SA Mining Sector - Is It Time for a 'Controlled Market'?

2014-04-23 06:14

(I apologise for the long article)

Supply Side - the dilemma

The strike in the platinum mining sector has gone on for over 3 months now. While there are signs that an agreement may be reached some time soon, the length of the strike and the big gap between workers’ demand and wage offers has highlighted some serious structural problems in this whole sector.

It is not just that Employers don’t want to offer the wages being demanded, they simply can’t afford to. As it is, at current prices, most mining houses are loss making, save for the weak Rand - which means that the shareholders/ investors are not getting a good return on their investment.

Again, it is not that the Workers are simply being unreasonable in their demands - they also want what they deem to be a fair wage given the risk to their lives that they assume on a daily basis while doing their job.

The government is somehow caught in the middle: The mining sector is one of the biggest employers in the country, but on the other hand, currently contributes very little in way of taxes (because of low profitability). It would seem the government has been ok with this apparent arrangement: if not taxes, at least create jobs for the people. But now here is a new dilemma – the workers are no longer happy. So who is now happy in this sector?

The main parties on the Supply Side are Investors, Employees and Government. Looking at the above analysis – right now, it would appear none of these parties are happy – no good return for investors, no fair wages for the employees, and not enough taxes for the government. Which begs the question – why does the sector exist then? Could we say that it merely exists to satisfy the global demand for the product then?

Demand Side - the joy ride

Let us now look on the other side of the market: the Demand side - The buyers/ users and other beneficiaries of this industry.

What is platinum used for? More than 40% is used in autocatalysts in the motor industry – basically to reduce emissions and limit environmental contamination. The Jewellery sector takes up about 30%, and rest is used for industrial & medical reasons. In recent years, we’ve seen Platinum increasingly being used for investment purposes (Exchange Traded Funds - ETFs), etc.

So, who do we have on the Demand side? Again: Investors (autocatalyst manufacturers, vehicle manufacturers), Investors (platinum ETFs), High Net worth Individuals (platinum jewellery), The People (workers), and Government (taxes).

In May 2013, German autoworkers went on strike. But not because they wanted a decent living wage - as is the case with mining workers in SA – but, they wanted more. A media report stated “German autoworkers want their share of the record profits announced by German carmakers last year.” Estimates indicate that German autoworkers earn on average $67/hour and US autoworkers earn on average $33/hour. I’m not going to vouch for the accuracy of these numbers, but I know for a fact if SA mining workers earned even close to this, there would most likely be no strikes. But I won’t dwell on this…

So, what do we gather from the above? Auto manufacturers are making good profits – which means good returns for Investors, good Tax Revenues for the government and good Wages for the people.

Let us then conclude that everyone on the Demand Side of this market is relatively happy. But not so from

the Supply side as we discussed earlier.

For purposes of this short article, I will not dwell on the actual autocatalyst sector or how profitable and lucrative the platinum jewellery market is.

The Maths – high level

Some high level analysis: How much platinum is used in a single car? Estimates range at 3-7 grams per catalytic converter in a car, depending on the size and type of the car. Local selling price of Platinum is currently about $1,400/ounce. There are about 28 grams in a single ounce – therefore, the cost per gram is roughly $50/gram. Which means, each car uses about $150 –$350 of platinum.

If the price of platinum were to be $1800 (which I believe is the price miners need to be sufficiently profitable), then each car uses about $195-$450 of platinum, an increase of $45- $100 per car. So, in simple familiar terms, if the Platinum price were to increase to $1800/oz, the cost of manufacturing each car would go up by about R1000 per car, (let’s say R2000 for other costs and mark-ups).

I doubt this would significantly affect the profitability of automakers, or the taxes collected. But it would be a saving line for Platinum mines locally, would boost tax revenue for the SA government, and will allow mines to pay employees fair wages: Supply Side as happy as the Demand Side.

Efficient Markets vs Intervention

In recent years, there has been an increasing activity in platinum investing through Exchange Traded Funds. This segment of the market still accounts for less than 10% of all platinum use – but I bet you the traders in these funds can have a big influence on the platinum price. In fact, there have been allegations that Banks on

Wall Street are actually operating a ‘commodity cartel’ and are effectively influencing the platinum price. So, you have a case where these few individuals (controlling less than 10% of the market) get to influence the platinum price – merely because of demand and supply dynamics in that tiny segment of the market. And the

main players in the market merely have to accept that as the fair market price. But is it?

When I was doing Economics 101 at university, we were once faced with the question: Are markets efficient? Looking at the high level analysis above, would I say the current price is the fair, equilibrium market price? Is Demand in sync with Supply? I would argue, Not. The Demand side is ‘happier’ than the Supply side. The User

is happier than the Producer. The Buyer is happier than the Seller.

The infamous economist, Adam Smith, conceived the concept of an ‘invisible hand’ in the markets. The Invisible Hand describes the ‘self-regulating behaviour of the marketplace where individuals can make profit, and maximize it without the need for government intervention.’ Maybe the invisible hand is not that effective in this industry, or it has become biased in favour of one side of the market.

So, if the market is not in equilibrium, because it is not efficient, then it calls for intervention to bring about this equilibrium. Which brings me to the crux of this article: Is it time for a controlled market? Maybe it’s time for a visible hand. Maybe it’s time for a market mechanism to be put in place to intervene to ensure ‘individuals can make profit and maximise it’.

Few weeks ago, there were reports about the CEO of the PIC, Mr Elias Masilela, who has previously alluded to the idea of a ‘cartel’ in the mining sector, which would aim to control production and effectively influence the price. But the recent media reports were about him backtracking on the idea - apparently after his comments attracted a lot of negative reaction from industry pundits. The Business Day reported - '…Almost immediately, fund managers, platinum industry executives and analysts warned of the legal and practical obstacles of forming a cartel, describing his suggestion as naive and unworkable.' I don’t blame him for backtracking, no one in a senior, high profile position wants his ideas to be described as ‘naïve and unworkable’.

But this is exactly what I’m arguing here - at least I’m not a high profile somebody. We need a controlled market, which will make sure that South Africa benefits appropriately from this precious resource of the land. South Africa has more than 80% of world reserves of platinum and currently produces about 70% of global supply – it only makes sense that this market position should carry with it some power in the market. But if that power cannot be translated into monetary terms, then it’s not real power. The local market is still controlled by the global market (read: users) – everyone else seems to have a say at what the price should be, except for South Africans. What makes it even worse is that the commodity is priced in a foreign currency, which exposes us to foreign currency volatility too.

Can the market be controlled? Yes. Should it be controlled? Probably. Is it a globally accepted practice? No. Is it done anywhere else? Yes.

International Examples

Let’s look at international examples of this.

The most popular one is OPEC (Organisation for Petroleum Exporting Countries) – effectively the oil producers’ cartel. Throughout history, we have learnt of interventions that this cartel has had in the market to control production, control supplies to particular countries (e.g. the oil embargo), and effectively influencing the oil price. Could we have OPEC 2.0, in the form of ‘Organisation for Platinum Exporting Countries’? Could it have as much influence?

Another big cartel is the Russian based Potash exporters cartel (potash is used as a fertilizer for crops and is a popular export to emerging markets.) This Russian cartel, made up of 2 companies, controls about 40% of world supplies of Potash. The cartel was disbanded in July 2013 when there was a change in shareholders, but as of early 2014, the 2 producers were in talks to re-establish the cartel.

When the cartel was disbanded, potash prices tanked about 30% and the companies’ shares and potash stocks worldwide crashed. Potash producers expect that potash prices could double within the next 2 years if the cartel is re-established. As reported, the cartel pricing scheme yielded high returns for potash companies from 2005-2012, but recent weak prices have made markets like Russia and Germany vulnerable.

Still, in the same industry, there is another Potash ‘cartel’ in Canada, Canpotex. Canpotex is made up of 3 potash producers (PotashCorp, Agrium and Mosaic) in Canada and also controls about 35% of global Potash supplies. Well of course, Canpotex does not claim to be a cartel, but rather a ‘marketing consortium’ – but adopting the concept of ‘substance over form’, it is a cartel.

In 2010 BHP attempted to acquire PotashCorp and they explicitly intended to exit the ‘cartel’ after the acquisition. The acquisition was blocked by the Canadian government and it was eventually withdrawn by BHP. The government raised some concerns about the acquisitions and BHP’s intentions – one of the concerns being that ‘the breakup of Canpotex would likely result in lower tax revenues for the government’.

Recently, the CEO of PotashCorp had some tough words regarding the collapse of the Russian cartel, saying that ‘the decision to collapse the cartel-like marketing company and max out production was “probably the single dumbest thing” he has ever seen in the fertilizer business’.

A fund manager also commented that a reunion of the Russian cartel ‘would support potash prices and promote supplier discipline within the market.’

The case for a controlled market

There we have it, 3 cartels that operate globally in what would otherwise be a completely ‘free market’. Is the market balanced? These potash producers generate good profits for themselves, but how many farmers in emerging markets can claim to be making super profits? Very few, if any. In the case of Platinum, it’s the other way around – the Buyers/ users benefit substantially to the disadvantage of the Suppliers.

Russia has a ‘cartel’ yet they only control 40% of the market. Imagine what they would do if they controlled 75% of platinum supply like we do. Would they leave platinum into the open free markets or would they try to control the market like they do with Potash?

After Mr Masilela’s suggestion, those opposed to the idea ‘warned of the legal and practical obstacles of forming a cartel’, and they went on to describe his suggestion as ‘naive and unworkable’. Reading these responses, all I pick up is fear. There has been no reaction from government, again because of fear: “Who can dare take on the global market?”

You see, South Africa is a very obedient and diplomatic country. We are probably the least rebellious country in Africa when it comes to Western ‘best practice’. We always want to tow the line drawn by the developed markets – even if it works to our disadvantage. No one dares take action against what is considered ‘international best practice’. We simply take the view that we will just let the market sort itself out, if we lose in the process so be it, the market has decided that it must be so. And of course, the market is efficient and ‘holy’.

And this is why things will remain as they are. Before we know it, our platinum reserves will have been squandered and we won’t have much to show for it – except be in good books with the rest of the world for having happily supplied them with the commodity when they needed it the most. By that time, they will have made their billions, developed their countries even further (from the taxes), and they will have much to show for our resources than we ever will.

If a structured, controlled market has worked in the above 3 cases, why would it be such a monumental task to make it work in this sector? This, regardless of whether or not it is an acceptable practice.

Following the recent strikes, mining companies (investors) have even talked about mechanising their operations, which will result in a loss of jobs. If they do this, they will, to some extent, secure their good returns. The SA government might or might not collect lucrative taxes. But the People on the ground lose out completely – no more jobs. Yet, as mentioned earlier, everyone on the other side of the market remains happy – they will still get their platinum, secured supply, at low prices, they still make their super profits, those governments still earn their taxes. But something must have to give on the Supply side of the market.

As it is, it is estimated that there are about 4 million ounces of platinum stock held by ETFs and other known inventory – which partly explains why the disruption in production has not really affected the platinum price. This tells us that SA producers are basically competing on production, thereby flooding the market with as much platinum as they can possibly produce. We know what this does to the platinum price. So, what if there was a consented effort to control/ limit supply?

If the platinum producers cannot do this of their own accord, then someone else with the right powers need to? Maybe the government is the one who can be trusted to put something in place in this regard (I apologise for using ‘trust’ and ‘government’ in one sentence). The government must take a firm stand and intervene. It is time for a visible hand in this market.

And yes, if platinum prices were to remain ‘too high’ for an extended period of time, eventually we’ll see alternatives/ substitutes being developed (esp for use in auto catalysts). Yes, that may well be, but until then, let us make our money, let us have something to show for this precious metal at our disposal.

In conclusion: Yes, it is time for a controlled market.

What think ye?

....

This is X at it again. Catch me on Twitter @xolanik

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