Potash: growth market in a changing economy

Emma Rowley / Daily Telegraph (UK)
Potash: growth market in a changing economy

Potash is the common name for various compounds containing potassium which are used mainly as fertilisers. Investors are betting big on fertiliser amid soaring global demand for crops. Emma Rowley reports.

Nearly half a kilometre under a nondescript industrial site in the Russian region of Perm, machines are gobbling up rock.

Boring through the Earth’s crust, their teeth leave great whorls scraped on the freshly-dug walls, striated pink and white.

Throughout the vast web of tunnels that expands day by day, conveyor belts carry tonnes of ore to a cathedral-sized underground warehouse before the rock is taken to the surface. These underground stores represent the fruits of an industry many believe could be of huge importance to the world economy in years to come. The piled pyramids are rich in potassium salts and, through simple processing, will be used as the fertiliser potash, the name given to these salts.

The company behind the mine, Uralkali, is far from a household name. Yet, last year it was the world’s biggest potash producer, with 9.1m tonnes. That was not enough for management, who have been busy showing off the expansion of the existing mines and shafts. Ultimately, the company aims to take its production capacity from the expected 13m tonnes this year to 19m tonnes by 2021.

It is not alone. BHP Billiton, the world’s biggest miner, has been talking up its ambitions in this arena, joining companies trying to woo investors as the commodity price boom wanes. The FTSE 100 giant has been here before, with a $40bn (£26bn) hostile bid for Canada’s PotashCorp in 2010. That attempt failed, but signalled the seriousness of its ambitions and the potential potash offered. Undeterred, BHP has continued with its Jansen project in Western Canada, the cost of which has been put at $14bn and which would be the world’s largest potash mine whenever it opens.

Closer to home is Sirius Minerals, a much smaller Aim-listed company with a big ambition: to mine for a form of potash in England – to be precise, in the North York Moors National Park. The plan has, unsurprisingly, faced hurdles.

Despite the obvious differences in scale, what all three companies share is a belief that potash is among the handful of commodities which will play a much greater role in the global economy as time goes on.

Simply, it is a gamble on the world’s growing population, which is projected to rise by 0.9pc a year until 2030. That will be 71m new mouths to feed each year, according to Goldman Sachs analysts.

Importantly, much of this population growth will be concentrated in places where arable land is already in short supply, while the growing role of biofuels represents still more competition for this acreage.

“In Asia, the upper limit of available land has been reached in several countries,” a study from the UN’s Food and Agriculture Organisation (FAO) notes. “In Latin America, the increase in arable land is achieved only at a high ecological cost [especially deforestation] which may have direct relevance to climate change.”

At the same time, the swelling ranks of the global middle class are expected to want a diet richer in meat, which will have to be supported by more crops per head, as well as more fruit and vegetables, requiring more nutrients to produce than a simple rice-based diet. The FAO has estimated that agricultural production will need to rise by 60pc around the world by 2050 to cope.

As a consequence, it is generally agreed that, alongside improved techniques, farmers will have to use more fertilisers, such as potash, to boost yields.

“On the demand side we will have to see more and more grains being grown to feed the world,” says Kona Haque, a commodities analyst at Macquarie. “We are not growing more land, so the way we are going to have to do that is yield improvement. There are only two ways: improving the genetics of the plant or improving the yield through fertiliser application rates.”

That said, some of what companies are saying about potash would appear to be tactical talk – saying what investors want to hear as China’s economy matures.

BHP, for instance, has appeared keen to emphasise its exposure to later-stage commodities in contrast to rival Rio Tinto’s dominance in iron ore, the steel-making ingredient that is in high demand during an economy’s early boom period.

But, undoubtedly, the long-term fundamentals behind the potash industry look attractive, not least because reserves are concentrated, the bulk found in Canada and Russia, and controlled by a small number of industry players, in contrast to phosphate and nitrogen fertilisers. In addition, handily for potash producers, there is no man-made substitute for their product. The problem is, long-term can be a very long time. No one really likes to admit it, but so far potash has not delivered the great promise embodied in all those population forecasts.

The graph familiar to weary investors shows that global demand has been disappointingly flat, hovering around 50m tonnes for a decade, other than a sharp plunge around the financial crisis. Before that crash, steep pricing by distributors had helped to push the potash price to nearly $1,000 a tonne, but today it is under $400.

“I was following this market back in 2007 when prices across the fertiliser spectrum were skyrocketing,” says Myriam Affri, a director in the natural resources team at ratings agency Fitch. “The maxim then was that we were not going to see any drop, because it was a re-basing [of the price], due to less arable land [and] changes in eating habits. [But] there is much more volatility than anticipated back then in terms of pricing and demand.”

She does anticipate a pick-up in demand as the global economy continues to recover from the financial crisis and growth gains momentum.

Farmers, like any business people, will sit on their cash in hard times, a phenomenon exaggerated by the fact that potash does not need to be applied every year.

But it is still not a straightforward waiting game, as the question is what new capacity is going to come on stream. This issue has been thrown into stark relief in recent weeks, as the potash industry has undergone what could be a total reshaping of its landscape.

Until now, the industry has been dominated by two cartel-like groups, one in North America and one involving Uralkali and its Belarusian state firm Belaruskali. That was until last month, when Uralkali announced it was quitting, complaining its partner had been selling potash outside their marketing deal. Uralkali’s management spoke of “deadlock”.

As recently as June, Uralkali’s strategy had been “price over volume”, in the words of chief executive Vladislav Baumgertner. Perhaps management’s admission then that its attempt to increase prices in Brazil had been “not very successful… we lost some market share” and that the “first quarter was slower than we would have liked” was a red flag of its impatience in retrospect.

For Uralkali has now changed tack, prioritising the amount it can sell in the market rather than price. This is a big deal, with some calling it the potash world’s equivalent of Saudi Arabia deciding to quit Opec, the oil producers’ group.

If the partnership to which Uralkali belonged is no more, the others are likely to also disintegrate as the remaining major producers likewise start chasing market share, driving down the price.

Since the industry is currently operating at only 80pc of capacity, there is a lot of scope to raise production and so to drive down the price. Uralkali thinks the price could drop by 25pc to below $300.

As one of the lowest-cost producers, it is in a position to take this risk. Some analysts think it could head towards $250 a tonne, around the cost of production or break-even price for German producer K+S, which is in the uncomfortable position of being at the top end of the industry cost curve.

No wonder, then, that shares in potash companies plunged as much as 30pc on the day of the announcement. In one fell swoop, Uralkali had thrown into question some of the great appeal of the industry as the control on the supply of potash, and, as a result, a source of support to the price is removed. As a result, the future of several expansion projects has come up for debate, with BHP’s Jansen mine the subject of speculation as to its viability at current prices. Indeed, the question of what capacity the industry will settle at is key to another big unknown – where the price will head.

And yet, markets can be short-sighted. If in the shorter to medium term the potash price could drop still lower, that does not undermine its long-term attractions. Certainly, BHP’s chief executive, Andrew Mackenzie, signalled as much earlier this month.

“We’ve always said that potash is a business which will lose some of its cartel-like structure and become in time globally traded like everything else, so we, to some extent, predicted what’s happened,” he said. “We have to look forward tens of years in terms of potash supply to really understand what, if any, investment we’ll make and at what pace.”

Meanwhile, even if investors in companies operating in the market are not happy, the move could be ultimately be positive for farmers and, by extension, global food security, notes Macquarie’s Haque.

“Farmers have been suffering from high costs of production for a while now – the cost of land, the cost of labour, the cost of fertiliser,” she says. “So, any reduction in the price they end up paying will be good for them. Ultimately, it will help them support supply and that will ultimately be good for food prices around the world.”

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