Is China building a rare metals cartel equivalent to OPEC?  Analysts began contemplating this possibility last month when a draft report by the Chinese government surfaced stating that China planned to ban the export of rare earth minerals.  Last week, Chinese officials stepped back from this claim and said they were only planning to reduce export quotas of rare metals to 35,000 tons per year from 53,000 tons in 2008.  World demand is currently over 110,000 tons and expected to grow to 188,000 tons by 2012, according to the U.S. Geological Survey (USGS).  Since China is responsible for 97% of the world’s current rare metals production, fears have developed that global green technology will be held hostage since hybrid cars, cell phones and wind turbines all require rare metals.  Moreover, the number of uses of these metals keeps rising.

To further compound the suspicion that China wants to control the world’s supply of rare metals, China has recently signed deals to buy large stakes in two Australian rare metals mines that could start production within one to two years.  It is estimated that these two Australian mines could have a combined production of 25% of current global output, according to the World Business Council for Sustainable Development. Additionally, China tried—unsuccessfully—to buy the U.S. Mountain Pass mine on two occasions.

The market is responding to the rising fear that China controls the world’s rare metals supply.  A reduction in Chinese exports could increase the price of these metals and metal-intensive goods like hybrid cars. These metals are not traded on any listed market, but the following are the stock gains from August 31, 2009 to September 8, 2009 for listed companies that participate in rare metal mining:

COMPANY                                                    Bloomberg Ticker       One Week Price Gain

Inner Mongolia Baotou Steel Rare

Earth Hi-Tech Co Ltd.                                     600111:CH                  39.8%                         

China Rare Earth Holdings Ltd.                         769:HK                       23.4%

Arafura Resources                                           ARU:AU                      25.0%

Lynas Corporation                                           LYC:AU                      23.25%

Avalon Ventures Ltd.                                       AVL:CN                      49.2%

Great Western Minerals Group                         GWG:CN                     63.0%

China insists that it is only trying to keep its natural resources available for its own needs while cutting down on environmentally-unfriendly mining.  In fact, China may find it difficult to actually control the rare metals supply in the long term, given the following market dynamics:

• The U.S. was the world’s largest rare metals producer until the mid 1990s, when China began heavily mining without the expensive clean-up standards of western miners, and flooded the market with relatively-inexpensive rare metals.  This made production unprofitable for the U.S. miners. U.S. mining of rare earth metals peaked in 1995 at 22,000 tons according to USGS data, before falling to 5000 tons in the late 1990s. The U.S. has one of the world’s richest deposits of rare metals at the Mountain Pass mine in California. The Mountain Pass mine still has previously mined stocks of rare metals and will restart production by 2012.
• Canada and Australia both have substantial deposits of rare earth elements (REE), as do Southeast Asia and South Africa.
• The Canadian companies Avalon Ventures and Great Western Minerals are expected to produce heavy rare metals within three to five years.
• Jack Lifton, an independent consultant specializing in the sourcing of nonferrous strategic metals, predicts that the world could be independent of China as the source of rare metals by 2020.
• Lifton also predicts that China will become a net importer of rare earth ores or metals by 2015.

With reserves of rare earth elements available around the world, it would be difficult for China to control the supply.  There may be short-term supply constraints and higher prices for rare earth metals and the goods that require them if China reduces its exports, as mines around the world would require time to reinstate or start mining their own deposits.  However, China does not have a monopoly on the reserves of rare metals, nor is it in a position to create a cartel among the firms mining rare earth elements. The U.S., for example, continues to process rare metals mined in the past. It’s even possible that Chinese producers can grow their businesses without substantially expanding China’s control of the market; given that many Chinese producers are small companies in Inner Mongolia, they indeed have incentives to maintain and even boost production.

The following chart, drawn from USGS data, shows 2008 production and estimated reserves of rare metals. The USGS also suggests that undiscovered deposits could add greatly to reserves in coming years.

For more on rare metals, see Controlling Rare Metals Key to Becoming Global Green Technology Leader.