Craig, its all about timing, supply/demand.
>>Published: January 21 2002 21:34 | Last Updated: January 22 2002 10:27
An armoured car will leave a secure vault in Pennsylvania this month and make its way to one of Ford's engine suppliers in North America.
In the back will be several plastic containers, each the size of a large coffee jar.
The containers are unremarkable. But each could be worth more than $1m: inside are some of the world's most precious metals.
Ford, General Motors and DaimlerChrysler have standing accounts with the vault at Malvern, on the outskirts of Philadelphia. The refinery - and 13 others around the world - produces "hallmark" metals crucial to the production of catalytic converters.
The delivery of such metals - mainly powdered forms of platinum, rhodium and palladium - has been occuring since the 1970s, when the US government mandated the use of catalytic converters to cut pollution. But in the past two years Ford has paid a heavy price.
The world's second-largest carmaker this month announced a surprise $1bn write-down on its stocks of precious metals. The move, part of Ford's $9bn restructuring, persuaded analysts that the carmaker had overpaid and over-stocked on platinum group metals (PGMs).
Like other big carmakers, Ford buys its own precious metals for use by suppliers. That means it can fix the price paid for catalytic converters rather than have to adjust constantly for changing PGM prices. But unlike other carmakers, Ford's purchasing department took a gamble on PGM stock and prices - and lost.
Many analysts think Ford was signing fixed-price PGM contracts and building up inventories, much of which may be held in "sponge" or powdered form in vaults at metal refineries, just as prices for PGMs were taking off towards the end of 2000.
The strategy has left Ford with stocks of palladium worth about $430 an ounce, some of which could have cost it as much as $1,100 an ounce if the company was buying in early 2001..
One London metals analyst estimates Ford's precious metals inventories at 2.2m to 2.5m ounces of PGMs, of which up to 1.8m could be palladium.
A stock of that size equals a quarter of gross palladium demand last year. "That's a central bank-like position," he said. Some analysts put the stockpile as high as 2m ounces.
Assuming the average car exhaust and catalytic converter uses 4-5 grammes of palladium, a stockpile of 1m ounces would be enough for 6.2m-7.8m vehicles. Even at full capacity, Ford could assemble 5.7m cars and trucks each year in North America. Last year it sold only 3.97m vehicles.
As part of its overhaul, moreover, Ford is cutting capacity by 1m units and closing five plants. But that, in itself, does not explain the write-down or Ford's PGM stockpiles.
The real answer lies in simple supply-side economics, which is believed to have panicked Ford's purchasing executives to buy high in 2000 and 2001. To understand Ford's strategy, it pays to understand the role of PGMs in catalysts.
Exhaust pipes filled with coated ceramic honeycombs or beads convert unburned gasoline, carbon monoxide and nitrogen oxide into less-harmful carbon dioxide, nitrogen and oxygen. The ceramics are coated in liquid precious metals, and a pre-wash of other oxides, which creates the chemical reaction to cut emissions.
In the late 1990s the US government reached a deal with the car industry to bring forward new emission standards from 2004 to 2001.
The only way to meet the standards without re- engineering entire vehicles was to increase the amount of palladium used in catalytic converters and, on some models, install two converters. That move coincided with soaring US demand for light trucks.
Assuming record industry sales, the company began to amass sufficient PGMs for a market of more than 18m vehicles. But sales last year fell back to 17.1m vehicles and could shrink to 15.5m in 2002.
Just when Ford was stockpiling PGMs to meet demand and new emission standards, Russia, which supplies two-thirds of the world's palladium, cut exports altogether, sending prices soaring. Anxious to reduce its dependence on Russian deliveries, Ford and other carmakers entered into fixed-price contracts with alternative suppliers.
According to one industry executive, mines including the Stillwater facility in Montana sold their entire PGM output forward for five years.
When Ford's purchasing department committed to those prices, it did not know that its own technology department was close to a breakthrough that promised to reduce drastically PGM requirements in future. GM expects to cut the amount of PGMs it uses by 30-50 per cent by 2004.
In simple terms, improved wash-coats mean fewer PGMs will be required to ensure vehicles meet rigorous emission standards.
"It was a confluence of events no one predicted," says one Ford insider. "We were in a hot vehicle market of 18m units a year; we had to meet new standards faster and those guys in Moscow were yanking supplies. So we said 'let's commit before it gets worse'.
"Then we got a technical breakthrough; PGM prices went down 70 per cent; vehicle demand started to slow and we felt 'let's take the heat now, let's get the bad news out'."
The final outcome is not yet clear. But most analysts agree Ford's excess inventories will keep prices subdued for some time. Its surplus supplies may also counteract the vagaries of Russian exports for the auto industry. For the world's second-largest carmaker, that may prove the only silver lining.
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