LONDON - CME Group is working on a plan to launch the world's first futures contract in rare earths, three sources with knowledge of the matter told Reuters, in a move that would allow governments, companies and banks to hedge exposure to a sector controlled by China.

Rival Intercontinental Exchange is also looking at rare earth futures, but is not as advanced in its planning as the CME, two of the sources said.

CME declined to comment and ICE did not immediately respond to a request for comment.

One of the main stumbling blocks in the West's drive to cut dependence on China, which controls 90% of processed material, is banks' wariness of providing finance to Western projects in an industry swayed by volatile prices.

Rare earths are a group of 17 elements vital for the energy transition, electronics and the defence sector.

TWO MOST IMPORTANT RARE EARTHS

CME, the world's largest derivatives marketplace, is working on a new futures contract combining the two most important rare earths, neodymium and praseodymium (NdPr), said the sources, who declined to be named because the information has not been released publicly.

The two elements, typically traded as a combined product, are rare earths needed to make permanent magnets, which are used in EV motors, wind turbines, fighter jets and drones.

"It's such a key missing piece of the puzzle for the industry right now," one of the sources said.

No final decision has been taken regarding any launch. One challenge is that rare earths are thinly traded and the market is tiny compared to those for most other metals futures.

Rare earths are a crucial part of the West's efforts to work together to increase production of critical minerals, with the US last week unveiling a preferential trade bloc with allies and launching a $12-billion strategic stockpile.

In the most high-profile US deal in the rare earths sector, Washington agreed a multibillion-dollar package last July with MP Materials, including a 15% stake and a price floor based on the NdPr price.

PRICES SET IN CHINA

Currently, NdPr prices are set in China, reflected in indexes from price reporting agencies such as Fastmarkets, Benchmark Mineral Intelligence and Shanghai Metals Market.

China has two exchanges for the spot trading of rare earths - Ganzhou Rare Metal Exchange and Baotou Rare Earth Products Exchange. The Guangzhou Futures Exchange has said it plans to offer rare earths futures in the future.

Benchmark Mineral Intelligence has also started publishing rare earth prices based in Europe and North America, where volumes are thin.

According to SMM, NdPr prices based in China have surged by 40% so far this year, to the highest since July 2022, but in a sign of their volatility, tumbled by 50% during the 15 months to May 2023.

Many rare earth mines and processing facilities outside of China struggle to get financing because banks are unable to forecast their future revenue and producers are unable to hedge potential price declines without futures.

Futures would also help industrial magnet consumers like EV makers hedge their exposure to magnet prices.

CME has already successfully launched futures in critical minerals lithium and cobalt, used in EV batteries.

Earlier this month, the CME reported fourth-quarter profit that beat Wall Street estimates and average daily volume that rose 7.5% to a record 27.4-million contracts.