PLATINUM. STATE OF THE NATION Roger Baxter, Chief Economist and COO, Chamber of Mines of South Africa

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1 January 214 PLATINUM STATE OF THE NATION Roger Baxter, Chief Economist and COO, Chamber of Mines of South Africa PGMS IN SOUTH AFRICA Introduction The platinum group metals (PGM) mining sector is the largest component of the South African mining sector on the basis of its contribution to GDP, employment and its overall contribution to the South African economy. In, the South African platinum industry contributed 4.1% of GDP (1.9% directly and 2.2% if the indirect and induced effects are included), accounted for 9% of merchandise exports (including the value of platinum sold to the catalytic converter industry and then exported) and helped create about 44, jobs in the economy. Direct PGM mining employment was 197,847 people who received R34.4 billion in salaries and wages. South Africa is richly endowed with PGMs and holds over 8% of the world s known resources and reserves. In 213, the country s PGM mining industry accounted for 53.4% of global platinum supplies, 26.4% of palladium and 58.7% of rhodium supply. Over the past decade South Africa s share of global supply of the three main PGMs has diminished from 51% of the total in 23 to 39.8% in 213, as the country has facing increased competition from lower cost producers in other regions and because of the large increase in scrap recycling. Over the past decade South African production of PGMs has declined annually by.4%, but more recently the country s production growth has reduced due to the significant labour disruptions the industry has faced since. At the global level, a significant share of the increase in PGM supply has been the quadrupling in the supply of PGMs from recycled materials. Recycling has grown at 17.2annually in the past decade. Nevertheless, while PGMs have similar chemical characteristics, they have different uses and different markets. Platinum, the dominant PGM, is used in diesel catalytic converters and jewellery, while palladium is dominant in petrol catalytic converters. However, in spite of the scarcity of PGMs, PGM prices are mostly driven by industrial, jewellery and investment demand but, unlike gold, platinum is not seen as an alternative reserve asset to gold or other currencies. From a strategic perspective PGMs not only contribute materially to South Africa s economy but also contribute substantially to the control and reduction of noxious gases from the world s vehicle fleet. It is dangerous to believe that platinum is indispensable and producers are aware of increased efforts by downstream users to find substitutes as South Africa s reputation as a reliable future supplier of platinum is coming under question. There is substantial competition for South African PGM producers from lower cost PGM producers in Russia, North America and Zimbabwe, for capital and markets. In addition, the large sophisticated international companies that have developed around the platinum sector are continuing their efforts to either thrift or substitute platinum and rhodium, and these efforts intensify each time production at South African PGM producers is interrupted. The South African platinum mining industry is in crisis. Demand for PGMs has reduced in Europe due to the recession in that region, demand growth has slowed in China due to that country s softlanding economy, and so with falling demand prices have also declined. The South African producers have been affected by falling demand and prices, and rapidly escalating domestic costs (driven mostly by electricity prices and labour costs). Strike activity, both unprotected and legal, has further exacerbated the situation. These factors not only impact negatively on the viability of the mines but also on their ability to raise capital. Based on the average platinum price in January 214 of US$1,434/oz and when combining cash costs and sustaining capital expenditure, 45% of the platinum mining industry is either marginal or loss-making. Over the course of the next few years, mining companies will need to restructure, by mothballing or closing uneconomic shafts and by cutting back on all costs where ever possible. Sustaining capital expenditure has been cut and long-term capital programmes continue to be reviewed and suspended. Restructuring entails a reduction in labour numbers across the board (all skills levels) as the companies fight to sustain the remaining production. However, this restructuring should enable the industry to survive the current crisis and reposition it for growth once global markets improve. Between June (just before the major strikes in July ) and September 213, employment in the South African platinum mining sector declined by 15,627 to 191,286 jobs.

2 Table 1: Summary of PGM mining contribution to the South African Economy 29 Average past 4/5 years Contribution to GDP Real Rm 27,21 26,592 28,151 28,33 24,921 26,998 % of GDP % GDP growth rate % (9.3) (1.6) (11.9) (3.3) Contributions to GDP plus multipliers & induced effect % Share of Mining GDP % Production (PGMs) moz 8,866,12 8,725,443 9,237,25 9,288,337 8,177,145 8,858,81 Production (PGMs) kgs 275, , ,34 288,9 254, ,54 % growth in production % (9.3) (1.6) (12.) (3.3) Sales value Rm 91,353 57,782 73,787 83,853 69,24 75,196 Exports as % of total merchandise experts % Employment number 199, , , ,98 197, ,781 Wages paid Rm 23,33 24,457 26,554 3,415 34,4 27,826 Wages paid per worker (annum) R 116, ,81 145, ,99 173, ,815 Capex spent (top five) Rm 17,13 12,691 15,63 17,648 15,633 Taxes paid (top five) Rm 7, ,455 6,84 5,184 Dividends paid (top five) Rm 16, ,66 5,373 Social taxes (SLPs, etc) Rm Source: COM Economics Advisory Unit, Mining Companies, DMR, StatsSA, SARB, IDC, Quantec Economics Economic contribution In, the PGM mining industry accounted for 4.1% of GDP, including direct, indirect and induced effects of platinum mining. The sector generated R69 billion in sales and was responsible for 9% of the country s total merchandise exports (including platinum sold to the local catalytic converter industry), making the sector South Africa s second largest mineral export after gold. In, the sector s expenditure was a significant R83.2 billion, comprising significant expenditures on salaries, stores and materials, steel, electricity, and stay-in-business and long-term capital expenditure. PLATINUM SECTOR COSTS AND EXPENDITURES at R83,2 billion (top 5 platinum companies) Labour Costs, C band and above 18% Stores and materials 16% Long-term project capex 12% Stay-in-business capex 9% Labour costs D band and above 8% Electricity costs 6% Steel costs 3% Other costs 28% Water costs % R&D expenditures % Collectively the platinum producers formal social and labour programme expenditure is more than R5 million annually in areas such as education and community development, enterprise, infrastructure, health and job creation. In, the top five platinum producers spent R17.6 billion on capital investment, paid over R7 billion in corporate taxes and royalties and paid R4 billion to the providers of capital, the shareholders. There is no doubt that the platinum mining industry has a profound positive impact on the economy and society of our country. Direct PGM mining employment was 197,847 people who received R34.4 billion in salaries and wages. With indirect multiplier and induced effects included, the platinum mining sector has created approximately 44, jobs throughout the South African economy. With a dependency ratio of around ten to one, this implies that approximately 4.4 million people are directly dependant on each platinum job for their daily subsistence. While platinum mining is now the largest employer in the mining sector, employment in the South African platinum mining sector has fallen sharply in the past 18 months due to global and local pressures affecting the viability of many mines. Between June (just before the major strikes in July ) and September 213, employment on South Africa s platinum mines declined by 15,627 to 191,286 jobs. In the past two decades, real earnings per employee more than doubled in platinum mining industry to reach R173,919 per employee in. PGMs LABOUR EMPLOYED AND REAL WAGES PER EMPLOYEE PER ANNUM PPI deflator , 25, 14, 1, 6, 2, Employees Real earnings per employee 1 Earning per employee (real terms per annum) 2 Employees 2, 15, 1, 5, In, the significant cluster of industries around the platinum mining sector creates about 4.1% of South Africa s GDP (down from 5.7% in due to the strikes and work stoppages). Not only are there significant side-stream beneficiation multipliers, where the supplier industries provide significant inputs to the mines, but there is also a wellestablished downstream platinum beneficiation sector where some 9% (down from 13% in ) of the world s platinum catalytic converters are fabricated by the world s leading catalytic manufacturing companies. In due course, South Africa could become the leading country in the

3 fabrication and adoption of critically important technologies such as platinum fuel cells. Substantial research by the Platinum Beneficiation Committees (I and II) highlighted the potential of further beneficiation in South Africa and the committees recommendations need to be assessed and implemented. However, the substantial downstream platinum catalytic converter industry is under threat due to changes to the incentive program for the automotive sector. PGM industry in crisis mode Despite the significant role and contribution of the platinum mining sector to the South African economy, the platinum mining industry is currently in a major crisis. The industry has been hit by the combined impact of slowing global demand, market surpluses and therefore falling prices, rapidly escalating domestic production costs (that have added to the high cost structure of the industry) and the impact of the unprotected strikes that hit the industry in. Weakness in the main PGM market of Europe combined with the increased availability of scrap and recycled metal and some substitution of platinum by palladium have exacerbated the weakness in the platinum market. The tarnishing of the reputation of South Africa as a reliable supplier of platinum to global markets has accelerated the move to greater secondary recycling. Based on a platinum price of about US$1,434/ oz per ounce of platinum and when combining cash costs and sustaining capital expenditure, 45% of the platinum mining industry is either marginal or loss-making. This is an untenable situation and restructuring and job losses are inevitable. Struggling demand In 213, platinum demand of 8.4 million ounces has only just managed to get back to the previous peak of 8.3 million ounces that was recorded in 27. In the intervening period platinum demand had fallen off precipitously especially in the wake of the global slowdown caused by the global financial crisis. Between 29 and, more than 1 million ounces of reserves of platinum were accumulated as supply exceeded demand, with the concomitant impact of pushing prices down. The slowdown in global economic growth, with a recession in Europe and a soft-landing in China had negatively impacted on PGM demand, the result being an excess supply of PGMs in the market, and a concomitant drop in PGM prices. While global platinum demand is now back to pre-gfc levels, the weak recovery in Europe and the surge is scrap supply have served to depress prices. Given that Europe accounted for 25.1% of global platinum consumption in, and 43% of global platinum auto catalysts, platinum demand is highly dependent on the recovery of the economy in this region. China is the world s largest consumer of platinum with a 27.9% share, but the slowdown in the economic growth rate also impacted on demand growth for platinum in that country. Over 78.7% of platinum demand in China is for platinum in the jewellery industry. China alone accounts for 67.5% of the world s demand for platinum in jewellery. A further challenge to the platinum market has been the tripling in the amount of metal supply reaching the market through recycling over the past decade. In 213, the amount of platinum from recycling was 2.1 million ounces, up from 645, ounces in 23. Concerns over South Africa s reputation as a reliable supplier have contributed to the increase in secondary recycling. Oversupply Johnson Matthey estimates that the global PGM market swung from an oversupply position of 45, ounces in to a deficit of approximately 34, ounces in. Global new mine supply shrank by 12% to 5.7 million ounces as strike activity affected production. In 213, production is expected to be flat at around 5.7 million ounces and the gross deficit is expected to rise to 65, ounces in 213. Weak market fundamentals have therefore kept the platinum price depressed. For South African producers, the production weighted basket price of platinum is more than $263 per ounce lower than the spot price of platinum. The graph below clearly shows the downturn in the platinum price from to 213. PLATINUM, PALLADIUM AND RHODIUM PRODUCTION WEIGHTED PGM BASKET PRICE for South Africa versus the platinum spot price US$ per 3E ounce South African producers battling rising cost pressures High operating costs can be attributed to systemic structural changes such as declining head grades, increasing mining depths, reducing productivity and increasing capital intensity. The recent labour unrest and safety stoppages have exacerbated the situation. The shift away from Merensky Reef towards UG2 ores has also impacted on grade. The rapid increase in administered prices such as electricity and water, diesel fuel and wages and salaries, and the import parity prices charged for inputs such as steel are key upward drivers of costs. In the past five years (27 to ): Electricity prices to the mining sector have risen by 238% from 18 cents per kilowatt hour in 27 to 61 cents per kilowatt hour in. Diesel costs have increased by 69.3% in the five year period, or an average of 15.7% per annum, on the back of higher international oil prices. Reinforcing steel prices have increased by 57.5%, or an average of 15.3% per annum in the same period. Average remuneration paid per worker employed in the RSA mining sector grew by 6% in total over five years or by 12% per annum, more than 5 percentage points higher than producer inflation. Over the past five years, the average cost of producing an ounce of platinum has increased by 18% annually and this clearly is unsustainable. The industry and relevant stakeholders all have a significant role to play in reducing these cost pressures and increasing productivity. COST INFLATION AFFECTING THE MINING SECTOR Average annual increase in costs, 27 to Electricity prices for mining PGM mining cash costs per 4E ounce Diesel Reinforcing steel Labour costs Structural steel Cement US$ Platinum price per oz $1,434/oz $1,172/oz US$ South African production weighted price per oz Total producer price inflation rate 213 Mining machinary 214

4 Lower prices and increasing rand cost pressures are affecting the viability of many companies in the short-run and will affect the industry s long-term capability to survive, grow and prosper. This has resulted in a significant 45% of the South African platinum mining sector being in a marginal or loss-making position on a cash production cost and including sustaining capex (to maintain production) based on an average price of $1,434 per ounce in January 214. Further costs pressures will prejudice marginal and loss-making production. Unfortunately, the price fell precipitously in early 213 due to on-going concerns about global growth, the recession in Europe, a faster than expected slowing in the Chinese economy, a likely early withdrawal of quantitative easing by the Federal Reserve and due to negative sentiment towards precious metals in general. The average platinum price of $1,434 per ounce in January 214 is more than $1 per ounce lower than the average of and $82 per ounce lower than the average price in 213. Even though there has been some compensation in the weakening rand-dollar exchange rate, the rand platinum price has fallen further placing more shafts and mines into loss-making territory. PLATINUM COST CURVE FY214 Cash costs plus stay in production capex US$ per oz 2, 1,6 1,2 8 4 Mogalakwena Platinum Mile Rustenburg tailings Bathopele Mototolo BRPM Pandora JV Kroondal Siphumelele Dishaba Two Rivers Amandelbult Tumela Booysendal Rustenburg Modikwa Lonmin Marikana Thembalani Bokoni Zondereinde Marula Khuseleka Union Impala lease area Eland Platinum Costs + sus capex January 214 price This is an untenable situation and absent an increase in platinum prices, restructuring and job losses are inevitable in order to reposition the industry for long-term viability, sustainability and competitiveness. This is before wage increases for the three largest platinum mining companies. Declining productivity Total factor productivity of the platinum mining industry has also reduced appreciably over the past 13 years. The industry produces nearly 46% less platinum output per worker, the industry s capital intensity has more than doubled and costs have risen by a compound annual growth rate of about 14% in that period. Some of the reasons for this decline are structural. Between 2 and the platinum industry s average head grade fell by 4%. One of the contributing factors to this fall in head grade has been the significant shift from the mining of Merensky Reef (>7% of total mined in 2) towards UG2 ores which now comprise over 7% of the total. UG2 ores have far less platinum than Merensky ores. Table 2: Average composition of precious metals in Merensky and UG2 ores Precious metal Merensky ore % of recovered metals UG2 ore % of recovered metals Platinum 59% 41% Palladium 25% 34% Rhodium 3% 9% Ruthenium 8% 12% Iridium 1% 1.9% Osmium.8% 1.7% Gold 3.2%.4% Total 1% 1% Source: Platinum Smelting in South Africa, R.T.Jones, Mintek While some of the structural issues such as declining grade are important, productivity is also being hampered by other key factors. For example, the industry is simply not getting enough productive blasts per calendar year (estimated as productive blasts per 365 day year), which means that fixed costs structures are not being efficiently covered by a more realistic number of productive shifts on an annual basis. Lower productivity then feeds back into rapidly escalating unit production costs. Productivity per worker has reduced by 46% from the peak of 2.37kg of PGMs per worker in 1999 to 1.29kg per employee in. In the same period real labour costs per kg of PGMs produced increased by over 233% from R4,618/kg, to R135,29/kg. RSA PLATINUM MINING LABOUR PRODUCTIVITY (KGS PRODUCED PER EMPLOYEE) AND REAL LABOUR COSTS PER KG OF PGM Based indexed to = Real labour costs per kg produced indexed Productivity, kgs per worker indexed There is no doubt that the industry and all stakeholders need to investigate ways to reverse the sharp increase in costs and downward spiral in productivity. Added pressures to the sector Labour unrest in South Africa Adding to the viability pressures facing many platinum mining companies, the unprotected strikes that besieged the industry in February and then August to November could not have come at a worse time. Lives were lost, the industry was brought to a standstill, fixed costs were being incurred but with no production to cover the costs, supplier industries came to a standstill, export earnings declined sharply and the economy was substantially negatively affected. Johnsson Matthey estimates that a total of 75,oz of production was lost in, due to strike action, safety stoppages and mine closures costing in excess of R13 billion in lost revenue and excluding other economic costs.

5 The platinum mining sector is likely to be further hard hit by potential strike activity in 214 (using 213 production numbers). This excludes the by-product production forfeited, costs of supplies not procured, wages not earned, taxes and dividends not paid and so on. Based on 213 data for the country s top three platinum mining companies, approximately 9,998 platinum ounces, worth about R198 million per strike day, could be lost in 214. Striking workers could lose R88 million per day in wages; mining companies will continue to bear the daily cost of R68 million of keeping shafts open;,, suppliers would lose about R17 million in sales; and capital expenditure of about R3 million per day will not be spent. In addition, the industry s taxation and development contribution will decline and companies will not be able to cover the costs of money borrowed from capital markets and shareholders. Based on 213 data, total expenditures by these shafts before strikes was R215 million and total revenue was R197 million per day. This means the industry before long-term capital projects made a loss of R17 million per day before any wage increases. Given that a substantial portion of the South African platinum mining industry was marginal or loss-making in 213, further substantial wage increases will threaten the viability of many shafts and more jobs will be placed in jeopardy. The loss of foreign exchange earnings comes at a time when the country is running a large 6.5% of GDP current account deficit. If one looks at the total opportunity cost of each day of strike action, we estimate the economy loses about R48 million daily which is made up of lost sales, wages forfeited, lost sales to suppliers, lost taxes and capex costs, lost development costs and so on. Broader impact of the strike action However, from an investor perspective the unprotected strike activity also tarnished the images of the South African mining industry and country. Foreign investor concerns have resulted in a country credit rating downgrade by Moody s, Standard & Poor s and Fitch, with further downgrades possible. The ZAR reached a multi-year low of US$11.2 on 23 January 214. The country s sovereign credit rating was downgraded further by the Fitch Rating Agency on 1 January 213 based on weaker economic prospects and continuing weakness in key industries like platinum mining. As the mining sector is the nucleus for many supply-side industries (timber, explosives, transport, etc.), the businesses supplying the sector as well as those surrounding affected areas were unable to operate during the strikes. Not only is mining production and the resultant tax revenue affected, so is the overall value-add of mining to the country s GDP. Lost production and hence lost export earnings are negatively impacting an already large current account deficit.. Weaker investment flows are cause for concern. In addition, the pressure on mining companies to up wages is likely to be compensated for by restructuring and the closure of loss-making mines, and the loss of much-needed jobs. Addressing these challenges Over the course of the next 12 months, the various mining companies are considering the viability of their businesses, by mothballing or closing uneconomic shafts or by cost cutting where ever possible. Sustaining capital expenditure and long-term capital programmes are also being reviewed. This restructuring could result in a reduction in labour numbers as the companies fight to sustain viability. However, any restructuring will enable the industry to survive the short-term crisis and reposition the industry for growth should markets improve in the medium to longer term. However, all stakeholders have a role to play in assisting the PGM mining industry through the short-term crisis and to help reposition the industry for sustainability and growth in the future. The industry is just too important and has too much potential for it to be dealt with in an ad hoc manner. The platinum mining industry needs to be stabilised in the short term and repositioned for investment and growth in the medium and longer term. Some key points include: Stabilise the industrial relations environment and promote peace and security in the platinum sector (progress has been made with the DMR Minister s Peace Accord and the Deputy President s Framework Agreement for a Sustainable Mining Industry). Try and reduce cost pressures, while minimising job losses (lower electricity price increases in 213/14 will assist, but still add another R4 million to the costs of the platinum sector. Reposition the industry for growth Take a strategic SA Inc approach to the PGM mining industry, away from an ad hoc approach. Collaborate on expanding demand (through R&D and market development). This includes implementation of the recommendations of the Platinum Beneficiation Committee 1 and 2 reports to encourage further beneficiation (e.g. the promotion of stationary fuel cell manufacturing in South Africa). Expand the growth potential of the mining sector (constraining costs and enhancing capability to meet growing demand). Leverage relationships and opportunities through structures such as BRICS. Looking ahead It is imperative that South Africa maintain its key position in the competitive supply of PGMs to global markets, given the country s rich endowment of PGM resources. All stakeholders need to, restore industry stability and the production cycle and assist in repositioning the industry for growth and sustainability by focusing on competitiveness, cost containment and productivity improvements. These goals are best achieved through collaborative efforts with all stakeholders agreeing on the challenges to be dealt with and working on the best way forward, however, short-term sacrifices and changes are inevitable. REFERENCES Department of Mineral Resources (DMR), Mining Labour Statistics, 213 Economics Advisory Unit (EAU), Chamber of Mines of SA Johnson Matthey publication, Platinum 213 Interim Review Johnson Matthey publication, Platinum 213 JP Morgan, Global Equity Research, Jan 214 National Treasury, Budget Review 213 Platinum Smelting in South Africa, R.T. Jones, Mintek. South African Revenue Services (SARS), Dept of Customs & Excise, IHS Global Insight, Annual Trade Statistics Statistics South Africa, Quarterly Financial Statistics, September 213 Quantec& the Industrial Development Corporation Input/ Output Models,