China still dominates the rare earths supply chain and building alternatives is proving slower and harder than expected. As governments push for supply security, are investors underestimating just how constrained and valuable these supply chains really are?
Sam Heithersay, Co-Portfolio Manager of the Fidelity Australian Equities Fund and Investment Analyst for the materials sector takes a look at why building an effective ex‑China rare earth supply chain will be a longer and more complex task than many anticipate and the important implications for investors.
How dominant is China in the global rare earth supply chain?
China is still the choke point in the rare earth supply chain. They dominate rare earth mining at 60% of the world's output. They dominate rare earth refining. 90% of the world's rare earth refining is done in China. They also own further downstream the magnet manufacturing which a lot of rare earths go into, so they are dominant across the entire supply chain, and they've been consolidating this position over the last 40 years.
But it's beyond just the supply chain itself. It's all the industrial complex that supports that supply chain, the technical expertise, the reagents, the components, and all of this poses a great challenge to any new supply that might be coming on the market to rival that dominant Chinese position.
How are supply chains outside of China evolving?
Ex-China supply chains are evolving, but fairly slowly and in a less coordinated way than we might expect. Western governments are certainly now trying to incentivise ex-China supply as supply chain vulnerabilities were laid bare. They're doing so by guaranteeing price floors and taking direct equity stakes in rare earth miners.
There is still a lot of work to be done, and we think it will probably take longer than the market expects. There are a number of reasons for that, but coordination is key. There's no point building a mine and generating a feedstock if there are no refiners to ultimately take that speed stock and no magnet producers to take that metal. It's quite difficult to coordinate a full supply chain build out at once, particularly when China's got the dominant position that they have. We ultimately think that the supply chain outside of China will get there in the end.
What is the critical role rare earths play in many strategic industries?
It willtake a lot longer and probably be a lot more challenging than the market currently expects.
Rare earths are critical for EVs, renewables, and defence. They are important, particularly for high performance, high temperature, permanent magnets, and there's no real way to substitute rare earths out of that supply chain.
There are no great substitutes. There are just trade-offs in terms of efficiency and weight. This is particularly important as we look to decarbonise the economy, but it's also important for certain military applications.
Some governments have recognised this supply chain vulnerability and have now legislated to prevent any rare earths appearing in their defence supply chain by next year. They are critical, not just in terms of their strategic importance for use cases like defence, but also because they are very hard to substitute out of this supply chain.
Is Australia well positioned to fuel an ex‑China rare earth build‑out?
Australia is very well positioned for the build out in ex-China rare earth supply chain. We have the resource endowment to begin with, but we also have a miner that already refines rare earths and has entrenched customer relationships further downstream with magnet producers.
We're already well positioned to fuel this ex-China rare earth supply chain build out, not just in one company, but a number of different companies that are now coming up to potentially rival China's dominance in rare earth supplies. This is particularly relevant for Australian investors because we have a number to choose from who are ultimately probably going to benefit from this ex-China supply chain build out that is only just beginning.
Where are the investment opportunities in ex‑China rare earths?
We recognise the incumbency advantage that existing producers and refiners of rare earths already have, the likes of Lynas in Australia and Malaysia and also MP Materials in the US, but we're also looking more broadly across the supply chain to understand if there are other companies out there too, that could potentially benefit from this rare earth supply chain build out.
Ultimately, they don't always have to be onshore in the US because the supply chain build out is so difficult that ultimately the government may settle for more of a friendshoring model where there are a number of different mines that could come to market from other parts of the world. We're very conscious of the geopolitical nature of demand and we're very conscious of co-investing alongside a government to ensure supply, but we're looking very broadly across the supply chain, because ultimately, we think it will benefit a number of different companies, because we'll probably need as much supply as we can get to rival China's supply dominance.
The Fidelity Australian Equities Fund was already well positioned through our holding in Lynas, an incumbent in rare earth mining and refining.
Longer term, we are thinking about rare earth as perhaps an extreme example of critical mineral supply chain complacency. We recognise now that governments are trying to build out more security in their critical mineral supply chains, and we've seen that most notably in copper already with stockpiling. But it's likely that as these critical mineral supply chains are built out, we will see a structural demand tailwind for a lot of these commodities. So, we are increasingly thinking of how to position the Fund to make sure we're ahead of that structural tailwind.
