Greenland PM's leave creates uncertainty for fledgling mining industry

(Adds PM avoids no confidence vote, parliament accepts request, analysts, background on mining)

By Teis Jensen and Sabina Zawadzki

COPENHAGEN, Sept 30 (Reuters) - Greenland's prime minister narrowly avoided a vote of no confidence on Tuesday but will temporarily leave office while auditors investigate whether she misused state funds, casting uncertainty over the country's fledgling minerals sector.

The turmoil is likely to paralyse the government at a critical juncture as international companies such as London Mining Plc and Greenland Minerals and Energy are considering opening iron ore and rare earth mines.

An audit committee told parliament last Friday that Aleqa Hammond, head of the social democratic party, Siumut, and prime minister since April 2013, spent 106,000 Danish crowns ($18,077) of state money on private flights and hotels for family members.

She replied to the committee then that her spending had been in line with previous practice that had only recently been changed and that she had paid back the money.

On Tuesday, she applied to parliament for temporary leave, naming fellow party member and environment minister, Kim Kielsen, as her preferred acting premier.

One opposition party demanded a vote of no confidence, rather than granting her leave, but the 31-member assembly narrowly rejected that demand and approved her request by 15 votes to 14, Hans Jakob Helms, a political adviser to Hammond's party told Reuters.

Greenland, an island of more than 2.1 million square km (830,000 square miles) is a part of the Danish kingdom but was granted self-rule in 2009, gaining control over financial and business issues including taxation and its resources.

Denmark contributes 3.5 billion Danish crowns ($594 million) to its coffers a year so the development of its resources, which also include rare earth minerals and potentially billions of barrels of oil, is a step towards further independence.

"CATASTROPHE"

Observers were split as to whether Tuesday's moves would prompt a new election, but said the temporary departure of Hammond, who was seen as a breath of fresh air in political circles, would be a blow for the country of 57,000 people.

"This is a catastrophe for Greenlandic politics; everything will come to a halt and no important decisions will be made during this time," said Poul Krarup, editor at Greenland's Sermitsiaq AG newspaper.

He said he doubted Hammond would return as prime minister, but believed the governing coalition would try to hang on by replacing her with a party colleague to avoid a general election, which the opposition would win, according to polls.

But Damien Degeorges, a Reykjavik-based consultant who specialises in Greenlandic affairs, said he would not be surprised should an election take place as pressure on Hammond had been building for some time.

"In a difficult economic period for the country and with a heavy international agenda ahead, Greenland cannot allow itself to face an even temporary departure of its premier. Either the current premier continues her work or a new election will have to take place," he said.

Should the opposition win the election, it is likely that the leader of the Inuit Ataqatigiit party, Sara Olsvig, would become prime minister. It was this party that had called for a vote of no confidence in Hammond.

Greenland ended a decades-long prohibition on mining for radioactive materials such as uranium last year in a tight vote in parliament, further opening up the country to investors from Australia to China who are eager to tap its mineral resources.

Uranium is often found together with rare earth minerals -- used in smart phones and batteries -- and Greenland's government has argued that the lifting of the ban, which still limits uranium production, was meant to encourage rare earths development only.

Olsvig and her party are amongst the group that opposed the change in law and aims to reverse it.

"The uranium debate could again be on the agenda with a government led by Inuit Ataqatigiit, creating then more instability for investors," Degeorges said.

Australia's GME and Tanbreez Mining, a unit of Rimbal Pty Ltd, are involved in rare earth projects. London Mining (Other OTC: LIIGF - news) has one of the most advanced plans for a mine but that is for iron ore and does not concern uranium.

Its shares fell 59 percent to a record low on Monday after it warned it did not have enough cash to operate its only existing mine in Sierra Leone. On Tuesday they extended the losses by another 12 percent.

Financial analysts have said before as long as London Mining's non-Greenlandic businesses sap its finances, development of its $2.35 billion, 15 million tonne-a-year project would not see the light of day.

(1 US dollar = 5.8953 Danish crown) (Additional reporting by Erik Matzen, Annabella Nielsen and Ole Mikkelsen, Editing by Dominic Evans)