China, which has about one-third of global rare earth reserves, currently accounts for around 95% of global production of rare earth metals. However, some reports are now suggesting that ballooning demand would force the country to become a rare earth importer within the next five years.

Enter the rare earth
China's domestic consumption for rare earth materials has gone up nearly 200% in the last 12 months, mainly due to an increase in demand for new technology. Rare earth metals comprise 17 chemical elements, which are used extensively to produce cell phones, computer monitors, and many other electronics. In fact, rare earth materials have been termed the "21st-century gold" since they are used in products as diverse as smartphones and hybrid cars. Rising demand for hybrid vehicles, such as the Toyota Prius, and an ever-increasing popularity of smartphones are leading to a spurt in demand for such metals.

The jump in world consumption is now forcing China to put a cap on exports as the country looks toward rising domestic consumption. In December 2010, China announced it was trimming its rare earth export quota by 35%, portending a shortage in the global market.

In late 2010, China's decision to reduce exports and a brief ban on exports to Japan forced the latter into paying nearly three times the price. In the meantime, China raised the export license fee charged on rare earths to an astounding $70 per kg from $2 a year ago. Some reports even suggest that China is considering a full export ban by 2015.

Current situation
In the wake of the current crisis in Japan caused by last week's massive earthquake and tsunami, rare earth prices are expected to fall in the short term. Japan is currently the largest user of rare earth materials, accounting for nearly 50% of total world consumption. With Japan's businesses facing a temporary shutdown and widespread damage to ports, delays in the shipment of metals is imminent. The supply shortage could lead to a rise in the prices of various technology products that use these metals.

What needs to be done
The recent surge in prices has caused companies such as Colorado's Molycorp (NYSE: MCP), Australia's Lynas, Toronto's Avalon Rare Metals (AMEX: AVL), Vancouver's Rare Element Resources (AMEX: REE), and Great Western Minerals Group to spring into action. These companies have started to redevelop mines that have the capacity to produce rare earth elements, but have so far remained in a dormant state because they take years to develop and are not environmentally friendly. This was why production of rare earth metals has more or less remained confined to China until now.

The Japanese Ministry of Economy, Trade, and Industry had, in February, said that the major rare-earth-consuming countries such as the U.S., Japan, and the EU should come forward to boost supply and develop alternatives for rare earth elements, as prices continued to rise. Recently, while China banned rare earth exports to Japan, Japanese manufacturing giant Hitachi (NYSE: HIT) said it had found a cheaper alternative to a rare earth metal, and it was able to develop a fully functioning motor using ferric oxide. Tweaking it a bit would allow it to use the oxide in hybrid cars.

Foolish takeaway
When these mines start functioning fully as expected, China's dominance in this sector will diminish, pushing prices lower -- a boon for customers but potentially hazardous for producers. We'll have to see what happens.

Shubh Datta doesn't own any shares in the companies mentioned above. 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.