Isaac74/iStock via Getty Images

Isaac74/iStock via Getty Images

The rare earths market is booming as a result of the electrification revolution. Those four metals, Neodymium/Praseodymium, Terbium and Dysprosium, are required for the permanent magnets that make the electric motors and turbines work. Great, so, as we electrify cars and build wind turbines then much more, much much more, of these metals is required. However, our interesting mineralogical and economic problem is that to get to those we've also got to extract piles of cerium, lanthanum and others.

It's also true that everyone's between bored and worried about relying upon China for perhaps 80% of world supply and 90% of world processing capability. Not that those numbers are entirely accurate but they're about right.

So, why wouldn't we be terribly excited to own the only non-China major and fully integrated rare earths producer: Lynas Corporation (OTCPK:LYSCF)(OTCPK:LYSDY) ? The truth being that many are and I'm much more hesitant.

Of course, it's entirely possible that the hesitancy is my problem and not everyone else's. Or, perhaps my knowledge of the details of the business blinds me to the possibilities - or even informs them.

I wrote about Lynas here a couple of years ago. Worth having a look at that, I haven't changed any major position from that. Gold Panda had a look at recent numbers here and that's also worth a look. I'm not going to go over operating numbers again in this. What I want to try and do is explain this wrinkle in the market that makes me worry about the finances of rare earth producers.

For there's something that makes a rare earth producer - and more especially a processor - much more geared to competition and market prices that result from it than is the norm. Sure, we all grasp that if lots of other people start to produce something then the price will fall - assuming demand doesn't rise to meet that new supply of course. More sophisticated investors will know that this is a potential problem in any minor metals market - Altura was a perfectly fine lithium mine that still managed to go bust after all. Market prices just didn't meet the assumptions made at the time of financing as other mines also opened.

The chemistry of rare earths simply means that it is not possible to be a producer of just the one of them. Or even of the few that are of current marketplace interest. You've got to go and get all of them that is.

That's not wholly and exactly so. It is possible to cut the cerium out - using the different reactions to nitric acid - and leave that aside as MP Materials is doing with its production at Mountain Pass. But other than that if you're going to try to produce any one of the lanthanum to lutetium series then you're pretty much tied into producing all of them.

Here are the rare earths we're talking about:

Rare earths from Periodic Table (Springer)

Rare earths from Periodic Table (Springer)

We're not talking about scandium and yttrium here but we are that bottom line, from lanthanum to lutetium. The essential problem in the chemistry is that you cannot pick and choose which you extract. You have to move from left to right along that spectrum. There is the exception of cerium, mentioned elsewhere here. But other than that, to get to the Pr - one of the ones we want for magnets - we have to take out the La and Ce first. Then we can get the Pr, but not before. If we want to take out the Dy - which we do, again for magnets - then we need to take out the La, Ce, Pr, Nd, (there is almost no Pm on the planet it's radioactive and decays too fast) Sm, Eu, Gd and Tb first.

We can stop whenever we like and just leave the rest to the right of our finishing point alone. But we must start at the left and work our way along. Logically, this means that if we want more Tb and Dy (again, for magnets) then we're going to have to create a lot of Ce and La.

This gets worse. We might have 25% Ce, 25% La and only 1% Dy in our concentrate. Every concentrate is different but those are likely enough numbers. Concentrations almost always fall dramatically as we move left to right along that spectrum.

If we want more of the heavier rare earths - we do - then we by definition have to create more of the lighter rare earths. Which we may or may not have any great use for.

Which is a problem because you lose money on La and Ce while you make it on Nd/Pr, Dy and Tb. But to gain more of the four you want then you've got to have more of what you make a loss on. That's just the way that it works - your costs and revenues are inescapably based upon the basket of production, it's not possible to be specific.

Just to be more annoying, you're always going to have much more Ce and La around than you are the others. Probably 50% and more of your starting concentrate will be those two alone.

So, think how this works. The price of Nd/Pr goes up, as it has been. OK, that's great, the average price of your basket just rose. So, then other people join the market. Which is what is happening. Pensana is building a separation plant in the UK, Texas Resources is doing something with Roundtop, Lynas is to build a plant in Austin I think? We've definitely got an increase in rare earth mining going on as well as a very large increase in non-China processing capability.

OK, that's great, so, the prices of Nd/Pr, Dy and Tb might not be as high as we'd like, well, that's competition for us. Except look at what also happens. Those others, to gain their desirable rare earths have also had to increase Ce and La production. That is, not only do the processor profits from the desirable fall, so all do the losses rise from the undesirables.

Not fake numbers, just not numbers from Lynas. In the business plan of an integrated mine and processing plant that's doing the rounds at the moment they give an all in production cost of $15 a kg. It doesn't even matter, for my point, whether that's Opex or Capex as well included. $15 per kg. For each kg of separated rare earth they produce the cost, from original mine to finished product, it costs $15.

From the Lynas latest report we can see that Nd might go through $100 this next quarter. Tb's at $1500, so this is all a most profitable exercise for Lynas.

Except. It's notable that in the Lynas report they don't give us the prices for the lighter REs, the Ce and La. But that's what we need to know to grasp the value of the bundle. Sure, Lynas is making money on its bundle, I'm not saying anything different. But I want to explain the working parts of that bundle.

If we go over here we can look at current prices. They're RMB and a quick and dirty conversion to $ - wrong but good enough - is divide by 8 to give US dollar prices. Lanthanum's at $1 a kg (yes, it's a per tonne price they're giving there). That's a $14 loss per kg. Recall, we're using that $15 a kg finished rare earth as our production cost. But our revenue is going to be $1 for the lanthanum. So is cerium. So, on half our output we've got to lose $14 a kg. No, we're not ever going to have half our output of that desirable Nd, not even of Nd/Pr (actually, we can reverse this out from the Lynas numbers, they're getting maybe 30% Nd/Pr from their concentrate).

Again, as I say, Lynas is doing fine at the numbers that it actually faces. The current mix of production and current prices produces a profit for Lynas, I'm not saying different. The point of this explanation of pricing is to show the difficulties in that pricing system for any rare earth producer. It's not obvious that everyone else will also do so, do well at these prices. But the point I'm trying to emphasize is that increased competition bears on both sides to this - both the price for the loss-making part and also for the profit-making part. Total revenues - and costs - depend upon the basket, not the individual element of interest.

Also, the effect I'm worrying about has already been happening. Yes, Nd/Pr has been going up these past few years. But then so have Ce and La been going down - I recall when they were both around $5 a kg (which was rather more recently than "When I were a lad" times).

They're doing well. There's nothing wrong I can see with their actions, management, operations. I'm simply not critiquing the company in any way.

What I do worry about is the very structure of the marketplace, dictated by that chemistry of the separation of the concentrate into the individual elements or oxides.

I just can't quite see how the industry - of which Lynas is the one currently quoted ex-China major producer and processor - works when driving up delivery of the magnet materials means, by definition, ever increasing losses on the cerium and lanthanum.

It might even be just that I'm puzzled by the economics here. I don't quite see how the end game plays out. Part of this is that we can all see vastly more competition coming into the marketplace. OK, we can all see that demand for the magnet materials is rising as well. But there's always that little trick that increasing production just does mean increasing losses from the major components of the concentrate, the cerium and lanthanum.

What I think this means for investors is that Lynas cannot just be a buy and forget about stock. I do think that Nd/Pr - the main drivers of profit currently - prices are going to remain strong until some to many of the new suppliers come online and that's not going to be immediate by any means. But I think there will be a problem at some future point. Not just competition from other producers of those headline magnet materials, but gross oversupply of the lights, the Ce and La.

It's also possible to be entirely contrarian and point out that as those two are already at $1 a kg this has already happened.

But my real point here is to make the point which is so important about rare earths. It's the price of the basket which determines revenues, costs are fixed. We can't just look at magnet material prices, we need to look at all the particulars.

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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.