Bring Commodities Market Regulators into the Critical Minerals Discussion

As the United States works to develop a larger and more resilient supply chain for critical minerals, it will take more than just mines, processing facilities, and strategic stockpiles. A functioning, efficient financial infrastructure to move commodities through the critical mineral supply chain is just as necessary.

The importance of market institutions in the supply chain becomes apparent when things go wrong—when markets create artificial price volatility, end-stage producers and consumers lose. Critical minerals markets have made the news in recent months for volatile and unpredictable pricing, a leading concern not just for U.S. end-stage buyers, such as electric vehicle (EV) makers, but also for private sector investors already reticent to commit to expanding the mineral supply. The lithium and cobalt markets have been particularly volatile in the past few years due to supply chain disruptions, geopolitical instability, market concentration and other factors. For example, in the cobalt markets, Covid-19 created supply chain constraints that affected availability in 2021–2022, and then when supply finally caught up to meet demand in mid-2022, demand shrank amid China’s slower economic rebound.

Critical minerals are commodities such as lithium and cobalt that the United States Geological Survey has put on a list because they “play a significant role in our national security, economy, renewable energy development and infrastructure.” These minerals are bought and sold in the extremely complex and ever-changing world of commodities trading, in which regulators, exchanges, investors and traders, and market intermediaries (such as clearing banks and warehouse service providers) are all key players. Derivatives markets for critical minerals play a crucial role in price discovery and risk management for processors, miners, and EV makers, as well as financiers. Miners might use hedging to reduce the risks associated with price changes for the commodities which they physically possess. Speculative traders profit from price changes and generally do not use the mineral being traded for their own business purposes.

There are a few reasons why commodities markets, as the critical last link in the minerals supply chain, warrant reform.

1. Current markets are unsafe and unsound.

First, the United States currently has low domestic production for many critical minerals, so the soundness of global commodities markets is crucial for U.S. companies, which need to buy them on markets beyond the U.S. regulatory jurisdiction. If the United States had a larger domestic supply and a functioning domestic market for these minerals, issues in the global market would likely be less important. The ability of the United States to set global standards in the space of commodities trading is limited by its footprint. While many major hedge funds and financial players are from the United States, only the Chicago Mercantile Exchange (CME) and the New York Mercantile Exchange (which are themselves both aligned under the CME Group) are large enough to trade meaningful amounts of commodities within the country. U.S. players also have less of an impact because there are fewer physical traders than other parts of the world, as EV materials’ mines and refineries are generally not based in the United States or owned by U.S. companies. In part, this is a cyclical problem related to broader critical minerals policy: because the United States lacks mining and refining capabilities, few U.S. miners and refiners are trading on global exchanges. In short, though, the United States’ ability to ensure that markets stay transparent and open to all relies on its reciprocity with countries housing other major exchanges.

Second, market concentration is generally much higher for critical minerals than for oil and natural gas. This makes market-cornering behavior more likely and harmful to the market ecosystem. China dominates the production of rare earth elements globally, and 70 percent of cobalt mined in the Democratic Republic of Congo is immediately shipped to China for refining. Such concentration can make it easier for dominant players to manipulate price and supply, leading to a vulnerability for end stage users. For example, the China-Japan rare earths dispute of 2010 became famous as a wake-up call for Japan and Western governments of the influence of China’s dominance in the rare earths industry. But China’s refusal to trade with Japan (amid its larger export quota system), over a fishing trawler dispute, also catalyzed a bull market for rare earth elements from 20102011. The discrete, immediate political implications from events like the 2010 embargo often overshadow the longer-term economic implications for the entire trading community. In addition, many of these commodities lacked large-scale commercial applications until a few decades ago. This means that current trading happens on markets that are sometimes immature but are growing rapidly.

Third, commodities today are regularly traded directly in so-called Over the Counter (OTC) deals. The fact that so many critical minerals are traded off exchange creates unique issues for regulators and market participants. Unlike with regulated exchanges, the public does not know who is buying and selling in OTC deals. Because OTC deals are a large percentage of some critical minerals trading, this means that it is often difficult to figure out who owns what commodity. This is a problem because when exchanges and regulators are unaware of who is buying or selling in any given transaction, untrustworthy market participants may be allowed to make risky trades which reduce the integrity of the market.

The private nature of commodities trading also makes it difficult for commodities regulators to foresee major market issues before they happen. For example, in the London Metals Exchange (LME) nickel pickle of 2022, large and lucrative trades were happening off exchange and out of sight of the LME and the UK regulators. UK commodities regulators simply did not know that a high volume of nickel was being held by only a few market participants, such as China’s Tsingshan, and therefore didn’t know that market intervention might be necessary. By the time those positions became clear, the LME was in a lose-lose situation: allowing the trades to go forward meant that some investors lost billions and required shutting off the exchange.

On the other hand, undoing the trades would have likely been even more costly and destructive to the exchange’s reputation and had political knock-on effects for the LME’s owner, the Hong Kong Stock Exchange. If the exchange had been aware of these holdings, the holder of the short position would almost certainly not have been allowed to increase his risky short position further once it became clear how much of the world’s supply of nickel was impacted by the bets. In fact, in the months before the Tsingshan crisis, LME regulators had shut off price bands that would have prevented prices from rising so quickly, without the LME CEO’s awareness.

2. Market conditions are a barrier to growth.

Ensuring that global commodities exchanges provide transparent and reliable pricing information should therefore be part of the larger critical minerals policy. As the United Kingdom’s 2023 Critical Minerals Refresh put it, “resilient global supply chains . . . rely on global markets and a transparent trading system.” Likewise, in a speech delivered by Jose Fernadez, U.S. under secretary for economic growth, energy, and the environment, he emphasized the importance that MSP partners work towards a framework that prioritizes transparency. Without access to accurate pricing and production data, it is difficult for investors and producers to make informed decisions about the commodities, and it is difficult for governments to support critical minerals efforts. As the United Kingdom’s 2022 Critical Minerals Strategy has pointed out, many of the minerals needed to produce EVs remain “incomplete markets” for which there is little standardization in trade, making it difficult to ensure that trade is safe and fair. Nor can governments craft effective critical mineral policy without understanding the market conditions and market failures that exist.

One of the reasons for the nickel crisis in 2022 was the LME’s efforts to court a new type of investor: electronic traders such as hedge funds who merely seek a profit from trades, versus the Exchange’s historic bread-and-butter, physical traders, who use the commodities in their businesses (such as miners and processors). The LME’s decision to shut down the Exchange hit hardest against electronic traders, especially hedge funds. This has impacted the LME’s reputation in an existential way: the LME has essentially lost its benchmark status for nickel markets. The prevailing prices for ferronickel—a type of nickel that is suitable for stainless steel and other ferrous alloys—are now based on the Shanghai Index as of June 2023.

3. Predictable markets will encourage growth of the supply chain

Additionally, price volatility and excessive speculation stymie supply chain growth. Speculation is generally good for markets when it provides liquidity that can help keep prices smooth from erratic fluctuations in supply and demand. By contrast, speculation is considered “excessive” when the price of a commodity becomes unhinged from its economic value in its commercial application.

For example, a significant price hike or uncertainty can affect the technical design of end products, such as EVs. Similarly, price volatility affects how likely banks are to back minerals enterprises, and how companies—especially nascent ones—are able to get innovative technology off the ground. Furthermore, while speculation is a legitimate market function, excessive speculation can make it difficult or impossible for EV producers to decide when to buy minerals for their batteries, and how much. It was excessive speculation that commentators blamed, at least partially, for the collapse of the LME nickel market in 2022. As the LME sought larger profits by enticing nontrade investors like hedge funds and financial institutions to buy and sell, there has been a dramatic rise in speculation—for example, for nickel trades in the last few years.

Finally, markets (and specifically exchanges) are often the only centralized way to ensure that metals are not produced using forced labor, child labor, or in violation of other international law. Controls at the exchange level can prevent bad actors from taking advantage from opacity in the markets and prevent well-meaning companies from inadvertently purchasing metals that have used these practices. Exchanges are the central node for minerals. The financial fingerprint of buyers and sellers is often the best tool tracers have, given that the physical commodity itself does not provide much helpful information in identifying its source.

Considerations for Regulatory Agencies

The Commodities Futures Trading Commission (CFTC) helps to monitor and prevent market manipulation, excessive speculation and other disruptive practices in the critical minerals markets. The CFTC therefore plays an important role in risk management for this growing sector. Outside the United States, the CFTC participates in international dialogues with foreign regulators and market participants to help ensure that global markets remain resilient.

Because of the CFTC’s jurisdiction over the critical minerals markets, increasing interagency collaboration between the CFTC and the U.S. federal agencies tasked with furthering U.S. critical minerals goals, such as the Department of Energy (DOE) and the Department of the Interior (DOI), is a clear benefit to U.S. critical minerals interests. The CFTC could host workshops and webinars for policymakers about the role financial markets play in price volatility and critical mineral availability. If or when policymakers consider support mechanisms for industries that use these commodities, such improved interagency communication could allow them to develop more successful mechanisms by more effectively factoring in the market and nonmarket forces that impact price of key critical minerals. These workshops and improved appreciation could be particularly valuable for startups and entrepreneurs and are necessary for policymakers to be able to ascertain the ramifications for critical minerals purchases from allies. By recognizing risks like loss in the faith of a market price, or extreme price volatility, policymakers will be better able to make investments into mining and processing enterprises that are forced to deal with these market issues. The CFTC already has an interagency structure with the U.S. Department of Agriculture given the importance of U.S. agricultural security. The CFTC’s partnership with the DOE could emulate that with the Department of Agriculture, including appointing a DOE liaison who is tasked with examining market integrity for key critical minerals.

In addition, the CFTC could assist policymakers at DOE and other agencies to explore market-based incentives to encourage sustainable production of critical minerals and the impact that such policies might have on the markets. This could involve using market research and price data to structure additional tax credits or a cap-and-trade system. Simply attending more meetings with interagency committees with the DOE, DOI, State Department, Environmental Protection Agency, and DOD could give CFTC staff the ability to not only see the potential for new contracts on U.S. exchanges in the future for these commodities, but also collaborate more effectively with regulators in the European Union, United Kingdom, Japan, and other countries with major commodities exchanges as those regulators begin to consider market security’s role in critical mineral policy.

Maria Krol-Sinclair is an adjunct fellow (non-resident) in the Energy Security and Climate Change Program at the Center for Strategic and International Studies in Washington, D.C.

Maria J. Krol-Sinclair

Maria J. Krol-Sinclair

Former Adjunct Fellow (Non-Resident), Energy Security and Climate Change Program