Engineer Broker's  Instablog

FACT:

China has been making strides in multiple manufacturing settings (not just REE's) to become more environmentally friendly.

OPINION:

These environmental issues are not USA types of issues, but severe population killing environmental effects.  They want to control their growth and improve their country. Imposing environmental regulations will both dampen growth while at the same time improve quality of living in their home country.  As we have seen, environmental policies keep improving over time here in the USA, and I would believe that as other societies modernize their people will also want better living conditions (at least not dying conditions).  This trend should be expected to continue.  One of the biggest culprits of the environmental issues is the black market strip mine operations.  China increasingly tough stance and socialization of parts of this industry should reduce supply in the near term.

3. Supply vs. Demand

FACT: 

Are there any real supply facts? Unfortunately the large Chinese black market probably clouds everyone's data.

OPINION:

The best method to determine the supply versus demand levels is to use today's equilibrium as a starting point and look at the effects of each supply and demand factor. The amount of rare earths in many products is negligible. For a lot of products this means that supply is much more important than pricing. 

The amount of REE supply from China looks like it will decrease in the next few years. China is nationalizing part of the country's mines in order to crack down on black market operations. Some estimates believe that these operations could be providing as much as 1/3 of China's REE output.  Who knows how effective that they will be, but nationalizing a region and centralizing processing should pack quite a bit of punch.  China is also imposing efficiency standards and environmental standards on current operations.  This move should also crimp production at legitimate facilities (strike two for supply).  China itself and many countries throughout the world are proposing building strategic REE stockpiles (strike three for supply).  All of these moves could significantly affect the market, but together could cause real panic. 

On the positive side for supply is that every current producer of REE's will be trying to produce as much as possible. Since 97% comes from China, this effect will most likely be insignificant due to the other issues mentioned above. The real supply story comes from Lynas and Molycorp. In the next three years they may increase production by as much as 59000 mt/yr if everything goes as planned. Yet, that is only an additional 11000 mt by the end of 2011, an additional 25000 mt by the end of 2012, and an additional 21000 mt by the end of 2013. By themselves these numbers seem good, but if China's black market supply goes down then things may not be as good as they seem.

On the demand side the world has been greatly increasing demand for a number of years. Various estimates have this demand rising by 10-15% per year in the near future. Using 12% per year demand could be 49000 mt/yr higher than today. Over the next three years it would take most of Lynas and Molycorp's increased supply to satisfy this demand. 

If China is successful in reducing black market REE's and increasing environmental standards then demand will be even greater than it is today. Without knowing what will happen in the future it appears to be rather safe to assume that for the next three years REE supply versus demand will be relatively constant to today's levels.

Also, for a second opinion please read Lynas’s report from Feb 2011

FACT:

First, only their smallest contract has a floor & ceiling clause, but even it is based mostly on market prices. Their newest larger contracts only have a floor clause.

From the 1/24/11 MCP Form S-1 page 11:

http://phx.corporate-ir.net/phoenix.zhtml?c=236277&p=irol-SECText&TEXT=aHR0cDovL2lyLmludC53ZXN0bGF3YnVzaW5lc3MuY29tL2RvY3VtZW50L3YxLzAwMDA5NTAxMjMtMTEtMDA0NjcyL3htbA%3d%3d

OPINION:

Because of market demand they were able to aggressively negotiate and protect themselves without giving up on the upside. That's a strong market. Also, none of their new doubled production has a contract at this point. When future contracts get announced one can expect the same market based prices, a protective floor clause, and no limiting ceiling.  This means that Molycorp will be able to profit from rising spot prices, and still be protected on the downside.