Contestable Markets - Rare Earths

There are 17 rare earth elements which, when mined and processed are crucial in a range of uses such rare earths including oil refineries, permanent magnet wind turbines, cars, and many high tech and household electronic devices such as smart phones and tablet computers

Global supply of rare earths is predominantly sourced from China. Until recently their mines accounted for 97% of world production and 30%of proven reserves. In other words, China enjoyed a dominant monopoly in rare earth supply and when in 2010 China decided to restrict rare earth exports, the world price surged creating a degree of panic for manufacturers of products reliant on rare earths as a key input.

One of China's justifications for cutting back export production was that rare earth processing / separation was extremely damaging to the environment, at the same time as their export cut-backs, they announced efforts to crack down on illegal mining products. But in March 2014 a judgement from the World Trade Organisation (WTO) said that the export restrictions broke world trade rules.

One of the effects of the increase in rare earth prices was to improve the incentives for other producers to increase their investments in extraction and processing. A good example of this is Lynas Corporation in Australia that expanded capacity at a key mine at Mount Weld and at their processing plant at Gebeng in Pahang, Malaysia. Molycorp - based in Colorado in the United States, restarted a rare earth mine in California that had been mothballed in 2002 over environmental concerns. Japanese businesses - which in the past have imported 60% of their rare earths from China - opted to source more supplies from mines in Mongolia which has a rich supply of proven reserves.

In this way, the dominant monopoly of China has become a contestable monopoly. Total market supply has increased by around a third and the inevitable result has been a sharp drop in rare earth prices. Lynas Corporation has seen its average rare earths 'basket sales price' fall from above US$200 per kilogram in 2012 to US$18.25 per kilogram in the summer of 2014. The risk for them is that this low price will fall below the price needed solely to cover operating costs and certainly well under the level required to earn a sufficient rate of return on their capital investment.

This reminds us that an expansion of market supply has the effect of lowering prices and eroding monopoly profits. It will take some time for the industry to settle down to a price level sustainable for suppliers in a complex and highly capital-intensive sector.