UPDATE 2-Malaysia dismisses appeal against Lynas rare earths plant

* Ministry rejects appeal, but imposes new conditions on plant

* Plant seen as crucial to offer alternative to China on rare earth

* Parliament still to debate plant safety (Adds comments from science ministry and Lynas)

By Siva Sithraputhran

KUALA LUMPUR, June 15 (Reuters) - The Malaysian government dismissed on Friday a citizens' appeal against a rare earths processing plant owned by Australia's Lynas Corp, removing the main obstacle to the start of production at the site.

The plant is seen as crucial to loosen China's grip on the global supply of rare earths used in a range of products from smart phones to hybrid car batteries. A series of delays to its start-up has rattled Lynas shareholders as the company waits to capitalise on high prices for the materials.

A statement from the Science, Technology and Innovation Ministry, which considered the appeal, said there was "no strong justification nor scientific or technical basis" to set aside the temporary operating licence given to the plant in January.

But the ministry told Lynas, which started building the 2.5 billion ringgit ($800 million) plant on Malaysia's east coast two years ago, it must take extra steps to prevent any radiation leakage before a suspension of the licence will be lifted.

Under the new conditions imposed, the firm must submit plans to immobilise radioactive elements in the waste it will produce and come up with an emergency response plan on dust control.

"We already have the answers for the two new conditions," Mashal Ahmad, the plant's managing director told Reuters.

Malaysia's licensing body, the Atomic Energy Licensing Board, gave the plant a two-year temporary operating licence on Jan. 30.

That was suspended after residents challenged the approval, citing safety and environmental concerns. They argued that the plant could contaminate its surroundings with radioactive waste.

The ministry's decision removes the bigger of two hurdles remaining before the plant can start production. A parliamentary select committee looking into the plant's safety is expected to release its report on Monday, with a debate to be held the day after.

The plant, the biggest in the world outside China, has been standing ready to fire up since early May. Demand is so strong that there are buyers for all the rare earths it can process in its first 10 years of operation.

The Lynas plant is one of a handful under construction in a number of countries. It would supply about 11,000 tonnes in its first year, eventually rising to 22,000 tonnes.

"We expected this result, we'll ask for a judicial review," Tan Bun Teet, who leads a group resisting the plant, told Reuters. "The new conditions are too general."

Opponents say the plant does not meet best practice standards for the industry as it is too close to heavily populated areas and in a place with a high water table. (Editing by Stuart Grudgings and Ron Popeski)