Molycorp’s $1 billion rare-earth gamble – by Richard Martin (Fortune Magazine – November 18, 2011)

How an American company is trying to break China’s monopoly on high-tech minerals.

FORTUNE — Few weekenders making the four-hour run from L.A. to Vegas notice the big mill works overlooking Interstate 15 at Mountain Pass Summit in California, near the Nevada line. Even fewer realize that the pale-pink buildings, gone patchy with age, are the focus of an extraordinary business drama that involves national security, China’s monopolizing the strategic market in rare-earth metals, and one company’s attempt to restore American preeminence in a crucial mining sector it once dominated.

Those sprawling buildings are owned by a Denver mining company called Molycorp (MCP), which is now spending nearly $1 billion to restart rare-earth-mineral production at Mountain Pass Summit and in the process revive a moribund U.S. industry. It won’t be easy. A decade ago the U.S. was the world’s biggest supplier of lanthanides, scandium, and other rare earths, and the Mountain Pass mine was the world’s largest producer of the minerals.

Rare-earth elements enable the creation of super-magnets, which operate at high temperatures and are also used for a range of high-tech applications, from missile-guidance systems to compact fluorescent light bulbs to wind power turbines to motors in electric vehicles.

Ironically, rare-earth minerals aren’t really rare; they get their name because they are spread widely throughout the earth’s crust in small concentrations that in most cases can’t be mined economically. In all, there are 17 rare-earth elements, which are typically found in varying proportions in the same ore deposits. China, with the world’s largest supply, has been ramping up production over the past two decades, leading to steep price drops that eventually forced the Mountain Pass mine to shut down operations in 2002. China now controls 97% of the market.

Over the last year, however, the Chinese government, which views rare earths as a key element in its move from a low-cost producer of cheap manufactured goods to a high-tech powerhouse, has drastically reduced its export quotas, particularly for the heavy rare earths, like terbium and dysprosium. That sent prices through the roof last summer: At one point the price of dysprosium, used in the manufacture of advanced lasers, more than doubled in a week, and overall rare-earth prices shot up 1,500% from 2009 to 2010, to an all-time high.

Wanting to capitalize on the rare-earth shortage, Molycorp, backed by $1 billion in private equity from Resource Capital Funds in Denver, began selling rare earths at its California mine in October and soon after announced third-quarter net income of $43.7 million, vs. a loss of $10.1 million a year earlier.

Running such an operation is not cheap, so CEO Mark Smith, a mining veteran who has spent nearly a quarter-century working on Mountain Pass, took the Denver-based company public last year, raising $379 million. When Molycorp stock reached its peak of $77 a share in early May, it was the most successful IPO of 2010 as measured by share-price increase since going public.

Since then the stock, which has a $3 billion market cap, has suffered a cave-in, dropping some 56%. Why? The rare-earth “crisis” has generated an old-fashioned gold rush, as miners in ore-rich countries like Australia, Kazakhstan, Mongolia, and even Afghanistan announced plans to bring new supplies to market. Influential minerals forecaster Dudley Kingsnorth of Industrial Minerals of Australia, reduced his prediction for 2015 demand by nearly 13%. Stock-trading blogs now talk of a “rare earths bubble.” Manufacturers in Japan and elsewhere, hesitant to trust their future raw materials supply to China, have embarked on an aggressive R&D search for rare-earth substitutes. That search could pay off in a few years.

With all the bad news piling up, Molycorp, a once highly touted company, now looks increasingly like a billion-dollar roll of the dice.

A customer for every bucketful

Standing on the edge of the open pit into which his company is pouring all that cash, Smith appears unfazed by recent developments. Yes, more suppliers are coming online, but he argues, “Look, we just do not see any way that the market for rare earths is going to reach equilibrium between now and 2015.”

Ruggedly built, with steel-gray hair that matches the frames of his fashionably narrow eyeglasses, Smith looks as if he could be an NFL head coach. He was, in fact, a promising defensive back, planning on playing for the Colorado School of Mines until a knee injury ended his football career. He wound up graduating from Colorado State and getting his law degree from Western State University in California, and has worked as an attorney for the mining industry ever since.

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