Wednesday, 31 July 2013

Uralkali and the Potash Industry

The Canadian government scotched BHP Billiton's proposed takeover of Potash Corp in 2010, largely due to the mining giant's plans to withdraw from Canpotex, the marketing arm through which Canada's producers sell and distribute their products.  The Saskatchewan government feared that a weakened Canpotex would mean a weakened price for potash, reducing royalties and income taxes for the province.  Today, the potash world saw that those fears were indeed valid.

Potash producers in Russia and Belarus have sold over 40% of the world's capacity via BPC, an institution similar to Canpotex, until Uralkali, a large Russian producer, abruptly announced that it will withdraw from the marketing body.  Instead, the company plans to market its own products, with an emphasis on maximizing volume, rather than withholding supply for a better price.  The company itself acknowledges that this move could reduce potash prices by 25%, to around $300 a tonne, at least in the short-term.  The share prices of all publically traded potash producers instantly fell by 15-25%. 

In the long-term, the supply-demand equation is likely to remain favorable to producers: in fact, $300 a tonne pricing will render any greenfield capacity uneconomic, and will reduce the number of proposed brownfield expansions that go forward, as well.  Interestingly, Uralkali itself has confirmed that it will put one of its own expansions on hold because of the move.  At the same time, lower prices will increase volumes, eventually raising the price of potash.  In addition, an industry where only three sellers - Canpotex, a smaller BPC and a stand-alone Uralkali - account for 70% of capacity remains a heavily consolidated industry (there's additional, though less visible, consolidation, as well, since Potash Corp holds significant sway with the company’s that it holds minority interests in, all of which operate outside of the main two marketing bodies).  

Still, the industry's future doesn't appear as bright today as it did yesterday.  If the marketing arrangement is permanently weakened, the average price of potash is likely to be lower than it otherwise would've been, and will crash harder in down markets than it has in the past, a dismal fact of life for producers of most other commodities.  Not only will producers be less profitable, it will force them to hold more cash - or take on less debt - than they would have under the status quo, which will increase a range of opportunity costs.
There are still many unanswered questions.  For one: Why?  It's possible that Uralkali is merely maneuvering against its Belarusian partner, due to reports that one or both parties have sold product outside of the arrangement.  Indeed, Uralkali appears no better off in this brave new world of its own making.  Its stock, too, fell by about 20%, and even selling at all-out capacity, the company predicts flat earnings, suspended its stock buyback, and, as mentioned, put at least one planned expansion on hold.   

Economists often use the classic "prisoner's dilemma" as a model to help explain - and predict - how players in this sort of situation will behave.  Uralkali is behaving in a way undreamed of in this formulation: it "squealed" on the others, but did so with no benefit to itself.  The prisoner’s dilemma assumes rational people making informed, disinterested decisions, however.  In this case, Uralkali may be attempting to correct a perceived lack of fairness (experiments show that people sometimes act counter to their own interests in the name of fairness) or it could simply be behaving foolishly.  Or the company may in fact be acting rationally, after all, with the explanation to be found not in an economics textbook, but at the poker table: this could be a bluff.

In any case, the industry appears less attractive than it once was – although it’s also more appealingly priced.  

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