Potash is a mineral that has seen a dramatic price increase over the past decade. Potash, along with nitrogen and phosphate, is one of the primary inputs for manufacturing of fertilizers. The need for increased global food production has led to massive demand for fertilizers and, in turn, has pushed the price of potash to a sustainable $400 per ton on the world market. Demand has led to increased exploration for new sources of potash, including domestically in Arizona. Two publicly-traded mining companies in Arizona, Prospect Global (NASDAQ:PGRX) and Passport Potash (OTCQX:PPRTF), present intriguing opportunities for investors looking to capitalize on the long-term potash market.
Potash Demand on the Rise
Never before have farmers had so much pressure to maximize their crop yields. Four powerful drivers are driving demand for increased food production: increasing population growth, changing diet in developing countries, a limited supply of arable land, and the expanded use of farmland for bio-fuels as an alternative to petroleum. In the face of these pressures, one variable that can be changed easily in favor of increasing food production is applying fertilizers for better crop yields.
Global population growth will continue to put strains on food production. The United Nations estimates that the global population will exceed 9 billion people by 2050 (an increase of over 25% from current levels) and that food production has to rise by 70% to meet their needs. Moreover, as the developing world has created a burgeoning middle class, tastes have changed. The prosperous can now afford to consume more calories as well as more meat. Increased meat production, in turn, means greater cultivation of crops for feed. At the same time, the increasing use of arable land for bio-fuels constrains the supply of land available for crops. Due to governmental regulations and rising oil prices, more and more of the land used for agricultural products has been planted with corn or soy crops that are used for bio-fuels.
Suppliers of Potash
Potash is either mined or synthesized chemically. Most of the potash in use today is mined due to its natural availability and the high cost of synthesis. The majority of the world's potash comes from either Saskatchewan, Canada or Russia. Other countries participating in potash production and exportation include Belarus, Israel, Jordan and Germany. More than 80% of the potash produced worldwide is exported to major consumers such as China, U.S., Brazil and India. These countries are expected to show the greatest demand growth over the next decade, as well.
The United States currently imports the majority of its potash from Canada. Saskatchewan potash deposits have the twin benefits of high potassium concentration as a percentage of ore mined and favorable topography for high extraction. In Canada, Canpotex (a potash marketing company owned by PotashCorp (NYSE:POT), Agrium (NYSE:AGU) and Mosaic (NYSE:MOS) control most of the country's long-term potash contracts.
Is $400 the New $100?
Potash prices rose gradually from $50 after World War II to $175 per ton at the end of the last century, according to the USDA. Global food shortages, higher demand for fertilizers, inability of producers to increase production quickly, and speculation in commodities pushed potash prices to above $1,000 per ton in 2008 from less than $200 during 2002. This was a 500% increase in less than a decade, rarely seen in commodity prices. Since its steep rise, the price of potash declined to a $400-500 per ton range, where it has recently stabilized for several months. Many analysts expect these levels to be sustainable long-term, leading to increased investor interest in the stocks of companies engaged in potash mining. Other mining companies have taken note as well. BHP (NYSE:BHP) made an unsolicited $38.6 billion bid for PotashCorp in August of 2010, which PotashCorp rejected because its management thought the price was too low.
There is certainly no guarantee that $400 is the new normal, but there are very few analysts arguing that the price will meaningfully drop in coming years. PotashCorp recently announced that earnings would come in at the low end of its estimate as a result of stalled negotiations with China and India, yet it is actively expanding potash projects. Expectations remain that farmers around the world will have to continue to increase their crop yields by using potash to remain competitive.
Although PotashCorp estimates came in slightly lower than expected, the price of potash has not declined below the $400-500 range, meaning that there are still plenty of margins left for junior producers anticipating costs per ton at fractions of that price range. According to CEO Bill Doyle,
Need for improved soil fertility to increase food production has not subsided. Our diversified fertilizer business and global footprint helped support our results for the quarter and we believe position us well to drive improved results as demand grows.
Brownfield and Greenfield Investments Rising in Popularity
Indeed, major producers need no convincing about the sustainability of $400; they are already actively increasing production. According to PotashCorp, over the next five years, approximately 12 million metric tons of additional global capacity will be added (PotashCorp will be responsible for more than half of that total). PotashCorp is halfway through a 10-year plan to double its annual operational capacity to 17.1 million metric tons of potash by 2015. The company is accomplishing this through a series of expansions of its "brownfields" (or existing mines; new mines are referred to as "greenfields"). In 2006, the second largest potash producer in North America, Mosaic, began an expansion program of its brownfields that was estimated to add 5 million metric tons to its capacity by 2021, a 50% increase from its current level. Likewise, Agrium has an $800 million expansion plan to add 750,000 metric tons of annual potash capacity to reach a total annual potash production rate of 2.8 million metric tons by 2015.
New mining capacity is also coming online. Major mining companies that were previously not interested in potash are also exploring for potash. These activities indicate that the industry expects prices to remain stable, because it takes approximately four to five years before a new mine can produce potash. Can new entrants to the potash mining sector overcome the challenges of raising capital, complying with regulatory hurdles, and successfully transitioning their operations from exploration to production? Barriers to entry can be significant. Conservative estimates for total capital investment for a greenfield project range between $3.5 to $5 billion.
Greenfield companies have a blueprint that they follow to move their business from the exploration stage to extraction and shipping. The road is challenging but not impossible.
Domestic Potash Production
For the most part, the U.S. has potash deposits that, until recently, have not been economically viable to develop. The U.S. imports 80-90% of its potash- an unashamed "net importer." Potash is mined in small amounts in Utah, Michigan and New Mexico. Intrepid Potash (NYSE:IPI) operates two potash mines in Utah and one in New Mexico. Mosaic mines potash in Michigan and also New Mexico. Potash from reasonably-priced domestic sources can have a competitive advantage because transportation costs are lower. Additional consideration is given to domestic potash because of the significant strengthening of the U.S. dollar versus the Canadian dollar during the past couple years.
Arizona may be critical to expanding domestic potash production. In addition to being one of the friendliest and safest areas of the world for mining, Arizona's deserts and plains have favorable year-round climates. Arizona's Holbrook Basin has between 682 million metric tons to 2.27 billion metric tons of potash deposits, according to the Arizona Geological Survey. This deposit underlies 600 square miles east of Holbrook, Arizona in the northeastern area of the state. The Petrified Forrest National Park is located squarely in the center of the formation. The site is served by railroad, highway, power and water.
Arizona's Holbrook geophysical formation is not a new discovery. Minerals were discovered here in the 1960s after initial mineral exploration. Exploratory holes have been drilled over the years, and there is a significant amount of historical information. The top of the potash deposit is situated from 700 to 2,000 feet below the ground surface; most of the deposit is found at about 1,200 to 1,300 feet deep. Maximum thickness of the potash is about 40 feet and averages less than 20 feet. In comparison to the large deposits in Saskatchewan, Canada, Arizona's potash is about 50% less thick yet 50% shallower, meaning that the mine will be about 50% less expensive to build. Reports of the average grade of Arizona's potash range from 6% to 20%.
Which Will Be America's Next Potash Miner?
Passport Potash and Prospect Global are two exploration-stage mining companies with significant claims to the potash rights in and around the Holbrook Basin of eastern Arizona. They are the only two companies seeking to mine potash from the basin besides one other private company: Hunt NZ. As previously mentioned, there is a blueprint that greenfield companies follow to move from exploration to production. Both companies are following this blueprint on the same trajectory.
Critical Milestones for Greenfield Companies:
- Obtain exploratory permits and mineral rights from state or federal authorities.
- Complete National Instrument 43-101 (NI 43-101), an independent technical opinion of a site's mineral resources. Canadian companies must obtain them as a prerequisite to listing on an exchange. Prospect Global was not required to file NI 43-101 since it is not listed in Canada, but it did so voluntary. Passport Potash will follow suit. NI 43-101 details the findings of any exploratory drilling, the analysis of the samples, and the inferred sizes of any deposits.
- Complete a Preliminary Economic Assessment (PEA). By incorporating the findings of the NI 43-101, the PEA models the feasibility of the venture using industry standards for revenues, costs, and processes. The report is also prepared by an independent authority and is a strong signal of credibility that a project has the necessary baseline requirements for a successful development.
- Obtain mining permits.
- Engineer and design operations.
- Develop mine and mill.
Without meaningful revenue, cash flow, or other financial metrics to distinguish between Prospect Global and Passport Potash, these two companies can only be valued based on other measures, such as market capitalization, the steps they have completed, and the estimated quantity and depth of their deposits.
|Milestones||Prospect Global||Passport Potash|
|Market Cap||$109 million||$33 million|
|Potash Depth||1,000-1,900 feet||670-1,300 feet|
Although both companies are valued at a tiny fraction of the basin's $1 trillion of potash, Passport Potash may be slightly undervalued on a relative basis. From the above table, it is easy to see that Passport Potash has 1/3 the market capitalization yet controls the larger land package. Passport Potash also has shallower and more continuous (less costly to mine) potash deposits. Moreover, Prospect Global's planned mine underlies federal park land which could delay its permitting by up to five years. Finally, Passport Potash also has far lower cash needs through 2013. (Passport Potash only needs $55 million for all operations through next year, yet Prospect Global needs $125 million by July 31 to finance its remaining 50% acquisition of its major operating subsidiary from Karlsson Group: American West.) In other words, Passport Potash only needs a fraction of the cash that Prospect Global needs, and it has twice as much time in which to obtain it.
Also supporting this conclusion are two recently announced significant developments by Prospect Global. The first was a tentative agreement with a subsidiary of the Apollo Group for a $100 million investment in convertible notes to be issued by Prospect Global. The second was an agreement with a Chinese import firm for a ten year take-or-pay supply contract valued at $2 billion using prevailing prices. With Passport Potash's greater mining acreage, there is reason to expect that a similar deal could be struck.
In addition, Passport Potash recently signed an exploratory agreement with the Hopi Indian tribe to jointly develop land owned by the tribe that is checker-boarded with Passport Potash. The agreement offers the potential for Passport Potash to increase its future mining efficiency and production. Following this agreement, Passport Potash obtained a capital infusion of $12.5 million from a private investor. Such developments are signals that institutional investors, industry participants, and other interested parties are confident in the Holbrook Basin's potash mining viability.
Timeline and Risks
Because both Passport Potash and Prospect Global and small, early-stage companies, it might be helpful to take a closer look at their risks in chronological order.
Both companies will complete drilling for the year and finalize year-end paperwork. Passport Potash is wrapping up drilling on its four-hole subproject and continuing initial drilling on Hopi-controlled land. Because it just signed the joint exploration agreement with the Hopi people in November, cooperative drilling is just a few weeks underway on Hopi land. Passport Potash will need to make a small payment for its Fitzgerald Ranch before the end of the year. There is no dilution risk for this payment, as the cash has already been raised from an offering at $0.18/share. Prospect Global could announce a financing to get a lead on the $125 million it will need by the upcoming summer.
Both companies will continue drilling to support pre-feasibility and feasibility studies during this period. Passport Potash is due to release its PEA report. This is a significant event and potential risk for Passport Potash shareholders. If the PEA report contains poor mineralization results, unexpected complications for the mine plan, poor potash grade/consistency/depth, the stock could fall rapidly. On the other hand, if PEA results are better than expected, there could be an immediate lift for the stock.
A risk for Prospect Global during this time will be its looming need for $125 million that is due July 31 to finance its remaining 50% acquisition of its major operating subsidiary (American West) from Karlsson Group. The market is still uncertain how Prospect Global will raise this money and/or renegotiate this obligation, but dilution is a possibility. On an optimistic note, Prospect Global has disclosed that it has already "had discussions with a number of leading sources of international mining financing who have indicated a strong interest in providing the required project finance debt, which we expect will be around $1 billion." Perhaps one of these parties could provide some financing to help Prospect Global with its Karlsson Group payment.
Passport Potash will be completing drilling for its pre-feasibility study and likely submitting a mine plan. Prospect Global will continue mining and complete its payment to Karlsson Group. Both companies will be pursuing permits, off-take agreements and strategic investments. A risk for both companies at this stage includes failed or stalled permitting- a particular concern for Prospect Global that has submitted a mine plan underlying a national park. Another risk is dilution at this stage, as both companies need money at this point for land payments (Passport Potash for its Fitzgerald Ranch, and Prospect Global for its Karlsson Group acquisition).
Passport Potash is expected to release its pre-feasibility study by the end of Q3 and begin signing small, project-level investments. Its final payment for the Twin Buttes Ranch is also due in August 2013 (unless renegotiated). Prospect Global should be working on feasibility mining at this point and attracting more project-level investment to propel it into 2014. Delays in strategic investment discussions, especially with foreign buyers, are the biggest risks to both companies at this stage. Prospect Global has already signed a 50% off-take agreement, but it will need to submit bankable feasibility studies in order to advance its mine to the stage where an off-take agreement becomes relevant.
At this point, both Prospect Global and Passport Potash will be completing more advanced-stage drilling programs, and the Holbrook Basin should be getting increased attention by U.S. investors. Passport Potash should be making its final payment for the Fitzgerald Ranch. Both companies will be vying for "first mover" status in the basin and/or considering a merger. Hunt NZ, the private company with an interest in the basin, will likely make a few announcements by this point about its progress. If the price of potash rises significantly by this point, all of the companies could see heightened investment interest; the inverse is also true.
Both Passport Potash and Prospect Global should have released bankable feasibility studies, drilling far deeper into the ground, finalizing permitting and licensing, and attracting project-level financing. Hunt Oil, the parent company of Hunt NZ, could make a strategic acquisition in the basin. Other major producers like PotashCorp, Rio Tinto or BHP could also consider an acquisition or joint venture. By late 2014, initial construction on a mine could begin. Dilution during 2014 is almost certain for both companies, pending the amount and quality of project-level investment that they secure.
This is the year to build the first potash mine in the Holbrook Basin. Advanced construction begins at this stage, including roads, rail lines, mining contracts, purchase orders for trucks, water and waste lines, etc. Capital expenditure at this point will be high and (hopefully) financed in large part from debt-based or project-based financing. Equity financing is possible if there is not sufficient strategic investment. Permitting delays, market conditions, environment group opposition and commodity price stability are all serious risks at this advanced stage.
The goal of both companies is to be mining potash by this point. By 2016, mergers or buyouts could have reduced the number of companies in the basin to just one operator. Any potash mine will need approximately two years to ramp up to full production.
As a number of permanent demand changes appear to be sustaining potash around $400 (well above its historical price range of $100), the potash deposits in the Holbrook Basin in Arizona have become economically feasible to develop. Prospect Global and Passport Potash are competing to take advantage of this opportunity by entering production within the next three to four years. Investors, looking for a way to gain exposure to potash exploration in the United States, may want to consider these two junior potash companies.
Despite their risks, both companies are legitimate options for highly risk-tolerant investors. Make no mistake about it- the risk of investing at this early stage is real, and both companies will need over $1 billion in project-level (non-dilutive) financing to actually build their potash mines. At this point, both companies are approximately four years away from any mining operations (lengthy preparation is typical in potash mining). However, both have the requisite resources for building a mine: supportive government, enthusiastic blue-collar labor force, no safety concerns, billions in potash deposits, and easy access to power, water, rail and highway. Exploration-stage potash companies are not the right investment option for every investor, but with the U.S. importing 90% of its consumption, there is an obvious need for new domestic producers.
Investing at an early stage is much riskier than waiting until closer to production, but only early shareholders can experience a full run-up in the thousands of percentage points. Risks to both companies are significant at this stage, as both need to raise money during 2013 for land payments and then attract project-level (non-dilutive) financing from a major producer like BHP in late 2013 or 2014.