The potash rebound (March 29, 2010)

VANCOUVER — The potash market felt the wrath of the recession more than almost any other commodity, as struggling farmers around the world forwent the potassium-based crop nutrient for a time. But crops need fertilizer at some point and it appears that point has arrived: a US$4.7-billion merger of two nitrogen majors combined with significantly increased earnings guidance from the world’s leading potash producer are sure signs that fertilizers, especially potash, are returning to the hot seat.

Shares of Potash Corp. of Saskatchewan (POT-T, POT-N) jumped after the leading potash producer substantially increased its earnings forecast for the first quarter. Only six weeks earlier, the company had predicted quarterly earnings of 70¢ to $1 per share. Now the major expects to earn between $1.30 and $1.50 per share in the first three months of the year and says it is already sold out of Q1 potash, several weeks before the end of the quarter. In addition, the company says it is also seeing higher-than-expected margins on its nitrogen and phosphate businesses.

“Strong farmer returns, a depleted distributer pipeline, and the agronomic need to replace soil nutrients have kick-started a potash rebound from 2009 lows,” said Potash Corp. CEO Bill Doyle, in a statement. “While we know that growth does not follow a straight upward line, we believe the increase in potash sales volumes this quarter represents the beginning of a return to long-term growth in demand.”

The company says the strong rebound in potash demand is expected to drive a record quarter for North American sales and strong offshore shipments. Potash Corp. did not revise its annual guidance numbers, saying it will do so when it reports first quarter results at the end of April. The company operates six large mines in Saskatchewan and New Brunswick and has investments in at least four major international potash producers.

The news stands in sharp contrast to the state of the potash industry a year ago. In 2009, global consumption of all fertilizers fell by 7% from the peak in 2007. Within that, application of potash and phosphate fertilizers declined more sharply — potash demand fell by more than 20% while phosphate needs declined by 10%. American farmers withheld fertilizer more than anywhere else in the world: potash applications declined 40% and phosphate use fell 30% in the U.S. in 2009, the largest declines on record. Nitrogen applications did not fall as much because nitrogen is not retained in soil and therefore must be replaced every season to prevent major yield loss.

Overall, in 2009 global potash sales declined to the lowest level in more than 35 years. Shipments totaled just 30 million tonnes, which is 42% below 2008 levels. In response, producers significantly curtailed production levels, producing roughly 25 million tonnes less than planned.

The first sign of the turnaround came in the fall, when Belarusian Potash signed a supply deal with China at US$350 per tonne. Subsequently, India returned to the market with a few contracts and Brazil soon followed. Then, in January, BHP Billiton (BHP-N, BBL-L) moved on Athabasca Potash (API-T), inking a takeover deal that offered $8.35 in cash for each Athabasca share. The deal valued Athabasca and its Burr potash project at $341 million. Burr, a prefeasibility-stage project near Saskatoon, is home to 424.8 million measured and indicated tonnes K₂O plus 186.9 million inferred tonnes of potassium oxide, in a deposit amenable to conventional hard-rock underground mining.

Now potash prices have edged back up to US$425 to US$450 per tonne and most analysts are back to being bullish on potash. Canaccord Adams agriculture analyst Keith Carpenter wrote recently that he has seen positive momentum in the potash market since December, including the return of purchasers in all markets but specifically in North America. Charlie Rentschler, an agribusiness analyst with Morgan Joseph, wrote in a research note that buyers are “reverting back to their traditional buying habits.”

Duncan McKeen, an analyst with Macquarie Research, said Potash Corp.’s increased earnings guidance is “a confirmation of a strong recovery in the potash market” where “we continue to believe we are in the midst of a reversion back to more normal levels of potash use globally after farmers have been under-applying this nutrient for almost 18 months.” And Fai Lee of RBC Capital Markets commented that the “rebound in potash demand appears to be happening a little more quickly than we had originally anticipated.”

Another potash industry mainstay, Belarusian Potash, also released positive news: the distributer is raising some of its prices by about 6%. Belarusian Potash is responsible for roughly 30% of global potash sales and the company increased the price for its standard grade of the fertilizer to US$410 per tonne from US$385 per tonne for major customers in Brazil and Asia. Belarusian Potash also said it expects overall sales to increase 50% this year compared to 2009. The Minsk-based company is the exclusive export agent for Russian potash miner Uralkali.

The bullish sentiments from producers and distributers don’t end there. U.S.-based Mosaic (MOS-N) just signed some potash contracts at US$430 per tonne and the company said it expects prices to climb up from that point this year.

There is no doubt the need for fertilizers will continue to increase. World population is rising and emerging economies are growing, both of which mean that more, better food is required. People with new disposable income tend to spend it first on food, prompting diets to include more grain-fed meats as well as fruits and vegetables. And urban and industrial expansion continues to encroach on arable land. Forecasts suggest that by 2020 there will be barely 0.2 hectares available per person for animal and crop production, which is about half of what was available in 1970, but that land must produce almost three times as much food.

Fertilizers include potash, nitrogen and phosphate. Among major world crops, corn, wheat, and rice require all three nutrients, while soybeans primarily need potash and phosphate. Potash is particularly important in the production of palm oil, fruits and vegetables. Before the recession took hold, world consumption of potash had been growing by 3.6% annually for a decade; in the four major offshore markets of China, India, Brazil and Southeast Asia, annual consumption grew by 7.5%.

These facts remained evident to Potash Corp., even as the potash market appeared to crumble in 2009. Based on its confidence that the world’s need for fertilizer would not only survive the recession but would grow, Potash Corp. continued to advance its $7-billion expansion plans during the recession. The company initiated its expansion efforts in 2005 and by the end of 2013 expects to have completed construction on project that will bring its annual production capability to 17.1 million tonnes. The new and expanded projects should be fully operational by 2015. At present, following completion of some expansion projects, Potash Corp. is able to produce 12 million tonnes of potash annually.

In general, expanding capacities at existing potash operations is highly preferable to finding and developing greenfields projects, for a few key reasons. Potash deposits that are economic to mine are quite rare and are geographically concentrated — roughly half of current global reserves are in Saskatchewan and, together, Canada, Russia, and Belarus account for just over two-thirds of world production capacity and more than 80% of worldwide reserves. Even if a company finds an economic deposit, to build a conventional 2-million-tonne mine even in a politically friendly and infrastructure- endowed place like Saskatchewan costs at least $2.5 billion and takes seven years on average to achieve full production.

But even Potash Corp. admits that relying solely on expanding existing operations would leave the po
tash industry under-supplied within the next 10 years and so greenfields development is required. The most advanced new potash project in Canada aside from Athabasca Potash’s Burr project is the Legacy project, which is wholly-owned by Potash One (KCL-T).

Potash One is working through a feasibility study for Legacy, which it expects to complete by the mid-year. The study is looking at the economics of developing a solution mining well field and processing facility able to produce almost 3 million tonnes of potash annually. A prefeasibility study confirmed a measured and indicated resource of 251 million tonnes KCl, at an average grade of 16.6% K₂O, and inferred resources of 850 million tonnes KCl, which would be enough to support at least 40 years of mine operation.

With Athabasca Potash now merging into BHP, several analysts have identified Potash One as the only advanced Saskatchewan potash project that remains available for acquisition by a major. In that context, it is useful to note that Legacy is just 30 km north of Mosaic’s Belle Plaine solution mine. Vale (VALE-N) also holds potash ground nearby, to the east. It was with an eye to the future, whether that be raising $2.1 billion needed to build the mine or negotiating an acquisition or sale, that Potash One brought in famed mining promoter Robert Friedland to serve as chairman.

Potash gets more coverage in Canada because of Saskatchewan’s important role in the industry, and the industry’s dominance in the province, but phosphate and nitrogen are also key fertilizers, and movements in each fertilizer industry impact the others.

The biggest news in nitrogen is a merger between CF Industries (CF-N) and Terra Industries (TRA-N).Under the proposed deal Terra shareholders will receive US$37.15 in cash and 0.0953 of a share of CF Industries for each share. The transaction carries a total value of US$4.7 billion.

And the deal essentially terminated two other proposed mergers. In February Terra signed a definitive agreement to merge with Oslo-listed Yara International, which had offered US$41.10 in cash for each Terra share. The Yara deal valued Terra at US$4.1 billion. Yara will receive a US$123-million break fee from Terra.

And the CF-Terra merger also threw cold water on Agrium’s (AGU-T, AGU-N) 16-month long attempt to carry out a hostile takeover of CF Industries. Agrium had offered one share and US$45 in cash for each CF share, contingent on CF abandoning its bid for Terra.

The battle for control of these significant members of the North American fertilizer industry lasted as long as the industry’s recession- induced price problems. Over the last 16 months the nitrogen and phosphate industries saw several instances of competing hostile bids and fights breaking out for control of board seats; all the while the companies’ stock prices climbed and climbed as demand for all types of fertilizers returned. Terra, for instance, traded as low as US$23.60 in June but has since climbed above US$46. Similarly, Agrium’s share price fell to $41 in July but, on news of its dropped bid for CF, reached a new high of $73.69.

The end result of the fertilizer battles is certainly positive for Terra shareholders: in addition to their merger proceeds they received a special dividend of US$7.50 per share in December.

CF Industries is a major producer and distributer of nitrogen and phosphate-based fertilizers. The Illinois-based company operates nitrogen fertilizer plants in Louisiana and Alberta, mines and manufactures phosphate in Florida, and distributes fertilizer products through a network of facilities in the midwestern United States. And Terra is a major North American producer and supplier of nitrogen products. The company had revenues of US$1.6 billion in 2009.

Terra and CF bring together different foci –Terra on industrial customers and CF on agricultural ones — and the companies are hopeful the diversification will ensure greater strength and resilience through tough industry cycles such as that in 2009. In addition, the merger is expected to create annual saving through cost synergies of up to US$135 million, driven primarily by the elimination of overlapping corporate functions, optimization of transportation and distribution systems, and greater economies of scale in procurement and purchasing.

Potash Corp.’s share price is currently near $129, after spending much of 2009 closer to $100. Potash One is trading near $3.20, after climbing back from $1.32 a year ago.