Bad News For Volkswagen, Good News For This Metal…

Dear Resource Hunter,

I’ve been following the Volkswagen scandal for the past two weeks. As you’ve probably seen in news accounts, Volkswagen apparently used “defeat devices” on its vehicle emission systems. It’s no one-off, “just an accident” glitch, either; the tricky systems cover upwards of 11 million Volkswagen cars and trucks, manufactured over many years.

Volkswagen shares have tanked. The company CEO resigned (got fired). VW car sales have fallen off a cliff, as the company’s reputation crashed and burned.

In government offices across the world, regulators are gearing up to investigate further. Right now, just in the U.S., Volkswagen may be on the hook for over $18 billion in fines – in the order of magnitude of what happened to BP when its Macondo oil well blew out in the Gulf of Mexico in 2010. It’s fair to say that Volkswagen’s future hangs in the balance.

Meanwhile, the price of platinum is heading down; and the price for palladium is heading up. What do all these things have in common? Are they investable? Read on…

Volkswagen Cheats

Here’s Volkswagen’s problem, in a nutshell. According to Stanley Young, of the California Air Resources Board (CARB), “Engines these days are very complicated. So there is a sophisticated and powerful computer inside all cars.”

Per Mr. Young, Volkswagen added extra algorithms to the software – a “second routine,” so to speak. The software sensed when the vehicle was being tested on a dynamometer. At that point, software told the engine to employ an emission control system to trap nitrogen oxide (NOX), a key ingredient in smog. Then when the car was back on the road, the computer would sense that too, and cut back on emission control – releasing from 10 to 40 times the permissible amount of NOX.

“It takes a very savvy program to fool the computer and detect the sophisticated test cycle,” said Mr. Young. “This was clearly well thought-out and took a lot of programming.”

Why Cut This Particular Corner?

Let’s boil it down. From all appearances, Volkswagen intentionally designed software to defeat emissions control regs. It was intentional, and not just a “whoopsie-daisy” kind of thing. Somewhere within VW’s management food chain, people knew what was going on. What were they thinking? Among other things, they must’ve figured they’d never get caught; else why do it? (Shades of Ashley Madison, eh?)

Then again, Volkswagen did get caught, and now the company is – corporately speaking – at death’s door. That is, VW share price is tumbling; car sales are falling; $18 billion in fines looming; probably millions of recalls costing billions of dollars; possible criminal probes; class-action lawsuits for whatever plaintiffs’ bar can dream up (and plaintiff lawyers have fertile minds, trust me); and much more, because this ain’t over.

Still. Why… Did… Volkswagen… Do… This?

It’s the Platinum-Palladium, Silly Goose…

Here’s why I think VW did this. To save money on platinum and palladium (platinum group metals – PGM) used in emissions control systems. VW managers thought they were saving money on scarce, valuable PGM materials; and the cost savings were “worth it” over the long haul.

Look back over the past few decades of auto manufacturing. The key to success has been squeezing weight and cost out of vehicles.

Weight has to go because that’s what allows the use of smaller, more fuel efficient engines; and this leads to better fuel mileage.

Cost has to go too, because auto manufacturing is a global, cut-throat, near-commodity business – certainly at low-end price points. Along these lines, mass-production auto builders tend to have excellent capital discipline. Managers typically can tell you where every penny of cost is located, from bumper to bumper.

Thus we’ve seen all sorts of weight-saving/cost-tradeoff developments in autos. Less steel and more aluminum. Thinner gauges of metal, too; with “safety” improved via different design philosophies like “crumple zones” and such. Lighter tires. Lighter glass. Different seat arrangements. Modern electronics, which weigh less than old-fashioned devices. All this, and much more.

Then We Get to the Tailpipe

For all the weight savings elsewhere in a car, there’s still a pretty well-defined set of gizmos that go into an emission control system. In particular, the catalytic converter requires PGM – platinum (Pt), palladium (Pd) and rhodium (Rh). That’s a chemical fact of life; these PGM elements are simply irreplaceable.

I won’t go deep into the combustion chemistry inside a catalytic converter, except to say that without PGM, it won’t work to clean up emissions. That, and in general, the more PGM one uses, the better the catalytic system operates.

Consider a world-class brand like, say, Mercedes-Benz. This iconic company simply loads up its catalytic converters with PGM. Mercedes bites the bullet and pays whatever it costs to have a high quality emissions control device under the car. Of course, you can do that if you’re Mercedes-Benz, and people don’t often balk at your sticker price.

If you’re Volkswagen? Well… VW is notorious as a “cheapskate” manufacturer. The purchasing department at VW is brutal towards suppliers. Indeed, I’ve been told that VW makes even General Motors look like a sugar daddy when it comes to paying for goods and services from the supply chain.

I suspect that VW managers believed they could stretch their cars’ emission systems by using less PGM, and working the issue by gaming software; thus cars would pass emission tests.

Looking Ahead

As the dust settles with Volkswagen, I suspect that auto makers across the world will take another look at their collective emission control programs. VW got caught cheating via software, and much of it likely had to do with saving PGM dollars within the tailpipe hardware. Across the world, I foresee auto makers will lean against gaming emission software, and go more in the direction of using whatever amounts of PGM are required to make catalytic systems work well, and last a long time.

As the Volkswagen scandal unfolds, I believe that well-run PGM producers will move ahead of the rest of the mining market. We’ll likely see more demand for PGM, despite current confusion in the trading pits. Be on the lookout. Only time will tell where the industry is headed.

Best wishes…

Byron W. King