China, Rare Earths and Quotas

Rare earths are an important group of 17 elements used in a variety of manufacturing industries including technology.

They are broken into two groups – 'light' rare earths and 'heavy' rare earths. Light rare earths are actually relatively common and are often a by-product of producing heavy rare earths. These elements are much rarer than 'light' rare earths and are used in products such as magnets, lasers, smartphones and plasma TVs.

The list of heavy rare earth elements include: yttrium, promethium, europium, gadolinium, terbium, dysprosium, holmium, erbium, thulium, lutetium and yterrbium.

China currently is the dominant supplier of rare earths, accounting for 97% of global production, so any action it takes in this sector is important.

Recently China raised its export quota for rare earths for the first time in six years. The country has used export quotas to restrict global supplies and therefore prop up prices. China lifted its export quota by a mere 3% from 30,246 tons in 2011 to 31,130 tons in 2012.

Even though the amount China raised the quota is small, it looks set to reinforce a trend that has already been in place...falling prices for many rare earths. Many prices are down 30% to 40% from record highs set in July 2011. Prices are down due to a stifling of demand from users by the historically high prices.

This is not good news for one of the two major non-Chinese companies in the industry- Molycorp (NYSE: MCP) – which has been adding to its rare earth production capacity. Its stockholders have seen the value of their shares fall by two-thirds from the 52-week high of $79.16 to $25.50.

The exchange traded fund which tracks a basket of rare earth stocks has also fallen sharply. The Market Vectors Rare Earth/Strategic Metals ETF (NYSE: REMX) is down from a peak of $28.91 a share to $15.65 currently.

However, it may not be all gloom and doom. In the newly announced quota system, China set up separate quotas for 'light' and 'heavy' rare earths. The government did this in an effort to stop companies from exporting those rare earths with the highest prices in order to increase profits.

Industry executives say the quota for the 'heavy' rare earths, 15% of the overall quota, may actually make supplies of these elements scarcer.

In addition, over the past few years China has been trying to clean up the highly polluting industry. The government has closed illegal mines, consolidated smaller mines and forced some processing plants to upgrade their environmental systems.

China's rare earth miners and processors are still adjusting to the country's new regulations concerning rare earth mining. This in itself will likely lead to reduced availability of heavy rare earths and push up prices for the scarcest ones.

The Chinese government is also well aware of the value of heavy rare earths over the long term.

Canadian rare earth company Neo Material Technologies operates rare earth processing plants in China. Its CEO, Constantine Karayannopoulos, expects shortages in heavy rare earths in 2012 due to changes in Chinese regulations and quotas.

He said the new quota system announced by China shows the country is serious about “the preservation of the heavy rare earth resources”.

The situation in China may mean it will be a bit of a bounceback year for shareholders in both Molycorp and the Market Vectors Rare Earths ETF. But the historically still-high prices for rare earths will continue to limit demand for the elements and price gains for MCP and REMX.

This article was originally for the Motley Fool Blog Network. Please see all of my articles for the Motley Fool Blog at http://blogs.fool.com/tdalmoe/