ore supply (spoiler alert: China just started importing ore from Guinea), China needed to unite its 7,000 steel producers. That moment came in 2022, when China formed the China Mineral Resources Group, consolidating more than half the Chinese steelmakers into a unified negotiating bloc — which is working. Last year, the Australian mining giant BHP agreed to settle 30% of its spot trades with China in RMB. And in December, China Mineral Resources Group forced Rio Tinto and Fortescue to abandon the dollar-based Platts index in contract negotiations. Rio switched to Fastmarkets (still dollar-based but less dominant), while Fortescue adopted an average including China’s RMB-denominated Mysteel index.
Major miners adopting China-based indices will probably only increase liquidity on the Dalian futures market and strengthen China’s hand in future negotiations — risking a self-reinforcing cycle where pricing power gradually migrates from West to East.
A mirror image for rare earths
The West now faces a similar challenge with rare earths, only in reverse: China is the major producer, and the West is the dominant consumer facing Beijing’s pricing power. A Chicago rare-earth futures contract would play the same role the Dalian iron ore futures played for China, creating a USD benchmark and hedging instrument.
But rare-earth futures face an uphill climb. The market is smaller, more fragmented (17 elements vs. 1 commodity), and more politically controlled than iron ore ever was. Even the contract design is harder than it sounds. The CME will need to pick a reference spec for NdPr and build independent verification infrastructure around it, neither of which is trivial. If initial participation is low, traders could be discouraged, depriving an illiquid market of the depth needed for reliable price discovery, hedging, and financing. The Dalian futures market also became wildly popular with Chinese retail speculators, creating volatility unrelated to fundamentals. Though it’s less likely, the same could happen with rare earths in the West if neodymium-praseodymium oxide becomes the new GME 0.00%↑ .
However, the strategic importance of rare earths is so obvious that we have to at least try. As Heidi Crebo-Rediker of CFR puts it:
“China’s global dominance of critical minerals supply and demand, paired with lack of commodity price sensitivity, gives Beijing control of global pricing power. China has weaponized this pricing power for the past two decades to put market-based mining companies out of business around the world.” (emphasis mine)
China’s iron ore futures alone couldn’t deliver pricing power in 2013, or 2015, or even 2020, until the China Mineral Resources Group coordinated buying power. And with these complementary changes, the Dalian iron ore futures became China’s first successful potential challenge to dollar dominance in commodity pricing.
The U.S. is quickly getting up to speed to mirror China’s strategy. The U.S. government’s Project Vault committed $10 billion in Export-Import Bank financing to create a strategic critical minerals stockpile. The Department of War has taken equity stakes in MP Materials, and established price floors for neodymium-praseodymium oxide (NdPr). And the U.S. is accelerating supply diversification with $1.6 billion in federal funding for USA Rare Earth, $600 million for Tronox’s Australian processing facility, and partnerships from Brazil to Australia.
A Chicago futures contract won’t immediately get the U.S. out of its rare-earth bind. But a decade from now, with liquid markets, government support, and engineering breakthroughs in processing and refining, rare-earth futures could be the platform that helps the West take back pricing power, secures access to the inputs upon which the future of energy and manufacturing depends, and ensures the world’s most strategic commodities are priced in USD1.