Disturbing input and power costs data for platinum miners

RBCCM analysts find that at least a third of southern Africa’s platinum group metals production now generates negative cashflows; the sector could see “free cashflow declining by between 30% and 50% in the near term”.

JOHANNESBURG - 

In a disturbing study of South African platinum group metal (PGM) miners, which dominate the global PGM market, Royal Bank of Canada Capital Markets (RBCCM) investment analysts anticipate severe declines in miner cash flows, despite substantial upwards adjustments in dollar PGM prices over recent years.

The two main culprits - of many - rank, perhaps equally, as runaway input costs, and longer term power shortages in southern Africa. At this stage, RBCCM analysts project a cost curve illustrating that at least a third of southern African PGM production is generating negative cashflows, "with almost another third very close to break-even. Another interpretation is simply that we could well see free cashflow declining by between 30% and 50% in the near term".

Given the many metals and minerals yielded up by southern African PGM mined ores, RBCCM analysts use a current PGM "basket price" of USD 1,300/oz (60% platinum at USD 1,500/oz, 35% palladium at USD 300/oz and 5% rhodium at USD 6,200/oz), and industry cash costs of some USD 800/oz PGM, plus some USD 200/oz PGM maintenance expenditure, giving a "best case" cash margin of USD 300/oz, implying only a roughly 15% nominal return potential.

During the first half of 2002, global industry PGM leader Anglo Platinum was producing at around USD 375/oz PGM, including capital expenditure. The combined number increased to more than USD 1,200/oz PGM in the first half of this year, compared to between some USD 800 and just above USD 1,000 for Impala, Lonmin, Northam, and Aquarius. Based on these numbers, Anglo Platinum is now close to being out of the money.

RBCCM analysts argue that given current declines in the metal price basket, "we believe cashflow and margins will be declining sharply across the industry". Platinum has declined to around USD 1,450/oz from its March all time record of USD 2,302/oz, but remains above its 12-month low of USD 1,267/oz. Palladium and rhodium have also fallen, along with practically all metals and commodities.

Current PGM prices, mixed with supply side issues, could precipitate a longer-term supply growth crisis in PGM output. Focusing on the recent results package from Impala, RBCCM analysts particularly emphasise the announcement that some capital projects will be delayed "by at least three years as a result of the power crisis in South Africa".

Impala's Leeukop Project, however, could well be shelved altogether, according to RBCCM analysts, if metal prices do not improve: "Not only is Impala guiding for a major delay to this project, but, more importantly, is now also forecasting the capital expenditure to have doubled from ZAR 3bn to around ZAR 6bn. Our model for Leeukop does not deliver a viable project under these conditions".

What is critical though, the RBCCM analysts continue, is to reflect on Impala's announcement, given the apparent attractiveness of certain PGM juniors. Impala paid ZAR 4bn for the Afplats project, and, according to RBCCM analysts, "would be looking to spend some ZAR 6bn over a seven year period before seeing the first production ounce from a mine that is expected to produce in the order of 200,000 to 250,000 ounces of platinum a year.

The analysts note that the capital cost of the new mine would be some USD 2,000/oz of annual PGM production - and that excludes the initial purchase price, and assumes a metal price basket with 55% platinum at a rand to dollar rate of 7.1. "Such an investment", the analysts explain, "generally buys a mine capable of producing for about ten years".

But long before the first ten years are done, "new investment must be started to expand the mine in order to maintain ongoing output". With current maintenance capital expenditure levels for the industry running around USD 200/oz PGM, as noted above, the best case margin (after including cash costs) of USD 300/oz only implies a roughly 15% nominal return potential. "This is not enough", argue the analysts, "in our opinion, to start such a massive project - in particular given the current escalation in cost (both capital and operating)".

Looking at current comparatives, RBCCM analysts find it most interesting that Anglo Platinum, Impala, and Lonmin (the three biggest producers in South Africa) are currently producing at cash cost levels above that of Northam Platinum. Northam is the deepest operating platinum mine in the world and the only one of the four producers in South Africa that has to refrigerate the underground workings (requiring at least 25% to 30% more power).

All three of the big producers will have to start refrigerating their respective underground working areas within the next five years, RBCCM analysts argue, as the mining depth on the Western Limb of the Bushveld Igneous Complex starts to exceed 1,100m. By implication, the cost pressure will only get worse - in particular if part power generation needs to be undertaken in the face of significant power shortages in South Africa.

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