China and a Game Called Supply and Demand

Breaking down the coterie that’s known as rare earth elements means taking it a wee bit further than simply defining them as lights and heavies.

Once you break them down into 15 or 17 separate components, it shines a light on some of the dynamics of the market and what China may be doing with the supply and demand equation.

Let’s start with cerium and lanthanum.

Call them industrial commodities – high volume, low prices. End-users were happy when these two metals traded at $5 to $10 per kilogram, but over the past year or so prices have moved exponentially higher, with lanthanum trading at an average price of $128/kg during 3Q11; cerium, at $126/kg.

Although the prices have slipped a bit from the 2Q11 average price, the light bulb has finally lit up in manufacturers’ minds; a substitute is needed for these commodity-like metals because the wild price swings are seriously disruptive and hitting margins.

Producers don’t care that lanthanum, as a fluid-cracking catalyst, is more efficient than alternatives, when the average price goes from $7.13/kg to $138/kg in one year. It’s time to strip out the volatility and find a cost-effective substitute.

There’s no geopolitical risk inherent in this part of the market, simply because these metals can be engineered out of the equation.

(You can see a listing of average prices for REEs through 3Q11 in Alkane’s just released presentation. – ed.)

The REEs in the middle – neodymium, dysprosium, gadolinium and others – are used by end-users who can afford price volatility, either by passing it on to customers or letting it eat into margins.

Dysprosium could treble or climb to 10 times the price it was last Tuesday, but the amount that goes into an iPhone is so small that, worst case scenario, the price of the smart phone goes from, what, $600 to $610. Who cares?

And while nothing in the near term is going to supplant the use of neodymium in magnets, the move toward recycling will become more pronounced, especially in the bigger ticket items, such as motors, battery applications and turbines.

Now come the heavy REEs, which are scarcer and the idea of substitution is a non-starter (to date). Recycling isn’t cost-effective, in large part because their quantity is so small within each component.

Prices have been flat or climbing, despite media reports that often tend to focus unwittingly on the lighter side of the lanthanum series. But metals such as terbium moved above $3,967/kg during 3Q11 versus $570/kg during 2Q10; europium moved above $5100/kg compared to $570/kg.

This is where the geopolitical risk can be found. And, from a North American point of view, it begs the question: What kind of U.S.-based volumes, especially in the heavies, are likely to come to the market?

You’ve got Molycorp, but its Mountain Pass production will be about 75-80% light REEs and the heavy REEs it does produce won’t be enough to meet demand in the U.S.

Obviously there’s room here to source from Australia, but now let’s consider what China’s been doing, which is somewhat akin to getting a tall ladder, pushing it against the Great Wall and peering over.

During the past five years or so, China has changed course with REEs, restricting the supply coming out of the south and, more recently, shutting down operations in the ionic clays. The word “restricting” is code for “we want to move up the value-added end of the market.”

The businesses outside of China that can afford to pay higher prices for rare earths tend to be those looking for medium and heavy REEs. These metals appear to be sourced from the Baotou and Sichuan districts, two areas that have a relatively high proportion of LREEs.

So, if 30,000+ tonnes of medium and heavy REEs are being exported, where did the lanthanum and cerium go? Why did the prices for those rare earths spike?

Two reasons: China must be stockpiling a significant amount of the two metals, creating an imbalance in the market. At the same time, because of the commodity-like nature of cerium and lanthanum, users had previously been sitting on bloated inventories, but as the market imbalance grew, those supplies were progressively wound down.

End result? LREEs customers found themselves with little or no stock during the past 12 months. So they came begging for more. Chinese exporters said, sure, but only if you pay the same margins we get on HREEs, otherwise, no sale.

Why would someone sell cerium at a $5 profit when he can sell yttrium at a $100 profit.

Customers who wanted the LREEs had to match the HREE margins or the sellers wouldn’t sell. And, whoosh, up go the prices.

So you’ve got a situation where guys on one end of the REE spectrum are paying a fortune for product while the guys buying medium and heavy REEs are paying higher prices, but not much above what they were prepared to pay.

In recent months, the market has been talking about the rare earths bubble bursting.

No it hasn’t.

It was a supply correction, probably because China decided to release more cerium and lanthanum. No surprise, then, that those two metals have almost halved in price. The others? Some are off 10% to 15%, which isn’t a big deal in the grand scheme of things.

The knock-on effect for Molycorp, Lynas, Arafura and GWG, of course, is that the markets clobber them and the rest of the REE companies for fear of that bursting bubble, even though the fundamentals haven’t changed much for companies who are HREE-heavy.

Clearly, the people who have an over-reliance on LREEs have a problem. This leads to an unsettling conclusion.

In a few years, Lynas, Molycorp, Arafura and, eventually, Great Western Minerals will start producing and, in all likelihood, they’ll overshoot demand in the market. And, don’t forget, the cerium and lanthanum users don’t want to be shocked by price hikes again, so substitution and, if possible, recycling will be much more prevalent.

So what happens? Those four LREE producers listed above will start competing on price. Historically, this isn’t at all uncommon with these two metals. But it means that in a few years from now, any business based on cerium and lanthanum sales, will be in trouble, because volumes will go down, thanks to excess supply, and prices will go down, thanks to competition and, again, excess supply.

And that scenario is a China-free scenario. The country could – at any time – flood the market with the two metals. Some say that would never happen. Really?