Despite China's efforts to forcibly combine its sprawling rare earths industry into just a few hands, the collapse in revenues and profits of its preferred lead player indicates U.S.-based Molycorp (NYSE:MCP) may have more problems on its hands.
Inner Mongolia Baotou Steel Rare Earth Group reported the other day first-quarter sales tumbled 53% leading to a 72% plunge in profits from the year-ago period. Although it tried to blame the poor performance in part on the ruling made by the World Trade Organization that China's export quotas violated global trade laws, as the decision was handed down at the end of March, its impact could only have been marginal at most on the results, but does signal that there may be further weakness on the horizon.
Earlier this year, the nation's rare earth producers were "encouraged" to consolidate themselves into six groups with Inner Mongolia Baotou Steel acquiring nine rare earth mining companies in the Inner Mongolia autonomous region. The move gave the producer a 51% stake in the nine firms at no cost and was part of a larger process China began several years ago to dictate pricing when it ordered 31 private processors to shut down for three months.
With less than a quarter of the world's supply of rare earth metals, China is responsible for almost 90% of global production. The Xinhua news agency reported industry executives are concerned the cancellation of export controls would "compound the struggling sector with a further price slump." And therein lies the problem for Molycorp.
Despite the use of rare earths in critical technology and defense systems, Molycorp's Mountain Pass has an overabundance of just two of the metals, cerium, and lanthanum, which happen to be among the least valuable of the 17 different rare earth elements. Any additional decline in their pricing will challenge its ability to achieve breakeven status, even with the addition of its chlor-alkalai plant that it's counting on to lower costs.
China continues to maintain its export controls aren't targeted at specific nations, but rather as a means of controlling pollution. The country notes that the U.S. has some of the largest reserves of rare earths, and between the 1960s and 1980s, it dominated the industry, but withdrew from the market because of the toll it took on the environment and resources. China says that's only what it's trying to get ahead of at the moment.
There is sense in that, and there has been significant illegal mining that has flooded the market with the unlawfully obtained minerals further depressing prices. It's also important to note that while China has set export limits on rare earths, they continue to run above prior-year levels (though admittedly they're well below what they were back in 2009). Last December, first-half quotas were set only 3% below their 2013 levels, and with China saying it will comply with the WTO's order, it suggests the numbers due to come out for the second half of this year will be significantly greater.
In all, with a market about to be flooded by greater supply at lower prices, the possibility that Molycorp will break even looks like it will also be a rare occurrence.
Rich Duprey has no position in any stocks mentioned, and neither does The Motley Fool. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.