After the Potash nightmare, there is a silver lining

“There are going to be winners”

 

For Potash Corp. investors hoping to wake up from a week of nightmares: it’s not a bad dream. The breakdown of the Belarusian Potash Company (BPC) agreement with Russia’s Uralkali has caused a paradigm shift in the way the potash industry will operate in the coming months. (For a reality check, watch this interview with Uralkali CEO Vladislav Baumgertner who states the crumbling of the cartel was unavoidable.)

But there may be a silver lining hidden in the industry shake-up, especially for the larger, low-cost global producers of potash. For any one holding Potash Corp shares—which lost 15% of its value this week—it’s small consolation.

The price discipline relied on by the global duopoly of BPC and Canpotex (Saskatchewan’s potash international shipping agency) has—at least for the time being—ended, but according to analysts it’s the big players who are really going to be able to weather the industry’s current troubles. In fact, for major low-cost producers of potash, there might be a hidden benefit.

A lowering of prices in the next six to 12 months “will lead to the delay, almost certainly, of additional green field [new] potash development in western Canada, and possibly also in Russia,” said Patricia Mohr, a vice-president and commodity market specialist with Scotiabank.

“That’s going to actually tighten the market in the next few years,” she added, noting that new potash developments would require much higher potash prices in order to justify the capital investment required to start these projects.

That means the potential entry of competitors like Australian mining giant BHP, with its proposed Jansen Project in Saskatchewan, have become much less financially justifiable ventures this week. If prices lower and the market tightens, the current incumbents may only have to compete with each other for the foreseeable future.

“There is pain for everybody” if this new potash paradigm persists, said Steve Hansen, an equity analyst with Raymond James. “But there are going to be winners in this somehow.”

Ultimately if other projects drop off, such as ones that would provide future potash supplies, and demand increases due to lower prices, “there will be an offset through higher demand, certainly,” he added.

“For a lot of these big producers they get operating leverage out of higher volumes, so they will survive in the low cost model.”

Some producers, including Canadian companies, who have operating costs in the $60 to $120 per tonne range, are still “clipping a tidy margin” even at a potential spot price of $300, “so it’s still very lucrative,” notes Hansen.

“For players like Potash Corp, they are at the low end of the cost curve. They are going to survive this… they still will produce a very large amount of free cash flow, [and] the dividend is safe.”

Raymond James has also pointed out that Canadian railway companies could benefit from higher volumes being shipped—particularly CP, which handles 80% of Canpotex’s volume.

Still, the effects of increased levels of potash production, as promised by Uralkali, on the demand for Canadian potash remains to be seen, said Paul Ferley, assistant chief economist with RBC.

“How aggressively some of the overseas producers do respond in terms of upping production—that’s going to be key. Because it could then weaken demand for production coming out of Canada,” said Ferley, adding that it will also have implications for potash prices, which in turn impacts income growth in Canada and Saskatchewan’s fiscal situation.

Uncertainty remains in terms of how much additional overseas production is going to “merge into the marketplace,” Ferley said.

“Once we get a better feed on that, we’ll get a slightly clearer picture in terms of what the production response might be here in Canada, and what the implications for the price of potash will be.”

 

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