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On June 29, 2011, the New York Times ran a story called “The Fear of a Toxic Rerun” that provided lurid accusations of environmental mismanagement at the Malaysian rare earth refinery owned by Australian company Lynas Corporation Limited (OTCPK:LYSCF) called the Lynas Advanced Materials Plant (LAMP):

A $230 million refinery being built here in an effort to break China’s global choke-hold on rare earth metals is plagued by environmentally hazardous construction and design problems, according to internal memos and current and former engineers on the project…the construction and design may have serious flaws, according to the engineers, who also provided memos, e-mail messages and photos from Lynas and its contractors…The problems they detail include structural cracks, air pockets and leaks in many of the concrete shells for 70 containment tanks, some of which are larger than double-decker buses.

Most of the alleged problems come from efforts to cut corners and save money. Alleged disputes over technical requirements surround other safety questions. Of course, Lynas disputed all the allegations, and executive chairman Nicholas Curtis insisted the company has followed all legal and environmental requirements:

…the project here met local environmental standards and…were consistent with international standards. ‘I have complete confidence in the Malaysian environmental standards and our ability to meet the requirements

Although Lynas management got the opportunity to thoroughly refute the claims in the article, Lynas still felt compelled to respond quickly to the NY Times article with its own official press release. It included the following reassurances:

Lynas confirms that the engineering design and construction execution of the LAMP have been implemented in accordance with all appropriate international standards and practices, suitable for the LAMP’s specific location, which are required to facilitate a safe and viable operation…

…In making decisions regarding equipment and/or vendors, Lynas will never compromise on these standards or required specifications versus cost savings…

…Lynas shall never compromise the health and safety of the environment, community or our employees through cost cutting efforts or accelerated delivery of the LAMP.

Filing boxes on a checklist of government standards may not be sufficient to quell opposition to the refinery. Six days before the NY Times article, Curtis admitted that he had committed a major error in not directly addressing the community’s concerns. This appeared in a Malaysian local newspaper called Malaysiakini (via Yahoo! News):

We made a mistake, and it was a big mistake, of thinking that because we have met the (Malaysian) standards (of safety), that it was enough. It was not enough. Our obligation is to continue to engage the community in Kuantan.

Curtis also acknowledges the gap in community relations when responding to the IAEA’s recommendation to increase engagement with the Kuantan community (June 30):

The IAEA report specifically mentioned that Lynas has an obligation to do more for the Kuantan community. We acknowledge that not enough has been done to engage with the community and we will correct that now. We intend to increase our commitment to community engagement and to engage in a long term conversation with the residents of Kuantan that will continue for the life of our plant.

Fortunately for Curtis and Lynas, some locals have already tried to engage on their behalf. For example, see “More Than 100 Rally In Support Of Lynas Project” from May 30, 2011.

In the June 23rd article, Curtis goes on to plead with everyone involved to focus on facts rather than emotions and politics. This request represents a tall order now that emotions have reached such a fevered pitch after being allowed to fester for so long. I am guessing it is easy to overlook the opinions of locals when dealing with a strong central government dominated by the same party for 54 years.

However, this neglect has come at a particularly contentious time in Malaysian politics. Elections are coming in 2012. The government is facing increasingly loud opposition that has sometimes prompted heavy-handed responses. For example, on June 27, reports appeared the government accused 30 members of an opposition party of “…conspiring to overthrow the government and to revive communist ideologies after the activists were arrested ahead of a banned political rally” (see “Malaysia protest backers accused of communist plot“). Activists are planning a large demonstration July 9th against the government:

The activists’ demands include overhauling voter lists and introducing transparent procedures for ballots to be cast and counted. The opposition has long accused Najib’s ruling coalition of manipulating election results to preserve its nearly 54-year rule, but the government says current election laws are fair.

Lynas not only needs to get the refinery running on schedule to take advantage of the high prices of rare earths, but also the company could face increasing political uncertainty. In such an environment, it is of utmost importance that management avoid creating any additional problems for itself. Investors must also stay on alert when management appears to stumble when facing large challenges and complexities. In this particular case, it seems Curtis has received the message and is moving post haste to make amends. (If I were still an investor in Lynas, I would write to management to make my concerns known at the same time I reaffirm my support for the company).

In the meantime, questions may persist about LAMP’s schedule.

Matthew James, a Lynas executive vice president, noted in the NY Times article that the facility remained on schedule but “…Lynas was waiting to see whether the I.A.E.A. panel recommended any changes.” The recommendations from the IAEA (International Atomic Energy Agency) panel arrived the following day. In “Malaysia says Lynas rare earths plant must meet conditions,” Reuters quoted a government official who claimed that it will take another year for Lynas to satisfy the requirements from the recommendations. In the same article, Curtis appears to indicate nothing has changed:

We believe the plant will be commissioned by the end of 2011…We expect to deliver some product to customers in the first half of 2012…We have always projected that…full ramp-up will occur by the second half of 2012. We believe that schedule is intact.

In fact, Lynas quickly moved to dispel the rumors about unofficial statements of delays. On July 1, Lynas issued a press release including this clarification:

We have received confirmation from the Malaysian government that no spokesperson for the government stated a 1 to 2 years delay as quoted by some media articles.

Going into a contentious election year, we should not be surprised to hear “unofficial” statements conflict with official statements as the government tries to manage its commercial interest in Lynas’s operations and its political interest in quieting protesters.

The troubles facing Lynas speak volumes about how premature it is to talk about imminent supply gluts in rare earth elements (REEs). (Still waiting to get more concrete details on a vast rare earth deposit supposedly Japanese scientists claim to have found on the floor of the Pacific Ocean near Hawaii). The Lynas experience is a sobering reminder of one of the many challenges facing companies that are rushing to produce rare earth elements and associated refined products. All these companies face various degrees of technical, financial, regulatory, and political challenges. Becoming a viable rare earth company is no simple task. Yet, the NY Times article claims:

Lynas has an incentive to finish the refinery quickly. Export restrictions by China in the last year have caused global shortages of rare earths and soaring prices. But other companies are scrambling to open new refineries in the United States, Mongolia, Vietnam and India by the end of 2013, which could cause rare earth prices to tumble.

This broad generalization assumes that Lynas is, and will be, the only company to run into obstacles and delays. I think the odds of everything falling into place neatly as planned for the entire collection of REE-aspirants is somewhere just north of zero. I strongly suspect that REE customers are duly noting the on-going challenges and will become extremely eager to lock up any and all supply that comes on-line for years to come. In an extreme scenario, we could see at least one panic that generates a self-reinforcing, upward price shock.

For now, the price shock is in the shares of Lynas. Lynas shares were halted ahead of the IAEA announcement, and they promptly dropped as much as 14% upon resumption of trading. The stock has bounced back a little to $1.92, and I expect it should stabilize here in the near-term absent any new bad headlines.

Molycorp (NYSE:MCP) moved in the opposite direction, gaining 7% on the heels of Lynas’s woes. This move pushed MCP right into its 50-day moving average (DMA) resistance as the stock bounced perfectly off 200DMA support and out of oversold conditions as discussed in my article at this link. The stock has also returned to where I originally thought a bullish breakout was imminent. I had to revise my technical assessment after the breakout failed to materialize and then MCP announced a convertible and stock offering that created a (temporary) overhang on the stock.

click to enlarge image

Molycorp

Molycorp's roundtrip back to the 50DMA seems to have carved out support at the 200DMA

Chart created using TeleChart

I think as Lynas works to resolve its issues in Malaysia, this entire episode will deliver new premiums for REE companies that are succeeding at hitting key milestones. Assuming Lynas will eventually overcome over its current roadblocks, it should also re-experience more upward momentum in due time.

Be careful out there!

Source: Lynas Stumbles While Molycorp Recovers: Sobering Reminders of Rare Earth's Challenges