The following is an edited transcript of a portion of a podcast interview with James Gallagher, president and CEO of North American Palladium (TSX: PDL; US-OTC: PALDF). Gallagher discusses the supply and demand fundamentals of the palladium market, and why palladium won’t likely suffer much substitution by platinum in the critical global autocatalyst market.
Gallagher joined North American Palladium in 2013 as chief operating officer to spearhead an operational turnaround of the firm’s Lac des Iles palladium mine in northwestern Ontario, and became president and CEO in August 2015. Before that, he worked more than three decades with Falconbridge and then 8 years with Hatch as global director of mining.
For the full interview, listen for free to The Northern Miner Podcast – episode 136: Palladium’s stellar rise ft NAP CEO Jim Gallagher.
The Northern Miner: Can you describe what’s happened with palladium prices the last couple of years?
James Gallagher: Certainly palladium has been the metal over the last two years. It’s outperformed any of the other major commodities, so it finally has gotten some attention.
A couple of months back it met and then has exceeded the price of gold so that’s really gotten on a lot of people’s radar.
It’s really driven now by market fundamentals. It’s always a debate whether palladium is a precious metal or an industrial metal. Clearly at this point it’s really more of an industrial metal and it’s a supply/demand deficit which has existed for several years now and is projected to continue to be in deficit from a supply side for the next few years.
That’s really being driven by several factors: its primary use as the key element inside the catalytic converter in every gasoline engine produced nowadays on the planet; very strict new emission standards; and the introduction of a much tougher testing standard.
There’s been a step change in the demand for palladium not because of total auto production, which in fact has been a bit flat for the last several months, but because of the changing emission standards. And critical to that is a new testing regime which is much tougher to pass.
TNM: Can you explain the difference between platinum and palladium in auto catalysts and why is one metal preferable to the other with respect to the technology and the price of the metal?
JG: Two years back, the prices for the two metals would have been reversed. Platinum floated around the US$1,600-an-ounce mark for a number of years and palladium languished in the US$700 to US$800 an ounce range, sometimes even lower.
And that’s really reversed. It’s a fundamental difference. Platinum has a much broader market. Last year I believe the number was close to 85% of palladium went into catalytic converters. In its heyday, about 40% of platinum was going into diesel-engine catalytic converters.
So there are different chemistries, different reactions to heat. Platinum performs better even though it was double the price of palladium, and platinum is still preferred in diesel engines and palladium in gasoline.
One of the key features that’s different between the two elements, is people will often say, “We’re just going to transfer and substitute platinum back in.” That’s because in the 1980s when they started, they actually started with platinum in catalytic converters.
But the modern catalytic converter is actually extremely efficient at removing some of the noxious gases. It’s a catalytic reaction. It requires high heat and it adds in oxygen and that tends to turn carbon monoxide, which is poisonous, to carbon dioxide. It converts some of the carbohydrates, breaks it down and you actually end up with water.
I always say if you sit behind a vehicle at a stoplight and see water dripping out of the tailpipe, which you will often see, that’s palladium at work.
One of the things they’ve done is gotten the heat in a catalytic converter much higher. They moved it much closer to the exhaust in the vehicle and the high heat helps with that reaction and helps with the efficiency.
And palladium responds much better in a high heat environment than platinum does. Platinum tends to break down, it clumps, becomes less effective and it tends to wash out and erode over time where palladium responds better in that environment.
So it’s one of the key reasons that platinum is not an easy substitute into the current catalytic converter and we’re not likely going to see a huge amount of substitution occur there. Different chemistries and different performances makes each one suitable for different environments.
Of course in the diesel market, diesels have very much fallen out of favour, especially in Europe where it used to be well over 50%. The last numbers I saw, it was down into the 30% range for the small engine market. And that’s really due to the Volkswagen scandal and the awareness throughout Europe that although diesel — modern diesels — tend to be cleaner from a CO2 point of view, they’re less clean from the other gasses and especially particulate matters — soot — the stuff that you visibly see in the air.
Diesels have really gotten a bad name in Europe and a number of cities are talking about outright bans and so diesel sales have fallen off dramatically.
TNM: One of the trends in mining investment the last couple of years has been the excitement around electric vehicles and the resulting plays on lithium, cobalt, nickel and other battery minerals. But palladium has a role, too, with the hybrids. Could you explain the role of palladium in hybrid cars, what’s going on with hybrid demand, and how that all plays into the EV story?
JG: Pure battery electric cars like a Tesla do not have platinum or palladium in the mix, but the bulk of the sales that most companies are talking about when they project these very significant electrification numbers for their fleets, the bulk of those certainly for the foreseeable future are going to be some variation of a hybrid.
And hybridization is actually quite positive for palladium, simply because it gets back to this whole heat issue for the catalytic converters. There is a higher loading in a hybrid engine to accommodate for the fact that because of the on/off cycling nature of the engine, it doesn’t run as hot.
In fact, the plug-in hybrid may not even kick in for 20 or 30 km, but as soon as it kicks in, it must meet and pass the emission standard. And so if it hasn’t had a chance to get up to temperature, that becomes a problem and they’re accommodating for that lower operating temperature on average by higher — up to 15% higher — loadings of palladium inside the catalytic converter attached to the internal combustion engine.
So it’s actually a slight net positive at this point.
TNM: Getting into some of the supply factors with palladium, it’s always been a very stable market over the past decades. Russia is the huge producer as well as South Africa and then Canada, the U.S. and Zimbabwe come in lower down. Could you characterize the mine supply worldwide right now?
JG: It’s basically referenced as a flat supply. The total market for palladium last year was about 10.2 million ounces. About 40% of that comes out of Russia, and that’s Norilsk, the big nickel-copper miner, and it’s a byproduct.
Over 90% of the world’s palladium supply is as a byproduct of other mining: 40% from Russia, 38% roughly from the platinum mines in South Africa, and the Sudbury nickel-copper mines, both Vale and Glencore, probably 7% of global supply.
So it really isn’t driven by the palladium price because Norilsk, for instance, isn’t going to significantly change their production profile just because of a byproduct. There is a caveat on that that they do have a project that they are going to bring into production, which will likely have some impact about five years down the road.
There are really only two primary palladium mines in the world and that’s Stillwater in Montana, which is now owned by Sibanye, which is a South African gold miner, and ourselves.
It makes North American Palladium quite a unique asset, as we’re the only pure play. If you really want to leverage off the price of palladium with a mining company, we’re really it on a global basis at this point.
TNM: Palladium is really a textbook example of inelastic supply.
JG: Absolutely. And obviously there’s some risk in South Africa: there are social problems, labour-cost problems, power-supply problems. There is some risk around the South African environment and also because of the very low price, relatively speaking, for platinum — it’s dropped from US$1,600 an ounce to the US$800 range over the last couple of years. Any of the platinum mines are hurting and have struggled and have not capitalized and not spent the capital to sustain long-term production.
There’s definitely some risk on the South African side to supply.
TNM: Has Russian palladium production been caught up in the sanctions regimes at all, or is that not a factor?
JG: No, that’s outside of that. The Russians always find a way to get product to market.
TNM: Looking at the palladium price today as we speak, it’s at a US$1,356 per ounce, gold is at US$1,276 per ounce, and platinum is at US$884, all with palladium peaking at an all-time record high of US$1,604 per ounce in mid-March. Is there a point where the palladium price gets too high, and you get a little anxious? Or do you watch the spread with platinum more? What do you make of the recent highs in palladium prices?
JG: I’m less concerned about the spread, although a lot of the publications pick it up and that’s that whole substitution issue. But again, as we explained, the substitution’s not unlikely to occur.
The other thing is, the platinum market is actually much smaller by 20% than the palladium market. You can’t really have a lot of substitution into a market that doesn’t have much excess supply itself. The price is driven by these fundamentals.
We deal with companies like Johnson Matthey, which probably produces a third of the world’s catalytic converters. None of the auto companies make their own catalytic converters. It’s a couple of big players.
And really, even if palladium hits US$2,000 an ounce, which some analysts have forecasted, that might be US$100 a vehicle, and that is not material enough to force the manufacturers to make a switch.
The auto companies do not want headlines around auto emissions — not anymore. They don’t want to take the risk of changing the formulation. If they did substitute, they would have to totally redesign where the catalytic converter is located, move it away from the heat source, etc. And there’s just zero interest in that.
The other driver is that it takes multiple years, not only to design, but then to go through the global testing regimen to pass the various jurisdictions.
Again, the auto companies have no appetite to do that. They’re spending their research dollars obviously on the whole electrification push, and the technology push.
For 100 bucks, they’re not going to sweat over the cost of a catalytic converter. They want it to work. The headlines are very, very negative around emission standards if they don’t pass. And to that point, it’s almost three weeks ago in the United States, where they’ve announced a million-vehicle recall for Fiat Chrysler to replace catalytic converters, and so there’s a negative headline.
The interesting thing is, what the U.S. is doing is unofficially doing what the Europeans have officially done and introduce their real driving emission tests. It’s okay to pass in the laboratory and that’s still part of the testing regime and on the treadmill, so to speak. But now you’ve got to go out in the real world, the Europeans have an official 16-kilometre loop, a high-speed passing stop-and-go traffic, cold starts, that sort of thing. It’s a much more difficult test to pass an emission standard.
The Americans haven’t officially adopted that. But inside of this message about Chrysler Fiat, they obviously tested them in the real world environment and said they don’t come close to enough to meeting the lab tests, and you’ve got to fix this.
That’s what I mean about not only have the emission standards increased — there’s Euro 6 and China 6a and 6b and 6c coming down, and so this trend is continuing.
But with the introduction of this real driving emissions test, it has offered a pass and that’s forcing up to 30% higher loadings of palladium in order for the auto companies to pass that.
TNM: A typical auto catalyst might have a 10th of an ounce of palladium, is that right?
JG: Yes, it’s three grams or so. It has been typical and that number is now moving up.
And with vehicle-buying trends, despite the green push, the reality is certainly still in North America that big trucks and SUVs are absolutely dominant in the market. Then, of course, these bigger engines require bigger palladium loadings. Recent announcements by GM and Ford show that essentially they’re getting out of the small car market and are shutting down some of those auto plants. All of that’s in the background.
Multiple factors are driving the demand for palladium and have resulted in the recent price spikes.
TNM: So if you look at a $70,000 SUV in a parking lot, the palladium in that vehicle accounts for maybe $100 or $200.
JG: Yes, exactly. It’s really immaterial given the risk of not passing and having a full recall or actually being forced to take a product line off the road. It’s something the auto companies don’t want to mess with.
TNM: What’s going on with palladium stockpiles? That’s one area where we do have movement. Where do you look for these stockpile numbers?
JG: There are the so-called visible stockpiles which are the exchange-traded funds (ETFs), which were certainly a big part of driving the price and the volatility, quite frankly, that did exist over the last couple of years in palladium.
But those visible stockpiles have been drawn down to near-record lows over the last decade. And that’s really the supply/demand fundamental. The auto companies have been buying out some of these stockpiles and so the visible stockpiles are at lows and the prices continue to rise.
There’s been a disconnect between the relationship in investor interest, loading up ETFs with palladium and the price would respond to that. Now the ETFs are at very low levels and the price has gone on to record levels. So it’s a fundamental supply/demand issue at present.
With the other stockpiles, which tend to be the government ones or what the Russians hold, the visibility we have is through companies like Johnson Matthey and Metals Focus and they really track the total supply/demand picture. When they see more palladium coming onto the market than they can account for, they usually account that to the Russians.
So there’s not a lot of visibility to what they do from government stockpiles. There was a belief they did sell off some over the last several years, but that’s probably remained fairly stagnant recently, and the only one that we do have colour on is Norilsk, which does talk about having pulled in, I think, about 600,000 ounces into a stockpile last year and it looks like they’re trying to help manage the market.
When you get a market as tight as it currently is for palladium, there is a danger of some real crazy price spikes, and we’ve seen a bit of volatility recently. And the real danger is destroying the market because GM or Toyota cannot physically put their hands on palladium and build cars, you know, this week or this month and that would be a crisis and that would force a substitution.
I think what Norilsk is trying to do, which is wise and they’re big enough to do it, is help moderate that in the market. If they see the market getting a little too tight for the good of the overall market, they would feed some back into the market. I think it’s a good thing for them to do, to be honest.
TNM: For palladium producers generally, how important is the spot price, and how much is forward sold?
JG: Our company sells concentrate, which all goes to Glencore — they’ve two smelters here in Canada, in Sudbury and then Horne in Quebec. And we settle on the spot price so it is important for us.
But on a bigger picture, you know, what’s really traded on the open markets is actually pretty thin, not a lot of it. Obviously the big producers have deals in the background from the primary suppliers.
Now unfortunately for us, because we sell a concentrate, we’re very disconnected from the end product. So we personally, as a company, do not have direct deals, but the refineries that produce the end product, Glencore as a metal trader, they would have long-term contracts with the Johnson Mattheys of the world, and BASF — that’s another big producer.
There are relationships and the long-term relationships there. So really what’s on the market is not always representative of what’s going on in the back rooms with the bigger deals.