Why are the Chinese worried about Potash?
We have read a lot in the press recently about BHP Billiton’s unsolicited bid for Potash Corporation of Saskatchewan. Fertilizers and specifically potash and to a lesser extent phosphate are likely to become the next battleground in terms of access to strategic resources, as they represent one of agriculture’s most important inputs.
Why all the fuss?
Why would BHP be so interested in the space and why might the Chinese enter into the fray? How does potash fit into the fertilizer mix?
The three types of fertilizers
Crops need three major classes of nutrients (apart from some micronutrients and of course water): Nitrogen (N), Phosphate (P2O5) and Potash (K2O). It makes sense to think of fertilizers in two segments: mined and manufactured. Nitrogen is manufactured using mostly natural gas as a raw material whereas both phosphate and potash rely on mined minerals as a key raw material. As a result, supply of phosphate and potash is less elastic and you are more likely to see a price spike for these two in times of elevated demand like in 2008 (see below).
Because of this price spike, farmers around the world (the example given is for the US, but the phenomenon was even more pronounced in many emerging markets) used less of the more expensive fertilizer and more of the nitrogen group of fertilizers, resulting in a demand collapse for potash and phosphate. It is likely that this is a temporary demand reduction as increased pressure to get more production out of land dictates higher fertilizer applications in all three groups – especially in the emerging markets.
What’s different about potash
The potash market is special because supply is so tightly controlled by three cartel-like export groups including Canpotex, which sells potash outside North America on behalf of PotashCorp, US-based Mosaic and Agrium of Canada; Belarusian Potash Company, the marketing arm of Moscow-based Uralkali and Belaruskali of Belarus; and PhosChem, which markets phosphate outside the US on behalf of Mosaic and PotashCorp. The nitrogen group of fertilizer, which uses natural gas rather than mined minerals as its main ingredient, is not subject to supply restrictions. These three groups, which are exempt from antitrust law because of special rules, control 70 per cent of global trade in the two key fertilizers which serve both to boost crop growth and protect crops from diseases.
The twist in the takeover saga is that BHP has indicated a desire – if it succeeds in its acquisition – to exit the Canpotex consortium and market the product independently. This would mean true market-based pricing for the first time since about 1971! Not a happy prospect for the other potash producers. What would happen to pricing in a free market environment? Demand would likely grow at its trend rate of about 3% p.a. and supply would likely keep up over the foreseeable future as there are plenty of “brown field” opportunities to expand existing mines rather than develop new ones. As a result, we are unlikely to see a recurrence of the phenomenal price spike of 2008 driven by a combination of strong demand because of high food prices and supply constraints because the industry had underestimated demand growth.
A leveraged way to play the coming agriculture boom
The bottom line is that while we are unlikely to see a repeat of the price spike of 2008, we are also unlike to see a repeat of prevailing prices prior to 2004 as demand growth is on a higher trajectory and capacity expansions are getting more expensive. Fertilizer companies with strong, low-cost assets may continue to attract attention from strategic buyers in China and elsewhere.
- Daniel Grasman