260. Study Prepared by the Ad Hoc Inter-Agency Group on Critical Imported Materials1
CRITICAL IMPORTED MATERIALS: STUDY OF AD HOC GROUP ESTABLISHED BY NSSM 197/CIEPSM 33
The action of a number of oil exporters in limiting supplies, embargoing shipments, and driving up prices has raised the question of the extent to which consuming countries are exposed to the effects of similar collusion among exporters of other critical materials. The recent tight supply situation for energy, food and many raw materials has also prompted a more general concern—that we may be passing from an era of abundant supplies into one of constant shortages.
The objective of the United States at stake in these concerns is an adequate supply of critical imported materials (non-fuel, industrial raw materials) at reasonable cost. The purpose of this study is, then
- —to assess the potential threat posed by shortages of critical materials in general and supply manipulation in particular;
- —to evaluate the prospects for achieving our objective of steady, adequate supplies at reasonable cost;
- —to indicate what actions the US might take, individually or with other countries, to improve these prospects;
- —to re-examine our planning guidance for the strategic stockpile in light of the current climate of raw materials trade.
Our Import Dependence
US import dependence on critical industrial materials, other than fuel, is modest—about 15% of our consumption, compared to 75% for Europe and 90% for Japan. Our dependence is concentrated on developed countries, particularly Canada, Australia and South Africa, with Canada alone supplying half our needs.
While our supply prospects are not centered on developing countries, these countries are significant suppliers to the United States of bauxite, manganese, tin and natural rubber. We rely on the USSR for [Page 899]significant amounts of two key materials—platinum metals and chromium.
Where We Are In Terms Of Trends and Cycles
Some raw materials prices have been on a rising trend for 10 years. The stronger pattern, however, is the historically cyclical movement of raw materials prices in response to the business cycle. The surge of industrial materials prices in 1973 was accentuated by a rare simultaneous business expansion in all major industrial countries, soaring speculative buying in response to inflation, currency fluctuations and shortages—real and imagined—and serious production problems for some metals. Since industrial growth has slowed, mineral prices should now level off and decline by 1975. Over the longer term, the best bet is that real prices of many minerals will decline further by 1980.
Natural Scarcities—We do not face risk of exhaustion of world reserves of critical materials within the period we can foresee, through the end of this century.
Embargoes—Basically, embargo actions do not make economic sense in terms of revenue objectives of producers of critical materials. Economic interest argues for selling at a high price, rather than denying the product altogether. An embargo is therefore likely to be undertaken only for political reasons. A realistic scenario for an export embargo by producers that would advance their political interests is hard to identify outside the oil field. A remote possibility is an embargo by Black African states against industrial countries with economic relations with minority regimes in Southern Africa. Such a move would affect primarily Western Europe.
Cartels—True cartels (combines which regulate amounts marketed) are not the heart of our problem. They have been rare in the minerals field and virtually all unsuccessful because of conflicting producer economic objectives and substitution of other products by consumers. Some producers of a few minerals have attempted to maintain a producer price, but awareness of long-term supply and demand responses has generally deterred large and precipitate price increases.
Greater Processing in Exporting Countries—The trend toward greater processing of materials in exporting countries will continue, but this does not conflict with our objective of adequate supplies at reasonable cost. In one significant respect this trend increases our flexibility, since processing here ties us to specific grades and sources of ore—for example, Jamaican type bauxite and Rhodesian and Soviet metallurgical chromite. The next stages of processing, however—e.g., alumina, ferrochrome—tends to be a more standard product our industry can obtain from a wider range of sources.[Page 900]
Supply disruptions from events other than embargoes present greater risks for us than embargoes. There is a possibility of disruption of supplies from Rhodesia as a result of internal disorders, and a more remote one in the case of South Africa. This would seriously affect US, European, and Japanese imports of two critical materials—platinum and chromium. There is also a possibility of sudden changes in export availability of these two materials from our other major supplier, the Soviet Union, because of our limited advance knowledge of political and economic factors determining its export plans.
Exorbitant Short-term Price Increases—The fact or prospect of exorbitant short-term price increases is the most likely form of producer government intervention that would affect US interests in adequate supplies at reasonable cost. Two factors in particular have increased concern that minerals exporters might start taking maximum advantage of short-term leverage
- —government regulation or actual control of production facilities has increased, raising the prospect of larger interjection of economic and political objectives beyond those of private companies;
- —the financial bind of higher oil import prices has created the risk that some mineral-producer governments, particularly in developing countries, may feel themselves under pressure to adopt a strategy of short-term revenue maximization for their materials exports. Concern over longer-term loss of market share, substitutions and lower revenues could be given lower priority under the pressure of imminent inability to pay for vital imports.
We distinguish two forms of producer action, involving exorbitant short-term price increases, to which we have assigned necessarily imperfect labels.
- Price Gouging: Because only modest changes in either demand or supply conditions can be expected in the short run, a key commodity producer can take advantage of a tight supply situation and raise prices exorbitantly. This happened in the case of Jamaican bauxite and Moroccan phosphate. How long this price gouging can be sustained depends on the length of time required to bring forth new production, reduce consumption or adapt to substitutes. This can take from a few months to several years depending on the commodity. Whatever the timing, the price gouger will soon have to restrict supplies if he wants to maintain his price.
- Cartel-like Action: There is also the possibility—but no current example in the minerals field—of an exorbitant administered price increase by one or more key producers supported by actual supply restrictions. This cartel-like action is exemplified in the recent OPEC price moves which were combined with the OAPEC supply restrictions. How long such exorbitant prices can hold depends mainly on alternate supplies and the will of the producers to restrict sales.
Although the market works over time there are some short-term (up to 3 years) costs to the US and world economy of price gouging and cartel-like action. The cost may be greater than absolute figures indicate because
- —the action tends to come at the peak of the business cycle when marginal inflationary pressures are most troublesome;
- —the resulting price increase may spread to substitute materials;
- —success in imposing a short-term monopoly price may prompt the initiating producer to press for the longer-term collusive restriction of supply by other key producers that is required to sustain the short-term price;
- —the signal of the temporarily higher price may stimulate costly investment in high cost alternate sources, with subsequent sacrifice of this capital or pressure to protect it from lower cost sources of supply.
US Vulnerability to Supply and Price Related Actions for Specific Commodities
We have reviewed 19 major industrial raw materials in world trade to assess (1) the prospects for price gouging and cartel-like action; (2) identifiable risks of supply interruption; and (3) the impact of any prospective action on the US economy and national security. Weighing these factors we find significant vulnerability in:
Bauxite—Over the medium term, Jamaica's 7-fold increase of its bauxite revenues may be unsustainable, in that several other producers (Guinea, Australia, Brazil) are anxious to expand their production and market shares and can produce vast amounts of bauxite and considerable alumina at prices well below the new Jamaican one. But for two years or so the US may have no choice but to pay the "short-term monopoly" price.
Platinum—Surging demand, producer leverage and lack of substitutes in important industrial processes create an opportunity for price gouging. Moreover, a remote supply interruption potential exists.
Chromium—With no substitute for high-grade chromium in making stainless steel and supply potential concentrated in Southern Africa and the USSR, a potential for politically-related supply interruption exists, and of price gouging through tacit cooperation among major producers.
Some risk exists with regard to a few of the other 16 materials examined. Under currently foreseeable circumstances, however, market forces, with all their imperfections, appear adequate to deter price gouging or cartel-like action for all 16 materials.
For none of the critical materials would the economic effect of price increases approach that for oil in 1973–74. Our petroleum imports amounted to $7.5 billion in 1973, or 11% of our imports, compared to $0.7 billion (about 1%) for iron ore, the most important critical industrial raw material outside the energy field. If oil prices and the import [Page 902]volume remain constant throughout the year, our oil import bill will increase $16 billion, causing nearly a 25% hike in our overall import cost. A similar price increase for iron ore would raise our overall import cost by only 2%.
The domestic impact of higher oil prices is also much greater in part because crude oil accounts for so large a share of the cost of petroleum products. For example, the recent almost quadrupling of crude oil prices increased gasoline prices by about 40% and the price of less taxed petroleum products such as fuel by even more. By comparison, a similar increase in iron ore prices—which is not likely within the foreseeable future—would result in a 13% increase in steel prices.
US Strategic Considerations
The degree of supply restriction entailed in price gouging or cartel-like action would have little effect on US defense, because the portion of US consumption of critical materials required for defense production—generally 10–20% in the event of war and about half that much in peacetime—can be met under any foreseeable restrictions of this type.
Meeting Current and Foreseeable Materials Problems
(Alumina/bauxite, platinum, chromium)
Given the limited extent—three materials—of the identified significant risk for price gouging, cartel-like action or supply interruption, the first question for US policy is whether a specific US program response, involving new legislation and expenditure, is warranted at all.
Option 1–A: No New US Government Program: Submit no new legislation; indicate that thorough review has revealed limited likelihood of injury to the US from supply and price manipulation; continue all planned stockpile disposals leaving it entirely to the private sector to stock bauxite/alumina, platinum and chromium.
Alternatively, the Government could informally halt stockpile disposals of alumina, bauxite and platinum and limit releases of chrome to maintain flexibility to seek authority in the future to use these for economic purposes.
This approach would arouse no new public concerns, such as Rhodesian supplies, while maintaining some protection against the identified risks. But it is not a convincing demonstration that the extent of US vulnerability has been pinpointed and dealt with; therefore, it is not likely to allay existing concerns or help break the Congressional/Administration stalemate over the role of the US strategic stockpile.
- Option 1–B: Develop explicit Administration program to deal with a specific, if limited problem, including legislation on a Government economic [Page 903]stockpile, or alternatively Government incentives for larger private stockholding; release the results of Government analysis of critical import problems as supporting material; use available USG financing instruments to promote diversification of our sources of problem materials; create an interdepartmental body to monitor critical imported materials problems. (Specific elements of such a program are treated as separate sub-options.)
This approach may best allay concerns by maximizing public and Congressional exposure to the facts and providing clear authority to protect against the limited risks identified. But the program is necessarily a modest one and an actual bill could attract Congressional and industry efforts to add a list of materials where increased stocking at government expense would serve only commercial interests.
Elements of a possible US program are considered below.
Where there is significant potential for price gouging (bauxite/alumina, platinum, and perhaps chromium), the US could seek to deter it or reduce its effectiveness by maintaining an economic stockpile of the materials in question or by providing financial inducements for industry to stock greater amounts of these materials. An economic stockpile of chrome and platinum would also effectively protect critical segments of US industry (steel, petroleum refining, fertilizer, automobiles) from temporary disruption of these supplies for which substitutes are not available.
Amounts of alumina/bauxite, platinum and chromium currently in US stockpiles and in excess of current strategic stock requirements provide the physical material for economic stockpiles. However, specific legal authority would be required to maintain and manage a US economic stockpile or to provide government incentives to private firms to hold greater stocks.
Option 2–A: A US Government Economic Stockpile: Submit legislation giving the President authority to maintain and operate an economic stockpile for such critical imported commodities as he may from time to time determine necessary to safeguard the domestic economy. Transfer to the stockpile as its initial capital the amounts of bauxite and alumina (together) and platinum, which are currently in this US stockpile and excess to strategic stockpile objectives plus an amount of chrome equivalent to a one-year supply from Southern Africa. Increased capital to acquire other commodities would be subject to appropriation or legislative transfer of further excess strategic stockpiles.
Government stocks, if promptly releasable, could serve to deter price gouging and cartel-like action and provide long-term protection against the risk of interruption of supply for platinum and chromium. [Page 904]But the distinction between price gouging and normal price movements will be a hard one for the government to make. We would be foregoing $320 million in eventual budget receipts from sale of these materials and would incur carrying costs of about $400,000 annually.
- Option 2–B: Government Contracts with Industry to Provide Financial Support for Larger Industry Stocks of Selected Materials: As an alternative to direct government held stocks, encourage private industry to hold increased inventories of the same commodities as in 2–A by seeking authority to provide assured recoupment of out-of-pocket costs. This could be done by inviting bids for specified quantities of selected commodities or by requiring specific percentage over-stocking levels of all producers at negotiated fees.
- Option 2–C: Provide a Tax Incentive in the Form of a Deduction of a Percentage of Raw Inventory Costs for alumina/bauxite, platinum and chromium materials to US industry to encourage greater stocking of these raw materials.
These forms of government incentives for larger industrial inventories of the problem materials would be less costly than a government economic stockpile and avoid government involvement in difficult decisions on timing of acquisitions and releases. But the government would have limited control over the purposes for which inventories were used, particularly price speculation as opposed to protection against disruption.
Diversification and Increased Production
Action on any of the stockpile options discussed above should logically be combined with longer-term measures to change the underlying conditions of short supply and concentrated producer leverage which make price gouging and cartel-like action possible and a supply cutoff from South Africa so potentially costly.
For bauxite and alumina, the prospects for diversification are bright. Guinea and Australia have substantial potential to expand production through new investment. Brazil, presently a minor producer could well become a major one. Brazil also has substantial reserves of chrome and the possibility of production for the US market should be explored. There are no current prospects for new sources of platinum.
Export-Import Bank financing and OPIC (Overseas Private Investment Corporation) insurance could play a role in diversification efforts. US support for an active World Bank role in minerals development in LDCs would help increase supplies generally. (See Options 3–A—3–C.)
Since we will necessarily continue to rely on foreign sources of alumina/bauxite, platinum and chromium for many years to come only more competitive conditions in international markets can eliminate the [Page 905]potential for price gouging, cartel-like action or supply cutoff from a major source. The US does have abundant reserves of aluminum bearing materials, but industry is not likely to make the substantial capital investment to develop these resources unless confident that bauxite prices will rise further and remain high (which is not a good bet) or that its investment will be insulated from competition with alumina/aluminum made from cheaper foreign bauxite.
Improving US Capability to Deal with Problems in Other Materials that May Arise in the Future
For the materials examined, other than the three discussed above, the international market seems likely to meet our requirements at reasonable cost for the foreseeable future, but there is no assurance that several years from now some different conclusions may not be warranted. Our capability to react could be improved.
US Government Organization
The US Government currently has no central system to monitor critical materials developments and to bring new problems to the attention of policy makers. The capacity for this oversight and analysis is there, but it is not brought together and focused on safeguarding the specific US objective of adequate supplies of imported critical materials at reasonable cost.
One way to improve the ability of the US Government to oversee raw materials problems would be to establish a standing interagency body on critical imported materials problems, with a very small secretariat staff. In the event we establish an economic stockpile, such a body would be needed to provide guidance to the stockpile managers as well.
Option 4–A: Establish a Standing Interagency Body on Critical Imported Materials Problems supported by a small secretariat staff, and under the aegis of one of the existing cabinet level policy-making councils in the foreign affairs area (NSC, CIEP).
Various solutions are possible for the chairmanship of the body and location of the small secretariat staff on the one hand, and the policy-making council for action on major issues developed and staffed out by the interagency body, on the other hand. In any event, State, CIA, Treasury, OMB, Commerce, Interior, GSA, DOD, and STR would have to be represented, and active, in supporting the work of the interagency body on critical imported materials.
- Option 4–B: Augment the analytical and monitoring capacity of one of the executive departments (State, Interior, Commerce) with specialists in imported materials policy—domestic and international. This department would be responsible for furnishing periodic reports to the [Page 906]President and other agencies on current and potential critical materials problems requiring government decision.
Both options would clarify responsibility for monitoring and be flexible enough to reflect greatly varying requirements over time for decision making in this area, but the Congress may expect more ambitious structures. An interagency body provides broader perspective, but perhaps less continuity.
US flexibility in responding to imported critical materials problems that may arise in the future would be increased by additional research on finding new mineral deposits, mining and treating low-grade ores and reclaiming and recycling scrap material. (See Options 5–A—5–F.) Over the long-term (5–15 years) our efforts to assure access to seabed resources involve significant additions to world reserves of manganese, nickel, copper and cobalt.
The Bilateral Dimension
Canada is by far our most important raw materials supplier. Of the critical imported materials considered in this study Canada is our largest single supplier of iron ore (50% of our imports), nickel (82%), zinc (68%), lead (29%), tungsten (61%), copper (31%) and mercury (59%).
It might be useful to explore further the costs and benefits of a sectoral trade liberalization arrangement with Canada, within the context of multilateral trade negotiations.
The United States, through reduced or eliminated tariff barriers, could provide Canada expanding opportunities for selling processed forms of raw materials. In return, the United States would be given assurance of access to specified Canadian raw materials (both in un-processed and processed form) at the same price as Canadian consumers. Such an assurance would be one possible form of a Canadian undertaking not to restrict exports by direct controls, export taxes or other measures, all of which would tend to introduce a two-price system. We would be consciously moving to rely increasingly on Canadian processing industries and requiring in return assured access to Canadian processed and raw materials for our industry.
Two other ambitious minerals producers, Australia and Brazil, will be increasingly important in world minerals production—a factor which should be reflected in our bilateral relations with these countries.
The Multilateral Dimension
Our long-term strategy should have a multilateral dimension to encourage constructive and non-divisive international consultation and rule-making in the field of raw materials supply. Elements of such an approach could include: [Page 907]
- Consultations in the OECD and elsewhere with Europe and Japan on critical imported materials problems. Our reading argues for quiet consultation in an existing forum, because 1) we wish to allay rather than reinforce concerns; and 2) an ad hoc review of critical materials problems could shift the emphasis to agricultural trade—where the US would be the target of European and Japanese concerns on prices and security of supply.
- Strengthening of existing GATT provisions on exporter obligations. In connection with preparations for multilateral trade negotiations US agencies are now considering possible new GATT provisions regarding supplier obligations. Over the longer term new international rule making in this area could be helpful in developing a greater sense of supplier country responsibility and subjecting their actions to structured international scrutiny.
- A more constructive US tilt in favor of consumer/producer dialogue—as a mild counter to increasing pressure for producer-only groupings.
Implications for Strategic Stockpile Guidelines
The results of this study indicate a few limited adjustments in strategic stockpile guidelines which may be desirable.
Our present stockpile planning assumption that supplies will be available during a conflict from Rhodesia and South Africa does not allow for possible disruption from internal disorders. Moreover, stockpile planning guidance states that stockpile levels should support requirements during the first year of a war without significant civilian austerity. However, at the level of current strategic stockpile objectives, there would be an imbalance in supply and demand at the end of the first year for a few materials for which substitutes are not available. Thus, larger stockpiles or a further degree of austerity may be necessary in order to balance supply and demand for bauxite, chrome, platinum and manganese.
- Option 6–A: Clarify Supply Source Reliability by having the Secretary of State issue instructions to stockpile managers on reliability of sources. If Rhodesia were removed from the list of reliable sources, the strategic stockpile objectives for the first year of a war would be increased by about $14 million of chrome; if South Africa were treated similarly, an additional $76 million would be added (consisting of chromium, platinum, manganese and vanadium).
Option 6–B: Provide for Requirements Beyond the First Year by adjusting stockpile levels to assure adequate supplies at a specific degree of austerity for the period required to bring supply and demand into balance.
To support per capita consumption at pre-war levels for bauxite, chrome, manganese and platinum until war time supply and demand [Page 908]could be squared or for three years, the stockpile would have to be increased by about $183 million.
- Option 6–C: Clarify "Significant Austerity" to specify the level of per capita consumption of the specific commodities which would be acceptable after the first year of a war. If consumption were set at 85% of pre-war levels, the additional stockpile required would be about $51 million vice $183 million.
If Rhodesia were excluded from the list of reliable sources and it was decided to support requirements for bauxite, manganese, chromite and platinum at pre-war per capita consumption levels up to three years, the total addition to the strategic stockpile would be about $238 million. These implied changes in strategic stockpile levels are moderate, but action on them could demonstrate that requirements have been reviewed and adjusted in light of current conditions.2
[Omitted here is the body of the study.]
- Source: National Archives, Nixon Presidential Materials, NSC Files, NSC Institutional Files (H-Files), Box H–203, National Security Study Memoranda, NSSM 197 [2 of 3]. Confidential. This study was prepared in response to NSSM 197, Document 255. Sent to Kissinger and Flanigan under cover of a July 11, 1974, memorandum from Lord.↩
- On July 26, Eberle and Scowcroft requested agency clearances, comments, and recommendations on this study. (Ibid.) On August 2, Yeutter sent Eberle a memorandum clearing the study on behalf of the Department of Agriculture. (Ford Library, National Security Council, Institutional Files, Box 13, Senior Review Group Meeting, 9/4/74—CIEP—Critical Imported Materials Study (NSSM 197)) In an August 8 memorandum to Scowcroft, Acting Executive Secretary of the Department of State Samuel Gammon wrote: "The Department continues to endorse the options presented in part IV of the subject study as appropriate for further consideration for the purpose of determination of an Administration action program." (National Archives, Nixon Presidential Materials, NSC Files, NSC Institutional Files (H-Files), Box H–203, National Security Study Memoranda, NSSM 197 [3 of 3]) On August 9, Deputy Secretary of Defense William Clements wrote in a memorandum to Scowcroft and Eberle that while his Department cleared the study's options, it was concerned about "the long-term strategic implications of the trends toward dependence on foreign production of finished products and processing of raw materials." (Ibid.) In an August 10 memorandum to Eberle, Stein wrote that the CEA objected to neither the study's analysis nor its conclusions and favored Option 1–B. (Ford Library, National Security Council, Institutional Files, Box 13, Senior Review Group Meeting, 9/4/74—CIEP—Critical Imported Materials Study (NSSM 197)) On August 29, Dent wrote in a memorandum to Scowcroft that the Department of Commerce was "in general agreement with the analysis and findings of the study" and that it supported Option 4–A. Commerce's views on the study's other options were offered in an undated attachment. (National Archives, Nixon Presidential Materials, NSC Files, NSC Institutional Files (H-Files), Box H–203, National Security Study Memoranda, NSSM 197 [3 of 3]) Treasury Department comments are printed as Document 261.↩