DETROIT () -- As I looked over the Johnson-Matthey publication, Platinum 2006, I couldn't help but think about the Jewish festival of Passover, which celebrates the ancient liberation of the Jewish people from bondage in Egypt. The traditional dinner for Passover always includes a ritual where the oldest male present asks the youngest male at the table the question, "Why (or how) is this night different from all other nights?" After reading through Johnson-Matthey's platinum, 2006, the "bible" of the platinum group metals marketing industry, I was tempted to ask "How is 2007 likely to be different from all other years with regard to the economics of platinum group metals?"
The answer to this modern question, like the answer to the ancient question has to do with liberation from the arbitrary control of non-believers. Only this time it's the liberation of platinum group metal users from the price control practices of the small group of PGM producers who today, along with traders and bankers, make up the basis of the London Platinum and Palladium Market (LPPM).
The LPPM has tried to position itself as the pricing basis for PGMs. Its small group of core trading members are the agents for the producers and users. They buy and sell the metal on offer among themselves either on their own behalf or for customers who may be end users or speculators. A very small fraction of these transactions are made public, perhaps only 1%, but those transactions are presented as trend and price establishing transactions, so that the LPPM can appear as the market maker in the metals platinum and palladium.
The London Metal Exchange (LME) operates in a like fashion in the sense that its trading members also buy and sell metals among themselves from and to producer members and end users; but, in addition, LME offers a large number of futures contracts for mostly base metals. These fix the price in 30 day intervals for as much as two years into the future. Delivery is guaranteed by the exchange itself from warehouse stocks, and this gives buyers and sellers the benefit of knowing future costs, and being guaranteed physical delivery, for the metals for which there are futures contracts available from LME.
The core industrial "base metals" of our civilization are identified by the very fact that you can buy a contract to sell or buy them in the future at a fixed price now. Copper, lead, zinc, aluminium, tin, nickel and lead future delivery contracts have long been available from LME along with those for gold and silver. Platinum and palladium futures are more recent, having been created only in the last 30 years or so. Theoretically the exchanges exist to limit price volatility by trying to be the place where buyers and sellers are matched to create an efficient market.
The LPPM only offers futures for platinum and palladium. It serves a different, producer oriented, market, but The LPPM, LME, NYMEX and COMEX are all businesses owned by shareholders for the primary purpose of making a profit. Note in passing that the freedom of these exchanges to set prices is now threatened by a competitor that has lately grown apart from their group but wields enormous power, the Shanghai Metal Exchange.
Three factors are growing in importance as I write to interfere with the market pricing control for PGMs that the trading members of the LPPM and its rival, the LME, try to exercise on behalf of their member producers:
- China in Africa;
- Secondary sourcing (recycling) from scrap, and;
- Economical mining of small deposits in which PGMs are a byproduct, but in which the primary metal or mineral was not valuable enough and/or was too difficult to separate from the PGMs to support the mine.
China in Africa is certainly a wild card in the game of making a central market in PGMs that is played by the trading and producer members of the LPPM and the LME. Chinese companies and the Chinese government, which are frequently difficult to tell apart, are determined to be the principal foreign players in the development of mining in Africa. They have succeeded in becoming the largest and most important investors and sources of aid in sub Saharan Africa and are politically as well as economically involved in East Africa. Governments run by presidents for life, Field Marshals whose previous rank was corporal, or emperors, all of which oppress their people do not seem to dissuade the Chinese from investing in infrastructure or mining enterprises, so long as the output of the mines is used as a currency of repayment of the investments.
The government and industry of the People's republic of China's sole concern in Africa is to advance the development of the Chinese economy while, at the same time, the political policies of developed nations that could encourage their private industry to invest and directly give government to government aid is to avoid dictatorships and other autocracies unless the product being sought is petroleum. Western governments rise to the level of Chinese hypocrisy immediately if their oil sources are at risk.
Chinese "businessmen" with the proactive backing of their government have become active in, for example, Zimbabwean PGM mining while the president for life of that nation is feted in Beijing where he is hopping for cheaper weapons with which to grind his subjects under his will. The PGMs produced by Chinese owned and operated mines in Zimbabwe will most likely not be offered for sale on the LPPM.
China has just announced that it will build an 800,000 million tonne per year copper smelting operation in Zambia. This will be upon full operation one of if not the largest copper smelter on earth. It will produce 4% of the world's consumption of copper. This type of project makes the price setting exchanges nervous, because there is almost always gold and silver as well as, frequently, PGMs found in copper, which is nature's best collector for the precious metals.
The world's largest secondary (from scrap) copper smelter in the mid 1980s was Amax's Carteret New Jersey facility. It produced 250,000 metric tonnes of copper per year along with 100,000 ounces of gold, 10,000 ounces of platinum, 1000 ounces of rhodium and an amazing 1,000,000 ounces per month of silver.
If the Chinese primary smelter in Zambia produced just this much precious metal output from three times as much copper, and the Chinese do not report it as is the norm in copper and gold mining outside of the U.S. then China will, just based on the output of the Zambian copper smelter, become a major factor in the pricing of precious metals, and those precious metals will completely pay for the cost of operating the smelter leaving China with copper at a real cost of zero.
The Chinese have recently publicly complained that they do not have a say in the pricing of "minor metals" commensurate with their participation in the market. They have now begun to reduce the export of many minor metals by declaring that export allocations have been used up and/or placing an export duty on the metals large enough to create a two tiered market, so that Chinese companies using the "minor metals' to produce in China have a significant advantage over foreign companies exporting the metals as raw materials - if they can get them at all. As the Chinese produce more and more PGMs, for example, there is no guarantee that they will market them through the LPPM in which today no Chinese company has a membership.
I might add at this point that Russian metal companies are consolidating under the watchful eye and, perhaps, control of the state to form market dominating producers of metals such as aluminium. Resource nationalism is a big driver in this consolidation. Russia is the world's major producer of palladium and when the day comes that their capital base is as enormous as it looks to be becoming it is very unlikely that Russian companies will allow the LPPM to set palladium prices without Russian oversight or perhaps even approval.
Secondary sourcing (recycling) from scrap is a growing source of PGMs that is not likely to be controlled by the members of the LPPM. In the U.S. the largest consolidator of automotive catalytic converter scrap is A-1 Services, Inc. It is said that A-1 handles 75% of the American produced scrap. A-1 processes the scrap by shipping it to the Republic of South Africa where the material becomes feedstock for the PGM refining process used by, it is said, Impala Platinum [JSE:IMP] to process the ore concentrates from mines in Southern Africa. Today A-1 dominates the market by paying more for the catalytic converter scrap than anyone else. This payment is based on a projected recovery of PGMs by Impala's operations.
This is a weak link in the recycling process when processes developed by companies like Pro-Or [TSXv:POI], which I on Resource Investor two weeks ago, are considered as the basis for operations by future competitors. Impala's recovery percentages of PGMs from the scrap it receives from A-1 are a trade secret, but it is generally considered by industry professionals to be lower than the projected recoveries from the Pro-Or process, in particular as it pertains to rhodium, the rarest and most expensive of the "commonly" used PGMs in the OEM automotive industry. In addition, the Pro-Or process can be set up for a trivial fraction of what it would cost to duplicate Impala's operations and the Pro-Or process, it is claimed, can be profitable with a feed of the scrap from 100,000 catalytic converters a year.
America now produces more than 10,000,000 scrap catalytic converters a year. A-1 cannot buy all of them for two simple reasons. First the buying price of a scrap catalytic converter is dictated by their loading and by the recovery percentages of PGMs attainable, and Pro-Or's process is claimed to have yields with much higher percentages of platinum, palladium and rhodium than Impala's does, and second, the buying price for scrap catalytic converters at the local level-from which A-1 buys-is currently between $15 and $200 each at currently loadings and PGM prices. A-1 would need $500 million of working capital to buy out this market.
Therefore, if the Pro-Or process is proved commercial at the recovery levels claimed, there will most likely be a half dozen competitors to A-1 by 2008 that, unlike A-1, are vertically integrated and are buying for their own account. Many of the regional and national candidates for this type of scrap business are companies that have grown by acquisition of smaller local firms, and not only have access to or own the local catalytic converter collectors, but would pay considerably less than A-1 at the individual purchase point. The question is whether or not A-1 could sustain paying higher prices than it does now to collectors; who can choose to process their own scrap for a considerable margin of profit. One that will most likely be higher than they can make by selling to A-1.
The crisis for A-1 and for the producer members of the LPPM may well come as early as 2008 when a scrap dealer offers a lot of 10,000 ounces of a PGM to the LPPM. The LPPM can absorb this amount, but what if 10,000 ounces are offered every few days by operations recovering PGMs from scrap? For how long will the LPPM's members agree to pay their own market prices when they will no longer know how much material is available? PGMs are priced on the margin and new material coming from unknown stockpiles will put downward pressure on the price immediately.
Economical mining of small deposits in which PGMs are a byproduct, but in which the primary metal or mineral was not in the past, valuable enough and/or was too difficult to separate from the PGMs to support the mine may become the straw that breaks the back of the producer members of the LPPM's price control.
In this category we again find the Pro-Or process, which will enable North American chromite commonly found in Eastern Canada, California, Oregon, Montana, Wyoming and Washington to be processed economically even in small lots and allow the PGMs contained in such ore to be separated out easily at the same time. This type of ore is too expensive for the Impala process, because it is so destructive of the linings of the furnaces used to collect the PGMs. Chromium prices have skyrocketed and recovering the metal and PGM byproducts contained in them from American ore will go a long way to reduce America's dependence for these products from South Africa, Russia and China.
To summarize: new production of PGMs in Africa by producers under the control of Chinese investors, more efficient recycling of global automotive catalytic converter scrap and both new mining and new processes for mining small lots of ores such as PGM containing chromite efficiently may dramatically increase the supply of PGMs in the next few years. The current producers of PGMs do not want this to happen other than in their controlled markets such as the LPPM.
There are just too many new sources of PGMs coming on line, and I don't think the current members of the LPPM will be able to control enough of them to keep the control over prices that it has had in the 30 years since the use of PGMs by carmakers ramped up demand. This loss of control is a natural evolution, but, of course, it will be fought tooth and nail by vested interests.
In the Soviet era, Russian state owned producers of PGMs, mainly palladium, sold metal through the LPPM and it was in their best interests to keep their production and inventory numbers secret, so that they could, through the LPPM, control the world supply of palladium. This control was exercised in collusion with the other members of the LPPM.
Russia's state owned primary nickel producer, Norilsk, announced late last year that it would adopt transparency and announce production and inventory figures for PGMs. This announcement was probably insincere or even disingenuous with regard to palladium. Norilsk wants to keep prices as high as possible, and it has found that since production and inventory figures can't be confirmed they make a great addition to pencil-created inventories and production figures that have been a staple of the PGM market for decades.
Today the Russian state owned companies that are successors to the Soviet ones are consolidating in compliance with Russia's clear policy of resource nationalism. The Russians like the Chinese are concerned only with their domestic economies. When it suits their convenience to return to murky reporting of new metal production and inventory they will simply do so. When they have sufficient cash and reserves they will no longer take pricing orders from entities such as the LPPM as the Chinese have begun to openly state with regard to what they call "minor metals."
What makes the next few years different from all past years? All of the above.