China Ponders REE Reserve in Bid to Stabilize Prices

China drew the attention of investors  earlier this month with the announcement that it is considering creating a national inventory reserve in a bid to stabilize rare earth element (REE) prices. In a separate announcement, the government confirmed that it will be looking to implement a new tax aimed at controlling the sale and production of REEs.

China’s domestic demand for rare earth tumbled in 2011 following Beijing’s tightened controls over production, resulting in many separation plants closing down as customers retreated from record-high prices.

Mechanism for open trading

According to a local media source, the Ministry of Industry and Information Technology will be leading research into creation of the reserve and an REE trading platform will be established on the basis of a mechanism for open trading by Chinese enterprises.

Enterprises will be required to purchase and reserve REEs according to a pre-set mechanism when prices fall to a certain level; when prices eventually rise to a set price, these same enterprises will then be required to sell. A plan for how the system will function is expected to follow communications with local rare earth enterprises, according to unidentified sources.

The system is bound to have repercussions across an already unsettled market. Some analysts feel that the move could further complicate an already tense relationship between east and west that culminated in the US, EU, and Japan moving in on the World Trade Organization to challenge what they labelled as restrictive Chinese rare earth export policies.

A case of déjà vu?

While the timing of the move is questionable, the concept is entirely novel. According to a report by The Wall Street Journal, the reserve theory is built from a model already used by Chinese government agencies managing other stockpiles, including copper and corn. In fact, many governments worldwide have built similar stockpiles to address temporary emergency shortfalls. Investor concern lies in the fact that in the past China has done so with little transparency and sometimes in ways that appear designed to manipulate prices.

Early in 2011, China’s State Council issued similar directions on promoting the development of the REE industry and called for the establishment of a strategic reserve. Also, market participants have been quick to point out that the country’s largest REE producer, Inner Mongolia Baotou Steel Rare-Earth (SHA:600111), attempted a similar strategy in the past and failed.

China Galaxy Securities, Beijing’s largest brokerage firm, responded by suggesting that drastic price fluctuations in 2011 “seriously hurt” the industry and brought increased difficulties in regulation, adding that the reserve mechanism would be helpful in controlling price fluctuations and illegal mining.

Details of the country’s past stockpiling capabilities were never made public; however, outlines of its plans were made clear when state-run media reported that facilities in the province of Inner Mongolia alone are capable of holding over 39,813 metric tons of REEs – more than the total amount of REEs China exported in 2011.

Investors will be keen to see whether the move will have a production knock-on effect such as that seen after last year’s announced intention of creating a strategic reserve.  In that instance, mining companies around the world responded by taking steps to dramatically increase production. Examples include Australia’s Lynas Corporation (ASX:LYC) and US-based Molycorp (NYSE:MCP).

REE tax permits

Adding to investor concern is news that China is looking to allocate a value-added tax (VAT) permit to rare earth companies in a bid to regulate overproduction and collect extra revenue. By issuing the special VAT slip, the government will effectively have full control over which companies are exporting REEs and what quantities they are able to export.

The move has attracted criticism in that although the percentage of the VAT is still unclear, traders claim that it is bound to lift prices of REEs exported out of the country. Once instituted, the tax will be almost impossible to avoid, allowing the government strict control and supervision over the entire mining process, from production to sale. Reports also indicate that rare earth companies in Sichuan and Inner Mongolia will be the first to receive permits.

The next few months will be a key period for investors and analysts alike. Barely a week goes by without China announcing some new form of legislation aimed at a sector that it clearly feels it is losing influence over. While the mining of REEs is a messy business, more and more companies are now stepping up to fill the gap in a market that will inevitably become less susceptible to Chinese influence.

Securities Disclosure: I, Adam Currie, hold no direct investment interest in any company mentioned in this article.