Niche Producers Poised to Plug Rare Earth Supply Deficits

The world's two largest rare earth companies outside China - MP Materials and Lynas - are facing challenges ramping up rare earth refining capacity needed for the green energy transition. Developing independent supplies has become more urgent after China recently imposed export controls on other critical minerals, raising fears they could restrict rare earths next.

Rare earths like neodymium and praseodymium are essential for magnets used in EVs, wind turbines, consumer electronics and defense applications. China controls 87% of global rare earth refining capacity, giving it significant economic and geopolitical leverage. The rest of the world is struggling to break this stranglehold due to the technical complexities in separating the 17 chemically similar rare earth elements, the lack of expertise outside China, and environmental concerns over current refining methods.

MP Materials, whose 2nd largest shareholder is a Chinese company, aimed to start refining its own rare earths from its California mine by the end of 2020 but has faced delays. It is still reliant on China for refining and revenue. MP is also building a Texas magnet plant for GM that requires its refining to be operational. The painstaking calibration of refining equipment has faced 'stops and starts'. MP's CEO has called the commissioning process 'painstaking'. Outside experts note refining the 17 metals with nearly identical properties is extremely 'finicky'.

Lynas is refining rare earths from its Australian mines in Malaysia, but faces potential export restrictions. Its plans to jointly build a US refinery with Texas partner Blue Line have collapsed. The reasons are unclear but this highlights struggles to scale up processing outside China. Lynas is now building its own refinery in Texas with Pentagon funding.

Chinese Dominance Set to Continue?

ChineseChina has invested heavily to control processing capacity from mine to magnet. This allows it to engineer rare earth prices in its favor at different stages of production. Low prices for finished magnets make it hard for others to compete. China also provides export rebates to manufacturers using its materials. This dominance allows China to boost its booming EV industry. China allows rare earth concentrate imports for refining, which helps supply mines globally but discourages foreign refining capacity. Both MP Materials and Lynas ship concentrate to China. Building independent refining has not been a priority even for those developing magnet capacity.

Technical innovation is also needed to develop cleaner refining methods. Current processes generate toxic waste, impeding projects in Sweden and elsewhere over environmental concerns. Tesla is trying to eliminate rare earths from its magnets altogether, citing "health and environmental risks." Experts estimate China's control of refining neodymium and praseodymium for EV magnets will only fall from 89% now to 75% by 2028. Its global control of dysprosium refining will edge down from 99% to 94%. New refining projects across several countries could supply just 8% of global demand if successful.

To reduce dependence, companies and labs in the US are studying alternative refining methods using bacteria, nanotechnology and biosurfactants. But these cleaner solutions are still years away. Pioneering more sustainable and efficient rare earth refining would provide a tremendous market opportunity given rising demand. However, China's dominance will be extremely difficult to dislodge without major technical breakthroughs.

In summary, surging rare earth demand for the green transition is heightening concerns over China's near monopoly on refining capacity. Current geostrategic and technical headwinds make it extremely challenging for Western companies to scale up independent and environmentally sound processing. But this also creates a huge market opportunity for innovations that can profitably crack rare earth refining. Investors should watch for advances that could start loosening China's grip, while closely tracking leading players' progress ramping up capacity despite current difficulties.

Opportunities for smaller public companies

• Developing alternative refining technologies: Smaller companies can focus on innovating new processes that are more sustainable, efficient and economical. If successful, they could license or sell the technology to larger producers or attract acquisition interest.
• Specialized processing: Smaller companies could target niche refining of specific rare earths rather than full-scale production. This allows focusing expertise and minimizes capital needs.
• Recycling: Recycling rare earths from end-of-life products and waste streams represents a big opportunity. Small companies are well positioned for these emerging markets.
• Downstream partnerships: Smaller companies could collaborate with larger miners by providing refining or further processing services, rather than mining themselves. Off-take agreements provide revenue stability.
• Geographical diversification: Projects in supportive jurisdictions with low environmental hurdles present chances for smaller firms to gain a foothold. This helps broaden supply chains outside China
• Magnet production: Smaller companies could skip mining and refining altogether and just focus on producing rare earth magnets. This allows capitalizing on processed materials without as much technical complexity.

What Should Investors Look for?

While barriers are high for smaller firms in rare earth refining, strategic niches exist around technology licensing, recycling, partnerships, and magnet making. Succeeding in any of these areas could position a company for significant upside. Based on the challenges summarized in refining rare earth outside of China, here are some types of rare earth focused companies that may have the highest likelihood of success:

• Recycling/urban mining companies - Recovering rare earth from waste streams and end-of-life products avoids many mining and refining hurdles. High profit potential.
• Refining technology innovators - Companies developing more efficient and sustainable extraction processes will be well-positioned if successful. Licensing potential provides upside.
• Niche/downstream processors - Firms focused on tailored rare earth refining, alloy/magnet production, etc. avoids the complexity of fully integrated operations.
• Strategic collaborators - Companies partnered with larger miners, magnet makers, auto firms etc. offer built-in customers and co-develop opportunities.
• Low-cost producers - Firms able to produce key rare earths at globally competitive costs will be viable exporters despite China's dominance. Vertical integration helps.
• Companies prioritizing sustainability and ethics - Strong ESG credentials could unlock financing and jurisdictional advantages as global scrutiny rises over environmental and social impacts.
• Geographic diversifiers - Projects located in stable, mining-friendly jurisdictions like Australia, Canada, U.S. avoid potential export restrictions and tensor global supply.
• Magnet makers and advanced materials companies - Focuses value-add manufacturing while avoiding the mining/refining complexity. Essential to supply chains.

Overall, innovative and specialized players with strategic partners are best positioned to overcome current barriers and capitalize on surging rare earth demand, despite China's competitive advantages.