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The global supply of rare earth elements faces a supply shortage because there is but a single source of approximately 97% of the minerals. That source is China, which has been fiddling with export quotas and prices for the past six months or so.

The US Department of Energy has just released a report outlining a plan for the US to develop a strategic plan to increase the supply of rare earths.  Perhaps the most salient point is this: “Several clean energy technologies—including wind turbines, electric vehicles, photovoltaic
cells and fluorescent lighting—use materials at risk of supply disruptions in the short term. Those risks will generally decrease in the medium and long term.”

The DoE defines short-term as up to five years. In those five years, the agency recommends that a strategic plan needs to address diversification of supply, development of substitute materials, and more efficient use of the rare earths through recycling.

Diversifying supply means opening, or re-opening, more rare earth mines in the US. One such effort, of course, is the development of southern California’s Mountain Pass mine by Molycorp, Inc. (NYSE: MCP). Molycorp came public in late August and has seen its share price more than triple and its market cap rise from zero to more than $3 billion. The company plans to start production in the second half of 2011 and get to full production by the end of 2012.

A second company, Rare Elements Resources Ltd. (AMEX: REE), has begun preliminary work on a project in northeastern Wyoming that incorporates gold production as well as production of rare earths. The company isn’t saying when production could begin, but it could be 2015 before the mine opens.

A third prospect, known as Elk Creek, in southeastern Nebraska is being pursued by Canada’s Quantum Rare Earth Developments Corp. (OTC: QREDF). A potentially large supplier of niobium and lanthanum, a mine at Elk Creek is not likely for another five years.

Other mines in Canada and South America could either re-open or expand within the next five years, helping to decrease Chinese dominance of rare earths production.

A second factor that would reduce reliance on rare earths in general is the development of substitutes. Researchers in Japan have succeeded in building electric-vehicle motors that do not include magnets using rare earth minerals. The government of South Korea is also subsidizing research into substitutes for rare earths. None of this research is likely to make any difference in demand for rare earths in the next five years.

Japan’s Hitachi Ltd. (NYSE: HIT) has found a way to recycle rare earths-based magnets used in computer disk drive motors, air conditioners, and other compressors. The company expects to begin a full-scale recycling operation by 2013, provided that it can be done profitably. The details of Hitachi’s recovery scheme were announced today.

The supply shortage of rare earths is temporary, but it’s impossible to say how temporary. Five years is a long time to be held hostage to a single supplier, especially when that supplier is saying that exports will decrease, export taxes will increase, and many of the small rare earths mines will be closed, further dampening production.

In the short-term, then, shares in Molycorp, Rare Elements Resources, and Quantum Rare Earths are poised to continue to appreciate. Molycorp, especially, since its production is set to begin two to three years ahead of the others. The Market Vectors Rare Earth/Strategic Metals ETF (NYSE: REMX), which also includes holdings outside of rare earths miners, should also do well.

But these miners don’t look like sure bets in the long term. Rare earth elements are not especially rare, but are found in varying concentrations in lots of places. Increasing demand for rare earths can easily be met by the amount of the minerals available. The determining factor is down to how quickly a company can get to production.

Paul Ausick