Russia Can Hit Back With Resource War
This week, heads of 28 nations gather in Newport, Wales, for a NATO Summit described by a former NATO military commander as “the most important since the fall of the Berlin Wall.” In the face of increasing Russian military action in Ukraine, NATO leaders will discuss what mix of tools, including new and stricter sanctions, would cause the Russian leadership to rethink its Ukraine policy.
Today’s headlines don’t tell the story, but in spite of the tumult in its eastern regions, Ukraine finds itself on the path of integrating itself into the so-called Deep and Comprehensive Free Trade Area with the EU - even as its government and private sector have to look ahead for ways to sustain commerce with its eastern neighbors.
Recent news stories highlight the impact of trade sanctions on the economies of Russia and Europe, and to a lesser extent the United States. What’s often overlooked is the potential exposure of Western economies to Russian counter-sanctions in the resource sector.
For the American economy, the emerging energy bonanza makes the U.S. less vulnerable to the vagaries of the pipeline disputes than our European partners. And yet one area where U.S.-based manufacturers have to hedge for increasing risks is in the global metals markets that are susceptible to disruptions of Russian supplies due to disputes, sanctions and retaliation cycles.
According to Daniel McGroarty, writing in RealClear World,
Boeing and United Technologies are now “stockpiling” – buying excess inventory – of the aerospace-grade titanium they need for airframes, from their major supplier in Russia. Sanctions jitters are beginning to drive up the costs – and shrink supply – of not just titanium, but Russian copper, nickel, and perhaps some of the niche by-product metals produced while extracting those base metals.
They’re not the only ones who should be worried. Even before the Russia-Ukraine crisis, the G20, of which Russia is still a member, warned that
“in the near term, policymakers need to deal with the macroeconomic consequences of high and volatile commodity prices, including inflationary pressures and real income losses, which tend to be especially severe in lower-income commodity importing countries. Over the longer run, the key issue is to ensure that commodity supply growth keeps track with the needs of a growing and more integrated global economy. Meeting this challenge is a precondition for sustained improvements in economic and social welfare worldwide.”
In other words, the conflict over Russia’s interference with Ukraine’s economic and political choices threatens to fracture the global markets by delivering a supply shock to many economies. While it is encouraging that Russian President Vladimir Putin has met with Ukrainian President Poroshenko and relevant EU Commissioners to discuss trade, Russia is running the risk of talking itself into a severe case of resource nationalism, which will hit metal markets in the most immediate way. Never far away, resource nationalism is yet again ranked as a top 5 risk to global mining industries.
The world is well aware of Russia’s oil and natural gas production, and the deep dependency many European nations have on Russian energy supply. But arguably Russian non-ferrous metals will be much more difficult to replace in supply chains of major manufacturers. Despite years of underinvestment and collapse of most R&D financing, last year Russia was the world's largest producer of chromium, nickel and palladium, and has the most iron ore reserves. It is the second largest producer of aluminum, platinum and zirconium. Russia also mines a significant amount of cobalt, copper, gold, manganese, niobium, REE, silver, titanium and vanadium.
According to the School of Russian and Asian Studies, Russia also produces 41 percent of the world's palladium (used in everything from catalytic converters to electronics to dental equipment), 8 percent of the world's cobalt (essential in the construction of space craft and turbine engines).
In the IMF’s August 2014 commodity price report, the signals are worrisome. Copper was up 3 percent in the last month, and palladium has skyrocketed 277 percent since 2009.
What would happen if Putin countered Western energy sector sanctions with resource export restrictions of his own? Nickel offers the most worrisome scenario. With Indonesia putting in place an export ban, nickel prices are up 35 percent since the beginning of 2014; even before Indonesia’s action, Russian nickel exports amounted to 23 percent of world consumption. A sanction on Russian nickel exports would eventually end up with customers paying more money for all stainless products.
All of which is a reminder for markets and policy-makers of the indirect consequences of sanctions escalation. Even small disruptions to the fragile EU economy – which is after all a $5 trillion trade partner with the U.S. - can cascade into big problems. Given the West’s low level of reserves of many of the metals supplied by Russia, this should be an area of strategic concern. Recent instances of export restrictions by China and Indonesia, who are both much more dependent on global markets than Russia, indicate how easy it is for governments to disrupt global commodity markets.
The fact of the matter is metals still bind global economies together more than we think. Russia can live without camembert cheese. Can we say the same about titanium, palladium, copper and nickel? NATO’s Wales Summit will be haunted by these global trade concerns.