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National security for sale.

In November of 1991, Thomas Neff had a stroke of genius. A year earlier, the once-fearsome Soviet empire had abruptly collapsed into a heap of disordered republics; and while this epic event was greeted with sighs of relief by most Americans, nuclear proliferation experts like Neff, a professor at M.I.T., knew better than to pop open the champagne just yet. True, the prospects of a nuclear armageddon with Russia had never been more remote -- particularly since, as a result of the START I and II treaties, Russia was already in the process of dismantling 80 percent of its nuclear arsenal. But this good news also had a dark side: once the nuclear warheads were taken apart, the bomb-grade uranium inside would be more vulnerable to theft. Meanwhile, hundreds of tons of bomb-grade uranium in Russia's existing stockpile lay scattered across the country in insecure storage sites -- guarded, if at all, by demoralized soldiers and nuclear workers who in many instances had not been paid, or even fed, by the cash-strapped Russian government in months. Given the small quantity of enriched uranium required to build a nuclear bomb, the possibilities for disaster seemed limitless: a terrorist group might break into one of the many nuclear warehouses that lacked even rudimentary electronic detection systems and make off with enough uranium to blow up Manhattan. A starving soldier might sneak home a few handfuls of the stuff to sell on the black market -- where it could be snapped up by eager buyers from Iraq, Iran or North Korea. A highly trained, but unemployed nuclear worker might be forced to make ends meet by going to work for one of those rogue nations. And most disturbing of all, in a quest for hard currency, the Russian government might itself be moved to sell wholesale quantities of nuclear material to the highest bidder. (In fact, in 1995 evidence surfaced that the head of Russia's Ministry of Atomic Energy, Victor Mikhailov, was trying to reach just such an arrangement with Iran).

Which brings us to Neff's ingenious proposal. Although of high, bomb-grade quality, the uranium from Russia's dismantled warheads could potentially be diluted into the lower grade kind used to fuel nuclear power reactors. And the U.S. government was already in the business of producing and selling such fuel to nearly all of the commercial nuclear power plants in the U.S. as well as one-third of those abroad. So instead of producing all of that nuclear fuel in our own facilities, Neff reasoned, why not buy a portion of it from the Russians. From the American point of view, the arrangement would cost nothing because we could still get the Russian material at a lower price than we'd be re-selling it to the power plants. Meanwhile, the Russians would receive a desperately needed infusion of cold cash -- a good chunk of which could be used to improve the security of their remaining nuclear stockpile. In addition, thousands of Russia's dangerously idle nuclear workers would once more be gainfully employed, this time in re-processing the bomb-grade uranium. Best of all, huge quantities of deadly Russian nuclear material would be moved beyond the reach of would-be bomb-makers.

It took some prodding, but the U.S. government, first under President Bush and then under Clinton, eventually took up Neff's plan. By August of 1992, the United States and Russia had reached a tentative agreement: Over the next 20 years, the United States would pay Russia about $12 billion for the reprocessed uranium derived from 500 metric tons of nuclear material from its warheads -- 40 percent of Russia's total supply of bomb-grade uranium and enough to destroy Hiroshima 25,000 times over.

The Russian uranium deal was, as its advocates have noted, a classic conversion of swords into plowshares. It ought to have been a crowning achievement of America's post-cold war foreign policy. But this is Washington, where even the brightest ideas can be clouded by muddy thinking. And unfortunately for the deal, at the same time that the United States and Russia were hammering out its specifics, proponents of privatizing government were gaining bipartisan support for a plan to sell off Uncle Sam's uranium production business. Thus the privatization scheme and the swords-into-plowshares deal evolved in tandem -- intertwined from the very start. And the unhappy impact of the former on the latter provides an instructive -- and depressing -- example of how a knee-jerk commitment to privatizing government can seriously compromise America's national interests.

A Private Matter

The notion that the private sector can run just about anything more efficiently and effectively than the federal government was well on its way to becoming international gospel by the early 1990s. In Western Europe, hundreds of billions of dollars worth of government enterprises ranging from telephone companies to steel mills were put on the auction block. The privatization wave attracted a strong following in the United States as well. However, in contrast to Europe, most major services in the U.S. were already handled by private industry. Undaunted, the privatization advocates found themselves a juicy target. "They were trying to think of something that no one else had thought of," Clinton's former chairman of the Council of Economic Advisers Joseph Stiglitz explains only half-jokingly, "and then someone had a brilliant idea: Why not privatize the making of atomic bombs -- or at least the processing of the uranium that goes into atomic bombs? And they were right, no one else had thought of that!"

To be sure, the government's uranium production program had room for improvement. For example, the Department of Energy had continued to build a new processing plant for several years after it became apparent that the facility would be unnecessary -- spending $3 million before the project was finally abandoned. The government was also encumbered by various requirements, for instance that it follow federal procurement rules, and that it apply to Congress for appropriated funds every year. This made the government's uranium processing business vulnerable to foreign competition. By the 1980s the U.S. world market share had declined precipitously from the near 100 percent of its heyday to less than 50 percent.

This downturn was of particular concern to two powerful Republican legislators: Sen. Wendell Ford of Kentucky feared that it might lead to pay cuts or even layoffs at the large uranium processing plant the government operates in his home state; New Mexico Sen. Pete Domenici worried that as more and more uranium production moved overseas, the large number of uranium mines in his state would suffer. Domenici and Ford concluded that the solution was to make the government's uranium business more competitive by handing it over to private owners. And as high-ranking members of the Energy and Natural Resources Committee, they were in a position to put their plan into action.

In the 1992 Energy Policy Act -- passed less than two months after the United States and Russia had reached their preliminary agreement on the swords-into-plowshares deal -- Congress directed the Department of Energy to transfer its uranium production activities to a newly created semi-governmental company, dubbed the United States Enrichment Corporation, or USEC, which would be charged with preparing itself for full privatization. The president would have the power to hire and fire USEC's board of directors. However in every other respect the company's employees would be autonomous from the government. As a further step towards privatization, USEC was also freed from many of the obligations that had been hampering the government's program. And sure enough, the result was that by September of 1994, USEC was able to boast of achieving an "all-time enrichment production record" at both of its processing plants.

So far so good, right? Not really. Economists note that even if a privatized USEC does become more efficient, it's questionable whether those savings will filter down to American nuclear power consumers: With an almost total monopoly on nuclear fuel production in the U.S., USEC would have little reason to lower its prices. So even on its own merits USEC is hardly a model candidate for privatization.

But even worse, USEC's privatization could deal a devastating blow to the vital swords-into-plowshares agreement with Russia. Recall that the whole idea behind the deal was to make it "budget neutral" by reselling the processed uranium purchased from the Russians to commercial nuclear power companies. And since USEC inherited the government's long-term contracts with nearly all American and over one-third of the world's power plants, it would be difficult for the Russian deal to be implemented unless USEC were charged with carrying it out. Thus, even before it was officially created, USEC was envisioned by the Bush administration as the deal's exclusive executor. But whereas the government's chief objective is to get as much bomb-grade uranium as possible out of Russia without losing money, as a private corporation, USEC's interest -- in fact its fiduciary obligation to its shareholders -- would be to maximize its profits. The billion dollar question, then, was whether USEC would be able to do so while still fulfilling the goals of the swords-into-plowshares deal. Or, to put it more starkly, would Usec's profit motive conflict with American national security interests?

The Deployment

One month after Clinton took office, the U.S. and Russian governments officially signed off on the swords-into-plowshares deal: Over the course of the next five years the United States would purchase the diluted uranium from 10 metric tons worth of bombgrade Russian material a year; for the next 15 years after that, the United States would buy at least 30 tons a year. However it was left to USEC's management team to work out the rest of the details -- including the price to be paid for the uranium -- with the Russians. By January 1994 USEC completed those negotiations, and the company's CEO, William Timbers, traveled to Moscow for an official contract-signing ceremony with Russia's minister of atomic energy.

The new agreement was hailed as a historic achievement and promisingly titled the "Megatons to Megawatts contract" But in reality, our former Communist adversaries had proved woefully inadequate on the battlefield of business. In the words of one source familiar with the negotiations: "We snookered them"

As Harvard professor and nuclear security specialist Richard Falkenrath has noted in a comprehensive study, the Megatons to Megawatts contract contained three potentially problematic provisions. First, while USEC was given the option of buying the Russians' Uranium, the contract did not actually obligate it to do so. Second, the contract established an initial price but stipulated that it was to be renegotiated each October. Finally, whereas USEC would pay the Russians upon delivery for diluting the bombgrade uranium themselves, it would not immediatedly ensate them for one of the key ingredients the Russians would have to use in the dilution process -- namely, the $4 billion worth of natural uranium needed to blend down the bomb-grade uranium into the lesser-enriched kind used for nuclear fuel. USEC would pay for the natural uranium that had been added in only after the company was able to sell or use an equivalent amount from its own reserves.

The Megatons to Megawatt contract's provisions would have made perfect sense if it had strictly been a pact between the United States and Russia. Given Washington's strong interest in ensuring the success of the swords-into-plowshares deal, it would have been unlikely to take advantage of the contract's flexibility to try to fleece the Russians. Similarly, if the primary goal had been to make USEC as attractive as possible to potential buyers, the leeway afforded USEC in the contract would have been an undisputed plus. However, in light of USEC's two potentially competing missions -- to maximize its profits and to implement the Russian deal -- the contract's leniency provided a dangerous opportunity for mischief.

The trouble began almost as soon as the Russians and USEC sat down for their first annual price renegotiating session -- held in October of 1994. USEC had calculated that, while not a money-losing proposition, buying uranium from the Russians at the initially agreed upon price was not nearly as profitable as producing it in the United States. Thus USEC sought to slash the price by nearly 20 percent. To make matters worse, USEC announced that, since U.S. trade restrictions prevented it from immediately selling an equivalent portion of the natural uranium ingredient in the diluted uranium purchased from the Russians, and since the company also deemed it unprofitable to use that equivalent portion of natural uranium in its own processing activities, USEC would be unable to pay Russia for the natural uranium ingredient until at least 2003. The Russians were furious. "This is robbery in broad daylight!" fumed Russia's minister of atomic energy, Victor Mikhallov. Mikhailov is hardly the saint in this story, but he had a point.

It soon became apparent that USEC was prepared to squeeze the Russians for every last advantage -- even at the risk of causing a breakdown in negotiations, and despite the fact that this might dangerously delay the removal of literally tons of bomb-grade material from unsafe Russian storage sites. And this, in effect, is precisely what happened.

By February of 1995 the talks between USEC and the Russians had reached an impasse. From a financial point of view this was no skin off of USEC's back. However, American national security interests were clearly being compromised. And by mid-1995 outside critics had begun to take notice. "[T]he agreement's imminent breakdown, clearly Washington's fault, is a huge national security blunder," wrote foreign policy analyst Jessica Mathews in a Washington Post op - ed.

It was only after months of stalemate that Sen. Domenici -- who was soon to question the wisdom of letting USEC implement the swords-into-plowshares deal -- found a solution to the natural uranium problem. Rather than paying in cash, USEC would compensate the Russians with natural uranium from its own reserves, and American trade restrictions would be modified so that the Russians could sell that uranium to prospective consumers for delivery at a future date. Domenici's scheme was set forth in the 1996 USEC Privatization Act. The act, which was signed into law in April, also gave congressional approval for USEC's privatization md requested that Clinton make a final determination on the matter. All that was now needed was a nod from Clinton, and USEC could be put up for sale.

The Final Countdown

An interagency group including representatives of the National Security Council, the State Department, the Department of Energy, the National Economic Council and the Council of Economic Advisers was convened to decide whether and when Clinton should sign off on USEC's privatization. One might have expected that, given USEC's key role m the swords-into-plowshares deal, combined with its lackluster performance as the deal's executor while still a semi-governmental corporation, the national security folks might be dead set against turning the company over to private ownership. Instead, USEC's privatization appears to have been regarded as inevitable. The only issue seriously considered was how to limit its negative impact. "People tried to deal in the art of the possible," explains one official.

Complicating the picture, by this point, anyone contemplating a halt to the privatization plan would have had to contend with an uncomfortable budgetary conun-drum. The 1996 USEC Privatization Act was lumped into a larger appropriations bill called the "Down Payment Towards a Balanced Budget Act," in which USEC's impending sale was counted as a $1.3 billion gain in revenues for the federal government. This was actually something of a gimmick -- at most the government would simply be getting in cash today an amount equivalent to the value of the revenues USEC would have brought in over the years were it not privatized. In fact, for just this reason, in 1987 Congress passed a budgetary law prohibit one-time sales of government assets from being counted as revenues. But in 1995 Congress changed its budget accounting rules such that USEC could be tallied in. As a result, a ruling against USEC's privatization would have created a $1.3 billion hole in the budget -- something many administration officials would be understandably loathe to do.

Yet, interestingly it was the economists at the Council of Economic Advisers -- led by Stiglitz -- who actually raised the possibility of vetoing USEC's privatization. The more Stiglitz analyzed the situation, the more convinced he became that privatizing USEC was folly: "You don't have to use a lot of imagination to see that the economic incentives are not there for USEC to import the Russian uranium. So you're putting something that's in our national security interests in direct conflict with USEC's private property interests."

Quite the opposite, argued William Timbers, USEC's CEQ "there is a confluence of interests between USEC and the federal government." Timbers contends that USEC has good reason to want to retain its position as sole executor of the swords-into-plowshares deal. After all, if USEC did not have the exclusive right to purchase the Russian uranium, other groups might begin buying md selling it -- creating competition for USEC and possibly flooding the market with enough fuel-grade uranium to cause a nosedive in prices. And since the U.S. government has the power to remove USEC's designation as sole executor with as little as 30 days notice, USEC has a strong incentive to demonstrate that it is carrying out the swords-into-plowshares deal in accordance with American national security interests.

But Stiglitz was unconvinced. The more USEC becomes enmeshed in contracts with the Russians, the more impractical it will be for the U.S. government to yank it out of the deal. Thus the threat of losing its status as executor of the Russian deal is hardly as powerful a deterrent as Timbers implies. Furthermore, once USEC is privatized, it will be tricky to monitor it. Thus, noted Stiglitz, the company might be quietly sabotaging the uranium deal without the government's knowledge.

As if on cue, even while still a semi-governmental entity, USEC provided Stiglitz with a perfect illustration of just this scenario. At a meeting in Moscow in January of 1996, the Russians offered to sell USEC nuclear fuel from six more tons worth of bomb-grade uranium than the 12 tons USEC had already agreed to purchase in 1997. From an American national security standpoint this was great news -- those six tons were enough to obliterate about 300 Hiroshimas. Had the Russians been making their offer directly to the U.S. government, the United States presumably would have jumped at the opportunity. However it was not in USEC's commercial interests to buy the extra uranium, so they declined.

The Russian offer and USEC's refusal were reported in diplomatic cables written by U.S. embassy officials who were present at the meeting, but there are conflicting accounts as to who in the government knew about it, and whether USEC had actually gotten clearance from the Department of Energy or the White House to turn the Russians down. Charles Yulish, USEC's vice president of corporate communications, says he "can categorically state that at no time has USEC made decisions with regard to contract quantities without consultation with national security [officials]." And one government source holds that, at the time, the administration had doubts as to whether the Russians were actually capable of processing the extra uranium and feared that ordering it would give the Russians an incentive to cheat by substituting m nuclear fuel that had not been made from the uranium in dismantled weapons. But other government sources contend that this is merely a bit of revisionist history intended for public consumption -- that in fact the Russians were perfectly capable of producing the extra fuel all along, and that while the State Department might have known, key officials in the Department of Energy and the National Security Council were simply unaware of both the Russian offer and USEC's refusal.

Either way, it doesn't look good. In the case of any officials who were aware, their acquiescence to USEC's actions is troubling. And in the case of those who were not aware, this raises serious questions about their fulfillment of their responsibility to monitor USEC's implementation of the Russian deal. There were, for instance, some grumbles among those familiar with his work that Dan Poneman, the point man at the National Security Council, was not sufficiently vigilant toward USEC -- regarding himself more as an ally than as an overseer. Poneman insists that "my focus was always on ensuring that whatever happened on USEC privatization, the [Russian] deal was protected." In any event, the incident remained under the radar until the following July.

Early that month, the Russians once again extended their offer to sell extra uranium. And once again, USEC turned them down. The company did, however, offer the Russian a $100 million advance on the uranium it was buying. The Russian accepted the advance but were not entirely mollified. About a week later, they mentioned their frustration to a group of US. nuclear weapons experts who were visiting Russian facilities. The experts reported this exchange in their cables back to the U.S.

Soon afterwards, Sen. Pete Domenici learned of the affair. Although an advocate of USEC's privatization, Domenici was incensed at the company's behavior. The senator fired off an angry letter to Deputy Secretary of Energy Charles Curtis -- subsequently leaked to Peter Passell of The New York Times -- in which he expressed his conviction that "USEC is acting directly contrary to the national security interests of the United States" USEC, said Domenici, should "be immediately replaced as executive agent" of the swords-into-plowshares deal.

As word of the matter spread, so did the outrage of administration officials who felt they had been deliberately kept in the dark. "You find out that when you went to a meeting where you were supposed to be discussing whether to privatize USEC, and you were weighing these incentive issues, at least half the people at the meeting don't even know that [USEC had refused to buy additional uranium]," explains Joseph Stiglitz. Furthermore the $100 million advance USEC had given to the Russians smacked to some of a kind of bribe to buy the Russians' silence.

At this point, Charles Curtis at the Energy Department sprang into action, urging USEC to buy the extra six tons. USEC quickly agreed. And, not long after, negotiated a five-year contract with the Russians that locked in a price and increased the yearly amount of uranium that USEC would buy. To USEC's credit, the contract actually increases the rate at which USEC will be buying Russian uranium such that when the contract expires in 2001, USEC will have purchased one-third of the 500 tons it is supposed to eventually buy -- 40 percent more than the amount it would have had at this stage in the game had it stuck to the deal's original time flame. A special interagency group was also set up to more closely monitor USEC's activities.

The Day After

Despite these measures, the danger of privatizing USEC was still considerable. After all, what would happen once the five-year contract was up? And how well would the interagency group be able to monitor USEC once it was in private hands? But if you think the revelations about USEC's behavior caused the privatization advocates both in and outside of the Clinton administration to reconsider their position, think again. The Clinton administration was clearly satisfied that enough safeguards had been put in place to justify preserving USEC's role in the Russian uranium deal -- and to allow the company's privatization to go forward. This past July, Assistant to the President for Economic Affairs Dan Tarullo and National Security Adviser Sandy Berger signed a joint memo recommending USEC's privatization. Soon afterwards the president gave his OK.

Citing Thomas Neff's efforts in "proposing ... the historic [Russian uranium] agreement" the American Physical Society chose to honor him with its 1997 Leo Szilard Award for Physics in the Public Interest. However, though he's still hopeful Neff concedes that, as a result of USEC's privatization, his plan has proved "a lot more difficult to implement than rd thought" when he first dreamed it up back in 1991. And the difficulties continue. Although it is now up to the Russians, rather than USEC, to find a buyer for their natural uranium, this has not proved easy Thus for much of this year Russia's shipments to USEC were delayed -- increasing the chances that the wrong people might get their hands on vast quantities of dangerous material. Meanwhile the Treasury Department is slowly moving ahead with USEC's sale either to another company or through a public stock offering. This is also causing some new national security headaches: Among the interested buyers is an alliance of companies that includes the Pleiades Group, a New York-based energy company whose chief, Alexander Shustorovich, though a naturalized American, has strong ties to Victor Mikhailov, head of Russia's Ministry of Atomic Energy.

Even if Shustorovich fails to buy USEC, it is by now painfully clear that the U.S. government will have to keep an eagle eye trained on USEC at all times. At best this will prove a time-consuming and difficult responsibility for succeeding administrations. At worst, once the five-year deal is up, USEC will once again engage in activities that sacrifice our national security interests to its commercial ones. True, at least on paper, USEC's sale has helped to offset our deficit by $1.3 billion. But when one considers the estimated $4 trillion we spent during the Cold War to build a nuclear arsenal capable of determining Russia from sending its nukes toward our shores, the fact that we would even contemplate endangering a plan to keep 500 tons of bomb-ready nuclear material -- capable of killing over 3 billion people -- out of the hands of tomorrow's Saddam Husseins and Timothy McVeighs, all in exchange for a piddling billion-plus dollars would be almost funny, were it not so frightening.
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Title Annotation:government privatization and nuclear terrorism
Author:Aizenman, Nurith
Publication:Washington Monthly
Date:Dec 1, 1997
Words:4310
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