September, 2001: Cover Story

By Greg Rushford
Published in The Rushford Report

President George W. Bush’s National Security Council is trying to decide what to do about the troubled U.S. Enrichment Corporation

Last month, U.S. national security officials had a special reason to commemorate the tenth anniversary of the communist coup attempt against then-Soviet Union President Mikhail Gorbachev. Ominously, the Pentagon wasn’t really certain for several days in August 1991 just who controlled the “nuclear suitcase,” as the clumsy rebellion was being put down by Boris Yeltsin, the Red Army, and the KGB. U.S. intelligence also “picked up several anomalous indicators involving the [Soviet nuclear] Strategic Rocket Forces,” former Secretary of State James Baker III recalled in his memoirs. By the end of the year, the USSR had disintegrated. Concerns that the cash-starved Russians would peddle their nuclear inventory in the Third World loomed large. Today, with remaining (although diminished) Russian nuclear forces still on alert, those concerns are still very real.

The nuclear frights inspired one of mankind’s most idealistic ventures since the Biblical swords-into-plowshares concept. The Energy Policy Act of 1992 created the U.S. Enrichment Corp as the only American agent that would, over 20 years, work with Russia to blend down 500 metric tons of high enriched uranium from about 25,000 dismantled Russian nuclear weapons — and convert it into low enriched uranium to supply fuel to nuclear power plants in the United States and abroad. The Bethesda-based USEC was at first a government corporation responsible to the Energy Department, which subsidized the “corporation” with some $2 billion in federal assets. The Clinton administration privatized USEC in 1998; the initial public offering raised some $1.9 billion.

But what began in high idealism has turned into an all-too-typical Washington lobby story, featuring insiders with sharp elbows who basically know how to game the system. Now, the important U.S. national security goal of preventing nuclear proliferation is at risk. Also at risk: the strong economic interest of helping provide domestic nuclear power plants — which provide the nation with some 22 percent of its electricity — with a reliable supply of fuel, at market-based prices.

The basic problem is that USEC has a built-in conflict of interest. Economists call it the “principal-agent problem.” USEC is the agent, the United States is the principal. As a private corporation, agent USEC’s marching orders are to maximize profits for its shareholders. If that means buying less Russian enriched uranium and dismantling fewer warheads, so be it. USEC’s obligations to its shareholders are of a commercial nature, not to advance broader U.S. national interests. Uncle Sam has turned over important foreign policy and economic responsibilities to a private interest — which has a self-interest that does not necessarily coincide with the public interest.

In essence, USEC — which had 90 percent of the domestic uranium enrichment market in 1995 and still has some 75 percent — is a heavily subsidized government-created monopoly. Domestic nuclear power plants are worried about being put in the position where USEC could make them pay higher prices for their fuel than the market would otherwise set. The power plants are particularly concerned that so-called “unfair trade” cases that USEC has filed against its European competitors would result in market disruption and higher tariffs, thus helping drive up the cost of fuel.

USEC officials declined to comment for this article. But in public appearances, company officials maintain that they are a free-enterprise success. “We are deeply proud of being a part of this nonproliferation program and equally proud of the results that are being achieved,” USEC’s president, William Timbers, declared in a recent speech.

But the company’s critics — who are legion — are blunt. USEC is “a mess — and one that is nearly certain to get messier,” Richard Falkenrath of Harvard University‘s Kennedy School of Government has written.

(Falkenrath’s Uranium Blues: Economic Interest vs. National Security, in the Fourth Quarter 2000 Milken Institute Review, a respected economics journal, is a must-read. Another authoritative recent article was written by Thomas Neff, a brilliant MIT physicist who is credited with originating the “megatons into megawatts” idea in October 1991. Neff’s “Decision Time for the HEU [highly enriched uranium] Deal: U.S. Security vs. Private Interests, appears in the June 2001 issue of Arms Control Today. See also: The Clinton Administration is Nuking a Good Idea, a column that I contributed to The Wall Street Journal Europe on September 21, 1995. USEC‘s portrayal of its operations can be found at www.usec.com.)

A mess indeed.

Even though it was handed a monopoly of the U.S. enrichment services market by Uncle Sam, USEC’s financial condition is not happy. The corporation’s stock last month was hovering near $7, having lost more than half of its value since hitting the $16 range in late 1998. Last year, USEC’s bonds were reduced to junk-bond status. USEC’s reported earnings of $41 million for the fiscal year ending in June 2001 were down from $109 million the previous year (USEC blames its European competitors for the drop). USEC is forecasting a negative cash flow of up to $50 million for the current fiscal year — and that’s apparently a best-case scenario.

USEC has shut down one of its two enrichment plants, in Piketon, Ohio. The future of the remaining USEC plant in Paducah, Kentucky is in some question. On Capitol Hill, lawmakers like Rep. Edward Whitfield (R-Ky), who represents Paducah workers, have asked in public why American workers should be thrown out of work when USEC’s top managers have been awarding themselves top salaries and benefits.

USEC President William Timbers, a former investment banker, has a base salary of $600,000. But count in the bonuses and a generous benefit package, Timbers has been raking in more than $1 million a year. Last year, while the corporation was headed south, USEC executives paid themselves $2.6 million in bonuses, according to published reports.

In its 1999 annual report, USEC expressed ambitions to “prosper as a fully functioning, profitable commercial enterprise dedicated to enhancing shareholder value.” Then the corporation turned around and asked for a $200 million federal subsidy to help it enhance that value, holding open the possibility that otherwise it might not keep buying Russian enriched uranium (Clinton’s energy secretary, Bill Richardson, quickly nixed that idea).

USEC seems to have antagonized nearly everyone it deals with.

First, the Russians are not happy. They tend to see themselves as being taken advantage of by a U.S. monopolist that basically controls their access to the American enrichment services market. “As the only U.S. authorized buyer, USEC has tremendous power to dictate low prices to the Russians,” points out MIT’s Thomas Neff.

USEC’s contractual feuds with the Russians are complex, even Byzantine. But basically, USEC’s idea of how the market should function is as follows:

USEC buys Russian enrichment services in units of measure called SWUs (Separative Work Units, which are a measure of how uranium isotopes are separated). It costs USEC about $105 to make a SWU in the United States, which is also the current market price. So the idea is to buy Russian SWUs at a substantial discount, and thus make a profit. Thomas Neff’s recent Arms Control Today article reported that USEC is now paying the Russians about $90 per SWU, but wants them to agree to agree to a pricing formula that today would be about $75 per SWU.

In effect, both the Russians and USEC’s own customers, the nuclear power plants, are being asked to subsidize USEC. The Russians sell SWUs to USEC at below-market prices, and the power plants pay USEC above-market prices for their fuel.

Naturally, U.S. nuclear power plants would like to be able to compete for that Russian supply. The Russians would also like this, because they would get better prices from the power plants than USEC is willing to pay. But they can’t, because Uncle Sam has made USEC the only agent to deal with Russia.

While USEC doesn’t have any domestic competition, it does have a problem with two competitors from Europe: Eurodif S.A., which is French; and Urenco Ltd., a British enricher that also has operations in Germany and the Netherlands. Eurodif and Urenco each have modern technology and have been cutting into USEC’s domestic monopoly share by selling enriched uranium services to U.S. nuclear plants.

USEC’s response to the competition was the classic protectionist’s cry of “unfair.“ In December 2000 USEC filed antidumping and countervailing-duty petitions against the Europeans. In July, an obliging-as-usual U.S. Commerce Department issued a preliminary ruling assigning an antidumping margin of 17.5 percent on Eurodif. The French firm was also hit with a 13.9 percent countervailing-duty margin (Commerce said that the offending subsidy was electricity provided to Eurodif by the French government).

Urenco got off much better, with only a 3.35 percent antidumping margin on its operations in Britain, and a 3.72 countervailing-duty margin, also in the UK. Urenco’s operations in the Netherlands and Germany escaped with de minimus margins.

These two cases are strange, and rife with more than the usual hypocrisy associated with trade cases — beginning with the fact that USEC is hardly in the position to express outrage at the other guys’ subsidies. (Just one example: Unlike truly private corporations, USEC doesn’t have to worry about paying the cleanup costs for radioactive pollution at its plants; Uncle Sam will pick up that tab.)

It is even debatable whether USEC is even entitled to use the antidumping laws, which are aimed at protecting products. Services are expressly excluded from these laws, and USEC is a service provider.

USEC’s 2000 annual report states that the company makes its money from “the sale of uranium enrichment services.” USEC has also argued successfully before the U.S. Court of Federal Claims in unrelated litigation that USEC’s services contracts are not covered by the Uniform Commercial Code, which covers goods, not services. Now, in its antidumping case, USEC is arguing the opposite: that it deals in products. The bureaucrats at the Commerce Department’s Import Administration bought that line.

The fact that USEC tried in the mid-1990s to get itself exempted from the antidumping laws carries no legal weight, but is still revealing. At the time, USEC was worried about a successful antidumping petition filed by the beleaguered U.S. mining industry against imports of Russian natural uranium. USEC wanted the freedom to buy the Russian stuff.

No matter. It turned out that USEC got plenty of natural uranium anyway. When USEC was privatized, the Energy Department gave the company 75 million pounds of natural uranium. USEC flooded the markets with it, with the predictable downturn on prices. Domestic producers were hit hard, but could not use the antidumping laws against the U.S.-based USEC.

“This has absolutely devastated the domestic uranium industry,” declares Fletcher Newton, who is president of Power Resources and Crow Butte Resources. These two companies together are the largest uranium producers in the United States, having contributed 1.5 million pounds last year out of a total U.S. production of 4.1 million pounds.

Also last year, an outraged Mark Stout, President of the Uranium Producers of America, complained to a congressional committee that every “U.S. uranium producer has curtailed its uranium production since USEC’s privatization.” New Mexico, Stout noted, “is producing no uranium for the first time since 1955.”

Despite the criticisms, USEC officials defend themselves. Senior Vice President Philip Sewell recently told the prestigious Atlantic Council that by the end of this year, some 7,000 potential Russian nuclear warheads will have been eliminated by the purchase of more than 140 tons of highly enriched uranium. “We are nearly one third of the way toward the 500 MT goal,” he declared. “I submit that this is a monumental achievement in nuclear threat reduction and a success story by any measure.”

But by some measures, the successes have been limited.

“USEC has been repeatedly forced by the government into performing, which was easier when it was a government corporation,” says MIT’s Thomas Neff.

In 1996, for example, the Russians wanted to sell to USEC 18 metric tons, while USEC only saw its commercial advantage in buying twelve tons. USEC finally relented after severe criticism from influential congressional figures like Sen. Pete Domenici (R-NM).

Sewell formerly worked for the Department of Energy, where he was a Deputy Assistant Secretary who oversaw uranium enrichment activities from1988-1993. He worked with then- investment banker William Timbers, who was awarded a $360,000 sole source, consulting contract with DOE, one industry source recalls. Timbers is now Sewell’s boss at USEC.

As a government employee, Sewell also was a key negotiator in the first purchase contract between USEC and the Russians. The Russian and American governments had originally agreed that the United States would buy at least 500 metric tons at a specified 20-year schedule. But the actual purchase contract that Sewell negotiated in May 1993 stipulated that USEC would have “the option” to buy up to those levels. To USEC’s critics, that was an early sign that USEC’s aspirations for commercial success could conflict with broader national security objectives.

Sewell then left the government and joined USEC, where he is now doing essentially the same job he did as a bureaucrat, but with far higher remuneration. Last year, Sewell’s bonus at USEC was $206,000.

For the embattled USEC, probably the biggest worry is that one of its critics could turn out to be President George W. Bush. At the National Security Council, officials are trying to figure out what to do with USEC.

One option the NSC is considering is simply returning USEC to the government fold, on the theory that USEC will never make it in the marketplace without massive federal subsidies anyway.

Another option, thought more likely, is to give USEC some much-needed market competition, by letting private utilities compete with USEC for the Russians’ business.

A decision is expected by the end of this year, when USEC’s current contractual arrangement to buy enriched uranium from the Russians.

The Bush White House hasn’t tipped its hand. But for USEC it appears that it is time to say, Uh Oh.

Harvard’s Richard Falkenrath, who wrote the devastating article in the Milken Institute Review calling USEC “a mess,” is now working on Russian nuclear issues in — George W. Bush’s National Security Council.

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