Geopolitical Signals in the Market Noise - The Uranium Edition
There is a new economic security paradigm. The world is entering an era of the Golden Rule: “He who has the Gold makes the Rules.” Or in the terms of this article: “He who has the Uranium makes the Rules.” It appears the US military agrees.
On April 13, 2018, a draft bill was sent to the Russian Duma which would ban all trade between Rosatom (the Russian state-owned nuclear company) and US nuclear utilities. These proposed sanctions on nuclear fuel exports were in response to sanctions that the United States imposed on Russia earlier in the month on April 6th.
The bill was unlikely to advance, given that Tenex (the marketing arm of Russia’s state-owned nuclear company, Rosatom) books over $6.5 billion in contracts with the United States every year, and the sanctions would only hurt Russia’s position in the global uranium market. However, this series of events highlighted a critical vulnerability for the United States.
The US is the largest consumer of uranium in the world, using 46 million pounds U3O8 per year to fuel its 99 reactors. Nuclear energy represents 20% of US baseload power, and yet, the US will produce only 1.1 million pounds U3O8 in 2018, which means it imports 98% of its annual uranium requirement (and that does not include its military requirement).
Of that imported amount, 40% comes from Russia, Kazakhstan, and Uzbekistan. Globally, Kazakhstan holds a dominant position in uranium production with 39% of the world’s annual mining output. Russia holds a dominant position in uranium enrichment with 40% of global enrichment capacity. So this threat from Russia has real substance and is a reminder that nation-state conflict is multi-dimensional, played out through kinetic violence but also through trade and financial flows.
The uranium section 232 petition
Commodity prices are famously cyclical given inelastic demand, unpredictable environmental and political factors, and long lead times for production. From the time a uranium deposit is discovered to the point a mine is permitted, built, and put into production - it can be 10 years or more. So when there are strategic vulnerabilities like uranium supply for the US - 98% of US supply is imported with 40% coming from Russia or Russian influenced nations - it cannot immediately be blamed on unfair trade practices or government subsidies for state-owned enterprises.
This must be said because the most extreme Free Trade activists will decry any intervention into markets with a religious ferocity, not realizing that all markets have an underlying political construction. So yes, this author acknowledges that supply destruction naturally occurs in commodity markets due to their hyper-cyclical nature. With that said, uranium is clearly already a highly politicized market and market intervention deserves an honest multi-dimensional (economic and national security) assessment.
The Trump Administration is currently reviewing a petition by two US uranium companies (Energy Fuels, UR Energy) that calls for 25% of the US uranium market to be reserved for domestic producers. In addition, it would require the US government to purchase uranium only from the domestic market. The Trump administration has already implemented trade restrictions on aluminum and steel based on a similar “Section 232” petition, so there is a high likelihood of trade actions resulting from the uranium petition (scheduled May-July 2019).
Market Pricing and the Strategic Objectives of authoritarian capitalism and democratic capitalism
Government intervention into markets is a spectrum ranging from completely free market pricing to government price fixing. The market “tool set” of authoritarian capitalism exists much closer to the price-fixing end of the spectrum. However, the failure of the Soviet and Maoist models have pushed authoritarian regimes to selectively implement market forces. Despite this, authoritarian regimes still distort global markets with their policies, subsidizing state-owned enterprises and their domestic resource markets. It satisfies their domestic population with lower input costs (fuel, materials) and with employment. When this subsidized source of supply is introduced into western markets, it acts as a syphon of financial resources and employment from the western world directly to the authoritarian regimes. In addition, it makes democratic capitalist economies more dependent on resources originating in the authoritarian capitalism sphere of influence, which satisfies a strategic objective for authoritarian regimes.
The uranium market is no different. State-owned uranium companies in Russia, Kazakhstan, and China are operating at a loss, driving out the private sector from the market such that there is only one producing mine in Canada and two producing mines in the United States. Indeed, up to 90% of global uranium mines are currently operating at a loss. Western companies like Rio Tinto, BHP, and Paladin are all either cutting production or selling their assets. In the meantime, authoritarian capitalists are consolidating their position in the market - China just bought a controlling stake from Rio Tinto in the the Rössing mine in Namibia, one of the largest uranium mines in the world. It has already invested in and seeks to invest more in Canada’s Athabasca Basin, the world’s leading source of high-grade uranium.
It must be mentioned that other political and environmental forces have also acted on the uranium market price for decades. One of the largest sources of secondary supply was the Megatons to Megawatts program from 1983 to 2013, when Russians were downblending highly enriched uranium from 22,000 ICBMs to low enriched uranium and selling it to American utility buyers. In some years, they sold as much as 20 million pounds of uranium.
Then of course the Fukushima disaster happened in 2011. Japan shut down all of its reactors (12% of global demand) and began to sell its uranium fuel reserves into the global spot market. For two years after Fukushima, the Megatons-to-Megawatts program continued to pour uranium onto the spot market, ultimately driving the price down to $18/lbs. In 2011 before Fukushima, the uranium price was $75/lbs, and in the commodity bull market of 2003-2007, the price of uranium reached $136/lbs. Thus, there are other secondary sources of supply that have weighed on uranium markets in the last few years besides government intervention by the authoritarian area into primary supply sources.
The point is that when commodity prices reach cyclical lows, authoritarian regimes can acquire assets cheaply and consolidate their position in the market so that when the price rebound occurs, they have already secured sources of supply. In contrast, at cyclical lows companies in the democratic capitalist area have trouble accessing capital and thus cannot accumulate assets at the same scale or speed as state-owned enterprises. Governments in the democratic capitalist area have an incentive to help commodity prices rebalance as quickly as possible so that capital flows back into democratic capitalist companies. Democratic capitalist nations can do this by collecting and broadcasting market data as well as direct types of action like the uranium Section 232 petition calls for.
Democratic capitalism relies on market price incentives for strategic objectives (like domestically-sourced uranium supply). Authoritarian systems can temporarily override market mechanisms to artificially inject capital into their state-owned enterprises at cyclical price lows and consolidate their market position at a time when no capital is available to democratic capitalist companies.
Is the US military engaging in economic security policy-making?
The uranium price is rebounding, up 42% in 2018, which means the market price is responding to a range of price-constructive supply and demand factors. The Megaton program is no longer running. Japan is now bringing its reactors back online. Kazatomprom has cut production. There are 59 reactors currently under construction worldwide. The IAEA estimates that the global all-in sustaining cost (AISC) for uranium production is $60/lbs. While Kazatomprom likes to tout production costs for its best ISR uranium projects in the teens, some analysts point out that the Kazakhs have not been reinvesting capital into their mines and the real cost of production is much higher.
Why then, is the Trump Administration considering the Section 232 petition if the uranium market seems to be operating according to supply and demand? If the global AISC is $60/lbs, and the market is recognizing that the global swing producer Kazatomprom actually has much higher costs than reported (perhaps $45/lbs), then the market price will rise from the current $29/lbs and US uranium producers will compete again at closer to free market prices.
Of course, it is a reaction to the fact that Russia and other authoritarian regimes have consolidated the uranium market effectively. Section 232 petitions originate in the Trade Expansion Act of 1962, which authorizes the President of the United States to adjust specific imports from other countries if the importation “is in such quantities or under such circumstances as to threaten to impair the national security.” What is interesting is that the CEO of UR Energy said in a recent interview that Rick Perry, the US Secretary of Energy, asked him to file the Section 232 petition. Meaning, the Trump Administration is pushing the Section 232 action, not responding to the appeals of domestic producers.
The U.S. Department of Energy is an integral part of the national security infrastructure. It oversees the US nuclear weapons program and naval nuclear reactors. Now it is stepping into the uranium market itself for national security reasons. This is part of what appears to be a larger move of the US military and defense establishment into a more active role in US economic security policymaking.
If true, it is not a surprise that the US military is taking on a more active role. Consider the newly implemented steel tariff. Inferior Chinese steel was being used for US military applications and was prone to failure. In fact, Chinese and Russian steel imports almost completely eliminated US domestic steel production capacity. Consider the recent news that chinese spy chips were found in hardware used by Apple and Amazon. Or consider that Russia supplies the RD-180 rocket engines used by NASA and the Pentagon because the US does not have a reliable domestic alternative. More than ever, the US military is being pushed into the realm of economic security, which has traditionally been the domain of financial operators.
When Admiral Michael Mullen said in 2010 that US debt levels are the most serious national security threat to the United States, it signaled a heightened economic security awareness and emphasis among the military establishment. That level of engagement is increasing as the US military sees that financial operations are no longer sufficient to meet US economic security strategic objectives. (A personal note: this author has worked with Wall Street veteran, Jim Rickards, who is now training the US military in financial and non-conventional economic warfare.)
A new economic security paradigm?
When the US developed its economic security doctrine in the 1940s, it was built around two pillars - trade policy and the US Dollar as global reserve currency. Access to the robust consumer economy in the US incentivized the cooperation of its western allies. USD status as global reserve currency and use in global payments also afforded the US an “exorbitant privilege”. However, the 2008 financial crisis was a signal that US consumption can no longer support the global economy, and while the US Dollar still represents 60% of global reserves and 80% of global payments, recent “de-SWIFTing” efforts and the Chinese/ Russian response prove that US influence on global financial flows is attenuating.
Under the Obama administration, the US waged financial warfare against Iran, imposing sanctions on Iranian individuals and entities, and banning Iran from the U.S. Fedwire payment system. So Iran switched to selling its oil for Euros and transacting through the international SWIFT payment system. Next, the US leaned on its SWIFT partners to ban Iran from using that system. This measure was effective, cutting off Iran from its major source of hard currency through oil sales. There was a run on Iranian banks, interest rates rose to 20%, and the Iranian rial collapsed. US dollars were smuggled in through Iraq while gold and consumer goods were smuggled in through Dubai. (The Obama deal in 2015 eased pressure on Iran, only to be reversed by the Trump administration. Iran is again under pressure.)
But how effective will such sanctions and “de-SWIFTing” measures be in the future? Russia has already created an alternative to SWIFT (the System for Transfer of Financial Messages) that is growing in use. China has created the China Interbank Payment System. These competitors to SWIFT will grow in use and compatibility, seriously limiting the US ability to wage financial warfare. The technology for digital currency and payment messaging is not difficult, and the distributed ledger technology used by cryptocurrencies helps to solve many of the Trust issues in information networks. So the outsized influence that the US holds over SWIFT cannot last indefinitely.
Likewise, in terms of trade, consider the example of Iranian oil - the US has no effective mechanism to stop China from buying Iranian oil, which gives the Iranian regime a substantial lifeline. Financial operations and trade mechanisms will be insufficient to ensure US economic security in the future. Both the United States “stick” (trade and financial enforcement mechanisms) and “carrot” (access to its large consumer market) are becoming weaker and weaker.
There is a common assumption in the United States that debt and other financial obligations have built-in coordination mechanisms (negative enforcement protocols and positive economic growth externalities). Likewise, the US and its allies are operating under the assumption that mutual gains to trade and increasingly complex multilateral expectations will lead to global cooperation. But these assumptions are built - whether it is acknowledged or not - on the monopolization of the use of force (US military).
The former US economic security paradigm resulted in a brilliant global market structure for over 60 years. However, the US military now sees that structure as a threat to its ability to operate in its traditional security capacity. There are many arguments for why (Clinton allowing China into the WTO, collapse of Soviet Union putting undue pressure on the US market, etc), but regardless, Trump is introducing the world to the new economic security paradigm.
The Trump Administration recently released a list of 35 “critical minerals”, including uranium. The US is 100% import-dependent for 14 of the minerals and 50% import-dependent for 16 of the minerals. It has already taken action on aluminum and steel, and probably will soon on uranium. The US is taking concrete steps to secure supply of strategic raw materials. This author would encourage US allies to consider that these efforts, while protectionist in nature, may be an effort to grapple with the new economic security paradigm, not necessarily a response to the complaints (or inefficiencies) of domestic producers.
From the beginning of the Trump presidency, this author has viewed the Trump administration as essentially a military operation. The move into politics by the US military, albeit behind the scenes, started in 2013 when the military made a public rebuke of the Obama team for its actions in Syria. Obama retaliated by reshuffling the military’s officer ranks.
What then are the intentions of Trump and the military? Secretary of State Mike Pompeo (who himself is deeply embedded in the US military establishment) said in a recent foreign policy speech that the Trump administration seeks to build a “new liberal order”, an “open, just, transparent and free world of sovereign states.” This mention of ‘sovereign states’ speaks directly against those elements in the US and European elite who are trying to build a world based on the primacy of multilateral institutions.
If and how that “new liberal order” is built remains to be seen, but US allies should consider that it may be an honest effort on the part of the Trump administration that ultimately originates from the national security establishment itself, particularly its oldest and original elements that are most loyal to America’s founding principles. If Pompeo is speaking honestly, actions by the Trump administration to reformulate American economic security are not necessarily isolationist in nature, but are attempts to grapple with a new security environment.