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Platinum and South Africa’s Precarious Power Supply

|Includes: IMPUY, PAL, ETFS Physical Platinum Shares ETF (PPLT), SWC

Platinum is a rare metal mined in a far lower quantity than is generally thought.  According to the USGS 2006 Minerals Yearbook, only 3.6 million troy ounces of refined platinum was sold that year.  A major producer like Impala produced a total of 1.04 million ounces in 2007.  The metal is mined in only a few countries. In fact, 80% of all production occurs in South Africa.

Perhaps most disconcerting, and indeed the focus of my argument here: 95% of South Africa’s electricity supply is produced by Eskom, a utility that for years has struggled with higher demand expectations, cavalier domestic coal producers, distracted government, and its own bad management practices.   With a brownout this January and the World Cup set for South Africa this June and July, the utility is now careening into the world limelight for its very own cameo. It might not be pretty. . .  .

The stability of the entire PGM supply this year now rests on whether South Africa can cope with the looming strains on its power supply. 

The country has struggled with the issue for years, suffering a series of rolling blackouts and suspended mining in early 2008 that deeply embittered the business community.
Though a national emergency was declared after that crisis, the issue has not been resolved. 

In February 2008, in his State of the Nation address, President Mbeki publicly apologized for his government’s mismanagement of the issue, admitting that Eskom reports from 1998 and 2004 that warned of a future crisis were not taken seriously at the time. 

Fast forward to February 2010.  Peak demand for electricity in the country remains at a level not far below the utility’s maximum output. Its reserve capacity is now at 8%, about half of what would be considered adequate reserves in any other country. 

As the country seeks to host the World Cup and enjoy the attendant economic growth that comes with 500,000 visitors, this mass tourist event will certainly strain the supply during the months of June and July.  That is clear.  Less discussed is the fact that this first African-sponsored World Cup will spike television use throughout the continent.   And aggressive business productivity prior to the event –and prior to the price hikes and rationing slated for April-- will likely trigger problems in the preceding months.   

The South African government declared two weeks ago that Zambia will be offering power during the World Cup. This should not be reassuring.  Zambia only generates 1400 MW of electricity with peak demand driving as high as 1500 MW.   That neighboring country had very little supply itself.    Zambia’s state utility Zesco quickly amended its support to off peak hours.  Let’s just say soccer is a popular game to watch in Zambia as well . . . .

The investment community has become more strident in their view. On February 9, 2010, a senior Southern Africa analyst, Anne Fruehauf, called South Africa’s power infrastructure “a material constraint to investment.” Her “RiskMap 2010” profile reports: "The consequent lack of spare capacity to support an economic upturn will once again impose an unbreachable ceiling on growth and expansion prospects."

Economist Azar Jammine, the director of the Econometrix think tank, is even less sanguine, having stated that "the most devastating blow is what this proves is that there is a ceiling of approximately four percent annual growth to what the South African economy can achieve for next six to seven years . . . and that is not as much as we would have hoped would have been achieved."

If this was not enough, new reports about the sorry state of South Africa’s water supply will further complicate the issue of productivity expansion in the country.  Water-poor for its population size, the country is now seeing infrastructure and mine pollution runoff problems in Gauteng province.

So what does this mean for platinum?  Last year’s severe downturn devastated car sales in the US, as financing dried up and fleet purchasing was put on hold.   Specifically, demand for auto catalysts fell to 2.5 million ounces in 2009, a 30% drop from the prior year. In fact, the year ranked as the lowest in demand in nine years.

2010 looks to be a bounce-back year.  According to analyst Evan Smith of US Global Investors, the worldwide automotive industry is expected to expand output 20% this year.  The Michigan-based Center for Automotive Research supports this forecast; it projects US car sale will rise to 12.4 million in 2010.  India and Brazil will see improved sales, and --according to GM-- China will likely see a respectable 15 million cars sold for the year.  And these cars will be “greener” –i.e. equipped with more platinum or palladium per catalytic converter for higher emissions reduction.  According to London-based Johnson Matthey, the producer of about 33% of the world’s auto catalysts, platinum may have a “modest deficit” in supply this year. 

I would argue that new recovery demand is emerging just as platinum supply is constrained by a unique set of circumstances in a pivotal producer.  Three great historic positives for the South African nation --the vast enfranchisement of the black population, the electrification of their townships, a decade of economic expansion—have left the country under-powered.   The major miners have lost faith and are already discussing private utility options to ensure the energy security of their operations. But this will take time and not offer a solution until later in the decade.

South Africa’s power infrastructure crisis is a problem that will plague the country for years.  More specifically to this topic, it will have a constructive effect on PMG prices over the next five months.  With a strong Rand and electricity prices due to rise at least 14% a year “into the foreseeable future,” as mentioned recently by South Africa’s own Public Enterprise Minister Alec Erwin, platinum might find itself in a proverbial sweet spot. 

Disclosure: PPLT. SWC. PAL

Disclosure: PPLT, SWC, PAL