Thursday, 1 August 2013

Potash industry cartel breaks up

Until two days ago there were two large cartels which controlled around 70% of global production capacity of potash (a fertiliser). However, on Tuesday, Russian-based Uralkali announced it would leave its cartel due to lack of discipline by its Belarusian partner Belaruskali, and instead focus on production volumes.

The Canadian Potash price looks set to fall to the marginal cost of production

Source: Bloomberg, Brewin Dolphin

The two cartels are Canpotex in Canada (encompassing PotashCorp, Mosaic and Intrepid) and BPC in the east (Uralkali and Belaruskali) which control around 40% and 31% respectively of global potash capacity. The potash industry has overcapacity. In 2012 it shipped 51mt which is only 78% of the 65mt capacity. Assuming a 3% demand growth rate (the same as 1996-2007 when China was growing at 9%), and no capacity growth (which there may well be) it would not approach full capacity until after 2018.

Other producers could cut capacity to accommodate Uralkali, but why should Belaruskali reward it for breaking the cartel, and why should the Canadians allow the eastern players to grow market share? We therefore expect prices move toward the marginal cost of production and remain there for as long as overcapacity persists - this corresponds to a fall of around 30% to $275-280/t, versus the recent $400/t contract price.

The stocks have reacted quickly with the Canadian sector down 20-40% since Tuesday. Some could well fall further as investors revise down expectations and as risk averse investors roll out of the shares. German listed K&S looks particularly vulnerable as one of the highest cost producers globally.

Mining company BHP Billiton is now less likely to approve the Jansen potash project in Canada despite having already spent over $1bn in ‘pre commitment’ capex. As an aside BHP now looks very lucky not to have been allowed to buy Potash Corp for US$38bn in 2010 (current market capitalisation US$26bn).

So how can investors play this theme? In its press release Uralkali left the door open to reforming the cartel, presumably if Belaruskali agrees to honour the cartel (although visibility on this outcome is very low). This would be very positive for potash pricing and expectations for potash prices could well move back to $400/t. Investors could choose a high quality company which a good position on the cost curve, waiting until the move in potash prices is priced into the shares, perhaps adding an extra margin of safely.

Nik Stanojevic CFA
Divisional Director

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