The potash cartel disintegrates
Russian potash producer Uralkali has pulled out of the Belarus Potash Corporation, which consists of itself and another producer, Belaruskali. The export cartel is one of two that control around 70% of the potash market in total.
The other cartel is North American Canpotex. It includes big names in the sector such as Mosaic, Agrium, and Potash Corporation of Saskatchewan.
Uralkali claims its Belarusian partner has been selling potash outside their partnership. (This is a classic problem with cartels – getting members to stick to quota. Oil cartel Opec has the same problem.) So it's decided to go it alone.
This will have a huge impact. Notes the FT, between them, the cartels "have maintained [potash] prices well above marginal production costs by refraining from flooding the market." But now Uralkali, which accounts for about 20% of global production, is going to produce and sell as much potash as it can.
Uralkali wouldn't be making this move if it didn't feel it could profit from it. Being in a cartel might keep prices up, but it comes at the expense of sales. If you think you can produce a commodity more efficiently than everyone else, your best bet is to compete on price.
If you are indeed the most efficient producer, you'll be able to sell profitably at prices that will put everyone else out of business. What you lose in margin, you'll make up in sales volumes.
That's the plan for Uralkali. It aims to boost sales from 10.5 million tonnes this year to 14 million in 2015. Chief executive Vladislav Baumgertner said he reckons the price of potash could fall from $400 per tonne to $300 as a result.
If Opec said the oil price was set to fall by 25% in the next year, what do you think would happen to oil company share prices?
Well, if you're at all unsure, you need only take a look at what happened to potash producers this week. Uralkali saw its share price drop by 17%. PotashCorp and Mosaic saw prices dive by more than 20%. And Germany's K + S fell by a similar amount.
Lex points out that "if the industry shifts its focus to volumes, the highest-cost producers will suffer most." K + S produces potash in Germany at a cash cost of "about $265 a tonne". Uralkali on the other hand, does it for less than $100.
Of course, this might be some sort of bargaining technique. But Uralkali's chief executive and its backers sound serious about the shift in strategy.
Catching falling knives is too risky So how can you profit from this? The thing is, the outlook for potash demand remains healthy. As the FT's Lex column notes, the global market for potash is set to grow by about 5% this year. "It should grow further as demand for meat in Asia drives the need for grain and fertiliser."
In the longer run, a lower potash price will put other competitors off entering the market. That means supply will drop. Potash can only be mined in certain parts of the world. But as the FT points out, "many of the new greenfield projects under consideration rely on a potash price of $450 per tonne or more." Already, advanced plans by BHP Billiton to open a huge potash mine in Canada, are being questioned.
In fact, this is probably one of the factors behind Uralkali's thinking. The cartel structure was under threat anyway, because more and more independent potash mines are being planned. If it can wreck these new projects by driving the price down now, it can hold onto pricing power for that bit longer.
Lower prices also mean higher demand. So while the near future looks bleak for producers, supply and demand may well balance out much more quickly than anyone expects.
Trouble is, we have to endure the short term before we get to the long term. Potash stocks are still tanking, and catching a falling knife is always very risky.
Take
K + S (Germany: SDF). It's been hit hard. And on a p/e of around seven, and a dividend yield above 7%, it looks tempting. The trouble is, some analysts reckon earnings per share could half if the potash price does collapse to $300. So I'd be inclined to wait until the dust settles before considering buying.
As for potential beneficiaries from a lower potash price, on a broader basis this would be good news for farmers, and India in particular. As investment analyst Don Coxe points out, India has to import all the potash its farmers need. The Indian government subsidises these, which means any drop in price will improve the state of its finances. But finding specific ways to play this isn't easy.
However, overall, the world's growing population still needs to be fed – and cheaper fertiliser will only make it easier for farmers to grow more. My colleague James McKeigue recently looked at one highly risky way to
invest in the farming business.
Got a comment on this article? Leave a comment on the MoneyWeek website, here. Until tomorrow,
John Stepek
Editor, MoneyWeek
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