The race to find rare earths outside of China

The key metals needed for hybrid cars, flat screen TVs and energy-efficient lighting could be in short supply in a few years time if rare earth element mines aren’t developed outside of China, some industry experts say.

About 95% of the world’s rare earths are produced in China where abundant sources and cheap production costs have made it the go-to source. But lately the Asian superpower has been limiting exports to the rest of the world in the name of developing its own manufacturing sector. Continued growth could mean China will need all the rare earths it produces by 2013, leaving the rest of the world in limbo.

Dudley Kingsnorth, a rare earths consultant and executive director of Industrial Minerals Company of Australia, predicts world demand will reach 230,000 tonnes per year by 2013, up from 135,000 tonnes this year, but production isn’t expected to keep pace. A 40-60,000 tonne shortfall is likely if there are no new rare earth mines up and running outside of China by then.

“We’ve got a whole lot of companies out there talking about their projects,” Kingsnorth says from his home in Perth. “They’ve got to stop talking about it; otherwise that gap won’t be filled.”

Kingsnorth says China has been putting structures in place that pretty much force manufacturers outside of China to buy value-added rare earth products instead of rare earths in pure form. The country has been upping tariffs and cutting export quotas. Tariffs vary between 15-25% up from 10% in 2006 and exports have been cut to 41,000 tonnes compared to 48,500 tonnes three years ago. To Kingsnorth it means opportunity for those developing deposits outside of China.

“Non-Chinese customers want to see some diversity of supply to minimize their sovereign risk,” Kingsnorth says.

But the potential for a shortage rings an alarm bell for Jack Lifton, a rare earths consultant and columnist for Resource investor.com. Lifton says that supply from China is not reliable over the long term and that rare earth consumers outside of China, “are working on the edge of a cliff.”

“We have been lulled into a sense of false security because Wall Street, Bay Street and the City all think that all you have to do if you want a commodity is just keep offering a (higher) price,” Lifton says. “China is not responding to that pressure.”

Lifton doesn’t understand why the financial community isn’t backing the development of non-Chinese sources.

“It’s necessary to bring all of the known Western deposits into production,” Lifton says. “I think it’s nuts not to make the investment.”

It’s true that the financial community is only now just becoming better versed in the opportunities for rare earths.Research Capital analyst Barry Allen says his firm had its first-ever rare earths conference this past April.

“It was considered very new,” Allen says. “If we roll down the road 10 years, rare earths are going to be a big part of our mining industry.”

Allen agrees that supply could be a problem in a few years time, especially for car makers who are seeing growing demand for hybrids.

“There is potential for a crisis looming in supply of rare earths,” Allen says.

But he expects a supply response. “The mining community has been pretty good about reacting to commodity prices,” he says.

One of the main hurdles in the rare earth industry is balance of supply of the individual rare earth metals because the ratio in which they occur in the ground doesn’t always match demand. The metals can’t be selectively mined they occur together and all have to be separated in processing in order according atomic number.

Kingsnorth says europium, terbium, dysprosium and yttrium will be in short supply even with the extra production by 2012. Demand for terbium is expected to be 600 tonnes while only 300 tonnes will be produced. On the other hand, demand for praseodymium will be 7,000 tonnes but supply is expected to be more than enough at 10,500 tonnes.

Prices have risen significantly between 2006 and 2008 for certain rare earths and on top of that, their value per kg greatly vary. In the second quarter of 2008, lanthanum oxide cost US$8.50 per kg, up from US$1.45 two years earlier, while europium oxide sold for US$480 per kg up from US$260 and terbium oxide cost US$730 per kg compared to US$455 per kg in 2006.

Although commodity prices for certain rare earths have risen significantly over the last few years, there’s not a lot of money to be made in rare earths as a whole. Fetching an average price of US$10-15 per kg this year, the entire rare earth market is valued at just US$1.5-2 billion. If the deposits outside of the west step up to fill the 20% gap that Kingsnorth is predicting, the total value would be peanuts to any medium or large producer of base or precious metals.

“That only leaves about US$3-400 million worth of sales for the non-Chinese companies in today’s terms,” Kingsnorth says.

Kingsnorth says China’s stranglehold on rare earths is not all about money but job creation downstream; it’s been putting structures in place that persuade people to value-add in China.

China wasn’t always the dominant producer. In the 1960s and 70s, India, South Africa, Australia and the United States were significant suppliers. But as environmental controls became stricter and production more costly, rare earth production shifted to China. Chinese producers over estimated demand growth causing prices to collapse in the 1980s, which forced many other mines elsewhere in the world out of business. By restricting rare earth exports, it’s ensuring all the development it wants.

Over the years, China has built upon the industry, starting with exporting mineral concentrates in the 1970s, mixed rare earth chemicals in the 1980s, mixed rare earth metals and oxides in the late 1990s. In the last 10 years, as more uses for rare earths have been developed in electronics, hybrid cars, LCD screens, China has been carving out its own manufacturing industry.

It’s still early days for rare earths in the financial community but the awareness is growing. Avalon Venture’s (AVL-V, AVVTF-O) president, Don Bubar, points out that his company was able to raise $16.8 million on the strength of the technical merits of its Thor Lake rare earth project near Yellownife.

But he admits that such attention is a new thing; he’s been in the business for a decade.”We were generally ignored early on,” Bubar chuckles. “I find in Canada we have such a long history with precious metals and base metals a lot of firms take comfort in those and don’t like to move outside of their comfort zone.”

During Avalon’s inception, Bubar focused his efforts in Europe and even the United States, where investors take a more generalist view.

But now with the transition toward hybrid and electric cars, investors are recognizing that rare earths are required in abundance. Bubar says that makes it much easier for people to wrap their head around why these obscure commodities are becoming important.

Jim Engdahl of Great Western Minerals (GWG-V, GWMGF-O) has experienced much of the same. Only in the last six months has his company, which has the Hoidas Lake rare earth project 50 km northeast of Uranium City, Sask., begun to get more attention. Engdahl thinks the supply gap could happen earlier than 2012 but wonders whether investors will truly see merit before that.

“It’s going to take some sort of major event like an auto plant having to shutdown because it can’t get material,” he said.

Engdahl’s company has a unique mine to market strategy eventually Great Western’s mining operations will supply its subsidiary Great Western Technologies.

Mark Ellis, president of the subsidiary, is already feeling the pinch when trying to get his hands on pure rare earths from its Chinese suppliers.

It’s getting much more difficult,” he says. “There is big pressure to have us alloy them with something.”

But creating alloys is what Great Western does, and since his company aligned with the minerals group, he’s been getting a lot of calls from other companies in need of rare earths.

I think I could sell everything the mine will produce, today,” Ellis says. “The Chinese have a huge stranglehold on supply.”

Manufacturers that use rare earths may find themselves moving operations to China.

That’s how Toronto-based Neo Materials secured its supply of rare earths. His company, which has an export quota set by the Chinese government, sells materials to customers in China, U.S. Japan and Europe but over the last six years, the major growth area has been China. In that time, sales in China have grown from 15-60%, he says, so the export quotas haven’t really mattered.

“We see indications that (the Chinese government) is certainly going to keep things tight,” Bedford says. “They don’t want to see the mass exodus of rare earths 10 years ago when prices came off.”

Yuri Lynk, an equity analyst at Canaccord Capital, isn’t convinced that anyone should be worried just yet.

“I don’t know if I see a crisis; there’s lots of supply in China, it’s just severely restricted,” Lynk says.

Companies outside of China that need rare earths will have to pay more for them down the line, Lynk says.

Cost is the main reason why China dominates the world scene in rare earths market demand is being met through a few sources that can produce them very cheaply.

Lynk says that new producers are at risk because not only does China control supply, it also has the power to manipulate the price of the individual commodities. Lynk says prices for rare earths will have to be substantially higher to make deposits outside of China economical and that at this point, China has the power to destroy the competition.

“It’s not an accident that China has 95% of the market,” Lynk says. “You have to believe that the Chinese could crush prices in an effort to drive these competitors out they could just open up the floodgates and supply the market with lots of rare earths in an effort to keep prices low and put these guys out of business.”

Kingsnorth says current prices are strong enough to support the development of projects outside China because 20% isn’t that much. On the other side, China will likely continue to meet demand if it can.

“If it were to not meet demand and allowed prices to go too high then illegal mining in China will become uncontrollable as it has in the past with very high price increases,” Kingsnorth says.

Even with all the opportunity out there, Kingsnorth says that developing rare earth projects is challenging because each project is so unique. After developing a resource companies need to build a demonstration plant so they can get supply contracts and do the engeinearilty so they have reliable capital and operating cost estimates.

And because China has dominated the market, this expertise is not readily available,” Kingsnorth says.

In addition to Great Western and Avalon, there’s are a few other advanced projects including Chevron Mining with the past producing Mountain Pass mine in California, the Mount Weld project in Malaysia held by Australia based Lynas Corp. (LYSCF-O, LYC-A ) and the Nolans project held by Arafura Resources (ARAFF-OM ARU-A).

At the end of the day, the opportunity is there but who will be the first new source of rare earths is yet to be decided.