Rare earths on a refining roll in Australia, but risks remain

Confidence in Australia’s rare earth industry grew significantly this week with news that it could soon have two world class refineries capable of competing with the dominant player in the rare earth element (REE) game, China.

Iluka Resources (ASX: ILU), better known as a producer of titanium minerals and zircon, is joining local leader, Lynas Rare Earths (ASX: LYC), in the complex business of “cracking” ore to produce a range of REE essential in advanced technologies.

Refineries offer potential for explorers

For smaller REE explorers and potential miners, the refineries could represent the creation of a local value-adding market for their unprocessed or part-processed ore though that would depend on compatibility.

Companies such as Arafura Resources (ASX: ARU), Northern Minerals (ASX: NTU), Hastings Technology Metals (ASX: HAS), Australian Rare Earths (ASX: AR3), iTech (ASX: ITM), Red Mountain Mining (ASX: RMX) and Resource Base (ASX: RBX) might be able to work with the local rare earth refiners rather than being forced to build their own processing facilities.

REE critical to governments worldwide

The move by Iluka, which has been more than a year in the planning stage, is being largely funded through a $1.17 billion loan from the Australian Government – a deal which carries two important messages, firstly that Iluka thought the project too risky to attempt on its own, and secondly that the government, with US encouragement, sees rare earths as a key part of its drive to develop a critical minerals industry to compete with China.

Always a complicated business, rare earths have been making headlines since 1992 when the late Chinese leader, Deng Xiaoping, famously said “the Middle East has oil, China has rare earths”.

Xiaoping’s boast, which remains largely true, is a thorn in the side of western world technology and defence industries which require some of the 17-member REE family in their manufacturing processes.

Neodymium and praseodymium (collectively referred to as NdPr) are the most valuable of the REE suite thanks to their use in the permanent magnets found in everything from wind turbines to electric vehicles to rocket guidance systems.

Interestingly, deposits of REE are not that rare and neither are the elements actually earths. They are metals, albeit exotic metals.

REE challenges

What is rare is the complex and expensive process of separating the raw material into a saleable form with China the only country to have, so far, mastered the challenges of the complete refining process for heavy rare earths, which leaves a radioactive waste which China is happy to deal with, but not many other countries.

The only rare earth mine in the US also ships its material to Chinese refineries.

Breaking China’s rare earth monopoly

Breaking the Chinese monopoly on rare earth refining has sparked a global rush.

The US is developing a refinery in Texas. Lynas is building Australia’s first refinery at Kalgoorlie and now Iluka is committed to a refinery at its Eneabba operations near Geraldton in WA’s Mid-West region where there is a stockpile of unprocessed “monazite” ore.

The monazite, which is mined in association with ilmenite, rutile and zircon, has never been considered safe for processing because of its high level of radioactivity. A French company once considered buying the monazite for use in that country’s nuclear power program.

Waste management will be an issue for any rare earth refinery, but it appears that concern over radioactive waste has been trumped by the urgency of developing a non-Chinese source of refined REE.

Lynas originally opted to ship its rare earths mined at Mt Weld north of Kalgoorlie in WA to Malaysia for initial processing.

While Lynas processes both its light and heavy rare earths at its Malaysian plant, its heavy rare earths are refined to produce a compound that undergoes final separation in China.

To avoid using China for its final heavy REE separation, Lynas is looking at establishing a heavy rare earths processing facility in the US.

Mastering the technology will be the first hurdle Iluka here in Australia and for Lynas to undertake the final step for its heavy rare earths in the US.

Once that’s done there will be the challenge of selling rare earths into a small market, because whatever the publicity, demand for NdPr and other metals such as dysprosium, lanthanum, terbium, cerium and ytterbium is modest and fickle and that’s before getting to the Chinese response to competitors in its backyard.

Pulling strings on global supply

In the past, China has aggressively defended its control of the rare earth market, all the way to “weaponising” supply, which is what happened in 2010 when a dispute with Japan over access to fishing waters led to a Chinese ban on rare earth exports to Japan.

The ban was lifted after a six-month stand-off, but it was an event which galvanized Japanese industry, triggering a deal to fund the Mt Weld mine of Lynas, which has become the biggest non-Chinese producer of REE.

China played the same control card last year when a plan to disrupt the flow of rare earths to the US was unveiled, after it was revealed that the most important fighter of the US air force, the F-35, requires 417 kilograms of rare earths to be operational.

Iluka could face similar Chinese pressure, if not through trade sanctions, then possibly through another Chinese tactic of flooding the market with surplus material to kill the price and drive a rival out of the business.

It’s the combination of historic Chinese tactics and concern about future supplies which makes the involvement of the US and Australian governments in the rush to build rare earth refineries easier to understand – not that all investment banks are lining up to invest.

Investment bank reactions

The reaction of banks is a warning for investors that rare earths really are tricky business, not in the discovery and mining phase of the industry, but in the refining, which is technically complex, and marketing, which almost always needs government backing to keep China at bay and to ride out price fluctuations in materials traded in small volumes.

Of the three major banks to so far analyse the Iluka refinery announcement it’s fair to say that the reaction has been underwhelming.

Morgan Stanley welcomed the deal, especially the government funding, but also pointed out that the project only had an initial nine-year life and would require additional material from Iluka’s operations in the Wimmera district of Victoria. The bank retained a neutral recommendation for Iluka – tipping a future share price of $9.75, which is 19% below the stock’s last sales at $12.09.

Citi was also wary of the risks associated with rare earth refining retaining a neutral recommendation on the stock with a future price tip of $10.50 – 13% below the current price.

Credit Suisse has the most bullish price tip of $13, and has lifted its recommendation from sell to neutral, but it also provides the most detail commentary on the risks involved, telling clients that “we believe there is elevated risk of failure in the complex task of rare earth oxide separation”.

But the most interesting aspect of the Credit Suisse view is that the WA plant is actually a “big call” on the Wimmera resource, because the proposed refinery is bigger than required for Eneabba alone, which opens the pathway to third party treatment which is what the Australian Government wants.

It’s a long shot but it might not be a surprise to soon see local rare earth explorers asking Iluka for the specifications of its refinery to see whether they can negotiate a supply deal which would help them move quickly from exploring to mining.