Don't Look Away from the Nickel Crisis

The West will find it difficult to sanction China economically the way they did to Russia because China has already owned so many business interests in our backyard.

The price of nickel in one year

Geopolitical events often have unintended consequences. Last week, while all eyes were on the ongoing Ukraine crisis, the London Metal Exchange (LME) did something unprecedented in its 145 years' history. It shut down its nickel trading market for days and canceled contracts worth billions of dollars so that a Chinese tycoon wouldn't suffer enormous financial losses.

I chose to write about the nickel crisis for three reasons: it is an underreported story; the situation has profound impacts on economies and geopolitics worldwide; it reveals China's overseas influence and how it has shaken the foundation of capital markets. It is a complex story to explain, so please bear with me. 

The LME was founded in 1877, but the market traces its origin back to 1571 when the Royal Exchange officially opened. The LME is one of the world's largest commodities exchanges that trade base metals such as copper and nickel through futures, forwards, and options contracts. 

Here's a quick primer about these future-oriented financial contracts. They have expiration dates and set prices of underlying assets upfront so that traders can lock in prices of the underlying asset in advance. These contracts, when used properly, serve as a hedging tool and provide market stability.

Investors of these financial contracts are not required to put up 100% of the contract's value when entering a trade. Instead, they can make big bets of the price movement by initially committing a small fraction of the total contract value, which is called an initial margin amount. Large banks often serve brokers/intermediaries between traders and the exchange.

Such highly leveraged trading can amplify gains as well as losses. The exchange requires each trader to keep a maintenance margin, a minimum amount of cash or securities deposited with their broker's account. At the end of each trading day, exchanges will calculate each trading account's paper gain or loss (a process is called mark-to-market).

When the investment value of an account drops below the maintenance margin, the exchange will make a margin call to the broker, who will then demand the investor to deposit additional money or securities into the account to bring the account value to the maintenance margin. If the investor fails to pay, he must close his position and turn his paper losses into actual losses. If the loss is significant enough, the investor may file bankruptcy. Investing in futures and options is not for the faint-hearted.

Now let’s talk about nickel, a base metal used to produce stainless steel and electric-vehicle batteries. Russia supplies about 10% of the world’s nickel and controls about 20% of the global supply for EV battery-grade nickel. Next to Russia, China is a significant supplier of low-grade nickel. Chinese companies developed the technology to make electric-vehicle batteries with low-grade nickels, but their manufacturing processes have generated excessive waste and greenhouse gas emissions. Still,  China “dominates the supply chain for electric-vehicle batteries, controlling 80% of the world’s raw-material refining, 77% of battery-cell capacity, and 60% of component manufacturing.”