Uncertainty Still Surrounds Molycorp

| About: Molycorp, Inc. (MCPIQ)
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Molycorp recently received a lifeline in the form of loans worth $400 million from Oaktree Capital.

The financing will help the company survive for now and possibly attain its target of reaching full production capacity at its Mountain Pass mining facility.

Molycorp has also struggled due to weaker prices, which came under further pressure this year after the WTO asked China to remove restrictions on rare earth exports.

China has found other ways to restrict rare earth supplies, which means that the WTO ruling is not expected to have a major impact on pricing.

Despite the recent developments, which are positive for Molycorp, I will remain on the sidelines.

Beleaguered rare earth minerals company, Molycorp Inc. (MCP) recently received a lifeline from Oaktree Capital Management (NYSE:OAK). The company's financials have been hit hard by production bottlenecks at its Mountain Pass mine and sharp fall in rare earth prices during the last three years due to a fundamentally imbalanced market.

Under the terms of the agreement, Molycorp will receive loans worth $400 million subject to some operational and financial conditions being met. Although the rate of interest is very high (12%), the deal will inject much needed working capital for the struggling rare earth miner. The company has been running out of cash.

According to a Bloomberg report, Molycorp, which hasn't posted a profit in the previous ten successive quarters, would have consumed all of its cash by the beginning of the next year had it failed to secure fresh debt.

So, securing finances at this juncture should help the company to attain its target of reaching full production capacity at its Mountain Pass mining facility, as early as possible.

Bloomberg, citing Kevin Starke, an analyst at CRT Capital Group Inc., reported that if Mountain Pass mining facility becomes fully operational then Molycorp's severe cash crunch problem will be solved.

Funding Not the Only Problem for Molycorp

Indeed, financing is one of the problems for the Colorado-based company. Another major cause for concern is the weakness in the average selling price or ASP of rare earth minerals.

As I mentioned earlier, rare earths prices, which peaked in 2011, have nosedived in last three years. Molycorp in its fiscal second quarter reported a 16% increase in the ASP from the earlier quarter. However, prices on a year-over-year basis were down sharply. ASP in the fiscal second quarter was $39.02 per kg, down from $45.04 per kg reported in the same period last year. In the fiscal first quarter as well, ASP fell to $33.69 per kg, from $44.71 per kg reported in the first quarter of 2013.

Similarly, Australian rare earth miner, Lynas Corp. has also seen its ASP plunge from $200 per kg in 2012 to $22.63 per kg in the most recently reported quarter.

Prices have swung in such a huge way due to China's monopoly in the rare earth market. China, as it is well known, accounts for about nine-tenths of the world's total rare earth production as it has a stranglehold over the supply of 17 elements. And from time to time, China tends to influence the market. The current disequilibrium in the rare earth markets is a result of China's manipulation. Back in 2010, China announced quotas and duties on rare earth exports, saying that rare earth mining caused considerable damage to its environment. There is no denying the fact that rare earth processing causes pollution but the main reason behind China's strict export laws was to protect domestic industries from competition. Rare earth elements have use in a range of industries from electronic appliances to renewables and defense. China deceptively wanted to maintain an advantage over manufacturing cost for its domestic industry through such trade practices.

Therefore, high export duties were imposed even as China defended itself by saying that it was necessary for a "sustainable" rare earth mining industry. As a result, rare earth prices jumped about 100%. That spurred excessive illegal mining in small villages of China. The growing need to cut reliance on China also resulted in several companies undertaking projects in locations other than China. Molycorp and Lynas were among those companies.

Not surprisingly, but just as production began rising sharply demand for rare earth minerals began to slowdown. The slowdown was partly due to the fact that the global economy lost its steam in subsequent years and also due to substitution. Concerns that China's dominance of rare earth market would have a negative impact on their supply chains prompted many companies to find substitutes for rare earth minerals. In addition China began to relax some of its discriminatory export laws. Consequently, the rare earth market has become oversupplied since 2011. The glut has pushed prices lower, hurting the financial performance of Molycorp.

Recent Developments in the Rare Earth Market

Things got worse for Molycorp and the rare earth market this year when the World Trade Organization (WTO) ruled against China in a case related to restrictions on exports of rare earth minerals.

After China started to impose quotas and duties on rare earth exports, the U.S., EU and Japan took this matter to the WTO, saying that China's export quotas were discriminatory and violated international trade laws. Although China continued to cite environmental concerns, it lost the case in March this year. China had appealed against the WTO ruling, however, earlier this month, it lost the appeal. Interestingly, China it seems was prepared for the outcome. Much before the WTO passed its verdict; China started to take several steps that could change the structural landscape of the domestic rare earth industry.

Since last year, the Chinese government has become very harsh on illegal mining, and smuggling. There have been major crackdowns, especially in Ganzhou region. According to Beijing Review, the crackdown campaign which was held between August 2013 and November 2013 saw 126 rare earth producers receiving orders to suspend their operations while another 161 miners got their licenses revoked. During that period, Chinese authorities detained 19,000 tons of illegally mined rare earth materials.

As a part of its broader strategy to restrict rare earths supplies and stop illegal mining, China has also started a process which would allow only few companies to have access to its resources. Accordingly, the production and processing will be now consolidated in the hands of just six major state-owned corporations. China is also reviewing the introduction of new taxes to cover costs related to environmental damage. Earlier this year, it was reported that China would charge a tax based on the value of rare earths instead of its volume.

Further, China is also mulling to set-up trading exchanges. According to Reuters, citing an official from Shanghai Futures Exchange, China could soon start futures trading on rare earth.

So what do all these moves from China mean for the rare earth market? After the WTO ruling earlier this year, there were concerns that the removal of China's export restrictions would mean an oversupplied rare earth market would be flooded with additional supplies. Of course, that would mean more pressure on prices. However, through the measures such as a clampdown in illegal mining and restricting access to resources, China has found another way to restrict rare earth supplies. The net result is likely to be that the removal of export restrictions will not have a major impact on prices.

What This Means for Molycorp

Molycorp's shares are down more than 67% this year. The stock currently trades at around $1.75, substantially below the levels it traded in 2011. Molycorp is not likely to find any takers, given the performance of the company and the stock in the last three years. However, the fact that the company has obtained funding from Oaktree is a positive development. Also, China's fresh measures to restrict rare earth supplies mean that there will not be a free-fall in rare earth prices. Indeed, these two positive developments make Molycorp worth a look. However, I will remain on the sidelines for now. Despite the recent developments, there is still far too much uncertainty surrounding the rare earth market and Molycorp. I will wait to see how the company progresses on Mountain Pass project, as well as how prices evolve over the next two quarters.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.