Newsminute Economics: #5 Nickel and Risk-avoidance

Hi there, I’m Professor Tigger and welcome back to another episode of Newsminute Economics. Today on the show, a crucial issue for all companies is how to avoid risk, especially when the prices get rocky.

In recent weeks, the price of nickel has been shooting up. One extreme example was on March 7th, nickel prices were at $48,000/tonne, and overnight, in the early hours of March 8th, this price doubled. All this trouble got caused by the Russian invasion of Ukraine. And Russia produces a fifth of the world’s purest nickel. So it was a hit to the nickel market as countries reacted, enraged. The LME (we’ll get into that later) then suspended trading in nickel, judging these prices no longer reflected the underlying physical market, fearing more misfortune approaching if the market continued unmonitored.

In this episode, we’ll look at one strategy used by the Tsingshan Holding Group to avoid the above kind of risk. Tsingshan is one of the biggest nickel and stainless steel manufacturers in China. It also occupies most of the nickel mines in Indonesia. Recently, though, the company has been short-squeezed, but before we get into how it got into that position, I should first briefly explain the nickel market.

There are two mined types of nickel. One is sulfide ore, mined in South Africa, Canada, etc. That could get refined into a high-matte nickel, the latter of which can make an electrolytic nickel and nickel sulfate. The first one has a 99.8% purity standard and can get used to making stainless steel. The second one could make lithium batteries, like those used in Tesla cars.

There is also an alternative to sulfide ore, laterite nickel, mined in Indonesia. Laterite nickel can produce nickel-cobalt hydroxide, an intermediate product, which could get refined into nickel sulfate. Laterite nickel could also make nickel-iron, which can also make stainless steel. Meanwhile, nickel-iron can also get used to producing high matte nickel, completing the entire nickel loop.

Because Tsingshan operates this entire supply chain, if the price of one nickel type went down, it could result in the price of others coming down too. For example, if sulfide ore dropped in price, it would impact high matte nickel and nickel sulfate. That could potentially impact the prices of stainless steel and lithium batteries. Tsingshan knows this risk, so it tries to offset that risk using a strategy, hedging.

In this game of prices, the seller is Tsingshan Holding Group, and the buyer is Batty Inc. (this company doesn’t exist, but it’s the first thing I could think of and does the job as an example). Tsingshan supplies the nickel, while Batty Inc., which makes batteries, buys the nickel. Batty Inc. doesn’t want to buy now. Instead, it wants the nickel in the future. Let’s say that today is April 1st, and the price per tonne of nickel is x, but the transaction date is October 1st. In these months, the price could change, either lower than x or more. This strategy works because the chances that the price would stay the same is slim since, as I have said before, one slight dip in one part of the market could result in the other parts crashing down. Both sides know this and want to avoid the risk as much as possible. Here, a third party comes in, the London Metal Exchange(LME), which acts as the middle-man.

Here’s how it works. Tsingshan agrees to give y amount to Batty Inc. while Batty Inc. will pay Tsingshan z dollars (here, we’ll presume z is about the current price). Let’s say that in the six months before the transaction date, the nickel price rises. What would happen in such a scenario? In this case, the LME would require Tsingshan to pay a certain amount of money as a mortgage. That’s because there’s a chance that Tsingshan would forfeit the deal. Tsingshan could only sell to Batty Inc., as said on the agreement, at z dollars, while the company could sell the same nickel for a higher price on the current market, thereby profiting more. If there was a mortgage at the LME, the chances that the seller (Tsingshan) would still forfeit the deal get lowered since they would lose money. If they still comply with the agreement, then the money in the LME would get returned.

What if the opposite happened, and the price went down? Well, in that case, Tsingshan would benefit since, on the market, they would have to sell at a lesser price than z, but Batty Inc. must buy at the agreed z price. In that case, the LME would have to charge Batty Inc. to ensure that they wouldn’t forfeit and buy on the local market instead of from Tsingshan Holding Group. There is a way for Tsingshan to directly get the money at the LME without giving the nickel to Batty Inc. That is to have a new agreement between the two companies and scrap the old one. Tsingshan wouldn’t give the nickel over to Batty Inc., and Batty Inc. wouldn’t pay the money for the nickel to Tsingshan. However, the catch is that the cash at the LME would get given to Tsingshan. If not, then Tsingshan could have used its advantage over Batty Inc. to gain more profit. But they forfeited that opportunity.

In economics, there’s the term “opportunity cost.” In our example, the nickel Tsingshan had would have been sold to Batty Inc. at a higher price than on the current market. But if you can’t wrap your head around that, here’s another example. Suppose that you’re a baker. You could either bake cakes or bake biscuits. Biscuits cost less time and money, but the profit margin is also less than if you bake cakes. Cakes take five times the time and money to make than baking biscuits, though the profit margin is higher too. In this example, if making the cakes’ profit is not five times more than the profit of making five times the biscuits, then making cakes isn’t the most efficient option profit-wise. However, in reality, things aren’t that simplified. It’s not just time and money in the equation but also supply and demand. If no one buys your cakes, you could be better off making biscuits instead, and vice-versa. Another factor that most wouldn’t include would be your happiness. Are you happier making cakes than biscuits?

Anyway, how did Tsingshan get short-squeezed? Continuing on our example of Batty Inc., Tsingshan can’t pay the mortgage, which gets higher and higher as the price of nickel shoots up. When Tsingshan can no longer afford that much mortgage (meaning the LME can’t necessarily ensure Tsingshan would comply with the old agreement), the LME forces the company to scrap the old deal with Batty Inc. and forfeit the money at the LME kept as mortgage. That could mean Tsingshan losing tens of billions of dollars.

From the above examples, you could get the idea that economics could get quite complicated. Oh, and there’s also another hidden risk-lowering tactic within Tsingshan’s operation of the nickel market. It’s not so obvious sometimes, but by operating both the whole nickel production line and manufacturing stainless steel, Tsingshan lowers the risk of not being able to sell out all the nickel, or in simplified words, the risk of the transaction part got offset!

Have you learned new things about the world economy in this episode of Newsminute Economics? I hope you did. If you didn’t, that’s OK because by reading more about the sort, even the slowest learners could understand part of it. And by the way, I wanted to know if the “nickel,” a coin minted and used as official currency in the United States, was made of nickel, the metal. It turns out that the “nickel (the coin)” had a 100% copper core, while it had an outer coating of 25% nickel and 75% copper. It should have been called a “copper,” it contains more copper than nickel! That’s the end of this episode. Thank you for reading. Bye!