Invasion effect on PGMs

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Base case unchanged, but upside price risk

The Russian invasion of Ukraine has not yet resulted in significant supply disruptions of platinum and palladium from Russia’s main producer, Norilsk Nickel. If the war escalates and if sanctions begin to slow palladium supply from Russia to the West, production could be diverted to China. South African (SA) production could then supply sanction-affected customers, resulting in a potential net zero impact on the demand-supply equation. However, the balance of risk is likely tilted towards supply disruptions and higher prices.

Russia’s importance in the PGM space

Russia supplies around 40% of the world’s palladium, 10% of its platinum and 7% of its rhodium (the three main platinum group metals (PGMs), of six in total) from mines in Talnakh, Norilsk and the Kola Peninsula. As a major palladium supplier, it is important as this metal is used in the catalytic converters for gasoline driven vehicles, which constitutes around 82% of total demand. Russia’s production of platinum is not critical to the market and rhodium even less so.

Latest developments

The London Platinum and Palladium Market (LPPM) recently suspended delivery of Russian PGMs from the Krasnoyarsk and Prioksky refineries. This only prevents ingots produced by said refiners from being delivered into the London OTC market. As neither are officially sanctioned entities and nor is Norilsk Nickel, there is nothing stopping individual companies from buying their metal and using it in industrial processes. Of course, if companies start self-sanctioning and refusing Russian metal due to increasing reputational risks and on moral grounds, then channels through which Russian metal can be delivered to the West would start closing.

Forecasts unchanged

Our base-case PGM forecasts are unchanged from our outlook published in December 2021, as we believe that any supply disruptions that might occur would likely be temporary. However, the balance of risk to our forecasts is for higher prices if disruptions are not temporary.

Likely winners…

Possibly non-Russian PGM producers with a high percentage of palladium in their metals split, such as Sibanye-Stillwater (SSW-JSE).

Likely losers…

Possibly Norilsk for geo-political reasons, though the company’s metals are still flowing to customers at present.

Winners and losers shown above do not translate into buys and sells as other themes (and valuation parameters) may conflict with this one.

Most likely scenario: Sanctions to slow PGM flow

Notwithstanding the LPPM suspension, we think that PGMs, and particularly palladium, are metals that the world cannot do without, since palladium is the most important metal in controlling emissions from gasoline vehicles, which, at 80%, are by far the biggest vehicle type sold today. It is likely, therefore, that the West will allow metal to continue flowing from Russia, as ESG demands for a cleaner environment are unlikely to be thrown aside because of the war. As a result of the sanctions imposed on Russia, payments made under current contracts may well continue to be made in foreign currency, but they may also go through a single local bank, which would convert this currency in rubles for exports not affected by the sanctions. There is no clarity on payment systems and which commodity they pertain to and payment methods could change on short notice.   

It appears that the Russian invasion has stagnated, leading us to believe that the probability of a prolonged war between Russia and Ukraine is not insignificant. We therefore think that PGMs will continue to flow out of Russia, but that there could be a slowdown of supply should sanctions be tightened. The lower supply could drive palladium prices to higher levels as the war drags on, and Western companies may, in our view, start self-sanctioning. Russia is not a major producer of platinum (around 600Koz a year out of 8Moz total supply) and a very small producer of rhodium (around 75Koz a year out of a 1.1Moz total supply). These two PGMs should be relatively unaffected by the war.

We understand that Russia’s main PGM customers are three major Western companies, a Japanese company and various Chinese companies that are still receiving Russian PGMs. If these companies (excluding the Chinese companies) are forced to stop trading with Russia due to some escalation of the war or a tightening of sanctions against it, we think that China, as it is friendly with Russia, could buy the PGMs even though China would still buy PGMs from South Africa. China is very concerned with security of supply and would not endanger its relationship with South Africa at any cost. However, if Russia is forced to sell more of its PGMs to China, we feel that the Chinese or other friendly countries would most likely buy the metal for onward trading. Hence, metals are likely to continue flowing from Russia.

The Chinese government will almost certainly not want to be seen to be sanction busting, so it may not want to be seen to exactly make up for the supply shortfall from Russia. In this case, the price in the West may again have to spike to incentivise marginal production.

If China is seen to be sanction busting, this could invite a response from the West (for example, sanctions on China), which could have the effect of causing an even greater spike in prices in the West over an even longer timeframe.

In the event of supply not being redirected via China, it is likely that the same considerations would apply to either Dubai or any of the other BRICS countries (Brazil, Russia, India, China, South Africa).

Conclusion: The longer the war, the higher the palladium price

We see the Russian invasion of Ukraine resulting in sanctions for some years to come. The supply of commodities out of Russia could become more difficult and prices are likely to rise over time.

Winners and losers: The producers with the highest palladium content in their prill split (a term used to indicate the percentage of each metal in the suite of platinum group metals produced, which differs with each producer) would be the winners if the palladium price rises as a result of this war. Norilsk would be a clear winner assuming sanctions are not implemented against the company. Other companies that could benefit can be determined by the amount of palladium they have in their prill split (Exhibit 1).

Palladium is a by-product of South African producers. Their main income is from rhodium and base metals nickel and copper, followed by palladium and platinum at current prices. South African producers have not spent much capex on expanding their production in the last seven years, as it is only in the last three years that PGM prices have risen significantly, and they are therefore unlikely to be able to increase production in approximately the next five years because of the lead times for new projects in mining.

Palladium is a by-product of Norilsk; its main income historically is from nickel and copper. Currently the base metals combined contribute around 43% and palladium 39% to revenue. Norilsk’s latest mine in the Talnakh area, the Skalisty mine, has recently reached full production and it will reach a depth of over 2,000m below surface. We estimate that the lead time to increase production from the Talnakh area, with a new mine to increase production, would be around 10 years at these large depths.

Also, with the permafrost melting problems in Siberia and the long lead times of getting its South Cluster into production (scheduled for after 2026), palladium supply is unlikely to increase from Norilsk in the next 10 years. As a result of these supply constraints, we think that the palladium price will rise as demand for autocatalytic converters will continue for several years before battery electric vehicles become commonplace.

The percentage of precious metals produced from the ores of the main producers, the prill split, is shown in Exhibit 1.

Exhibit 1: Prill split of the main producers (%)

Source: Edison Investment Research, company websites April 2022. Note: *Sylvania Platinum is an Edison Research client, www.sylvaniaplatinum.com.

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