Rare earths pull Wesfarmers into their orbit

Rare earths have been a graveyard for investors in the past which is why the share price of Wesfarmers dropped after it lobbed a $1.5 billion takeover bid on Lynas Corporation Australia’s leading producer of an unusual family of minerals which are neither rare nor earths.

Since the fall of $1.23 (3%) last Tuesday Wesfarmers has recovered most of the lost ground, but that has done little to satisfy doubters who wonder whether a company best known for its retailing interests is taking a step too far, as it did three years ago with the disastrous expansion of its Bunnings hardware chain into Britain.

This time, the argument goes, it will be different because rare earths play a key role in the electrification of everything as the world shifts away from fossil fuels and embraces renewable energy and long-life, rechargeable batteries.

As well as an interest in rare earths, Wesfarmers is also reported to be looking for a way into lithium, another metal high on the Australian Government’s list of strategic elements which could become a major future export industry.

The role of rare earths in a world of electric cars “fueled” by power from solar farms and wind turbines is not in the power cycle or battery storage. That job goes to lithium, cobalt, nickel and other metals such as vanadium.

Where rare earths enter the game is through the particular properties of two of the 17 elements which are classified as rare earths; neodymium and praseodymium, metals which can be turned into the permanent magnets which are found in the heart of all electric motors, large and small.

Many of the other rare earths, such as yttrium, cerium and europium, have valuable properties and exotic uses, and while they are sold for high prices, they are used in small quantities which means demand can quickly overwhelm supply.

Matching supply, which has been dominated by China for decades, with demand from countries with major manufacturing industries such as Japan, the US and Germany, has been a problem for the rare earth industry -- made worse by China sometimes cutting supply either because it wants the material for itself or because rare earths can be used as an economic weapon.

Because China commands around 90% of rare earth production it has been able to play games with supply. In the past Lynas has been both a winner and loser from those games.

In 2010, when a dispute broke out after a shipping accident, China restricted shipments of rare earths to Japan, hitting that country’s electronics industry and the production of electric cars such as Toyota’s Prius.

Lynas, which mines its rare earth at Mt Weld in WA and processes them in Malaysia, was a major beneficiary of the squeeze with its share price rocketing up by more than 400% to $25, before plunging to 38c after it encountered processing problems and China flooded the rare earth market – partly as an attack on Lynas which threatened its near-monopoly on the business.

Since those erratic days of market manipulation, which even earned rare earths a cameo performance in the television series House of Cards, in which the US and China almost go to war over rare earths which have a use in rocket guidance systems.

Having survived the wild ride caused by China’s rationing of rare earths Lynas has been able to build a valuable business, largely thanks to the financial backing of Japanese customers keen to trim exposure to China but also because China is cutting production as it cleans up what has become a highly-polluting industry.

Unfortunately for Lynas the problems keep coming with the latest being a threat by Malaysian politicians to close the processing plant unless radioactive waste generated in the rare earth separation process is taken back to Australia.

Wesfarmers, which once controlled the Mt Weld rare earth deposit and looked at entering the business in the 1990s, reckons it has the balance sheet strength to help solve the Lynas waste problem, plus a team of scientists in its chemicals, energy and fertiliser division who could provide a technical solution either in Malaysia in arranging the relocation of the processing operations to Australia.

Whether Wesfarmers can get control of Lynas is the immediate question with the stock market discounting the chances of success. Since the offer of $2.25 was launched last week Lynas has consistently traded below that price, dipping at one stage to $2.08 before recovering to around $2.14.

But even if the bid succeeds there is the issue of managing the Malaysian waste problem and while that is possible it carries a political risk in a foreign country which makes Australian investors nervous.

Alkane Resources

Lynas is the leading Australian player in the rare earth business, but it’s not alone with a number of local companies either in the early stages of small-scale production or sitting on a world-class but undeveloped asset.

Alkane Resources, which has spent the past 20 years trying to build a rare earth and zirconium project near Dubbo in western NSW, is potentially one of the winners from the latest rush into exotic minerals.

Strong international interest in Dubbo, including Japanese companies looking for alternative supplies of critical elements, could see the project overcome a financing challenge with the development cost estimated to be around $800 million.

While it waits for partner with deep pockets Alkane ticks over as a profitable, but small, goldminer, though it did enjoy a burst of investor interest last week when Wesfarmers moved on Lynas, an event which lifted Alkane’s share price by 15% to 28c.

If the battle for Lynas heats up a spotlight could be thrown onto Alkane.