Researchers at Wharton and Harvard University have unveiled a proposal that they say addresses two of the most important issues that the world will confront in the coming years — global security and the future of energy markets in the face of increasing demand for non-carbon energies to tackle global warming.

In a new paper, Erwann O. Michel-Kerjan and Debra Decker argue that it is critical for the international community to ensure reliable supplies of uranium-based fuel for nuclear reactors to all nations, even regimes with potentially dangerous motives, while at the same time reducing the risk that some nations may use their nuclear capabilities for non-peaceful purposes. They believe these goals can be achieved by building on the experience of private-sector companies in the fields of nuclear safety and catastrophic risk management to develop an insurance market that will provide added security to nuclear fuel users.

Specifically, the authors recommend the establishment of a mutual insurance company owned by its policyholders and including private insurers and reinsurers. The company would provide financial indemnification for economic losses suffered by both public and private nuclear utilities due to supply disruptions over the full fuel cycle of uranium, which entails enrichment, fabrication and transportation, and would facilitate the restoration of nuclear fuel supplies through the use of supply options. The authors say that if their ideas were implemented — so that all nations could have a secure supply of enriched uranium — rogue nations would be less inclined to develop the capability to enrich their own.

The paper is titled, “A New Energy Paradigm: Ensuring Nuclear Fuel Supply and Nonproliferation through International Collaboration with Insurance and Financial Markets.” Michel-Kerjan is managing director of Wharton’s Risk Management and Decision Processes Center. Decker is a research associate with the Belfer Center for Science and International Affairs at the John F. Kennedy School of Government at Harvard University and a consultant with Booz Allen Hamilton.

The authors’ proposal comes at a time when the thirst for energy on the part of industrialized nations and the emerging economies of China and India is growing substantially. It has been predicted that global energy demand will rise by more than 50% by 2030. Heightened concerns over the effect of carbon-based energy — oil, natural gas and coal — on global warming have revived interest in non-carbon-based energy sources, including the sun, wind and alternative fuels like ethanol. At the same time, supplies of petroleum are subject to serious disruption, given that much of this energy source comes from politically unstable nations.

One potential source of non-carbon-based energy is nuclear power. If more atomic power plants are constructed, as seems likely, owners of those plants will require reliable sources of uranium. Yet the desire for nuclear facilities by countries such as Iran arouses fear in world capitals about the development of nuclear power, particularly the enrichment of uranium to produce the fuel. This is because enrichment facilities could also produce nuclear weapons to threaten other countries. Mahmoud Ahmadinejad, Iran’s President, has stated in the past that he believes Israel should be destroyed. More recently, on April 10, Ahmadinejad said that his country is now capable of industrial-scale uranium enrichment, in defiance of United Nations resolutions against such a program in Iran.

In an attempt to dissuade states from launching their own uranium-enrichment programs, the International Atomic Energy Agency (IAEA) is considering various mechanisms to assure these states that they can obtain enriched uranium without political interference. But users of nuclear fuel care about all aspects of managing the risk of fuel supplies, not just the politics of obtaining enriched uranium — which is a very small portion of the total cost of building and operating a nuclear plant. In addition, some states might be worried that any solution exclusively supported by the IAEA would remain susceptible to political pressures from producer members. Michel-Kerjan and Decker discussed with Knowledge at Wharton how their idea would allay the concerns of all countries that need a reliable stream of uranium supplies.

Knowledge at Wharton: What’s the general theme of your paper? Why is your plan needed?

Michel-Kerjan: From a business angle, this study focuses on the future of energy markets, business needs and real market opportunities. From a public-policy angle, it focuses on international security. You combine the two and you have several challenges to contemplate at the crossroads of energy markets and security; thus, you are talking risk management. Since we focus on nuclear security, that immediately becomes managing extreme events in world markets. It is critical to understand here that this is not the thinking of academics in their ivory towers: The expansion of nuclear power is happening as we speak. Currently, 435 nuclear power plants operate in 30 countries — including 103 in the U.S., 59 in France, 55 in Japan and 31 in Russia. But an additional 28 plants are under construction, another 64 are planned, and 158 are proposed by countries ranging from China to South Africa. And this does not even include the recent expression of interest in nuclear power from Saudi Arabia and the Gulf Cooperation Council.

Increases in world population and per capita energy demand in the next few decades are expected to cause a substantial rise in world energy use. In addition, growing concern over carbon-based energy’s effect on global warming has revived interest in noncarbon-based energy sources such as nuclear power. With that in mind, it is simple math that the demand for enriched uranium will strongly increase in the coming years. As a result, several countries are contemplating building their own enrichment capacity rather than relying on a limited number of foreign suppliers. Up to this point, nothing’s wrong. The problem is that the same process used to enrich uranium for fuel to produce electricity can be used to further enrich uranium to produce weapons-usable material. Of course this is not new, but the world has changed a lot in the past 20 or 30 years and thus the international community is thinking hard how to manage the nuclear-fuel market. It sounds like we, as a society, have so far not been able to solve the problem using only diplomacy.

Decker: Last fall, I was at the IAEA’s 50th Anniversary Special Conference in Vienna on nuclear-fuel-supply assurances and realized that few of the several hundred attending were business people. And certainly none were in insurance and finance. So I e-mailed Erwann from the conference and said there’s got to be a way to look at this issue from the insurance angle.

Michel-Kerjan: Yes, the simple idea that really triggered all of this is the need to bring to the table a new and necessary partner: the private sector in its broadest sense, including what has become the largest industry in the world: insurance and finance.

Diplomatic efforts to limit the will of countries to develop their own enrichment capacity have proved they cannot work by themselves. Diplomacy alone will prove even more insufficient as demand for greater fuel assurance causes more countries to seek greater self-sufficiency in nuclear fuel. Indeed, nuclear utilities are concerned about not just the availability of enriched uranium, but also about the fabrication and transportation of uranium along the whole fuel cycle. There is a need to develop complementary solutions to what has been proposed so far.

Decker: Everyone is looking for energy security through energy independence. We suggest energy security through energy inter-dependence. Our plan can apply to any energy market and could expand to cover any type of supply disruption, not just political interference in supplies.

Knowledge at Wharton: Would your plan, in any way, make it easier for states to use nuclear fuel for weapons? How do Iran and North Korea fit into this picture?

Michel-Kerjan: If you agree that our scheme would limit the necessity for some countries to invest in enrichment capacity, then the proposal should limit the potential for these countries to develop nuclear weapons. Had this system been in place earlier, it is clear that Iran would have had fewer excuses to do this. Many countries are now contemplating building enrichment capacity. It’s more than just Iran and North Korea.

Decker: Because the cost of setting up an enrichment facility is high, countries enrich uranium for security of supplies, for technology development and prestige, and also for more nefarious reasons. Providing effective supply assurances would take away any real commercial necessity for local enrichment. So, Iran and North Korea would have no commercial reasons to proceed. Without that enrichment capability, countries cannot develop their own weapons-grade uranium.

We recently saw Russia delay the delivery of nuclear fuel to the Bushehr reactor in Iran. If our program had been in place 15 years ago, for example, we wouldn’t be where we are today with Iran developing its own enrichment capability. Aside from bomb making, you want to have a secure source of fuel for reactors. Now, if we say to Iran we have a secure source for you and it’s insured through a third party, and Iran still goes ahead and develops enrichment capability, which they might well do, then it becomes clear that they can’t hide their aspirations for nuclear bombs.

Knowledge at Wharton: Describe how nuclear fuel is currently made available to countries that need it to power reactors for peaceful purposes. Is it bought and sold by governments like other commodities, albeit with strict oversight? From whom do nuclear power plants in the United States and other industrial nations obtain fuel?

Decker: Most nuclear reactors use low-enriched uranium as fuel. This fuel is made by mining, converting and enriching uranium ore, and then fabricating it into fuel rods. Nuclear fuel is purchased by utilities that are either private or government-owned. Utilities buy the uranium typically under long-term contracts from mining companies like Cameco in Canada, and then buy the conversion, enrichment and fuel-fabrication services from various providers. Natural uranium has not been actively traded like other commodities, but this may be changing as hedge funds have entered the spot market and contributed to larger trading volumes. There are trading platforms but there is no formal and accepted market. Trading in enriched uranium is minimal but could be developed with standardized contracts. Delivery is controlled, of course, and has to be to secure facilities.

Restrictions on who buys fissile material and its security are covered generally by agreements like the Convention on the Physical Protection of Nuclear Material. There are some voluntary measures in place, like the Code of Conduct on the Safety and Security of Radioactive Sources, and others, like U.N. Security Council Resolution 1540, which requires countries to institute some system of controls over nuclear materials that would criminalize personal possession and transfer of these materials for illicit purposes. But it’s largely up to each state to implement their own laws and institute controls.

Non-nuclear weapon states that have signed the Non-Proliferation Treaty have to enter into a safeguards agreement with the IAEA in which the states declare their activities, which IAEA verifies by on-site inspections to ensure that materials are not being diverted. The five nuclear weapon states — China, France, Russia, the United Kingdom and the United States — have voluntary safeguards. The IAEA’s inspectors cover about 900 facilities in 70 countries. This covers materials containing Uranium-235 and -233 and Plutonium-239, which are the fissionable materials.

Michel-Kerjan: Nuclear fuel is difficult to commoditize. Even if a stockpile of low-enriched uranium is set aside at one or several locations, the fuel would need to be enriched and blended to the appropriate level and fabricated specifically for a designated nuclear reactor. Today, six states enrich most of the uranium for supply: the U.S., France, Germany, Russia, the U.K. and the Netherlands. But other countries are suspicious of whether these six can be trusted not to collude to hold nuclear fuel hostage to compel certain behaviors. 

Knowledge at Wharton: What does “converting and enriching” uranium mean?

Decker: When you get uranium, you mill it to get rid of other substances. Then you convert it to uranium hexafluoride. That’s usually stored in gaseous form in containers. Some reactors use natural uranium, which means the hexafluoride doesn’t need to be enriched. But most reactors in the world are light-water reactors and need enrichment. This means increasing the percentage of U-235 in the uranium. That’s what makes it fissile. [Fissile materials are made up of atoms that can be split in a self-sustaining chain-reaction to release energy.] Uranium from the mine usually only has 0.7% U-235. For light-water reactors, the uranium in fuel rods is enriched to 3-5% U-235. Weapons-grade uranium has at least 20%, and usually 80% to 90%. But over 20% is considered significant.

Knowledge at Wharton: How does your proposal differ from — and is it better than — ideas or formal proposals suggested by others? Have you submitted your plan to any government, association or company for review? Will it be published in an academic journal?

Michel-Kerjan: Our intent is not to propose a “better” plan. There are currently several plans being discussed from different countries. We simply believe that none of them might be enough to solve the problem, and that it is critical to provide complementary approaches. In the same way that you can’t get too far driving a car with just one wheel, you won’t solve this issue only though diplomatic or bureaucratic answers. We suggest bringing in the private sector and specifically those who deal with risks on a daily basis: insurers and financial experts.

The innovative aspect of the proposal is that it brings together two worlds that rarely talk to each other: the worlds of international security and insurance/finance. To the best of our knowledge, this path has never been considered before. We propose that the mutual insurance company cover economic losses due to business interruption — that is, no fuel in the reactor. But we also propose creation of an options and futures market that will make the uranium market a more liquid one. Note that for many years the spot market for uranium remained quite low, trading below $40 a pound (if not $20); but that changed radically in the past 15 months and the price went up to $75 a pound in February 2007 and it was over $115 at the beginning of April 2007. What we envision here is the development of a market that makes buying and selling uranium easier.

Our proposal has been discussed informally with representatives of several governments and industries. We released the white paper just last month and we are now receiving e-mails and calls from all over the world to discuss different aspects of the proposal. Once revised, we will submit it for publication. What is at stake here is nuclear energy and energy security in an increasingly interdependent world.

Decker: Academic journals can take a long time to publish pieces. We wanted to get the idea out in a timely enough fashion so that it could be discussed at the World Energy Congress, the IAEA and in other forums. Warren Buffett’s admirable pledge through the Nuclear Threat Initiative to contribute $50 million to the IAEA’s establishment of some type of nuclear fuel bank certainly raised awareness on the whole issue of fuel supply assurances. We just wish we had Mr. Buffett’s insurance savvy working on the issue, too.  

Knowledge at Wharton: Are insurance companies currently involved in any way in insuring the purchase, delivery and availability of nuclear fuel? If not, why not?

Michel-Kerjan: Not in the way we are envisioning it here, because the IAEA world has very little interaction with Wall Street. Moreover, our concept would only work if a critical mass of insurers and reinsurers, backed by governments, join. When you have a coalition of three or four leaders, you easily get five or six, and when you get six, you get ten of them, etc. — a positive tipping effect. A single company might not want to take the lead on that if its competitors are not doing it. The existence of a global structure, a framework, is very important here. Global risks create massive opportunities, but also require global coordination. That’s precisely what is missing today and what we have proposed.

You might also ask how is our proposal different than the pooling system we have in the U.S. for nuclear plants? The purpose is quite different. Several countries that run nuclear plants have established a system of coverage for the potential victims of a nuclear accident. In the U.S., the Price-Anderson Act assures that companies that run nuclear plants will be held financially responsible — through mutualization of the risks — if one of the plants suffers an accident. Above a certain threshold of economic losses paid by the nuclear operators, the federal government would pay. In our case, we propose to cover against the possibility of not getting the fuel necessary to have nuclear power plants operate in these other countries; that’s quite different.

Knowledge at Wharton: What financial incentives exist for insurers to support the proposal you put forth? It seems ensuring availability of enriched uranium would be awfully risky.

Michel-Kerjan: The first discussions we had with large insurers and reinsurers have been very encouraging, in that if their exposed capital is well-defined and quite limited and they participate in the pricing process through the quantification of the risk and the indemnification process, the interest is real. The proposal might be quite appealing for many of them, not to mention hedge funds that look for portfolio diversification.

Also, we envision them being actively involved in the development of the solution from day one. We believe that if a sufficient number of them decide to participate, then others will follow, generating that positive tipping effect. What we are talking about here is not only a market opportunity but also the contribution of the largest industry to creating a much safer world.

Decker: And keep in mind that this would be a mutual-insurance mechanism, whereby those in the mutual company would be providing their own coverage in the first instance — with the insurers and reinsurers providing additional backing, further supported by governments. 

Knowledge at Wharton: What countries would be most interested in the kind of insurance you propose?

Decker: Countries that don’t have electrical grids to turn to. If a nuclear power plant goes down in the U.S., the electrical grid is big enough that you can tap into other sources for quite some time. For countries without that grid system, it would be much more necessary. I’m thinking any small country that’s very dependent on outside sources of energy would be interested.

Knowledge at Wharton: Can your plan be implemented in stages, over a period of years? Or does it require participation by all, or nearly all, IAEA members to get off the ground? Who, exactly, would have to participate for your plan to work?

Michel-Kerjan: That’s a good point. From experience, if you wait for a perfect agreement among all IAEA members — 147 as of today — you’re pretty sure nothing will happen in the foreseeable future. We would suggest starting with a core team of companies and countries that are interested in the concept and building up from there. It takes innovation and a good dose of leadership. In the last section of the study, Debra and I highlight what could be the next steps in the following 12 months. We went from words to concept; let’s hope for enough momentum from markets and the international community to go from concept to actions.

Decker: The OECD [Organization for Economic Cooperation and Development] countries got together as a result of the 1970s oil crisis and formed the International Energy Agency to deal with energy security mainly in terms of reducing the risk of oil supply shocks. A crisis generated interest in coordination. We are hoping that we won’t need a crisis of a new type to spur broad international coordination on the nuclear energy front.