Late last month, the World Trade Organization (WTO) ruled against China in a case related to the country's policy of restricting exports of rare earths. As I noted in an article last month, the ruling will have a major impact on the rare earth market by increasing supplies. Given the weak demand, this would hurt prices, which is not good news for North American producer Molycorp (NYSE:MCP). However, maintaining export restrictions would hurt Chinese rare earth miners the most.
WTO ruling and China's appeal
Last month, the WTO ruled that China's trade restrictions on rare earths went against the spirit of the trade agreement. China accounts for nearly 90% of the world's total rare earths production. Back when the restrictions were placed, the country's share of world production was even higher. Its move to curtail supplies raised fears of supply chain disruptions and pushed up prices of rare earth minerals. The case was jointly filed by the U.S., the EU, and Japan. China argued that rare earth mining was causing substantial environmental hazards and illegal mining, but WTO members suspect it was a deliberate move to provide undue advantage to domestic industry
While there is no denying the fact that rare earths mining causes environmental damage, WTO members say that China's bigger motive behind its rare earths export restriction is to meet its industrial policy goals. Rare earths have wide applications in hi-tech items, wind turbines, defense equipment, and batteries for hybrid cars. It has been alleged that by keeping prices of raw materials artificially higher through export quotas and duties, China wants its domestic industries to retain their competitive edge over international manufacturers.
Not surprisingly, China recently announced that it would appeal the WTO ruling.
Export restrictions not sustainable
Even if the WTO had ruled in favor of China, maintaining restrictions was not going to be sustainable.
China imposed barriers on rare earths exports in 2010 by cutting export quotas by 40% to about 30,000 tons, but it has relaxed quota restrictions somewhat since 2011. In addition, Molycorp and Australia's Lynas have been raising their production. These factors have ended the global demand and supply mismatch.
While rare earth supplies have been increasing, demand in China and overseas has weakened. This has thrashed rare earth prices lately, affecting the financials of some state-owned rare earth miners such as China Minmetals Rare Earth Company Ltd. The company has been witnessing a sharp slowdown in business due to sluggish domestic and international demand.
China Minmetals' net profit in the first quarter ended March dipped 94.1%, compared to the same quarter of the last fiscal while revenue slumped 98.5%. In the 2013 fiscal year, the company saw net profit decline by 20.5% while revenue fell 57.6%. Another concern for the company is its rising inventories level. In 2013, the company's rare earths inventories rose by 167.8%.
Molycorp had also posted a bigger-than-expected loss per share in its fourth quarter. This was due to lower average selling prices and higher costs, which hurt margins.
WTO Ruling not likely to be overturned
Minmetals' deteriorating financial performance and rising inventories level highlight the fact that export restrictions placed by China have ended up hurting the country more than benefiting. Still, the country wants the restrictions to remain place. However, it is unlikely that the WTO will reverse its ruling. This would of course mean more supplies would hit the market, further hurting prices.
Of course, that is not good news for Molycorp. The weak outlook for the rare earth industry is reflected in the performance of Molycorp shares so far this year. Year-to-date, the company's stock has fallen more than 8.50%, compared to a gain of 2.04% for the S&P 500. Molycorp has also underperformed diversified miners such as BHP Billiton and Rio Tinto, which are themselves under pressure due to a sharp decline in iron ore and copper prices.
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Varun Chandan Arora has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.