Potash producers plummet after Russia’s Uralkali quits cartel

VANCOUVER — Russian major Uralkali (LSE: URKA) has apparently bowed out of one of the world’s two big potash cartels, which together supported prices by limiting supplies. It was an unexpected move that stunned the potash market on July 30 and led to widespread forecasts that already weak prices for the fertilizer component are set to plummet another 25–40%.

For eight years Uralkali, the world’s biggest potash producer, has sold its product through Belarusian Potash Co. (BPC) alongside Belarusian producer Belaruskali. In North America most potash is sold through a similar cartel, known as Canpotex, which markets for Potash Corp. of Saskatchewan (TSX: POT; NYSE: POT), Agrium (TSX: AGU; NYSE: AGU) and Mosaic (NYSE: MOS). 

The two cartels represented 70% of the global potash market and supported each other’s efforts to keep prices strong, settling deals at similar prices and not hesitating to turn off the spigots if needed. The result was a seller’s potash market set more by price than volume.

Uralkali has now abandoned that tactic and plans to sell its product at a discount. That likely means a rush of supply and a drop in price.

“Discipline and price-over-volume leadership in the potash industry seem to have crumbled,” writes analyst Joel Jackson of BMO Nesbitt Burns, in a research note titled “The end of the potash world as we know it.” He continues that “we expect a major exit by investors out of potash producers . . . and the fertilizer sector in general after a stunning announcement by large Russian low-cost potash producer Uralkali to change its strategy to volume-over-price, and to market itself.”

Indeed, investors fled the sector immediately. Potash Corp. shares ended July 30 down $6.24 — or 16% at $32.66 — while Agrium fell $4.69, or 5%, to close at $89.15, with its decline somewhat sheltered by a focus on nitrogen rather than potash. Mosaic shares fell US$9.16, or 17%, to US$43.80. 

Uralkali shares dropped too, ending the Moscow trading day down 19%. The company’s shares fell as much as 26% in London before recovering slightly to also close at a 19% loss.

Those share price drops mirrored forecasts for the potash price. BPC said Uralkali’s pullout could push potash prices below US$300 per tonne in the second half of the year, compared to the current US$400 per tonne. Analysts agreed a 25% price drop was likely, though some suggested the potential for a more bearish 40% decline.

Uralkali blamed Belaruskali for BPC’s demise, arguing that the Belarusian producer had been selling some of its output outside of the cartel. Negotiations over the impasse had apparently stalled and Uralkali notified BPC of its intent in late July.

Observers may have realized Uralkali was plotting a major move. Over the last month two Russian billionaires sold their holdings in the company. Uralkali bought out shareholder Zelimkhan Mustoev’s US$1.3-billion stake in mid-July. Two weeks later Alexander Nesis sold off his 5.1% stake, worth $1 billion.

Uralkali’s move comes at a tough time for potash producers. In late July, Potash Corp. cut its earnings outlook for the year by as much as 25%, citing weak prices amidst high global supplies and reduced Chinese demand. The Chinese have improved domestic fertilizer production in recent years, reducing the need for imports. 

The North American drought in 2012 further reduced demand, creating surplus supplies. In the U.S., potash inventories are 37% above the 10-year average, according to Bloomberg. And now corn prices, regarded as the best way to estimate future fertilizer demand, are falling, taking potash prices with them. 

But if any potash producer was going to move to a volume-over-price strategy, Uralkali is the one to do it. The Russian producer has the lowest costs among its global peers, with each tonne of potash costing the company US$62 to produce. By contrast North American production costs average $100 per tonne, while production costs in Europe are even higher, averaging almost $240 per tonne. 

As such Uralkali can handle lower prices, especially if it ramps up output — which is what the company plans to do. CEO Vladislav Baumgertner said on a conference call that Uralkali will run at full capacity next year, producing 10.5 million tonnes, and output will climb to 13 million tonnes in 2014. Baumgertner also said that Uralkali expects stable revenues, with increased sales volumes compensating for lower prices.

Such certainty is not in the air in Saskatchewan, where potash mining represents 2% of the province’s economy. It’s a sector that had been expected to grow by 13% this year, according to Royal Bank of Canada’s Paul Ferley. Uralkali’s move could well force producers to reduce output, eliminating projected growth. 

That alone would reduce Saskatchewan’s gross domestic product by one percentage point. If sinking potash prices also sideline new mine builds or mine expansions, the collapse of the Russian cartel could halve Saskatchewan’s expected growth this year, though Ferley cautions that it is too early to rely on these estimates. 

The players that might come out on top of all this are the world’s farmers, who might now be able to buy potash from a market controlled more by competition than cartels.