A rare opportunity in mining stocks

In my Sept. 9 column, "Plug into electric-car batteries," I explained how the growing need for batteries used in hybrid and electric cars would cause demand for lithium, the key ingredient in the next generation of batteries, to surge from a projected 11,000 metric tons in 2012 to almost 90,000 metric tons in 2020.

Well, the same need to develop less-polluting, more-energy-efficient cars is driving demand for the rare-earth elements. And so is the growing market for wind turbines. And the ever-present market for military guidance and control systems.

A little goes a long way

Adding a bit of one of the 17 rare-earth elements to a magnet in the engine of an electric or hybrid car increases the power and efficiency of the engine, because rare-earth magnets are the strongest type of permanent magnets now made. Rare earths -- Nos. 57 to 71 on the periodic table of elements -- improve the color in TV screens and in lasers. You'll also find rare-earth elements in tunable microwave resonators, and terbium, No. 65, is a key ingredient in low-energy light bulbs.

And we're not talking about trace amounts of these elements either. The electric motor in a Toyota Prius uses about 2 pounds of neodymium in its permanent magnets. Each Prius battery also uses 20 to 30 pounds of another rare-earth element, lanthanum.

Because the magnets in wind turbines are so huge -- you need big magnets to maximize the amount of electricity generated from each revolution of the relatively slow-moving blades -- these generators need large amounts of rare-earth elements. It takes about a ton of neodymium for every megawatt of generating capacity from wind turbines.

Fortunately, despite their name, rare-earth elements aren't especially rare. They're found in relatively high concentrations in the Earth's crust. One, cerium, is the 25th-most-abundant element in the crust.

Global production came to about 140,000 metric tons of refined rare earths in 2008. Compare that with projected lithium production of 11,000 metric tons by 2012.

But supplies of the rare earths that can be profitably mined aren't distributed evenly across the globe. Partly, that's the luck of the geologic draw. But mostly, it's a function of the huge environmental costs of mining these rare earths. The traditional method has been to bore holes into promising rock formations, pump acid down the holes to dissolve some of the rare earths and then pump the slurry into holding ponds for extraction of the rare earths. That extraction leaves behind a lake of water mixed with acid and various and sundry dissolved minerals.

Mom-and-pop mining

It's much, much cheaper if a company can get away with spending just about nothing on controlling and treating the resulting sludge. The world's low-cost producers of rare-earth elements are not huge and efficient open-pit mines but small, completely unregulated mom-and-pop mining companies in China.

It took the Chinese overplaying their hand, however, to turn that modest trend into a speculator's dream come true. The Chinese, remember, control about 95% of global production for all rare earths. They also control about 99% of the production for rare-earth metals, such as dysprosium and terbium, and 95% of neodymium. Recently, China started to reduce the amount of rare-earth metals that could be exported, and this year the plan is to reduce exports further. The Chinese Ministry of Industry and Information Technology has cut authorized production targets this year by an additional 8.1%.

Companies outside China face the very real possibility not only of paying higher prices but of not being able to buy the raw materials they need at all.

Forcing relocation

This seems to be a key goal in China's strategy. By restricting exports, China would force high-technology companies that need these rare earths to relocate production to China -- accelerating the transfer of intellectual property to Chinese companies. It's no secret that China wants to create major wind, solar and hybrid-car industries.

That's made it possible once again to raise money to start or restart a rare-earth mine outside China. For example, Chevron (CVX) sold Molycorp Minerals, which it had acquired when it bought Unocal, to a group of private investors that included Goldman Sachs (GS) in 2008. Molycorp will need Goldman's deep pockets, since it has to drain 95 million gallons of water out of the open-pit mine in Mountain Pass and then strip away tons of rock before it can begin mining in 2012. Initially, Molycorp will process 1,000 tons of ore a day -- enough, the company estimates, to produce 20,000 metric tons of rare-earth oxides annually.

In Australia, Lynas and Arafura were relatively close to production until the global economic crisis pulled the financial rug out from under them. A planned bond offering by Lynas failed, and Arafura raised less money than it had hoped in its initial public offering.

The Chinese stepped into the gap, buying 25% of Arafura and offering to buy 51.7% of Lynas. That second offer, which would give the Chinese majority control, has sent Australia into a frenzy, coming as it does on the heels of the detention in China of four staffers from miner Rio Tinto (RTP) on charges of stealing state secrets. The Australian government has until Sept. 17 to rule on the bid.

Elsewhere, Ucore Uranium is at work on a project in Alaska, and Great Western Minerals is working to refurbish the Steenkampskraal mine in South Africa.

Caution advised

Be very careful when you evaluate any of these highly speculative stocks. Great Western Minerals submitted its application to update the mine's paperwork only in April, and it is still updating its feasibility study. The risk is very real that some of these projects will never get to actual production.

Why bother? Because Chinese production is projected to reach 160,000 metric tons a year by 2015 or so. That would be up from 139,000 tons in 2008. But global demand is projected to rise even faster, resulting in an annual shortfall of 40,000 tons by 2015.

The two companies that I'd be most interested in watching are Molycorp, should it ever go from a private to a public company, and Lynas. Molycorp's Mountain Pass mine is a huge proven reserve, and the group of private investors is solid. And I'll keep an eye on Lynas, provided the deal with China is for something less than majority control.