By David Stanway and Polly Yam
BEIJING/HONG KONG (Reuters) - China is preparing to scrap controversial tariffs and quotas on the export of rare earth materials after a World Trade Organization (WTO) panel branded them discriminatory earlier this year, a source with direct knowledge of the matter told Reuters.
China is responsible for more than 90 percent of global rare earth production, giving it a chokehold over the supply of 17 elements with a wide range of uses in high-tech sectors such as defence and renewable energy.
The move to comply with WTO rules would reflect a tactical adjustment for Beijing, but its long-term plan to improve pricing power and gain market share in lucrative downstream industries is expected to remain unchanged.
"The WTO decision does not change the strategy, just the means at China's disposal," said David Abraham, an independent resource analyst.
"The tools of the day are now taxes, exchanges and regulations to consolidate companies into a few champions."
After complaining that global market prices were too low to cover the huge environmental costs of production, Beijing imposed tough output quotas and export tariffs in 2010 as part of a wider crackdown on the sector. Exporters have paid a tax of 15-25 percent this year.
The measures saw prices jump threefold, but a WTO panel said in March that the tariffs violated trade rules by giving domestic consumers an unfair advantage over foreign competitors.
Despite appealing the decision, Beijing expects to have little choice but to accept the ruling and could cancel export restrictions on rare earth, as well as tungsten and molybdenum, by next year, an industry source with ties to the government said. He declined to be identified as he is not authorised to speak with media.
"They may be cancelled next year," the source said, adding that if the move goes smoothly, export quotas on other products could also be scrapped at a later stage.
Prices are likely to be supported by a change in resource taxes, with several pilot regions -- including Ganzhou in eastern China's Jiangxi province -- already preparing to shift.
"I don't think the outlook is good for their WTO appeal and they realise it," said Amsterdam-based consultant Ryan Castilloux, founding director of Adamas Intelligence.
"So I think they're looking at what they need to do in the long-term to take what was once an export tariff and turn it into a resource tax so the net result is positive."
The ministries involved, including the Ministry of Industry and Information Technology and the Ministry of Commerce, were not available to comment. The Association of China Rare Earth Industry also did not respond to requests for comment.
Michael Silver, chief executive of American Elements, which sources rare earth supplies from China, said the policy shift would be a "significant step in the right direction".
"China has every right to charge whatever the market will bear for rare earths," he said. "But they should not use them to advantage their own end-product producers or extort foreign companies into manufacturing in their nation."
He said China's curbs were counterproductive and encouraged overseas consumers to pursue alternative technologies.
"My argument to China is why would you want the brightest minds on the planet to devote their careers to researching ways not to use a material you have control over forever?" he said.
As well as export restrictions, China's campaign to "rectify" the sector also included a strict domestic output quota as well as efforts to smash an illegal supply chain in which small-scale village producers mined large amounts of rare earth that would then be smuggled out of the country.
To strengthen its control over the sector, the government also sought to consolidate production and processing in the hands of a small number of large and mostly state-owned firms.
It has also tried to improve its pricing power by establishing trading exchanges, while an official with the Shanghai Futures Exchange said at a conference last month that China was mulling the launch of rare earth futures trading.
(Additional reporting by Eric Onstad; Editing by Joseph Radford)