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China’s near-monopoly brings challenges, opportunities to strategic metals space

Countries dependent on Chinese supply of strategic metals are pursuing strategies to respond to potential shortages of these metals. But while China’s dominance is causing due cause for concern, it also opens up opportunities for juniors developing alternative supplies outside China, writes Liza Mayer.

Many governments are recognizing the growing importance of strategic metals to economic competitiveness and are actively making efforts to mitigate supply risks.

Strategic or critical metals are metals that are essential for industry and national security, but for which a nation has little or no domestic supply. The list of strategic metals includes some of the rare earth elements (such as dysprosium, terbium, europium, neodymium and yttrium), manganese, molybdenum and vanadium, to name just a few.

We often do not see critical metals as finished products but they play a role in our everyday lives.

“Critical metals are important for improving the energy efficiency of all kinds of electrical devices and appliances, such as washing machines, air conditioning units and industrial equipment. They are used in high-performance, permanent-magnet materials, which are important for electric vehicles of all flavours, as well as for gearless, next-generation wind turbines. And they are important for the production of phosphor materials used in displays and in energy-efficient light sources such as compact fluorescent lamps,” says Gareth Hatch, Founding Principal of US-based Technology Metals Research.

The United States, which relies on many countries around the world for the supply of many of these strategic metals, in December 2011 released a report that examines the role of rare earth metals and assesses their criticality and their markets and identifies potential challenges.

The Critical Materials Strategy report by the US Department of Energy lists five rare earth elements — dysprosium, terbium, europium, neodymium and yttrium — as facing critical risk of supply disruption in the short term, defined as present to 2015. These five are used in magnets for wind turbines and electric vehicles or phosphors for energy-efficient lighting. The report found other elements — cerium, indium, lanthanum and tellurium — as facing “near-critical” risk of supply disruption.

“Governments around the world have examined their resource vulnerability under a multitude of scenarios. Changes in China’s mineral policies over their last two strategic five-year plans have prompted many of the more recent studies,” says Catherine Virga, Senior Commodities Analyst at CPM Group.

Supply and demand imbalances

As the producer of about 95 percent of the world’s rare earth materials, China’s decisions regarding its rare earth production impact not only the industry but individual consumers as well. In 2011, China  shut down dozens of domestic rare earths producers for three months to address pollution problems. As a result, the average price of  fluorescent bulbs in the United States rose by 37 percent that year, reported The New York Times. “Obviously we don’t want to pass along price increases to our customers, but occasionally market conditions require it,” the paper quoted a spokesperson for Wal-Mart, which acknowledged having to increase prices on some brands of compact fluorescent bulbs.

Countries depending on Chinese supply are vulnerable to China’s moves.  Japan, which imports nearly 100 percent of its rare earths from China, announced in February it aims to cut domestic consumption of dysprosium by 30 percent over the next two years as China keeps a tight grip on the metal’s export, Reuters reported. Dysprosium, a heavy rare earth, is used widely in hybrid cars and electronics and is commercially available at reasonable cost only in China. The Japanese government will spend US$65 million in two years on helping manufacturers cut their usage of dysprosium through recycling and the development of dysprosium-free products, the report added.

In the United States, the Department of Energy report recommends three key steps to addressing an expected shortage of critical metals: Diversifying supply, developing substitutes, and improving recycling, reuse, and more efficient use. The US government has allocated US$20 million for this fiscal year to an “energy innovation hub” that will help advance these three pillars.

Japan, the United States and Europe currently account for more than 50 percent of rare earth element (REE) demand. Growth from those regions is expected to be relatively slow, Doug Horn, Research Analyst at CPM Group told Resource Intelligence. It is the BRICs — Brazil, Russia, India and China — that will remain the critical driver for underlying demand growth, he said.

“The pace of growth in the BRICs will remain one of the key drivers behind the need for new supplies. These specialty metals are still reliant on more traditional metallurgical applications. Infrastructure and construction, energy and aerospace are some of the end-markets where we are expecting elevated growth rates into the foreseeable future. Manganese, molybdenum and vanadium will benefit from these strong end-market trends. Clean technologies such as wind mills, solar panels, energy storage and electric vehicles are exciting, new applications for many strategic metals. The rate of growth is expected to be phenomenal over the coming decades even though these emerging applications represent a small part of the absolute demand equation at present,” he said.

Junior explorers are redefining the supply chain

The opportunities arising from the scenario of supply and demand imbalance are not lost on exploration companies. “From the rare earth elements perspective, there are interesting projects all over the world,” says Hatch.

“As of January 2012, Technology Metals Research was tracking over 400 different active projects, being run by over 250 juniors, in 36 different countries outside of China. Canada and Australia have the most number of ongoing projects, not unlike other sectors; Quebec alone has over 70 different active exploration projects for REEs. Of all of the projects around the world, just under three dozen have defined mineral-resource estimates. Canada, Australia and perhaps surprisingly Greenland have the largest quantities of REEs contained within defined resources,” Hatch tells Resource Intelligence.

He adds that the role of juniors cannot be ignored. “I spent much of my career at the end-user side of the supply chain — way downstream of the explorers and miners. It’s only relatively recently that I’ve come to understand the huge importance of the junior-mining sector to the technology supply chain. These are the companies with folks getting out there to turn over rocks, and to find and to develop new resources. For rare earths especially, there is virtually no activity from the large major players. Of course there are investment opportunities in the junior sector, but from the supply chain point of view, without the juniors, we won’t have access to new sources of supply. They are a vital part of the technology-metals ecosystem.”

Doug Horn of CPM Group agrees. He told Resource Intelligence, “the junior sector has been and will continue to be important in advancing projects and bringing new production to the market.”

Investors have been looking for attractive investment targets across the natural resource sectors, adds Horn. “The interest in strategic metals is an extension of this interest. While precious and base metals companies receive most of this attention, some investors have turned to molybdenum, vanadium, manganese and other off-exchange commodities where investor interest is less saturated. The second point of interest is the underlying fundamentals. Many of these strategic metals have had very strong demand and constrained supply growth. Some of them are controlled by a handful of countries or companies, which can lend itself to higher prices.”

Over the past two years, the tremendous amount of publicity rare earths got from the mainstream media created what some have described as speculative bubble, which pushed valuations of equities with exposure to rare earths higher. The global market correction last year has dragged equity prices down.

“The decline in equity prices has made it far less attractive to raise capital under current valuations,” observes Catherine Virga. “Since the fourth quarter of 2010 the number of deals completed has been steadily declining. The value of these transactions has followed a similar trend, excluding a jump in IPOs in the second quarter of 2011.”

Virga notes that “capital is available for exploration plays in strategic metals but principally for those opportunities which either possess experienced management teams with relevant track records while offering compelling value propositions not dependent upon metal prices rising from today’s levels, or where the management team is replicating something they’ve done successfully before.”

While investors could adopt such criteria in evaluating equities, Horn says economic trends are also a factor to consider. “Investors in the strategic metal markets, similar to other markets around the world, need to adjust to underlying economic volatility in terms of determining which new projects to finance and understanding changes in supply and demand balances,” he notes.

Then there’s the China factor, again.

“Changes in Chinese policies and development plans also can have a large effect on the supply and demand fundamentals,” adds Horn. “Market participants and investors need keep abreast of China’s strategic plans and government responses to international pressures. The market was anticipating China to consistently squeeze the global market of its domestic supplies. However, China can change its policy direction rather quickly.”