February 6, 2002
Leader (U.S.)
A Mismanaged Palladium Stockpile
Was Catalyst for Ford's Write-Off
By GREGORY L. WHITE
Staff Reporter of THE WALL STREET JOURNAL
DEARBORN, Mich. -- Last month, Ford Motor Co. shocked Wall Street with a
$1 billion write-off of the value of its stockpile of precious metals, primarily
palladium. Why had the No. 2 car company made a massive bet on a commodity
notorious for its price volatility?
All of the big car makers buy precious metals used in exhaust systems to
make emissions cleaner. Ford accumulated an unusually large hoard in recent
years, anticipating growing need and fearing unpredictable supplies from
Russia.
But the car company left the job of acquiring palladium to the same purchasing-department
employees who buy its steel and copper, according to Martin Inglis, Ford's
chief financial officer. He says the purchasing staff didn't take the sort
of precautions sophisticated buyers routinely use to hedge risk in dicey
markets. What's more, Ford's own engineering innovations were shrinking its
need for palladium, even as the purchasing department was loading up on it
at near-record prices.
Credibility Questions
Now, Ford has way too much of the stuff at a time when palladium prices have
fallen drastically and seem unlikely to return to their highs. The result
was the big write-off, which elicited dismay from some investors and securities-industry
analysts. "These surprises over time begin to affect the credibility of the
company," says Rod Lache, an analyst at Deutsche Banc Alex. Brown, noting
that Ford stunned Wall Street late last year by warning that its once highly
profitable finance unit had stumbled because of rising losses on loans.
Last week, an investor filed suit against Ford and its top executives in
federal court in Manhattan, alleging they misled investors about the risks
from precious metals. Ford denies the allegation.
The controversy comes at a particularly bad time for Ford. Last year, it
ran its first annual loss in nearly a decade, putting it under closer financial
scrutiny than usual. And in light of the Enron Corp. scandal, any massive
corporate write-off is getting extra attention these days. In Ford's case,
there isn't any indication so far that the palladium misadventure involved
accounting practices similar to those that got Enron in trouble.
Ford officials point out they repeatedly warned in regulatory filings that
the company faced risks in commodities markets. Some analysts complain, however,
that the notices were written in boilerplate and didn't signal the extent
of Ford's palladium bet. Announced at the same time as a broad restructuring
of the company, the write-off's effect on Ford's depressed stock price is
difficult to separate out. In New York Stock Exchange composite trading Tuesday,
Ford shares closed down 59 cents, or 4%, at $14.04, just three cents above
its 52-week low.
Rival auto makers also use palladium to scrub pollutants from exhaust but
say they don't have anything like Ford's precious-metal problem lurking on
their balance sheets.
For years, Ford has prided itself on trying to stay ahead of the curve on
emissions technology. On the third floor of its modern research building
here in Dearborn, Haren Gandhi's corner office is adorned with certificates
attesting to the patents he has been granted for advances in the field. A
35-year Ford veteran, Mr. Gandhi joined the auto maker with a corps of other
Ph.D. chemical engineers trained in catalyst technology, as Detroit geared
up in the late 1960s for the first wave of federal auto-emissions rules.
Mr. Gandhi, now 61 years old, has since risen to the rank of technical fellow,
Ford's highest post for scientists.
Across the hall from his office, a lab full of equipment quietly tests Ford's
latest catalytic converters. These are the usually cylindrical units in exhaust
systems -- some about the size of a one-liter soda bottle -- that cleanse
emissions.
For most of the last three decades, progress in this field has relied on
increasing use of the related precious metals platinum, palladium and rhodium.
The metals are dissolved in liquid that is spread thinly over ceramic honeycombs
within the catalytic converter and then dries. These rare, naturally occurring
elements have a unique ability to stimulate chemical reactions in hot exhaust
that convert pollutants into largely harmless compounds.
The metals occur in only a few remote locations. Most of the world's output
comes from mines in South Africa and a giant arctic complex in Russia built
by Stalin's prisoners in the 1930s and 1940s. Unpredictable supplies, especially
from Russia, have periodically caused wild price swings, particularly in
recent years.
Big Discovery
Through most of the 1980s, platinum was viewed as the most effective of the
metal catalysts. Palladium, which was cheaper, wasn't widely used in the
auto industry, and its price hovered below $100 an ounce. In the late 1980s,
however, Mr. Gandhi and his colleagues at Ford discovered that they could
lower costs and still meet federal emissions standards by using more palladium
in each converter to replace platinum or rhodium.
"Even inside [Ford], people didn't believe that palladium could be put to
such good use," the chemist recalls. Vehicle engineers worried the less-expensive
grayish metal might somehow be inferior to platinum, he says. But Mr. Gandhi
persisted. He wanted to make a real advance in improving the technology and
economics of pollution control. "I had an absolutely mad desire to make palladium
work," he says.
By the early 1990s, most of Ford's converters relied heavily on palladium.
Usually, less than an ounce of the metal is required per vehicle. Other auto
makers, including General Motors Corp. and Chrysler Corp., also were discovering
the value of palladium, particularly as new, tougher emissions rules came
into effect.
From 1992 to 1996, global auto-industry demand for the metal nearly quintupled,
to 2.4 million ounces, according to estimates by Johnson Matthey PLC, a British
chemicals and metals company that is one of the biggest players in the precious-metals
business.
Prices rose a bit along with demand in the early 1990s, but auto makers figured
the market would continue to remain roughly in balance, according to industry
veterans. Russia had massive stockpiles of palladium built up during the
Soviet era, when demand had been slight. The cash-strapped government of
then-President Boris Yeltsin seemed likely to remain a willing seller.
But in 1997, the Russians shocked the market by holding up palladium shipments.
Outsiders could only speculate on what motivated the move: perhaps internal
political or bureaucratic wrangling, or maybe a conscious effort to cause
a panic -- and higher prices. Whatever lay behind it, the disruption resulted
by early 1998 in a price surge to the previously unheard of level of $350
an ounce.
Alarm bells went off within the big auto makers. Most engineers finalizing
plans for how they would meet tighter emissions rules that would take effect
in 2000 had been planning to add more palladium to catalytic converters.
Armageddon Speech
David Andres, the man responsible for buying precious metals at General Motors,
began giving what he calls "the Armageddon speech" to GM engineers in late
1997. He recalls warning that if they didn't find ways to use less palladium
-- and fast -- there might not be enough of the metal available.
A potential shortage could be critical. Cars can be sold without compact-disc
players or power windows. By federal law, they can't be sold without a catalytic
converter that works well for 100,000 miles.
GM teams responsible for engines and catalytic converters, which had typically
worked separately, cooperated to come up with ways to reduce the need for
palladium and still meet the new emissions standards, Mr. Andres says. The
redesign process was slow, and GM's palladium usage began to fall just last
year.
In the interim, Mr. Andres, a GM veteran who has dealt with the commodities
markets since the early 1990s, began to use a range of complex financial
and trading strategies to lock in supplies and at least partially insulate
the No. 1 auto maker from the effect of soaring prices. These include the
use of options, which are contracts allowing the holder to purchase a commodity
at a set price in the future, even if the market price has risen higher.
GM expects to cut its use of precious metals by 30% a year over the next
few years, Mr. Andres says.
Ford, which by some estimates was the heaviest palladium user in the industry,
wasn't as well prepared for the price spike. Churning out millions of gas-guzzling
sport-utility vehicles, the company was eager to burnish its reputation as
environmentally concerned. Using the slogan, "Cleaner, Safer, Sooner," Chairman
William C. Ford Jr. regularly touted his company's advances in public appearances.
But much of the company's progress on emissions came thanks to increased
reliance on palladium, including numerous catalytic converters that used
the metal exclusively.
Ford was aware of the danger of unpredictable Russian supplies, executives
there say. But unlike GM, where the "Armaggedon" warning came loud and early,
Ford initially hunkered down, hoping the price spikes would pass without
requiring a fundamental change in strategy.
The pressure only continued to grow. Palladium prices jumped again in 1999,
amid uncertainty about Russian shipments. Anxiety deepened when President
Yeltsin resigned in December 1999. By spring 2000, the major metals exchange
in Tokyo temporarily froze skyrocketing palladium at $700 an ounce.
By early 2000, Mr. Gandhi and his team were scrambling for ways to reduce
palladium use. They found no quick answer. "We had to develop the chemistry,"
he says.
Worrisome Developments
Worried by these developments, Ford's top managers in 2000 approved a proposal
from the purchasing staff to begin stockpiling palladium and lining up long-term
supply contracts, even though prices were at record highs. This was an unusual
move for the purchasing department. It bought a lot of steel, copper and
other materials whose prices weren't very volatile. But generally, it maintained
only modest stockpiles of rare commodities such as palladium and, as a result,
didn't regularly use options and other esoteric financial tools used to hedge
risk, according to Mr. Inglis, the Ford CFO.
Ford's treasury department regularly used such tools to buffer risks related
to interest rates and currency exchange. But the more financially savvy treasury-department
employees as a rule didn't work closely with the purchasing staff.
The upshot, says Mr. Inglis, was that the company focused only on building
up supplies. "What people were doing was protecting against a lack of material
that would put us out of production," he says. The purchasing department
wasn't taking steps to protect Ford if need for the commodity dropped and
prices began to fall, Mr. Inglis says.
'Much More Dialogue'
The purchasing staff also appears not to have consulted closely enough with
Mr. Gandhi and the research staff to forecast palladium needs. In the future,
there should be "much more dialogue on any out-of-the-ordinary positions
that we take on any materials," Mr. Inglis says. Ford declined to make purchasing
officials available for comment.
Mr. Inglis declines to say just how much palladium Ford bought. He will acknowledge
only that it was much more than a few months' supply. The company used about
1.5 million ounces of the metal in North America in 2000, he says. That was
about half of all the palladium used in the auto-catalyst market in North
America that year, Johnson Matthey estimates. As Ford kept buying early last
year, continued anxiety about Russian supplies pushed prices to a record
of $1,094 an ounce in January.
Mr. Gandhi and his team, meanwhile, were racing to come up with ways to reduce
Ford's reliance on palladium. A venture begun in 1996 between Ford and research
institutes in China yielded new insight into how chemicals known as rare-earth
elements can make the precious metals in catalytic converters remain effective
longer. Other advances included the invention of better techniques for spreading
precious metals on the parts of the converter where they were most needed.
By late last year, Mr. Gandhi says, he and his colleagues had amassed definitive,
striking results: Improved converters would allow Ford to cut its use of
precious metals in half across its entire North American lineup of cars and
trucks, starting with the 2003 models that go into production this summer.
But what about all of the palladium Ford had been scooping up? Not only was
the company now overstocked in an exotic commodity it had much less need
for, but demand generally began to fall last year while supplies stabilized.
In other words, the value of a stockpile of palladium was about to take a
nosedive.
Demand was falling in part because other auto makers had also succeeded in
capping or reducing their use of palladium. Demand from the electronics industry,
which also consumes a lot of palladium for use in capacitors, had diminished
with the overall weakening of the world economy.
On the supply side, high prices had spurred mine operators in South Africa
to increase palladium production. And the unpredictable Russian supply began
to stabilize.
Prices Fall
After reaching their peak above $1,000 in January 2001, palladium prices
fell steadily through the summer to their lowest levels since 1999 -- about
$350. Ford executives realized by last fall that their fears about availability
had proved to be overblown. "You've got a free supply situation now," says
Mr. Inglis. "In retrospect, did we have too much [palladium]? Yes."
Market analysts estimate Ford could hold more than two million ounces of
palladium, either warehoused in physical form or in long-term supply contracts.
The $1 billion write-off came as Ford marked down the value of its excess
holdings to the market price at the end of the year, which was $440.
Mr. Inglis declines to comment on what Ford plans to do with these holdings,
although palladium traders say they are watching closely for any sign of
the cash-strapped company unloading its stockpile. Such a move could drive
down prices further.
Ford has instituted new procedures to ensure that treasury-department staffers
with experience in hedging are involved in any major commodities purchases
in the future, Mr. Inglis says.
The company is also trying to allay investor concerns that its balance sheet
conceals other billion-dollar surprises. The palladium holding "is by far
and away the largest thing we've got out there," and now it has been accounted
for, Mr. Inglis says.
He says that as a result of writing down the excess palladium holdings, the
average cost of the metal Ford uses in each vehicle will, on paper, be lower.
This economy -- which Ford expects to amount to $300 million to $400 million
this year -- will appear in Ford's financial statements. But it doesn't represent
an actual cost reduction, Mr. Inglis says. He explains that Ford wants to
make this known because, "we're now doing double somersaults not to mislead
anybody on anything."
Mr. Gandhi, for his part, is testing the latest converters and trying to
use as little palladium as possible. "We are going to work like mad to keep
the amount of precious metal from rising," he says.
-- Peter A. McKay contributed to this article.
Write to Gregory L. White at greg.white@wsj.com