Monday, December 27, 2010

Looming Peak Coal in South Africa and the World

South Africa is about to reach Peak Coal, or has already passed it. Mean while the world will reach Peak Coal soon, said Cal Tech scientist David Rutledge. Mr. Rutledge surveyed coal production history of major producing counries all the way back to 1880, and applied the math model pioneered by King Hubbert, who accurately predicted the 1971 Peak Oil production in the USA, using his math model. Rutledge concluded that previous estimates of global coal reserves were outdated and too optimistic. He believes that there were roughly 662 billion tons of ultimate recoverable coal reserve on earth, among which 59%, or 400 billion tons, still remain underground. To put the numbers in prospect, the world produces and consumes about 7 billion tons of coal a year. China is responsible for about half of that number, or about 3.5 billion tons.

South Africa produces 242 million tons of coal last year. David Rutledge predicts that South Africa's production will peak in 2011 at 253 million tons a year. Peak Coal in South Africa has huge implication to the global economy and to the supply/demand of a critical natural resource that the world can not be without, especially as we move towards alternative energy solutions. South Africa is responsible for 85% of the world's platinum production and 40% of palladium, two noble metals used extensively as catalysts to cut air pollution from automobile emissions, and as catalysts to produce synthetic fuels and used in fuel cells, among other things.

Peak Coal in South Africa also means Peak PGM for the world, just as the world has an increasing demand of PGM metals for the environmental and alternative energy needs.

I discussed previously that mining of Platinum Group Metals (PGM), platinum, palladium and rhodium etc., is extremely energy intensive. Based on reports available from South African PGM mining companies like Anglo Platinum (AGPPY.PK), it costs roughly 1x10^10 joules of energy to produce just one troy ounce of PGM metals. That is the direct energy cost. If you include the indirect energy cost, the energy required to build and replace the mining equipments, build and maintain the mine and provide for the mining workers etc, the total energy cost to mine one ounce of platinum or palladium could be five times higher, or roughly 5x10^10 joules.

The 5x10^10 joules total energy cost to produce one ounce of platinum or palladium is equivalent to 13,890 kwh of electricity, or 7.64 metric tons of coal, or 30 barrels of crude oil, or 160,000 cubic feet of natural gas, or 0.556 miligrams of mass. At their recent prices in the US market, these energy commodities would be worth $472 in electricity, or $955 in coal, $655 in natural gas, or $2730 in crude oil. (Calculated using $0.034 per kwh electricity, $125 per ton of coal, $4.09 per thousand cubic feet of natural gas, and $91 per barrel oil.)

Remember in early 2008, electricity shortage almost knocked out the electricity grid in South Africa. The PGM and other mining industry was forced to shut down for 5 days, causing a market panic that sent platinum price to $2300/oz and palladium to near $600/oz.

Has ESKOM, the nation's semi-governmental electricity company, fixed the electricity supply problem in that country? Not by a long stretch! So far ESKOM has not even touched ground to start building any new power plant, even though there has been lots of talks. They promised in 2008 to quickly return three mothballed coal fired power plants back to service in a few months, but the first of the three mothballed power plant did not return to service until October, 2010.

The problem is that ESKOM is financially crippled due to the low electricity tariff in South Africa. Based on their latest annual report, ESKOM burned 122.7 million tons of coal and generated 215940 GWH of electricity, or roughly 0.57 kilograms of coal to generate each kwh of electricity.
Cost of electricity generation was 0.282 rands per kwh, half of which is fuel, mostly coal cost. So ESKOM paid roughly 250 rands per ton for coal, or US$25 per ton, using last year's exchange rate. Current international coal price runs as high as US$125 per ton. Imagine what kind of craps (discard coal) ESKOM burns to generate electricity as they could only pay a fraction of the going market price of coal!

ESKOM is vulnerable to lose its domestic coal supply to international buyers who have insatiable demands and who can pay much higher prices. Look at India with an economy growing at 8% and who faces peak hour electricity shortage of 14%, and who will boost coal import from 80 to 100 million tons next year. The increased will mostly come from South Africa. China is also approaching peak coal. China begins coal import from South Africa just as Asia tops Europe to become South African coal's biggest buyer. China experiences such acute coal shortage in major cities recently that they inadvertently cut power supply to critical oil refineries, resulting in a diesel shortage that crippled the truck transportation, leading to skyrocketing vegetable prices while some produces are left rotting in the fields unharvested.

Let's look at South Africa's coal again. Last year's 242M tons of coal production was mostly used by ESKOM (123-million tonnes), Sasol (40-million tonnes) and export (66-million tonnes). ESKOM's expansion program can use an extra 50M tons while Sasol's new project requires an extra 20M tons annually. And we are also talking about insatiable international demands from India, China and Europe. There is no way South Africa can meet all these coal demands.

Some one has to yield! Who is least capable of affording high coal price, namely, ESKOM, must yield! ESKOM must drastically cut electricity supply and aggressively boost electricity price to stay in business and keep the country's electric grid up and running.

We are not talking about events a few years down the road. These events are rapidly unfolding in front of our eyes now. I have been monitoring coal price and see how it rallied from $90/ton in August, 2010 to now $125/ton, a 40% surge in just 4 months.

What's the implication if ESKOM has to take those drastic measures? The country's energy intensive PGM mining industry will crumble! Simply put, platinum and palladium will have to be produced at much higher cost. The production volume has to be cut dramatically. The PGM mining companies will demand much higher metal prices to compensate for the increased cost to stay in business.

That, of course is bad news for the world, but music to the ears of wise investors who put their money in physical precious metals, palladium and platinum. These two metals, particularly palladium, are the ultimate alternative energy investments as I discussed.

Full disclosure: The author is heavily invested in palladium and owns large long positions in North America's only palladium mining company, Stillwater Mining (SWC) and North American Palladium (PAL). The author is also heavily invested in coal mining company PCX and is looking to buy other coal mining stocks.

Wednesday, December 8, 2010

Norilsk Nickel's Strategic Moves and Palladium Super Bull

Russia's Norilsk Nickel, the world's single largest nickel producer who is also responsible for 45% of the world's palladium mine production, made two big strategic moves, one of which escaped everyone's attention except for mine, and another one caused every one's attention but still caught me by a big surprise.

The surprise move is that Norilsk Nickel actually meant it when they said early in the year that they were going to sell their stake in Stillwater Mining (SWC), the only US based palladium and platinum mine, an extremely important strategic asset that Norilsk Nickel acquired in 2004, after going through the trouble of getting two superpower presidents involved in the negotiation, among other things. I could not believe Norilsk Nickel will sell their SWC stake, because Norilsk Nickel and SWC combined gives them the monopoly power of controling more than half of the world's palladium supply. But they did just sell their SWC stake. They acquired their SWC stake for US$100M cash and 877K ounces of palladium, valued at today's market value, their investment did not bring them much profit after all.

What made the Russians change their strategic mind regarding palladium, at a time when palladium price looks spiralling higher by the day? They no longer consider themselves a key palladium supplier to the world in the future?

The Russian riddle is solved when I noticed another less noticed, but much more significant strategic move made by Norilsk Nickel. The story goes back to 2007 when Norilsk Nickel outbid Xstrata to acquire LionOre in an all cash offer worth more than US$6.5B. At the time analysts could not understand why Norilsk Nickel paid such high price for a mining company of limited mineral reserves. The answer became clear only recently, long after the LionOre acquisition, in a Bloomberg news story:

Norilsk Nickel Plans $20 Billion Program to Boost Arctic Output

New Technology

“We’re considering switching from pyro-metallurgy to hydro-metallurgy based on Activox technology,” Muravyov said. Within a year, the company will test whether the technology, which Norilsk bought in 2007 as part of its $6.5 billion LionOre acquisition, will be suitable for Arctic ores. Activox uses chemicals to dissolve nickel from concentrate and then produce the pure metal.

“The cost of applying Activox in Norilsk still needs to be evaluated,” Muravyov said. Installing the technology at all of Norilsk Nickel’s facilities, at a cost of as much as $10 billion, would allow the company to “remove all ecological problems and cut electricity and gas consumption,” he said.

I suddenly had an eureka moment: The Activox Process, originally owned by LionOre, was the real reason for Norilsk acquisition. Norilsk Nickel mine, being one of the top ten most polluted places on earth due to sulphur dioxide and heavy metal emission from the smelters, and facing deteriorating nickel ore grade in coming years, desperately needs this new chemicals based metal producing technology that cuts pollution and production cost drastically.

Except for one catch. Platinum and palladium are very stable and extremely chemical inert metals. Therefore unlike nickel and copper which are easily dis-solved, these two precious metals are virtually impossible to be leached from the mineral ores, using any chemical solution. A demonstration chart of the Activox Process confirms my intuition. The lower left corner of the flow chart indicates that the leach residue, containing the precious metals, are either simply disposed, or be send to alternative precious metal recovery process.

After base metals are extracted, the leach residue would contain virtually all of the original material from the mineral ores: rocks, sands, dirts grinded into fine powder, and wet with all the nasty chemicals mixed in during leaching. It probably contains no more than a few part per million precious metal content. Once again those precious metals: palladium and platinum, are chemically inert and can not be extracted efficiently using any chemical solution. The only way to process them is to use high temperature smelters, which bring back all the air pollution problem and high energy cost, problems that Norilsk wanted to solve in the first place, moving away from smelter based pyrometallurgy towards Activox Process based hydrometallurgy.

The unescapable conclusion is that Norilsk Nickel will become just a low cost nickel and copper producer, and will cease to produce palladium and platinum as byproducts, once they adopt the Activox Process!!! This is true unless palladium and platinum prices are driven to such high levels that it makes economical sense to try to recover the trace amount of precious metals contained in the leach residue despite of the high processing cost!

A technical paper discussing the Activox Process running at the Norilsk Nickel owned Tati plant in Botzwana, written by experts of that plant, confirms my conclusion. The 16 pages technical paper contains not a single word mentioning of either palladium or platinum:

Solvent extraction design consideration for the Tati Activox® plant

This shocking development is very bullish for palladium and is a very good news to fellow palladium investors. We are talking about 45% of the world's supply of palladium removed when Norilsk ceases to produce byproduct PGM metals. Of course, I do not expect this paradigm shift to occur overnight. But shouldn't it be time that precious metal investors leverage the opportunity to hoard the palladium metal and ride the palladium super bull up to the moon, and mean while industry users like GM (GM), FORD (F) and TOYOTA (TM) need to start panic now and build their strategic palladium inventories before it is too late. If 4% of shortage was enough to drive rhodium price from $300-ish to $11000 per ounce, I don't know how high palladium price can go to if we have more than 50% shortage in the global supply!!!

Maybe, just maybe, the recent remarkable surge of palladium price indicates that some investors out there have already figured out what the Activox Process means to Norilsk Nickel and to global palladium supply, and are already quietly loading up while keeping their lips sealed.

Full disclosure: The author has studied global palladium market for a few years and is heavily invested in physical palladium metal, as well as in stocks of the world's only primary palladium mining companies: SWC and PAL. The author has no position in Norilsk Nickel (NILSY.PK).