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Platinum Pie Crust Promises
Wednesday, April 3, 2013

In response to promise that they will always be good, Mary Poppins chided her charges with the term “pie crust promise”.  This was a promise that was easily made and easily broken; a promise that held no security and had no purpose other than the immediate goal of easing the current situation and making those involved feel good.  
What does this have to do with platinum?  Well, last week at the BRICS summit in Durban the South African Minister of Mineral Resources and her Russian counterpart entered into an agreement relating to their countries’ respective production of platinum and palladium.  Together the countries control about 80% of the global reserves in these two metals.  So at first glance the idea of a cartel looks like a good idea, as reflected by the Russian minister who evidently commented, “It can be called an OPEC”.  Minister Shabangu commented more enigmatically by saying “..without creating a cartel, ... we want to influence the markets”.  
Forming a cartel is more than just controlling access to a resource.  Any economics first year student will be able to tell you that a successful cartel has to fulfil at least five separate criteria.  The first is control of access through a limited number of suppliers.  With 80% of the global supply under the soil of the two countries, we meet that condition.  Check!  
The second condition is that there has to be agreement between the members of the cartel.  Economic history is replete with examples of cartels that have ended in the gutter as a result of conflict between the members.   The third condition is that this agreement must be formal, in other words it is not simply a loose acknowledgement of one another’s production capacity.   It seems that the two countries have reached some agreement, given that they have signed a framework accord to discuss future action.  Second condition? Check!  Third condition? Check!
The fourth and fifth conditions are more problematic and relate to the product itself.  
The fourth condition is that the product must be demand inelastic.  This term simply means that no matter what the price, the demand for the product will remain relatively constant.  As the price for something increases, demand for the product normally falls.  Not so with a demand inelastic product.  Think of filling your car; you might gripe about how much you have to pay to fill the tank, but you will continue to fill the tank, even if you drive a little more conservatively or rationalise your travel in various ways.  The demand for fuel remains relatively stable, no matter the price.  
The fifth and final condition must be that there is no suitable replacement for the product  If there was a suitable replacement then as the price increased buyers would simply choose the competing product.  
It is these last two conditions that raise issues that demand further investigation.  
Platinum group metals are to some extent demand inelastic and in addition, supply is limited.  The metals are generally difficult to mine.  In fact there was an estimated platinum shortfall in 2012 of about 400000 ounces and a shortfall of double that in palladium for the same year.  However, in spite of this shortfall, the price didn’t shoot through the roof as it should have for a demand inelastic resource.  Why? Because these was an alternative source of supply.  
Platinum and palladium are readily recyclable, supplying between 20 and 25 of the global demand for the metals – a significant alternative supply source.   The tightly controlled recycling of auto catalysts is an extremely profitable and reliable source of platinum and palladium, with recyclers often hoarding stock until they feel the price is right.  This industry lies outside the control of the two signatory countries and the existence of this source starts impacting on the first condition for successful cartels of limiting the number of suppliers.  In 2011 and 2012 the recycling industry supplied the equivalent of ninety percent of South Africa’s contribution to the global supply in the same two years.  
And  what of a suitable replacement?  Given that platinum and palladium are such rare metals, there has always been a tendency to minimise their use in applications.  Some industries, such as the electronics industry and the automotive industry continue to use the metal in large quantities, but in both these cases the search is on to reduce the amount of PGMs in use, and for finding suitable alternatives.  Following Marikana, which resulted in a significant rise in the price of platinum anticipating a shortage of this metal, industries have continued to pursue the search for less expensive, more readily available alternatives.  
Are suitable alternatives going to be available tomorrow?  No, it’s not likely, but statements about cartels and influencing markets are not going to slow the search for alternatives. 
For short term gains, reflected in the platinum price increases after the announcement, the framework agreement is a good thing.  For longer term planning within the industry and for beneficiation within a sector facing difficult times, talk of cartels and influencing the market make it a pie crust promise.