During the commodity bubble of 2003-2008, potash was one of the hottest commodities surging from $200 a ton to a staggering $1000 a ton in June of 2008. The market was in love with stocks like Potash Corp, Mosaic, and Agrium. Analysts were constantly raising their price targets and boosting earnings projections due to strong fundamentals. The general market wisdom at the time was that investing in potash companies was a no-brainer because "people have to eat" and "farmers have to buy potash." They were thought of as recession proof stocks and considered safe investments. This market enthusiasm did not last long as investors dumped potash stocks during the market crash of 2008 and have largely stayed away from the sector through 2010.
The potash market has suffered from low agricultural prices, obstinate farmers, and a deflationary environment thanks to large excess capacity within the industry. These factors have lowered the price of potash on world markets all the way down to around $350 a ton. In response to lower prices, the official potash cartel known as Canpotex has dramatically reduced potash production to keep prices artifically high. While the cartel itself has done an excellent job manipulating the market, its brethren in Belarus, known as the Belarusian Potash Company, have been very keen on selling potash at the market's prevailing price (they need the money).
The question is: Will the market will turn around any time soon? I believe the answer is no because the supply/demand fundamentals just don't merit any sharp increase in potash prices. Demand remains weak (estimated at between 45-50 million tons) and their is ample excess capacity (60-68 million tons). Another factor is that farmers have shown themselves quite willing to reduce or completely halt potash applications for their crops if prices spike too high. In fact, potash prices at $350-400 are historically high when you consider that for a long time during the 80's and 90's the price of potash was below $200 a ton. A further nuance in the world market for potash is the increasing power of China and India which have become two of the largest buyers. Recently both countries have taken hard lines against Canpotex and have won major price concessions. These annual price negotiations have become the benchmark for world prices, and as long as China and India hold the line, they can help keep prices low. I also wonder how long the Canpotex cartel will be able to keep members fully compliant with production quotas. So far, the members have cut production by approx. 6 million tons since 2008, but prices have continued to fall nevertheless. At a certain point it may make more sense for some Canpotex members to quit the group and increase production. After all, they are leaving a lot of money on the table as potash at $350-400 a ton is still very profitable.
Another negative factor for potash supply/demand is the entry of BHP Billiton into the market with their Jansen Mine. According to BHP, Jansen will have an estimated output of approx. 8 million tons of potash and will begin production in 2015. More importantly, BHP had indicated that it will not likely join the Canpotex cartel because it has little need and does not want to have its production restricted. BHP will be more interested in selling as much potash as it can to recoup its significant investment, which is estimated at over $8 billion. If BHP refuses to join the potash cartel, it could put Canpotex out of business as it becomes less relevant in world markets.
In conclusion, I see little reason for potash prices to pick up from here, which means that potash companies will continue to lag the market. Investors need to look past simple cliches such as "people have to eat" and so on to better understand the fundamentals of the potash industry. We have learned over the last two years that people do indeed need to eat, but that does not mean farmers have to pay $1000 a ton for potash. Those lofty price levels show no signs of returning in the future. If anything, prices could revert to their normal level of around $200 a ton, which would make potash stocks poor investments.
Black Swan Insights
what about Magindustries Corp(TSE:MAA)? I think Chinese will buy Potash from this company. MAA need the capital to run the business.
ReplyDeleteCommodities are cheap.
Deletethanks for the comment. I am not familiar with the company but see that it has a potash project in the Congo. The chinese will really like this and may invest because they want to secure potash sources outside Canpotex. One company I am following is Allana Potash which has a project in Ethiopia and has already received an investment from the Chinese.
ReplyDeleteMr. Crawford: Your analysis speaks nothing to the recent fundamental of increasing corn prices that is the key element for farmers to increase fertilizer purchases. With the March forward contract for corn now being in excess of $4.00 per bushel this is very favorable for upward price pressure on fertilizer prices.
ReplyDeleteTo further support corn prices is the likely ethanol mandate that may be increased to 15% from 10% which will impact the corn carryover.
Contributing to the upward bias cited to the price of corn is the increasing purchases of corn from China as their food inflation is increasing and they are using increased purchases to thwart food inflation. Their purchases are the largest since `98 and they are contracted for increased purchases next year.
Whereas, the increasing value of the dollar has reduced the price competitiveness of corn and fertilizer prices, China's statements to appreciate the yaun as well as the increased value of the Euro from recent levels and there is additional upward price bias for soft commodities in general.
Lastly, there is a huge migration of people in China from the rural areas of China into the cities and the demand for increased high protein diet is demanded. China has increased dramatically the size of its hog farm operations and this is increasing the demand for feed corn.
In conclusion, all of these fundamentals have nothing to do necessarily with "people have to eat" per se, but instead represents an increasing demand for a higher protein diet. Also, the mention of BHP and their influence on the cartel and potash supply is five years away and requires significant mining expertise as the Jansen project from what I understand has extreme risks from too much water intrusion.
Thanks for the comment. I have no doubt that potash demand will increase my point is that current supply (and excess capacity) will easily meet future demand. Especially with the entry of BHP Billiton who has all the money in the world to develop their mine. So there is no reason to see potash prices go back to $800-1000 a ton. I think this is why potash stocks have lagged the market over the last year.
ReplyDeleteYou brought up a good point about corn prices increasing recently. That may give farmers more of an incentive to buy potash. Its interesting that in the US 45% of potash demand is for corn but in China only 25%. The majority is used for vegetables, fruits, and rice.
One thing I do not like about Potash, Mosaic, and Agrium is that they have mislead investors about potash demand. They keep saying the market is turning but it never does. I remember in late 2008 when they were saying things would turn in mid 2009, then late 2009, then 2010.
I am in the industry selling to farmers in the USA. Most have learned to take a hard look at their potash needs. They broke a very strong habit in 2008,2009 and applied little or NO potash. They now take a very hard look at how much they will use.
ReplyDeleteIf the market breaks $400 plus transportation costs you will see a push back by retailers and farmers in 2011.
You can try and make the case that rising grain fundamentals support a higher fertilizer price but it is a weak case at best. Farmers are independent businessmen. They are not uniform, large companies. They are thousands of independent businessmen making decisions for their own personal business.
Fertilizer dealers took huge write downs and losses in recent years because they thought that farmers would simply go along with the trend. Just the opposite happened and many retailers lost millions in write downs or lost profits. Now retailers pay much closer attention to the desires of these independent businessmen.
Bottom line is that emotions and overall farmer profitability will dictate how much fertilizer the grower will use. They painfully learned to do without once before and they will do it again.
Your statement regarding the amount of "excess capacity" is at variance with published figures I have seen insofar as your 60-68 million ton range already exceeds current operational capacity of all facilities. You say that the members of Canpotex have been misleading investors about potash demand in that they say the market is "turning' but in your words "it never does." Well, it is turning now. Your assumptions regarding the viability of potash companies as good investments going forward is seriously undermined by the possibility of BHP Billiton becoming a serious competitor down the road. However, given your pessimistic sentiments regarding forward pricing heading back towards $200 per ton, it is hard to understand why BHP would enter a business which will take them years to develop only to lose massive amounts of money. Instead, it is more likely that either BHP Billiton will decide to attempt to acquire an existing potash business in order to profit from improving conditions in the marketplace or alternatively will decide to develop their own business because they believe that the then current potash pricing will more than justify their investment. In either case though, your pronouncements on the subject would be at variance with their business judgment. Your comment that farmers can essentially take or leave potash is belied by decades of applications. Record yields deplete the soil of nutrients and failure to restore a proper balance of nutrients will invariably affect yields sooner or later which is why, for example, the Chinese and Indian farmers already produce far less per acre than farmers in North America. Whether the potash companies do well or not in the future has as much to do with volumes as it does with pricing. While you predict flat or dwindling sales, the members of Canpotex continue to spend billions annually to increase their operational capacity. Such CAPEX makes no sense if the future portends poor sales at significantly lower prices. At current prices, members of Canpotex will do quite well if world potash demand considerations require the potash they are endeavoring to produce. You believe the demand won't be there and these companies are wasting their time and money. On that point and others, we will just have to wait and see who is right.
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