Uralkali bombshell hits the potash market, but value remains strong if you avoid herd mentality
Potash and Phosphate Month in Review: The InvestorIntel Potash Sponsor membership fell 10.63% for the month of July. The drop betrays the fact, however, that potash juniors have actually shown some strength over the past month, rising week after week. Allana Potash (TSX: AAA | OTCQX: ALLRF) reached CAD$ 0.56/share for the week ending on July 26. Admittedly, this was not a landmark valuation – given that Allana got close to its all time highs a few months ago after announcing that it was ready to submit the final mining license application before the Ethiopian government – but it did show that in the face of an uncertain potash market, concerned by oversupply and the emergence of huge new players such as BHP Billiton’s Jansen mine, the juniors were surviving and advancing their projects. Then the bombshell dropped. July 30, 2013 represented as close to a ‘Black Monday’ for Potash companies as there ever has been in the past few years.
Most potash companies suffered double-digit losses, as Russia’s Uralkali, the lowest cost large scale potash producer, announced it was pulling out of the price control mechanism with Belaruskali (BPC). The potash majors such as Potash Corp. and Mosaic lost significantly more than the potash juniors: at the start of trading their shares fell by close to 25%. Even as they recovered some ground since then, the sheer ‘steepness’ of the drop caused potash investors to panic. The repercussions of this were felt by the potash middleweights and ‘heavier’ juniors. Karnalyte Resources lost 45%, Encanto Potash lost 36%. Intrepid Potash suffered 20% while Allana Potash lost 27% for the day.
Why the mass panic? Once upon a time (until last week) there were two cartels that controlled up to 70% of global potash market. One of which was in Russia / Belarus, the aforementioned BPC, and the other, Canpotex, in North America, represented by PotashCorp, Mosaic and Agrium). BPC has collapsed as a result of Uralkali’s announced departure on July 30. Uralkali had been a member of BPC since 2005 just on the edge of the major push in potash prices seen in 2007-2009. BPC’s departure has left the five largest producers the market with approximately 10 million metric tons of overcapacity if they produced a 100% capacity at a cost of USD 300 per metric ton. The current spot price is about 380 USD per metric ton. Nobody could have foreseen the timing of the development, which hit the potash market like a bomb.
The potash market had become accustomed to working around the Canpotex/BPC duopoly; however, as noted in two articles published last week, there are still opportunities (here and here) and hopes in the potash market, despite the gloom left in the wake of the Uralkali bomb. Indeed, one big question that will be raised in the next few weeks is how exactly Uralkali plans to benefit from this move if potash prices fall to a new floor of USD 300/ton as predicted. That said; why would any company then sell potash at that price if the market price is closer to USD$ 400/ton? Uralkali said it will increase production to over 2.5 million metric tons/year boot.
Potash market followers, especially the panicky ones that so quickly pulled the trigger on the ‘sell’ button as if they were in the final scenes of the movie ‘Trading Places’, did not ask themselves For how long can Uralkali produce at that rate? What about all of their customers who already committed to the higher end of the price bracket? How long will the Uralkali production ramp-up take? An analysis of these issues would suggest that the new USD$ 300 floor may be harder to reach than the panic button reaction suggests. Moreover, Uralkali’s own shareholders have not exactly warmed up to the idea, failing to see how the move is intended to raise the value of their investment. Surely, the BPC collapse will have some effects. BHP will likely delay or abandon the Jansen mine project and some juniors at early stages of development will find getting favorable answers to financing requests a rare treat. However, for those juniors at more advanced levels of exploration and with projected low operational costs, owing to specific geographic location and extraction technique (i.e., high year round heat areas such as Utah, New Mexico, Ethiopia with solution mining and solar evaporation separation) should endure the Uralkali aftershocks quite well after the market settles over the next few months.