Avalon Rare Metals Inc. – Industry consolidation underway

by Sam Kiri CFA ACMA

As concerns over a prolonged recession fades away precious metal and base metal stocks have started attracting investor interest. While perceived prosperity has helped precious metals, the prospective revival in industrial and construction sectors owing to government stimulus packages has underpinned base metals. Interestingly, investors appear to have missed out on the potential for Rare Earth Elements (REE) which have widespread critical applications in green technology. The REE sector is marching towards consolidation and companies in the REE business are set to benefit.

There aren’t too many REE companies around the world and much less in North America. Among the few, Toronto listed Avalon Rare Metals Inc. (TSX: AVL). The company has five rare metals and minerals projects in Canada, three of which are at advanced stages of development. These projects provide exposure to a broad range of rare metals such as lithium, indium, tantalum, gallium, neodymium, dysprosium and lanthanum.

Perhaps it is appropriate to provide a primer for those who are not familiar with REE. The rare earth elements (or "rare earths") are also known as the lanthanide series of elements and include the 15 elements in the lanthanide series of the Periodic Table, plus yttrium and scandium. However, cerium, lanthanum, neodymium, terbium, europium, dysprosium and samarium are the best known due to their range of applications.

It is astonishing to realise the diversity of REE applications and their increasingly important role in our everyday life. These include automotive catalysts, magnets for electric motors, electronics, TV, computer and other screens, rechargeable batteries, glass and ceramics. In other words, we use REE when we drive cars, when we use computers, when we watch television and during many other day-to-day activities. Amongst them, REE’s role in green technologies for energy efficiency makes them particularly interesting especially in the wake of rising energy prices.

In addition to its plethora of applications, the firm control China holds over these metals makes companies such as Avalon particularly important. Currently, China accounts for over 95% of world supply. The world is expected to be at their mercy as China is gradually imposing restrictions on rare earth metal exports. For instance, China recently announced a 22% cut in rare earth exports to 11,376 tonnes for 2H2008, thus reducing the total exports for 2008 to 34,176 tonnes compared to approximately 43,600 tonnes in 2007. As China further reduces rare earth exports, the industrial world and end-users outside China are expected to feel the pinch.

China is making further inroads to the industry and taking a firmer grip on the supply side. In what could be a significant development, Australian rare earth project developer Lynas Corporation Ltd (Lynas) and China Non-Ferrous Metals Mining (Group) Co., Ltd (CNMC) have signed an agreement for CNMC to become a new majority shareholder in Lynas with a 51.6% stake. The full transaction, comprised of a combination of equity, debt and loan guarantees, is valued at US$366 million and provides a glimpse of what REE companies are really worth.

The transaction also confirms China’s interest to expand its ownership of REE deposits and projects beyond its national boundaries. The Lynas acquisition marks the third notable Australian mining company to be acquired by Chinese interests this year, with two of them in the REE space, namely Arafura Resources and now Lynas. CNMC is an international mining company operating under the direct administration of the state-owned Assets Supervision and Administration Commission of China.

Clearly, the REE sector is entering a phase of industry consolidation. The recently announced transaction involving Great Western Minerals and Molycorp Minerals in North America further confirms this trend. Industry consolidation is likely to provide further upper hand to China thus potentially leaving the industrial world desperately reliant on Chinese REE suppliers.

It is hardly surprising that China turns itself into a thrifty accumulator of rare earth metals. According to industry sources, global consumption of REE in 2007 was approximately 108,000 tonnes. China consumed a whopping 65% of that amount with the remainder split between Japan & South East Asia (25%) and the US (10%). At a growth rate of 10-15% per annum, REE demand is expected to reach 190,000 tonnes per year by 2012, potentially exceeding the projected supply available from currently known sources. With the growing demand for automobiles in China, where electric cars have to be a priority in order to avoid making an already serious air pollution problem a lot worse, demand for essential rare earth elements is certain to increase.

It is but a matter of time investors realise the importance of REE and the resounding investment case of REE companies such as Avalon.

The wholly owned Thor Lake project is its top priority project due to its enrichment in REE and the high proportion of the more valuable Heavy Rare Earth Elements (HREE, europium through lutetium plus yttrium). HREE are in short supply and are vital to many current applications in electronics (colour phosphors) and hybrid cars (high strength magnets and rechargeable batteries). To put matters in perspective, HREE such as europium, terbium and dysprosium fetch prices as high as US$450/kg, US$350/kg and US$95/kg respectively compared to US$6.50/kg by lanthanum, US$6.50/kg by lerium and US$14.00/kg by neodymium (average prices as of February 26,2009).

As rapidly rising fuel prices underpin the demand for more fuel efficient cars especially hybrids such as the Toyota Prius, demand for HREE is also expected to gather pace. A hybrid car such as the Prius is estimated to contain an aggregate of 30kg of REE, including light rare earths used in the rechargeable battery and the catalytic converter. Consequently, the Thor Lake project is expected to help underpin Avalon valuations.

Avalon has a new NI 43-101 compliant resource estimate for Thor Lake’s rich Lake Zone REE deposit. This large deposit has a rich sub-zone containing a high proportion of the Heavy Rare Earths called the Basal Zone. It contains an inferred resource of 28.4 million tonnes grading 1.99% TREO of which 22.1% is comprised of HREE, a remarkable enrichment considering that most deposits contain just 1-3% HREE. The company’s current focus is to better define the highest grade portion of the Basal Zone resource and define the deposit in more detail in order to move more of the inferred resource to the indicated level of confidence..

Avalon also owns a significant lithium resource on its Separation Rapids project in northwestern Ontario, which is a potential source of lithium minerals for use in the glass and ceramics industry. It is attracting new interest because lithium additions to a glass batch can reduce energy consumption and greenhouse gas emissions. Lithium usage is expected to increase as a consequence of this and its projected new demand from lithium ion batteries.

Development efforts are also underway at the East Kemptville tin-indium project, leading to a 43-101 defined resource estimate and a preliminary economic assessment. This project also has near-term economic potential but at this stage Avalon’s efforts are focused on its top priority project, Thor Lake, which clearly offers the best potential for near-term value creation for the shareholders.

As industry consolidation gathers pace with China securing an even firmer grip Avalon is poised to establish itself as a premier REE company in North America. Avalon can also be viewed as a contributor to a greener planet as many of the REE applications involve energy efficient technologies including wind and solar power. China’s prominence and increasing appetite for the acquisition of non-Chinese REE resources coupled with the growing demand for greener technologies that require new REE supply sources makes for a promising scenario for Avalon. As the market becomes more aware of the critical nature of REE, particularly with looming supply shortages, Avalon is bound to receive the respect and valuations it richly deserves.