Since China imposed export restrictions on Rare Earth Elements (REEs) in 2010, investors have flooded the sector in search of an alternative supplier of these elements, which are critical in high-tech manufacturing. Kyrgyzstan, home of the Soviet Union’s primary REEs industrial complex and one of the world’s few previously-proven asset sets outside China, appeared set to capitalize. Kazakhstan, already a global mining hub, signed investment deals with German and Japanese interests early in 2012. Whether either country will gain from the boom will depend on their ability to attract and maintain investments sufficient to build alternatives to China, a country with entrenched interests in the industry which may prefer to see its neighbors fail.

BACKGROUND: Rare Earth Elements are seventeen chemical elements that are actually quite common features of Earth’s crust. They are components of high-capacity batteries, lenses, lasers, wind turbines, hybrid car motors, and more. The ‘rare’ moniker is derived from the fact that REEs have rarely been found in concentrations or locations suitable to industrial-scale exploitation. India, Brazil, South Africa, and the U.S. took turns as leading producers through 1990, when low-price Chinese exports began flooding world markets. By 2010, China provided over 90 percent of the world supply. Domestic consumption of the elements by its manufacturers will, by some estimates, absorb all of its REE production by 2014.

As demand began to outpace supply, the Chinese government began imposing increasingly effective export quotas. The quotas first impinged Japan, the world’s top importer, and have since spread to other countries and elements, rattling global markets as well as governments in Tokyo, Madrid, and Washington.

Presciently, several Canada-based mining startups had already started searching for alternative sources. Among these was Stans Energy Corporation, a Toronto-based venture formed to prove the viability of Kyrgyzstan’s Soviet-era REE industry. The firm won an agreement with the Kyrgyz government in December 2009 to explore the Kutessay-II pit mine at Ak-Tyuz, high in the mountains 140 kilometers east of Bishkek. Subsequent agreements that winter expanded Stans’ footprint to include a plant that formerly refined REE ore, as well as railway access and a number of other points for mineral exploration. Stans owned full rights to the assets under these initial agreements. Unfortunately for Stans, its agreements were made just months before the government of President Kurmanbek Bakiev collapsed.

Despite lacking the Soviet-era proven reserves and processing assets of its southern neighbor, Kazakhstan may leave Kyrgyzstan behind. Kazakhstan signed major agreements with German and Japanese companies in early 2012. At first glance, it faces a longer journey before it can become a source for REEs.

IMPLICATIONS: Bakiev was largely perceived, not without reason, to have run Kyrgyzstan as a family business for his five year reign. Popular discontent over the perceived fire sale of national assets to foreigners was a factor in his ouster. The new authorities in Bishkek used such sentiments to justify a series of privatizations and nationalizations throughout their first year in office, starting with the country’s largest bank and mobile operator. Along with Gazprom, the government took over the lucrative jet fuel supply contract for the U.S. military transit center at Manas airport. An ongoing struggle to increase the state’s stake in the Kumtor Gold Mine, the country’s flagship industrial enterprise, looks set to restart yet again in September. All these agreements were reneged and renegotiated on the pretense that seemingly any state-level contract signed during the Bakiev reign benefitted the first family, and thus, is fair game. Stans’ time would surely come, and finally, it has.

At the end of June, Kyrgyzstan’s populist Parliament has recommended revoking Stans’ most recent production license extension, claiming the company had failed to meet some unspecified commitments of the agreement. Stans contended it more than fulfilled the terms of these agreements, and that the process of reviving such long-abandoned industrial assets takes time. Stans filed a legal complaint, noting that Parliament has no legal right to overrule the State Geological Agency, which reports to the government of Prime Minister Babanov. The Agency has stood behind the agreement, but its own authority is tied to Babanov’s which has been plagued by allegations of corruption and threats of an imminent vote of no-confidence in his leadership. Stans’ once promising prospects are suddenly in doubt.

While Kyrgyzstan’s elites continue a fight over the distribution of state wealth that has hampered foreign investment for two decades, Kazakhstan has made steady progress in its bid to enter the sector by building on the contacts it has made over the same time period.

In March, Kazakhstan guaranteed an alliance of German companies exploratory rights in exchange for investments in technology and other fields. Western human rights campaigners’ complaints about the German government’s willingness to expand business ties with a seminal abuser received more press than the agreement itself. Germany also signed a similar agreement with Mongolia, and appears committed to guaranteeing its industrial champions access to potential alternatives. Whether these agreements will lead to actual REE production is unclear at this stage.

On the production front, Kazakhstan’s agreement with Japan’s giant Sumitomo Corporation, signed in April, appears to have more realistic prospects. Kazakhstan controls a 51 percent stake in the company through state-owned KazAtomProm, with Japan’s Sumitomo holding the remainder, in the Summit Atom Rare Earth Company (SARECO). The company’s initial focus is narrow – it will export up to 60 tons of dysprosium, about 10 percent of Japan’s annual demand. SARECO will pivot off eastern Kazakhstan’s existing industry, refining the mineral from soil processed for uranium. State ownership and comparative political stability should insulate SARECO from the intrigues that have plagued Kyrgyzstan’s mining startups. Also, Sumitomo’s significant capital resources should insulate the venture from the volatility that plagues this rapidly changing industry.

The competition is stiff, which will require Kazakhstan and Kyrgyzstan to provide ideal conditions for their respective foreign investors. Japan is exploring further agreements with Brazil, India, and Russia. Canadian startups are also looking at the potential to restart the South African and American REE industries. Mongolia has attracted significant interest. Competition is ominous for Kazakhstan and Kyrgyzstan, according to the Frasier Institute’s Study of Mining Companies 2011/2012, which ranked Kyrgyzstan as one of the six least attractive destinations for mining investors. Kazakhstan ranked poorly as well, dropping significantly from previous years, partly due to the contentious two-year dispute over revenue sharing between the government and foreign investors in the Karachaganak oil field.

CONCLUSIONS: Forays by Kazakhstan and Kyrgyzstan into the REE market have further highlighted the divergence of these neighbors over twenty years of independence. Kyrgyzstan, unable to build a foundation for economic growth and a revenue stream stable enough to solidify an elite cadre in power during the 1990s, has little to show for its theoretically promising minerals sector. Kazakhstan managed to attract foreign investments in the 1990s that provided revenue sufficient for political stability, which brings spillover effects as seen in recent deals with German and Japanese interests. Kazakhstan may overtake Kyrgyzstan and its Soviet-era advantage in Rare Earths, but whether either country can provide an investment market sufficient to survive in the global market is another question.

Finally, China’s domination of the REE market may not be rescinded quietly. Whether China’s sizable influence in Kazakhstan and its even greater influence in a particularly fragile Kyrgyzstan will play out as these industries develop may yet become matters of further intrigue.

AUTHOR’S BIO: Myles G. Smith is an analyst and consultant based in Central Asia.