China is currently waging war on its unruly rare earths sector, with state inspection teams in the middle of a four-month campaign to crack down on illegal producers, processors and traders.

China produces more than 95 percent of global rare earth metals and its efforts to bring the sector under greater control have alarmed its overseas customers as supplies dwindle and prices surge.

Demand for rare earths -- a group of 17 elements used to produce catalytic converters, permanent magnets and battery cells -- is expected to double in the next five years, but Chinese output growth is likely to be much slower, and the United States and Japan are considering taking legal action.

WHAT ARE CHINA'S AIMS?

Few doubt that the unregulated exploitation of rare earth resources has caused untold damage to China's environment, especially in the northern region of Inner Mongolia, where about half of China's rare earth oxides are produced.

Officials have said it is unfair to expect China to maintain output at unsustainable levels just to supply the global market.

China's dominant role in global production has created incentives for miners to flout rules, especially as global demand surges, with illegal production and smuggling still rampant.

But China has greater ambitions for the sector than simply cleaning it up. Beijing has long been keen to improve its pricing power in the global rare earths sector. It also wants to encourage foreign processors of rare earths to set up shop in China, instead of shipping raw materials out of the country.

WHAT ARE CHINA'S POLICIES?

China has capped production at 93,800 tonnes and exports at 30,184 tonnes, saying it simply cannot sustain the sort of output levels demanded by foreign customers.

It has also banned new projects as it prepares to release comprehensive new guidelines for the sector, including new entry thresholds and technological specifications.

China ultimately wants to streamline the industry and put production in the hands of favoured state-owned mining firms. It has already ordered firms in Inner Mongolia to merge with the Baotou Steel Rare Earth Group, China's biggest producer.

Baotou Rare Earth is also setting up a strategic rare earths stockpile that could eventually reach 200,000 tonnes.

WHAT HAS THE WTO SAID?

There is a reason why Beijing continues to emphasise the damage caused by unsustainable rare earth mining: World Trade Organisation rules allow the restriction of exports on health and environmental grounds.

China has also sought to invoke a rule allowing trade restrictions relating to the conservation of exhaustible natural resources.

Its current crackdown on the domestic sector is partly designed to show it complies with a rule stipulating that any curb is imposed equally on both domestic and foreign users.

However, officials have admitted in the past that the restrictions on exports were partly motivated by the desire to ensure domestic firms were adequately supplied.

The WTO said in July that Chinese restrictions on raw material exports -- including a variety of quotas, tariffs, permits and minimum prices -- were illegal.

Beijing plans to appeal the decision, but it remains unclear whether the WTO move will lead to formal legal action by Japan, the United States or the European Union.

WILL CHINA'S POLICIES BE SUCCESSFUL?

China has so far struggled to impose a production cap, with actual annual output exceeding official quotas by 40 to 50 percent since 2007. Last year, China set a cap of 89,200 tonnes, but production is believed to have been as high as 118,900 tonnes.

But by reducing legally available supplies and driving up prices, Beijing has effectively created more incentives for producers, processors and traders to resort to the black market.

Smaller miners used to selling rare earths outside the official channels could benefit, thereby undermining Beijing's consolidation efforts.

Much depends on the success of the inspections running until the end of the year. They will pay particular attention to companies accused of violating production quotas, and will also punish firms found to have purchased illegally produced rare earths. Dozens of mines and plants have already been shut.

Over the longer term, China's restrictions on exports of rare earths are encouraging other countries to step up production, and the days of absolute Chinese dominance over the sector could be numbered, according to a report published earlier this month by Technology Metals Research.

China produced around 96 percent of total rare earth oxides in 2010, and that could fall to as low as 41 percent by 2017 as new projects go into operation, the report said.

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