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China is consolidating its rare earths industry, and with more centralization could come better control over export quotas and smuggling, potentially leading to tighter supply and higher prices.
As we have reported frequently in these pages, 2013 has not been a good year for REE prices, which as a group, have fallen around 60 percent since reaching record highs in 2011. Rare earth investors with long memories will recall that was the year that the rare earth market “turned bubbly,” with most rare earths gaining in price to never-before-seen levels and rare earth equities riding along on their coattails — as explorers began hunting for new deposits to fill an expected shortage of the metals.
The reason? China prior to 2011 made a conscious policy decision to implement export restrictions, ostensibly on the grounds that it needed higher quantities of REEs for its clean energy and high-tech sectors, and that it needed to clean up its notoriously polluting rare earth mines. But with no rare earth production outside of China (Molycorp’s (NYSE:MCP) Mountain Pass mine shut down in the early ’90s due to low prices), the effect of the restrictions was a cross-the-board rise in rare earth prices, leading to complaints from downstream consumers of rare earths, forced to pay higher prices, that China’s actions violated international trade rules set out by the World Trade Organization.
As we now know, that bubble popped in 2012 and the rare earth market has yet to regain its former glory, despite a few flashes of hope this year due mostly to measures by the Chinese government to close illegal mines, thus putting a dent in Chinese production upon which prices are so heavily dependent.
(For a good review of the ascent of China as the world’s prominent rare earth producer, including why the United States lost out to China in the 1980s, read an analysis by Ming Hwa Ting of the University of Adelaide, published in East Asia Forum).
China consolidates
On Friday it was announced that Inner Mongolia Baotou Steel Rare Earth Group (SHA:600111), China’s largest rare earth producer, has acquired nine rare-earth mining companies, under the auspices of a government plan to consolidate the industry through state-owned giants buying up smaller producers. The same thing is happening in the coal and aluminum sectors.
According to The Wall Street Journal, the consolidation is China’s way of dealing with unlicensed rare-earth miners and processors that pollute the countryside, and traders, who regularly smuggle rare earths out of the country and dump the materials onto the world market, thus adding to supply and depressing prices.
The move makes sense because with China up to now failing to control smuggling of rare earths, Chinese producers aren’t able to take advantage of higher prices that would likely accrue if the smuggling problem was greatly reduced or eliminated.
In a further development, China announced on Friday that Beijing will set up a group to coordinate rare-earth production quotas, mining permits and other related policies. The group members will include Baotou, China Minmetals Corp, Aluminum Corp. of China (NYSE:ACH), Ganzhou Rare Earth Group Co., Guangdong Rising Nonferrous Metal Co. and Xiamen Tungsten Co. (SHA:600549) Together, these companies account for about 85 percent of China’s rare-earths production.
Effect on prices
The question is, could Chinese consolidation cause rare earth prices to rise again, as they did in 2011?
It’s difficult to predict exactly how the consolidation will affect Chinese production of rare earths and their prices, but it’s clear that the Chinese government is sending a signal that it is prepared to tighten global supply. The Ministry of Commerce said in December that it will trim the initial batch of its 2014 export quota for the first time in two years, as per the Wall Street Journal.
However as we reported back in September, lessening the import quota does not necessarily have any effect on global rare earths supply, since most of Chinese production is used internally, and Chinese producers have not recently come even close to meeting their export quotas.
Perhaps of greater significance, is the government’s intention to lessen the number of rare-earth players in order to further centralize the industry. East Asia Forum reported that in 2010 there were 32 companies with a license to export rare earths, and while a firm number in 2014 is hard to attain, WSJ reports that the rare earths industry in Northern China is dominated by Baotou, and in Southern China, China Minmetals Corporation is the main producer, with other main players including Aluminum Corporation of China Limited and China Non-Ferrous Metal Mining.
Whether the new group set up to coordinate production quotas, as described above, will be able to properly police the industry including tackling the endemic smuggling problem, is anyone’s guess, but what we can say is that the government’s attempts this year to crack down on illegal rare earth mining have yielded higher prices. In June, the prices of terbium, praseodymium/neodymium and dysprosium, all rose due to a crackdown on illegal rare earth concentrate in Jiangxi province.
A wildcard in the prices game is how non-Chinese production will play into the prices of rare earth metals and oxides. Quoting Roskill Consulting Group, Shanghai Metals Market reported in October that non-Chinese rare earths, particularly light rare earths, are expected to increase 27 percent a year to 101,100 tonnes of rare earth oxides by 2020.
However for the more valuable heavy rare earths, most of which are produced in China, the Chinese are expected to continue dominating the market. According to Roskill, Chinese HREE production is expected to grow from 2013 to 2015 despite illegal producers being closed down.
“[I]n the rest of the world it is unlikely that operations will make any significant contribution to HREE supply before 2017. Potential producers continue to be afflicted by low rare earth prices and difficulty in obtaining finance in the current climate. This means that a number of projects have either been being pushed back or are being reevaluated,” according to Shanghai Metals Market.
On the other hand, some rare earth market observers are predicting a rebound in the sector, as end users tire of the Chinese monopoly and look to Western producers for a more steady supply stream.
“Do not be surprised to see the beaten down rare earth miners propel once again to the front pages of the mainstream media. End users will no longer rely on China and the highest quality assets are already gaining attention from the Europeans, Americans, Canadians, Japanese and Koreans,” wrote stock analyst Jeb Handwerger in his recent commentary “Ready for Rare Earth Rebound in 2014?”
Among Handwerger’s reasons for optimism: a perceived slight by Japan’s Prime Minister Abe against the Chinese for visiting the Yasukuni war shrine; and growing tensions between China and Japan over a set of disputed island in the South China Sea. Readers will recall that it was a 2010 collision between a Chinese fishing trawler and a Japanese Coast Guard patrol boat near the islands that led to China halting exports of rare earths to Japan, and as Handwerger describes it, “a mania in the rare earth mining sector in the West as end users realized the need for a secure supply for these critical elements needed for high tech industries such as telecommunications, defense and the automobile sector.”
The bottom line for investors?
Don’t give up on rare earths as an investment thesis and watch events closely in China that could presage a price hike leading to a much-needed uptick in REE equities.
Securities Disclosure: I, Andrew Topf, hold no direct investment interest in any company mentioned in this article.
Related reading:
Rare Earths Outlook: Prices to Rise, Western Producers Cutting into Chinese Monopoly
Prices, Quotas and Smugglers: Making Sense of Rare Earths in China
Rare Earth Prices Rise on Chinese Crackdown
Rare Earths Supply Diversifies Amid First Signs of Market Recovery