Look for Exploding Profit Margins for China Rare-Earth Companies

by: George Maniere

It is no secret that China dominates the production of rare earth elements. More than 97% of the world’s production comes from China, but over the last few years the nation has tightened its control over the production and export of the 17 elements to the tune of between 37 and 50%. News of further controls over the industry has come out over the last few weeks, including a major shakeup in the establishment of a rare earth exchange in Baotou, Inner Mongolia.

In April, China did increase this year’s production quota of rare earths by 5 percent over 2010. However, the government took serious steps to clamp down on illegal mining operations that, through the black market, have added a significant amount of supply to a starving market. The crackdowns on illegal mining have only served to aggravate the already constrained supply issues - it is estimated that 30-40 thousand tons of rare earths are smuggled out of the country every year. Chinese officials also suspended new mining licenses until June, 2012, which will not help alleviate supply tightness.

Along with the cutback from anywhere between 37% and 50% on exports for 2011, to add insult to injury, a hefty tariff was imposed on rare earth elements. Right now the Chinese are saying the tax will be small, $9.22 per ton of light rare earths. This marks the first time that they have differentiated between light and heavy rare earths. Moreover, there are already whispers by analysts that have noted that this may also change future export quotas to reflect the law of supply and demand for the different elements.

In an attempt to further regulate the market a major new development has been the creation of the Baotou Rare-Earth Products Exchange. The exchange will be the first and only rare earth product exchange in the world. The exchange will not trade futures, but only spot products. The process of establishing the company is nearing completion and is scheduled to be registered on or about August 11th, 2011.

According to the China Daily, Ms. Wang Caifeng, a former official at the Ministry of Industry and Information Technology who is setting up the country’s Rare Earth Association, said “that the exchange will help increase the transparency and regularization of the rare-earth trading market.” The exchange will act much like the China Iron and Steel Association, which will assist companies with exports as well as aiding negotiations with foreign buyers. The exchange will also allow for Chinese producers to have more leverage over the market, and further help them in their efforts to consolidate the rare earth industry. I have long suspected that the Chinese government has wanted to consolidate the rare earth industry, allowing the largest companies to take over smaller producers. Inner Mongolia Baotou Steel Rare-Earth Hi-Tech Co Ltd., the largest rare earth producer in the world and the main power behind the new exchange, may benefit dramatically from a consolidated market, and has been charged by the Chinese government to build a strategic reserve of rare earths.

On May 19, the State Council stated publicly for the first time that it plans to consolidate the rare earth industry allowing the biggest players to control the industry in the next two years. The Chinese government wants to eliminate small scale rare earth producers citing environmental concerns. While it is important to remember that China is not a free market economy, I feel that this is yet another ploy to further constrain the exports of rare earths as China seeks to monopolize the export of rare earths. As reported the Chinese newspaper,Business China, The State Council said “the country aims to concentrate 80% of southern China’s heavy rare earth mining assets in the hands of the three biggest companies in the next one to two years,” One of the companies that will most likely take over production in the south is China Minmetals Corp.

As reported in Reuters, in April, exports were slashed in half year-over-year, yet the value of the exports raised tenfold averaging $121,933 per ton.

The benefits to the producers of rare earth elements are clear. Exploding prices will help grow profit margins on their balance sheet. It is unlikely seeing the consolidation and reduction of exports over the last year that China will relinquish their power over this market in the near term.

Disclosure: I am long AVL, OTCQX:UURAF, GMO, OTC:TASXF.

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