NEW YORK — A rich vein of mining business runs through Gareth Penny’s career – first in diamonds and now in metals as chairman of Russian mining major Norilsk Nickel.
When legendary mining executive Julian Ogilvie Thompson is your godfather, a healthy interest in the sector is inevitable.
Gareth Penny, chairman of Russian metals giant Norilsk Nickel, recalls sitting around the dining table on many occasions when he was growing up, listening to Ogilvie Thompson, who was a friend of his father, talk about mining majors Anglo American and De Beers - for both of which his godfather was eventually chairman. At that time, Anglo owned a 45% stake in De Beers; this has since risen to 85%.
“At a very early age, I had thought I’d join De Beers and try to make a career in the diamonds business because it was really part of my upbringing in those very early years,” Penny told Metal Market Magazine. And that is precisely what he did.
Thirty years ago, a 24-year-old Penny joined Anglo American, working as a management trainee in various departments before moving across to diamonds at De Beers. His first assignment was to set up and run a diamond polishing factory in a village called Serowe, in Botswana’s Central District. Penny was suddenly in charge of around 400 people, recruiting and training polishers from Antwerp, and teaching people how to cut diamonds.
“I had no experience in polishing diamonds, but I knew how to manage a business,” Penny said. “It was part of an agreement with De Beers to promote downstream beneficiation.”
Not only did he fall in love with diamonds, he also began a life-long relationship with Botswana – “one of my favorite countries on earth” – that continues today. When he later became De Beers' chief executive officer, he worked very closely with Debswana, an equal joint venture with the Botswana government, and also served on the government’s Economic Advisory Council.
From Botswana, Penny moved to the De Beers marketing office in London. “If you’re going to be in the diamond business you’d better understand the product and why people buy it, including how important it is not to treat diamonds as a commodity, but as a treasure of nature,” he said. “Spending time in the downstream is a very important part of understanding what it is that fundamentally underpins the economics of the diamond business.”
He then spent a decade in Johannesburg, in his native South Africa, working in various roles – including as personal assistant to the De Beers chairman and as diamond consultant for Southern Africa, where he was responsible for the sales of rough diamonds to the Southern African cutting industry.
Reshaping the diamond trade
It was in Penny’s next role that he was accredited for helping to reshape not just De Beers, but also the diamond industry itself. In 1999, he became director of transformation, his “most exciting assignment at the group,” and began guiding De Beers through a period of significant change.
“The supply-side model of the old central selling organization had outlived itself and was no longer appropriate for all sorts of reasons, both economic and legal. So we decided to fundamentally transform the business from one that was essentially supply-focused to one that was demand-driven,” Penny explained.
Under his guidance, De Beers began extricating itself from third-party contracts, including with other major producers. “After this, De Beers only dealt with its own production and that of its joint ventures, and was focused on demand,” he added.
According to Penny, it was an “extraordinary period of change” – De Beers had run the same business model for over 100 years – that was difficult for a lot of people. But it made sense.
“De Beers at that point was a separately listed company, and there were large periods of time in the 1990s where the value of De Beers’ holdings in Anglo American was more or less equal to the market capitalization of De Beers. In other words, the diamonds business was effectively valued at almost zero,” he said.
“In terms of the economic rationale for coming up with a new business model, it was overwhelming. There was no doubt that the old model of a supply-focused business was destroying economic value,” he explained. There were also significant legal complications because directors of De Beers were not allowed to travel to the United States, which was a legacy of the 1948 ban on the company from directly distributing and selling diamonds on that continent due to antitrust concerns.
“The USA was the single biggest diamond market in the world, so there was clearly need for change. Even though it was self-evident, it was fine to agree that intellectually, but to get the whole industry to think about doing something in a different way was very difficult. It was hugely challenging,” Penny recalled.
Working with then-chairman Nicky Oppenheimer and CEO Gary Ralfe, Penny developed a new model called supplier of choice.
“It required working with all our customers in an entirely different way – they in turn had to work with their customers downstream in order to grow the market and ensure there was sufficient demand for diamonds,” he said. “If you look back over the last 10 years, it’s been pretty successful. De Beers now accounts for about 40% of Anglo American’s earnings.”
The model filtered through to the rest of the industry as the way to do things, spawning enormous changes to methods of marketing and branding. It also meant the industry was in the right mindset to create the Kimberley Process – a vast initiative involving 70 sovereign governments and the entire diamond industry spectrum designed to tackle blood diamonds.
“To be so successful that the conflict minerals issue was managed to a point where it didn’t have a dramatic impact on consumer desire for diamonds was key,” Penny said.
A challenging time
In the early 2000s, Penny became CEO of the group’s marketing arm, the Diamond Trading Company (DTC), and in 2005 was appointed De Beers CEO from the start of 2006 until the end of 2010. With Penny leading De Beers through the “extremely difficult” global financial crisis of 2008-09, the group emerged in good shape and, in 2011, posted its highest earnings ever.
Penny said that 2009 was one of the most difficult years ever for the DTC - and probably his personal career low point. “Diamonds are very much luxury goods so are very much a discretionary purchase. It was a very, very challenging time,” he added.
Through the global financial crisis, “demand for diamonds was significantly impacted. It was less impacted at the consumer level, which was down high single digits, but as you came up the pipeline, that ripple was more and more pronounced, so the impact on De Beers was enormous,” Penny told Metal Market Magazine.
“We had just finished building two mines in Canada with quite high gearing, so we had to restructure all our debt. At the same time, we had to make sure we didn’t oversell, because our clients were finding it very difficult to buy diamonds... We had to be careful about how we managed the business,” he said.
De Beers’ sales fell by 50% in the first half of 2009, and the group set about dramatically reducing its costs. “What we did in those years was so important in terms of keeping consumer, trade and also banking confidence,” he said.
“The ability of the industry to hold its wealth in diamonds as a store of value is a tremendously important part of the whole fabric of the diamond business – and if it’s not, then it’s not fully understood,” Penny noted.
From diamonds to nickel
Eventually Penny decided to leave De Beers – “I felt I had been very focused on diamonds for over 20 years and I wanted to do other things in the mining space” – and was approached to become chairman of Norilsk, the world’s lowest-cost nickel producer and the largest in palladium with more than 40% of world output.
Since Penny took on the chairman’s role at the start of 2013, Norilsk has significantly outperformed its peers, an achievement that is something of a personal career high for Penny: “The average total shareholder return (TSR) of the major miners is down 32% over the last five years. In 2013-17, Norilsk’s TSR rose 60% and its next closest competitor was up 26%,” Penny noted. Similarly Norilsk’s dividend yield over the same period was 10.6%, while the industry average was 2.5% and the next best after Norilsk was 5%.
To be fair to its peers, Norilsk’s 2012 performance had been depressed by a dispute between the company’s two major shareholders: “Obviously if you come off a low base, it’s that much easier to show an uplift in value,” Penny acknowledged.
But from 2013 onward, a combination of other factors - including a reconfiguration of the company’s downstream operations, particularly Norilsk’s processing facilities - played a vital role in its revival. “We modernized the Talnakh concentrator and the Nadezhda metallurgical plant, we shut down the oxide leach nickel plant in Norilsk, and we modified the flow of materials to the Kola division,” Penny said.
Over the same period, Norilsk significantly reduced its working capital from $3 billion to around $1 billion.
“What makes me proud is that we weren’t just cost cutting and paying out big dividends – it was actually during the same time that we invested in a totally new mine called Chita. It’s terribly important that you try to invest through the cycle,” Penny noted. “When things go bad and the whole industry cuts back, it means that when things start to improve again you do not have the extra capacity to benefit from this. We brought on new capacity in the down-cycle, and that will play out positively for Norilsk in the next five years.”
Penny is also proud of the “tremendous improvement” to governance at Norilsk – “the board, the underlying subcommittees, the systems and processes... It’s clear now things are looking pretty interesting going forward,” he said.
While Norilsk has performed well, Penny believes miners all too often lack a clear purpose and fail to approach investments with the appropriate due diligence – a situation that has driven average shareholder returns lower.
“As a mining company, you’ve got to be really clear what your specific purpose is. So many mining companies are opportunity-driven and – particularly this last super-cycle – would chase after anything. Fear of missing out drove all sorts of behavior where people invested in a huge number of projects and [mergers and acquisitions] activity and, frankly, we all know the consequences were disastrous,” he said.
Norilsk was also guilty of this, he admitted: The company bought assets in Australia, Africa and other parts of the world where it lacked competitive advantage. “They weren’t tier-one assets, and all the rest of our assets are very clearly defined in the top quartile in terms of returns and size,” he noted. The company has since exited almost all of its international assets; there are just two remaining – in South Africa and Australia – and those are up for sale.
“Mining companies need to be very thoughtful about what business they’re in – where are they playing, and why have they got a competitive advantage in that area,” Penny added.
He also believes the sector needs to keep a close eye on gearing, which is a “huge concern” for miners. “I hate gearing in any industry, but the mining industry is particularly badly suited for a highly geared balance sheet because you don’t have visibility of earnings through any significant period of time, not least because of commodity prices,” he explained.
“You can be in a situation where you think you’ve got one or two times debt to earnings before taxes, depreciation and amortization, and a year later you find you’ve got five and it’s heading north. We all know the impact that’s had on the biggest and best mining companies in the world. There are lots of lessons to be learned from what we’ve gone through in the past five years,” Penny added.
Norilsk is currently embroiled in a dispute between its largest shareholders: Vladimir Potanin, with a stake of more than 30%; and UC Rusal, which is controlled by Oleg Deripaska, with a stake of more than 27%.
The situation has arisen since a shareholder agreement that included a lock-up on the sale of shares expired in December last year. Minority shareholder Roman Abramovich said that he may reduce his stake in Norilsk, which stood at 6.3% before the lock-up ended, and a subsequent tussle emerged to acquire parts of his stake.
Penny stressed that the matter is between the various shareholders, and that he’s optimistic a resolution will soon be found.
“The company is not changing something in terms of the way it operates; it’s an issue between three shareholders, not Norilsk,” he said.
“At the end of the day, it’s about one shareholder wanting to sell some - not all - of its shares in Norilsk, and the other two shareholders coming to some kind of arrangement as to who buys what portion of that stake. It’s early days and I‘m hopeful a sensible solution will be found. But in any event, it doesn’t change the nature of how Norilsk itself will be run and the things we will focus on as a board,” he added.
Although the lock-up on the sale of shares in Norilsk terminated in December 2017 at the end of the initial five-year shareholder agreement – which triggered a court battle between major shareholders – Penny said that a further five-year extension of other elements of the agreement has automatically continued and so is already in place now.
“I would hope and anticipate that we would continue to create successful shareholder returns while broadly understanding that the arrangement embedded in the shareholder agreement continues on. I don’t think it makes any difference to that at all,” he said.
Norilsk is now turning its sights on the next cycle, with one of its major deliverables being minimizing the environmental impact of its production units.
As the largest industrial company in the fragile ecosystem of Russia’s Arctic zone, Norilsk has often attracted criticism for its environmental performance - in particular for excessively high levels of toxic emissions.
No more, according to Penny. “It’s going to take some money – about $2.5 billion, almost $500 million a year – and a lot of time and effort. That’s going to create enormously reduced sulfur emissions levels from Norilsk,” he told Metal Market Magazine. “We’ve already made significant steps in improving our environmental footprint, but this is a step-change rather than an incremental change.”
The improvements will include new technologies and infrastructure, none of which will create a significant uplift in tonnage in the next five years, but which will create the foundation for the next big growth period after that, Penny said. Central to this may be the development of Southern Cluster – a joint venture platinum group metals (PGMs) project with Russian partners that will be a “significant step in the next chapter of Norilsk’s life.”
Penny ascribed the focus on improving Norilsk’s environmental performance to three key things: the unacceptability of bad environmental practices; a clearly identified corporate purpose; and a genuine push by management, including majority owner Potanin as well as by Deripaska’s UC Rusal, to clean things up.
“Firstly, it’s the right thing to do – the pressure is there and it’s just unacceptable for a company like Norilsk, which wants to be the leader in its field, to be behind the curve on its environmental practices,” Penny said.
“Secondly, all businesses need to be really clear about what their purpose is. Norilsk has a real opportunity to supply the key ingredients in the world of tomorrow, particularly around electric vehicles [EVs] and hybrids. Our metal basket is peculiarly well-suited for copper in batteries, palladium in hybrid electric and petrol engines, [and] nickel in batteries of the future,” he noted.
“If you’re going to position the company there, you’ve got to have a joined-up story. You can’t be saying, ‘We’re the company that produces all these good things in a more environmentally friendly world’ and at the same time, in your back yard, the manner in which you produce these metals which are all good for the environment is unacceptable,” he said.
The metal value measured at the point of mining in a gasoline or diesel car is $250-400 per vehicle; for electric vehicles, the metal value is more than $1,800, Penny noted.
“There’s a curious irony in that when consumers think of EVs, they think of more environmentally friendly products, and they are, but they just happen to use four times as much metal to produce that product versus a gasoline car,” Penny said.
“It comes back full circle to ensuring that Norilsk, which mines the raw materials, does so in a way that the consumer doesn’t mind there’s four times as much metal, because the company is responsible in the way that metal is mined. That’s a big part of why we’re doing what we’re going to do on the environmental side,” he added.
Finally, Penny said there is a real desire by management “to be on the right side of history. We want Norilsk to have a carbon-friendly environmental footprint that is aligned with the way the world is going.”
As the electrification of the global economy continues to increase demand for the metals that Norilsk produces, particularly nickel and cobalt, Penny predicts a dramatic shift in commodity demand patterns.
“Like most of these things, the move to EVs will take longer than people think, but when the time arrives, it’ll be even more dramatic,” he said.
Penny noted that hybrid battery vehicles in the US currently account for 9% of the market, with annual growth of 18%; battery EVs have around 3% market share but growth of 25%. Fuel cell EVs are meanwhile just 1% of the market, but growing at an annual pace of 41%.
Although Norilsk is synonymous with nickel production, roughly 27% of the company’s revenue actually comes from the metal, compared with 30% from palladium. With around 8% of Norilsk’s revenue coming from platinum, over a third of its earnings come from PGMs.
Penny remains unperturbed about the potential loss of demand for palladium – his top commodity pick currently, despite his self-confessed love for diamonds – due to the elimination of catalytic converters as the world electrifies its cars. This is largely because he expects the biggest absolute growth in the next 10 years to be in hybrid vehicles.
“You cannot make a diesel engine a hybrid as you need a very light engine, which is by definition a petrol engine. Palladium is the catalytic converter of choice for petrol engines, while platinum is for diesel,” he explained. “We are confident that in the next 10 years, demand for palladium in hybrid vehicles is going to grow very rapidly and probably outstrip the absolute growth of battery and fuel cell EVs,” he added.
Norilsk might even get involved in new areas of the battery production chain, Penny said, with a joint venture its likely method of entry.
“Norilsk will definitely look at some form of partnership at different levels in the industry in order to maximize the value of its product. That’s something we’re actively considering at the moment,” Penny said. “I don’t know about developing batteries, but we’re looking very carefully at working with European chemical company BASF, with whom we’ve had relationships before.”
He noted that royalties and streaming deals will become more common when downstream players seek ways to shore up future supply and miners change the way they operate. “I find it very difficult to imagine that selling products at mine head is the best way for mining companies to operate. It makes complete sense for miners to put at least part of their production into an integrated downstream arrangement that gives much better certainty. And in a world of tomorrow, where you have people developing new technologies, you can’t do that without supply,” Penny said.
This article was first published in the April issue of the Metal Market Magazine, which carries in-depth feature articles, analyses and reviews of metal and steel markets.