The Iranian Connection

Why the US sanctioned Russian metal now

The views expressed herein are the author's alone. First published 14 April 2024.

To understand the likely impact of the US’ recent decision to sanction Russian aluminium it is important to understand why this was done now and what the US hopes to achieve. This can illuminate what risks were weighed up in taking the decision and the possible outcomes. It also helps to estimate the possibility of a miscalculation.

In our view the move to sanction Russian metal is directly linked to Iran’s decision to launch drones against Israel last weekend. The two happened almost simultaneously. We believe the US administration was likely pushing for a de-escalation and when this was seen to be impossible they punished Russia, who they see as responsible for this frustration, in a way they had so far resisted.

Iran launching drones in effect put the initiative for next steps in the ongoing Middle East conflict into the hands of Netanyahu, who in many instances has been no friend of the Democrats. It significantly increases the likelihood of escalation either in Gaza or with Iran in a wider regional conflict in an election year – even if Israel does not immediately respond to the strike.

Therefore, it represents a significant risk to the Democrats as well as an insult to them since they expended considerable political capital under Obama sweet-talking the JCPOA and more recently at the outset of the Ukraine war holding out reintegration and an eventual lifting of sanctions as an incentive if Iran supported the west. As we know, Iran rejected this, throwing its lot with Russia and even supplying them with drones.

The current Iranian decision as well as their complicity in potentially escalating what is an increasingly difficult situation for the Biden administration has, we believe, triggered the swift and unusually severe action by America in the metals market. In doing so the US is punishing Iran’s only friend in the region and the party they see as ultimately responsible, their backer Russia.

The timing is far from ideal. If metals prices were to rise considerably because of this the administration could be accused of recklessly stoking inflation. Last week in particular US CPI data was released which ran hot for the third consecutive month, strongly suggesting that interest rate cuts are not yet imminent. Oil prices also rose last week approaching $90/bbl.

In justification, administration officials have said that many metals markets may well be in “surplus” and so price spikes should be limited. This may well be true – in our view it is true – but it does contradict the view of many paid experts on the sector. It is also unusual for a government to peer into the crystal ball of commodities markets (albeit correctly) and take a position – especially such a consequential one – in this way.

Although the US government may well be right on this issue, both ethically and in their view on supply and demand, it clearly risks introducing more volatility and carries a greater-than-usual chance of unintended consequences.

Instead of stabilising or moderately raising the price of aluminium the LME price could weaken as previously-manufactured Russian metal is delivered into the exchange. Alternatively, and more likely, the rule changes open the door to trading strategies that could result in old metal being taken out of the LME warehouses and a sharp reduction of warrantable stocks in future. This has been reflected in the switch from contango to backwardation in the last few days. Also, the so called "Russian discount" has been narrowing in recent months as the prospect of regulatory action against this metal receded. This discount may now widen massively as it is locked out of the US banking system, causing problems at new points in the supply chain. Previously, as much as 91% of the aluminium in LME warehouses was of Russian origin.

We believe the proponents of Russian sanctions intended to stabilise the price or even see it rise slightly. Nevertheless, given the timing and the background to these sanctions, the possibility of a miscalculation either raising or lowering prices unreasonably should not be ignored. We would put this at least at 25%.

A further area which may see unintended consequences will be the semis and secondary markets. Many semis producers in markets like China, India, Turkey and others rely on the Russian discount to make their business viable. Sanctions of this nature are good for them and can help them price their products more competitively. The banned Russian metal may now flood these markets leading to higher output and putting significant pressure on western suppliers who cannot match their prices. We put the probability of this outcome at 80%.

While we broadly support the action by the US and see it as bringing a degree of moral clarity to the complex situation in the metal markets, and having economic logic in supporting domestic producers from unfair competition, we nevertheless caution against any complacency in underestimating potential short-term economic costs and market dislocation.

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