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The U.S. Sanction Commodity Shock

Aluminum

The past few weeks have been an extraordinary roller-coaster ride for the global commodities markets. Rocked by concerns that the US could impose new sanctions on Iran in mid-May, saw the price of Brent crude oil rise to $74.74 after French President Emmanuel Macron said he expected Trump to pull out of the Iran nuclear deal. The rise came mere days after the US Treasury’s announcement to consider easing the sanctions imposed on the world’s second largest aluminum producer, Rusal, sent ripples across the commodities sector. As the price for aluminum plummeted, it dragged Brent crude down by 1 percent.

Oil’s fluctuation may not seem like a big deal but it provides a textbook illustration of the risk to which commodities are exposed. The oil price remains the yardstick measure of economic activity, rising and falling depending on the whether the economy is expected to expand or contract. But in the era of “America First”, the United States has turned into a disruptor across global markets of unprecedented magnitude. So when on April 6 Trump imposed sanctions on various Russian individuals and businesses, including Rusal’s owner Oleg Deripaska, the price of oil surged. This price spark signaled the growing expectation that key markets, primarily Europe with its close links to Russia’s market, would be looking at an economic crunch.

And as recent weeks have shown, aluminum has been impacted most directly. The “aluminum sanctions”, in the words of the secretary-general of the International Aluminum Institute (IAI) Ron Knapp, have disruptive effects that are “industry wide and globally damaging”. That is because the extraterritorial nature of the White House’s moves mean that not only Americans are barred from doing business with Rusal. In fact, secondary sanctions can also be extended to any other foreign actors that enable “significant transactions for or on behalf of” the sanctioned entities. Related: What's Behind Today's Cybercrime Explosion?

With that clause, Washington’s unilateral move succeeded in severing aluminium’s global supply chain. Consequently, a commodity analyst described the market as being “in complete shock”. Most of the shock comes from the fact that aluminum, unlike copper or rare earths, was traditionally considered relatively shielded from geopolitical impacts owing to the abundance of bauxite, the raw material used to eventually produce aluminum.

The negative fallout of this is hard to overstate. With the aluminum supply chain now on the brink of collapse, and thousands of companies worldwide in jeopardy of suffering from supply shortages, the push-back against the sanctions is in full swing. At the forefront are the leaders of the European Union, whose downstream industries are highly reliant on Russian aluminum. France, Germany and Italy have been instrumental in lobbying US President Trump to ease the Russia sanctions to alleviate the impact on the EU’s own industries – especially car manufacturing and aerospace industries with their pedigree of small and medium-sized enterprises (SMEs) acting as vital component suppliers.

Italy’s economy relies heavier on the innovative ideas and entrepreneurial spirit of its SMEs than politicians are ready to admit. Together, they are largely responsible for pulling the 2016 record level of almost $29 billion in foreign direct investment (FDI) into the country. Similarly, French SMEs with strong export activities expected a solid positive growth in their business until 2020. Especially companies in the aerospace sector have shown impressive growth numbers. For example, Figeac Aero, a manufacturer of structural parts and engines, has seen an average growth of 20 percent over the last five years.

However, no other EU country is so disproportionally dependent on its SMES as Germany. 99 percent of all firms in the country are unlisted SMEs, employing around 15.5 million people. In 2011, excluding foreign subsidiaries, these companies had a turnover of €2 trillion, thereby outpacing the turnover of the then 30 DAX-listed firms of €1.19 trillion – a number including their international subsidiaries. In light of this economic power, it is not surprising that Germany’s powerful business associations have so far been the only ones to openly speak up and exert pressure on politicians to cut a deal for the German industry.

The German-Russian Chamber of Commerce, for example, quickly pointed out that while the exact size of sanctions-induced damages is difficult to predict, they are expected to cause losses of “hundreds of millions of euros” in the short term, and even “billions” in the long run. At the same time, another association that combines 655 metals firms called WirtschaftsVereinigung Metalle, cautioned that the sanctions could result in several of Europe’s aluminum smelters to close down.

Furthermore, aluminum companies have already clarified that establishing new trade connections and certifying alternative suppliers will take a long time, especially when they are from China. The consequence is that there might not be enough alumina to keep the smelters running. In full effect, it is estimated that the sanctions could obligate European aluminum producers to cull up to 20 percent of all primary aluminum operations – a worst-case scenario that is both costly and difficult to reverse.

Related: Why Goldman Loves Commodities

However, Europeans are not alone in their desire to see global aluminum trade flows restored. The American domestic aluminum industry itself has been rather outspoken about what Heidi Brock of the Aluminum Association scathingly referred to as government policies that “do not recognize the importance of mid- and downstream markets”, which are causing “significant financial and labor impact”. Tesla, America’s flagship electric car company, warned in its recent annual report that the lack of aluminum will increase manufacturing costs, stating that its “operating results, business and prospects will be harmed."

The fierce criticism coming from both sides of the Atlantic suggests that the respite granted for Rusal by the Treasury was greeted with a sigh of relief. Yet any bounce-back can only be temporary. As long as no solid political solution to the conflict between Russia and the US is found, commodity markets will remain jittery as uncertainties remain in this era of geopolitical volatility.

By Christopher Stakhovsky for Safehaven.com

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