The global potash industry has long operated as a quasi - duopoly with Canadian producers (34% of total potash sales) acting through an agency called Canpotex and Russian/Bel orussian producers (33% of global potash trade) acting through another agency, Belarusian Potash Company (BPC).
On Tuesday 30 July, Russian producer Uralkali's board released a statement saying the company had decided to cease export sales through BPC and would instead pursue a strategy that emphasises volume over price. The company plans to produce 10.5mt of potash over 2013, approximately 19% of global demand, increasing this to 13mt next year. Furthermore, Uralkali also stated that they see potash prices falling from the c urrent US$400/t to US$300/t in 2014. Separately, they announced a new 500,000t contract with Chinese buyers at US$350/t, which is US$50/t below the prevailing contract price and in - line with the current Chinese domestic price.
The company cited Belaruskali’s exports of potash outside of the BPC marketing organisation as impetus for the action. This is a major negative for an industry which has historically constrained production to match supply in an effort to support prices. Following this announcement, potash companies sold off sharply in anticipation of falling global potash prices.
What are the implications going forward?
• Potash company earnings need to be downgraded: to reflect a $300/t and possibly lower price (depending on how existing producers react to this news ) – Canadian and Russian producers are currently operating at 70 - 75% of capacity .
• Potash companies will de - rate: previously high P/E multiplies justified by an attractive industry structure and lower earnings volatility will be undermined by the prospect of deteriorating industry discipline.
• A shift to spot pricing: the potash market is likely to move towards spot market pricing with future contracts likely to reflect volumes, rather than volume as well as price. An upshot will be the removal of protracted biannual negotiations and potentially greater potash price transparency.
• Demand elasticity: demand may increase as lower potash prices may encourage increased Indian and Chinese customer demand, meaning that despite lower prices, industry participants could receive some offsetting benefit from higher volumes.
• Beneficiaries: soybean farmers can expect around $10 - 15/ha reduction in their costs due to $100/t lower potash prices. Palm oil companies will benefit by roughly 3% reduction in costs. Brazil as a significant importer will be an immediate beneficiary.
• Greenfield projects will be harder to fund for small and mid - cap companies : l ower potash prices will be a disincentive to greater supply and this should improve the industry’s structure over the long - term.
• Short - term: we expect potash consumers to hold off purchasing until there is more pricing clarity, which could create additional price volatility .
• Longer - term: the industry will be in much better shape with some new projects and expansions suspended, lower prices encouraging demand and companies operating at bet ter capacity utilisation rates.
What impact did this have on the fund?
The First State Global Agribusiness Fund was well positioned for this news by being significantly underweight the sector. While we did not anticipate the oligopoly structure unravelling so rapidly, our detailed analysis led us to position the portfolio for the eventual breakdown of the industry’s structure. Cracks had been emerging and this recent disruption accelerated the transition. The potash industry’s high valuation had become increasingly difficult to justify and drove us to underweight the sector before recent events. Despite this negative development for the potash sector, our portfolio positioning delivered positive absolute and strong relative returns for the month of July. Finally, potash remains a key nutrient requirement for plant development. We are monitoring the situation to ensure we can take advanta ge of opportunities that negative sentiment towards the sector may create.
