MOUNTAIN PASS, Calif. (Reuters) - The United States wants to curb its reliance on China for specialized minerals used to make weapons and high-tech equipment, but it faces a Catch-22.

It only has one rare earths mine - and government scientists have been told not to work with it because of its Chinese ties.

The mine is southern California’s Mountain Pass, home to the world’s eighth-largest reserves of the rare earths used in missiles, fighter jets, night-vision goggles and other devices.

But the U.S. Department of Energy (DOE) has told government scientists not to collaborate with the mine’s owner, MP Materials, the DOE’s Critical Materials Institute told Reuters.

This is because MP Materials is almost a tenth-owned by a Chinese investor and relies heavily on Chinese sales and technical know-how, according to the company.

“Clearly, the MP Materials ownership structure is an issue,” said Tom Lograsso, interim director of the institute, the focal point of the U.S. government’s rare earths research and a facility that typically works closely with private industry.

“We’re going to allow the people in Washington to figure this out.”

The DOE instruction, which has not been previously reported, illustrates the competing pressures facing officials looking to resurrect the U.S. commercial rare earths industry, which has all but disappeared since its genesis in World War Two’s Manhattan Project to develop the atomic bomb. Lograsso did not say how the guidance was delivered to the institute.

Reviving domestic rare earths production has become a priority in Washington as relations with China, which dominates global supplies, have become increasingly frayed and U.S. lawmakers warn of the dangers of relying on a competitor for critical defense components.

Even as the DOE has blacklisted MP Materials, the company is a candidate to receive up to $40 million in funding from the Pentagon to produce light rare earths, according to two sources familiar with the matter. Light rare earths are the most-commonly used of the specialized materials.

The Pentagon has yet to announce its decision on that funding, which could go to more than one project, after delaying the decision from March due to the coronavirus crisis.

Late Wednesday, MP Materials said it had been awarded Pentagon funding for a facility to process heavy rare earths, a less-common type of the specialized minerals. The amount was not disclosed, but the funds will be used for planning and design work. MP will have to solicit the Pentagon again for construction-related funds.

MP Materials is by far the most advanced player in the U.S. rare earths industry, given no rival project has even broken ground. As such, Mountain Pass is widely seen by industry analysts as a front-runner for Pentagon funding.

The DOE did not respond to requests for comment on the instruction to scientists or any potential conflict with Pentagon policy.

The Pentagon is working closely with “the president, Congress, allies, partners and the industrial base to mitigate U.S. reliance on China for rare earth minerals,” said spokesman Lt Col Mike Andrews. The department did not respond to requests for comment on whether it might fund Mountain Pass or potential conflicts with DOE policy.

APPLE TO LOCKHEED

MP Materials, which bought the mine in 2017, describes itself as an American-controlled company with a predominantly U.S. workforce. The privately held firm is 9.9%-owned by China's Shenghe Resources Holding Co 600392.SS, though, and Chinese customers account for all its annual revenue of about $100 million.

“Had we not had a Chinese technical partner helping us do this relaunch, there’s no way this could have been done,” said James Litinsky, chief executive of JHL Capital Group LLC, a Chicago-based hedge fund and MP Materials’ majority owner.

Litinsky declined to comment on the Pentagon funding.

Asked for comment on the DOE instruction to scientists, Litinsky said: “MP is on a mission to restore the full rare earth supply chain to the United States of America, whether the government helps us or not.”

Shenghe did not respond to requests for comment.

MP Materials is among a slew of U.S. companies dependent on China's rare earths industry. Apple Inc AAPL.O uses Chinese rare earths in its iPhone's taptic engine, which makes the phone vibrate. Lockheed Martin Corp LMT.N uses them to make the F-35 Lightning fighter jet. General Dynamics Corp GD.N uses them to build the Virginia-class submarine.

The COVID-19 pandemic has further driven home the global nature of supply chains and just how heavily Western countries rely on manufacturing powerhouse China for a host of key products, including drug ingredients.

MANHATTAN PROJECT

Mountain Pass first opened in the late 1940s to extract europium, a rare earth used to produce the color red in televisions. It drew heavily on technology developed by Manhattan Project government scientists to separate the 17 rare earths, a complex and expensive process.

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By the early 1980s, the mine was a top global rare earths producer. Its minerals were in much of the equipment that U.S. soldiers used during the first Gulf War in 1990.

However, China ramped up development of a massive rare earths refining network and began boosting exports, undercutting other producers. “The Middle East has oil. China has rare earths,” then-Chinese leader Deng Xiaoping said in 1992.

In 2010, China halted supplies to Japan during a diplomatic dispute, unnerving U.S. military officials who wondered if China could one day do the same to the United States.

That refocused Washington’s attention on the mine and its then-owner Molycorp, which launched a $400 million initial public offering the same year.

Even as U.S. government scientists began research projects with Molycorp, though, the company went bankrupt in 2015 under the weight of its debt - partly built up to comply with tightened environmental regulations from the Obama administration - and cheaper Chinese competition.

Two years later, Litinsky’s group and Shenghe bought Mountain Pass out of bankruptcy. The processing equipment installed by Molycorp, however, remains unused because of poor design, Litinsky said.

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For now, MP Materials ships more than 50,000 tonnes of concentrated rare earths per year to China for processing, the Achilles heel of the U.S. industry.

The company aims to restart its own processing by the end of 2020, Litinsky said. The goal is to produce about 5,000 tonnes per year of the two most common rare earth metals, more than enough for U.S. military needs.

Some rare earths analysts and academics have doubted whether Mountain Pass can resume processing so soon, citing concerns about its plans for waste disposal and water filtration.

‘NATIONAL SECURITY MALPRACTICE’

Florida Republican Senator Marco Rubio told Reuters that the United States’ reliance on China for defense components could pose a strategic military threat.

“It would be national security malpractice not to address this,” said Rubio, who sits on the Senate’s Intelligence and Foreign Relations committees.

This was echoed by Representative Chrissy Houlahan, a Pennsylvania Democrat, who said the issue of creating a viable domestic industry had been ignored for too many years.

“This isn’t an issue we can just kick down the road,” said Houlahan, who sits on the House Armed Services Committee.

The Pentagon asked miners in early 2019 to outline plans to develop rare earths projects and processing facilities, according to documents seen by Reuters.

President Donald Trump sharpened the directive last July, telling the Pentagon to fund U.S. rare earths projects and find better ways to procure military-grade magnets made from rare earths.

Earlier on Wednesday, Australia-based Lynas Corp LYC.AX and privately held Blue Line Corp also said they were chosen by the Pentagon to process heavy rare earths imported from Australia in a plant to be built in Texas. The deadline to apply for that for that project was in December.

Other applicants for the Pentagon funding programs included Texas Mineral Resources Corp TMRC.PK; a joint venture between Alaska's UCore Rare Metals UCU.V and Materion Corp MTRN.N; Medallion Resources Ltd MDL.V and Search Minerals Inc SMY.V, both of Canada; and Nebraska's NioCorp Developments Ltd NB.TO.

For a FACTBOX about these projects, click here:

Meanwhile, U.S. government scientists at the DOE institute are studying ways to recycle rare earth magnets, to find substitutes and to locate new sources of the strategic minerals. None of that research is shared with MP Materials.

“MP Materials recognizes they have become the elephant in the room that the U.S. government doesn’t want to acknowledge, given their relationship with Shenghe,” said Ryan Castilloux, a rare earths industry consultant at Adamas Intelligence.