Welcome to the Potash Corp. first quarter earnings conference call. (Operator Instructions) I will now turn the call over to Denita Stann, Senior Director of Investor Relations.
Good afternoon. Thank you for joining us and thank you for joining our first quarter earnings call. In the room with us today, we have Bill Doyle, our President and CEO, Wayne Brownlee, our Executive Vice President and Chief Financial Officer, Jim Dietz, Executive Vice President and Chief Operating Officer, Joe Podwicka, Senior Vice President and General Council, Garth Moore, President of PCS Potash, Tom Regan, President of PCS Nitrogen and Phosphate and David Delany, President of PCS Sales.
I'd like to welcome the media who are listening in and remind people that we are live on our web site. I would also like to remind everyone that statements made in this call that express the beliefs, expectation or intention as well as those that are not historical fact are forward-looking statements. Such forward-looking statements are given as of the date of this call and involve risks and uncertainties. A number of factors and assumptions were applied in drawing a conclusion or making a projection as reflected in forward-looking information and actual results could differ materially from what we think appears the most likely at this time.
I'd like to turn the call over now to Bill Doyle for some comments, and then we'll go to questions.
Thank you for joining Potash Corp's first quarter conference call. We appreciate this opportunity to discuss world fertilizer markets as we believe factors are aligning that will position us for strong second half of 2009 and an exceptional 2010.
The first quarter of 2009 however, continued to challenge our company in very difficult market conditions. Our earnings of $1.02 per diluted share were a reflection of stable potash prices and effective tax planning work by our finance department. With our disciplined approach to managing our assets, Potash generated almost three quarters of our $229.6 million in first quarter gross margins once again demonstrating its value to our company.
Through the last five years of record performance we were often asked what potential speed bumps were on the road ahead. We said the answer was a global depression, and while we may have the chance to avoid that extreme situation, this economic downturn has certainly been severe and continues to hold agriculture in a state of paralysis during the first quarter.
Potash Corp has the experience and assets to manage bumps in the road. Our strategies are designed to maximize our performance even in the most challenging conditions. We are a market focused company with an ability to shift gears quickly as we've had to do many times before and which we're doing now in this weak market.
Beginning last fall, fertilizer and industrial customers, like all consumers, became very cautious about new purchases. This caution continued in the first quarter as dealers continued destocking inventories. As a result, sales volumes for all three nutrients declined while prices for phosphate and nitrogen fertilizers could not recover ground lost late in 2008.
For our company, potash is much different than the other nutrients. Although first quarter potash sales volumes were significantly lower than the robust first quarter of last year, prices were substantially higher. With weaker market conditions, we have the ability to exercise the defensive part of our strategy and match potash production to demand as necessary.
This response to short term changes in potash demand is the same strategy that has supported our success for more than 20 years now. We followed this approach as recently as 2006 when buyers in China and India waited until July and August respectively to settle contracts and the rest of the world reduced buying to await the outcome.
Our management team has been around for a long time and we've seen these conditions before. When it's time to gear down, we know how to do that rather than driving full speed off the edge of a cliff, and when it's time to open up and race forward, we are better prepared than ever to meet growing demand.
At Potash Corp. we keep a laser focus on the long term and we make decisions to deliver the best performance over time. Our potash ore in the ground is our primary asset and we will always maximize the value of this limited strategic resource for our owners. While economic conditions have been the focus for most people in recent months, the world's attention must return to the science of food production.
A year ago, concerns over world food shortages were headline news and little has changed to alleviate the pressure on food supply. The world's population continues to grow. Economies in countries like China and India, although not as robust, keep expanding giving their people more money to spend on food. At the same time, global grain inventories remain historically tight.
This was brought to the forefront again earlier this week as G8 officials called for increasing public and private investment in agriculture citing growing concerns over the global food supply. A dangerous game is now unfolding around the world. Fertilizer applications are being reduced at unprecedented levels, with our estimates for North American potash applications falling as much as 30% to 35%, phosphate by 20% to 25% and nitrogen by 5% to 10%.
To put this in context, U.S. applications this fertilizer year are expected to be similar in total volume to the 1983 pick year while farmers now need to generate 90% more production than in 1983 and will plant 25 million additional acres of corn, the most fertilizer intensive crop in the U.S. Clearly, nutrient replenishment will suffer.
This level of reduction has never been seen before. No one can state precisely what the impact will be on the world's food supply immediately or over the longer term, but we know with scientific certainty that nutrient under application damages both crop yields and quality.
Farmers in the southern hemisphere reduced their potash applications for the current crop just now being harvested and the timing could not have been worse. Potash is a quality nutrient. It improves the taste and nutritional value of food. It enhances water retention, raises yields and helps plants fight disease and drought.
With less than ideal growing conditions this season, those farmers in Argentina and Brazil are now experiencing a substantial decline in yields. We would not be surprised to see farmers in other major producing regions having similar declines this year. After two record world crops in 2007 and 2008, the year 2009 could be a completely different story.
The most valuable part of a farm is the quality of its soil and large amounts of nutrients are mined from the soil with every harvest. Every time farmers grow a crop without replacing the nutrients, it's like borrowing money with no repayment plan, and there is no magical bail out for lost fertility in the soil bank.
We believe farmers' decisions to cut back applications are not being made out of fiscal necessity as tight grain fundamentals continue to support crop commodity prices; farmer returns are well above historical averages. The reduction in fertilizer applications is more about psychology than economics and the sudden slow down in volumes is forcing producers to make some tough decisions about production and price.
In phosphate fertilizers, prices were slashed with Tampa and Central Florida prices falling from $1,200 per ton to about $300 per ton. It's like a monkey on a greased pole. The slide down is fast and hard to stop, while every inch on the way up is a fight, even with favorable medium term supply demand fundamentals for phosphate. While phosphate demand will inevitably rebound, pricing may take longer to recover.
At Potash Corp. our higher quality phosphate rock allows us to produce for higher margin industrial and feed markets when fertilizer prices suffer. This has always been what makes our phosphate assets unique and special.
In nitrogen, pricing also plummeted but began to regain ground through the first quarter. With our long term lower cost gas contracts in Trinidad and well positioned U.S. nitrogen plants recently benefiting from favorable gas costs, we have some protection from market volatility.
But our core business is potash. We view leadership in this nutrient as a natural responsibility and manage our assets properly to capture value and ensure secure supply for the future. That is why we took 39 mine shut down weeks during the first quarter in response to slow sales volumes and why we will continue to reduce production by as many tons as it takes.
We believe this short term pain is much better than putting profitability and future supply at risk. This discipline is essential to protect needed reinvestment in potash capacity that will serve our customers well and define our business for years to come.
Our industry has shifted from one that for decades had considerable excess capacity to one that is expected to be supply challenged for the foreseeable future. Through much of 2007 and 2008, the world was short of potash. This nutrient has been under applied for decades and despite occasional short term demand deferrals, the strong upward trend line is undeniable.
Potash demand is expected to continue growing as developing countries that are far behind the curve in balanced crop nutrition strive to improve crop yields and quality. New potash capacity will be necessary and that can only happen with prices that support reinvestment.
The estimated cost to construct a conventional underground two million ton Greenfield mine in Saskatchewan is $2.8 billion Canadian. That is just the cost inside the plant gates. The mine and mill are only the front end of the project. You need to get your product to customers around the world which requires a significant investment in infrastructure such as roads, utilities, rail lines, a rail car fleet, a warehouse system and port facilities. This can easily add up to another billion or more.
To begin however, you need a good deposit which is a rare find. Securing an economically viable potash deposit could potentially carry a significant cost. Last year, Russian deposit auctions drew prices ranging from $200 million to $1.4 billion while reserves in Argentina and Saskatchewan have recently sold for $850 million.
A realistic range for the all in cost of a new Greenfield mine in Saskatchewan is now $3.5 billion to $4.5 billion without counting the cost of reserves. That is a lot of money in any economic environment, particularly considering it will take at least seven years to generate the first cash flow.
For us to commit that capital today and generate an acceptable 15% return on investment starting eight years from now, potash need first to be stable and second, significantly higher than current pricing. We simply will not sacrifice the long term value of our operations or undermine our ability to reinvest in new capacity that takes years to build by taking any short term decisions.
Our company has committed over $7 billion Canadian to projects in Saskatchewan and New Brunswick that will raise our capacity to 18 million tons when fully ramped up in 2014. Those projects are continuing on schedule.
We expect a resurgence of potash demand to begin in the second half of 2009 leading us to an exceptional 2010. History has shown us that when farmers defer potash purchases or applications even for a single season, it typically creates a significant rebound. The destocking efforts that have kept customers out of the fertilizer market over the past eight months are nearly complete with signs some major offshore markets are preparing to return.
China and India are still without contracts, but both are expected to negotiate new agreements by the end of the second quarter. Many people are watching for that as a signal that demand is returning, but other key markets like Brazil and Southeast Asia have worked down large portions of their inventories. Now they are already beginning to resume purchases.
In North America, movement is much slower but it is evident that potash supplies are running low in the soil, on farms and in dealer warehouses. As we look ahead, we see an extended empty pipeline that will need to be refilled.
While there are inventories at the producer level, replenishment could be a challenge as nearly 12 million tons of capacity has been curtailed across our industry since last September. With most major markets expected to return to purchasing along similar time lines, we expect to need our new capacity to keep pace with demand.
Given current conditions, we expect second quarter earnings in the range of $1.10 to $1.50 per diluted share. We've adjusted our full year guidance to $7.00 to $8.00 per share to reflect the extremely slow first half of this year.
Predicting the timing of the return of fertilizer customers is like trying to pick the first day of great summer weather. We can't say exactly when it will happen but experience has taught us that it is just around the corner. The question is not if demand will return, but when.
And when it arrives, Potash Corp. will be ready and fully prepared to meet the world's potash needs and capture the value for our shareholders.
Thank you for your interest in Potash Corporation. I'm joined today by members of our executive management team and we would be pleased to answer your questions.
(Operator Instructions) Your first question comes from Vincent Andrews – Morgan Stanley.
Vincent Andrews – Morgan Stanley
I'm wondering if you could give us a sense of what type of volume you're expecting out of China and India and if you still expect price on those contracts to increase year over year.
In terms of volume for 2009 we're expecting China to import 5 million tons. That's just about the same level they imported in 2008 and I would tell you that China, there's no question has been mining the soil bank both in 2008 and 2009 and the early indications we're getting from our partner in China is that 2010 is going to be a big rebound year and we need to be ready for it.
You can only mine that soil bank so long. Chinese soils are some of the oldest soils in terms of being worked in agriculture in the world if not the oldest and with the new target of 550 million metric tons of grain, the Chinese know that they can no longer deplete the nutrient levels especially for potash going out into 2010. So we expect a very robust China year in 2010.
To speak to you about the price, the negotiations to the best of our knowledge right now will begin in earnest at the EFA meeting in Shanghai which is at the end of May and we expect a conclusion before the end of the second quarter. Prices, because of the DPC is the one that's negotiating the contract, we're not exactly where prices will end up.
Your next question comes from Jacob Bout – CIBC World Markets.
Jacob Bout – CIBC World Markets
First, on North America the $639 million you posted in the quarter is well below posted prices. Can you talk about industrial volumes maybe you can help us with the pricing on the industrial volumes and what the quantities are there. Secondly, on the offshore market, $493 a ton, how much of this was to India and China and why we saw the decline in pricing from the last quarter. And then you talked about capacity expansion to 18 million tons, but I think you said by 2014. Have you now changed your thoughts on that? You're basically pushing it out a couple of years.
We will have the capacity finished, the construction finished by 2012, but by the time you fully ramp up to capacity to achieve 18 million tons, that will be in 2014. So the time line hasn't changed. All the expansions that you see that we've shown you over the years, announced world wide, are for construction to be completed, but it always takes time to get up to full capacity.
Regarding North America, if you recall last year we shipped 967,000 tons. This year 134,000 tons, so obviously a substantial decline. I would say about 70% of what we shipped in the first quarter was to the industrial business. We have one account in Canada that is well below market price. The remainder of our industrial business is fairly close to the current ag market.
Customers were destocking in the first quarter. There was not a lot of activity. The current market today is primarily being driven by the Russian imports and the folks that have bought those imports. They have taken that market from $825 to probably $650 to $700 on a terminal basis.
We have chosen not to participate because the amount of demand is extremely low and as Mr. Doyle said in his comments, that slide down is fairly quick. So we just think it's a matter of time before our customers destock and we're on to a much better second half of the year with still a very sound farm economy here and around the world.
India and China took about 75% of the first quarter Campatex volume which was negotiated last year and there was very little new business taken. That's one of the reasons for the lower price. In addition, our freight management contracts are above market on an annualized basis by about $60 million. That was another reason, and with lower volumes our fixed costs between rail cars and lower volumes through our west coast terminals are also at a higher basis unit cost.
If I just follow up on David's comments, if you look at the final projection for this fertilizer year 2008, 2009 ending June 30, in terms of global market reductions, you look at potash, we're going to have 12 million tons less potash. Phosphate estimate 10 million tons less phosphate, nitrogen 11 million less nitrogen.
And you get some reports from the retail market that oh my God, potash producers are out to lunch because they've maintained their pricing and look what a great deal phosphate and nitrogen have been, and then you look at the numbers and you see that the reduction in nitrogen and phosphate is also substantial and yet the prices for those were dropped precipitously. So the price drop did not increase demand for those products. It only destroyed value for those companies that are producing those products.
So we think once again, it's been proven that dropping the price does not increase the demand for fertilizer products. Fertilizer is not like shoes. I've talk to you before. If you have a half price sale, people might buy two pair of shoes, but if you have a high half price sale for phosphate or nitrogen, they aren't going to be able to buy that same ton on nitrogen or phosphate.
It just doesn't work any different and you think that people would start to understand that after years and years of being in this business.
Your next question comes from Fai Lee – RBC Capital.
Fai Lee – RBC Capital
I was wondering, in the press release it states that you believe farmers and dealers are waiting for price breaks to follow downward trends similar to phosphate and nitrogen. You indicate that such farmers and dealers have misguided expectations. I'm just wondering if you could elaborate on the basis for your belief if we don't know what will happen with the Chinese potash contract price.
What I would say is there are two reasons why we've seen such dramatic decrease in potash. Again not so much more dramatic as phosphate or nitrogen decreases but obviously the global economic collapse is one of the prime reasons, but secondly, the psychological impact that falling, and when I say falling I don't mean just a slow fall, I mean a rapid fall like cutting the cords to the elevator in phosphate and nitrogen.
You had just dramatic, precipitous decline over just a few short weeks, and what happened then is that fertilizer dealers and even at the farm level said, well heck if phosphate prices have been nitrogen prices have been dropping, surely potash will be the next to go. And when I say in the general comments that we think that's mistaken, it just shows the lack of understanding of the fundamentals of the potash business.
The fact that it's got a much different structure that we've talked about, the fact that government ownership is much less, the fact that there are far fewer producers, the fact that it takes much longer to get in the business, the fact that the expense of getting in the business is far greater than nitrogen or phosphate, the fact that you have projects around the world underway that would be stopped immediately if the price of potash decline.
And then we have some customers around the world, wonderful customers, but they tend to take short term. And I'm just saying this is a minority of these customers. I think it's fairly well published the Indians would like $200 potash to break the price in India from $625 to $200 for the 2009 negotiations. Well that's not going to happen.
But even if they were lucky enough to get their wish, you have to careful what you wish for because if you had $200 potash, all potash expansion projects around the world would cease immediately. Then as the return in demand which is coming at us in the second half of 2009 and again strong in 2010, you'd have even a much shorter situation than you had in 2007 and 2008.
So rather than have this rumored $1,000 potash this last go round, you remember last year when I said people asked me the question, "What do you think $1,000 potash from the Russians?" I said it was too far too fast.
So the $750 price that we see today being garnered around the world I think is a fair price and I think that it's something that will hold up and I think it's something that will allow for these potash expansion projects to be maintained.
But if you have $200 potash like the Indians say they would like to have, and you stop all these potash expansions, then you have a much dearer shortage, much more severe shortage of potash in the next year or two, you wouldn't have $1,000 potash; you'd have $2,000 potash. And that's not what the world needs and it's not what the global food production system needs.
You've got to have stability in the potash price first of all which is what we've been trying to maintain by taking all these shut downs, and secondly, you have to have predictability. Our customers want stability and I would tell you that around the world, the great majority of our customers have been very thankful to us for maintaining the potash price by taking shutdowns because they haven't had to write off the value of their inventory like they did in phosphate and nitrogen which destroys value for them as well and makes it a very, very difficult business to maintain any type of supply relationship with either between us and them or between the retailer and his customers.
So what we do is dedicated to price stability and dedicated to the long term needs of agriculture around the world.
Your next question comes from Steve Byrne – BAM-ML.
Steve Byrne – BAM-ML
If I understood you correctly I thought you said that you're expectations for domestic shipments of potash and phosphate in the '08/'09 fertilizer year to be down I think you said 30% to 35% for potash, 20% to 25% for phosphate. If I look at your business and the three quarters in that fertilizer year so far and making some assumptions about the second quarter, it would look like your own shipments of potash could be down by as much as 55% or even 60% year over year, phosphate down by 35%. Is this a case of consumptions versus shipments and inventory destocking? Is that the difference?
That's exactly what it is. 35% is applications, and the shipments, that number you related for us is shipments. Although I will tell you we're taking the biggest part of the hit. There's just no doubt about it. You look at market share numbers, which we get; we're taking the biggest brunt of the burden both in the offshore market and in the domestic market. But that comes with leadership and that's the price that you pay.
Your next question comes from Don Carson – UBS.
Don Carson – UBS
We've heard a lot of talk about mining the soil both in the U.S. and abroad so two questions I would have, one on Brazil where there's lower potash utilization. What specifically can you attribute the lower yields to? Is it more weather or can you break out weather versus lower fertilizer consumption? What declining consumption are you expecting in the '08/'09 year in the U.S. market and what impact if any do you think that will have on yields especially now that we have improved genetics in the U.S. market?
What I'd say is that in Brazil and Argentina both, I think Argentina yes, you had some weather factors in terms of drought. But you know, potash, lack of potash application really shows up in a drought period. There's just no question it helps a crop sustain itself through water retention during periods of drought.
The overall fertility rate in Brazil, those Brazilian soils as I've said many times are very poor, and extremely potassium deficient soils and it's the only country in the world which uses more potash than nitrogen and so when you have a reduction in potash applications in Brazil it shows up. We are getting estimates of yields in Brazil this harvest anywhere from 7% to 10% down and in Argentina as high as 20% down.
It's a bad start to the global crop year and those two bread baskets are very important, and it remains to be seen whether you'll see similar results in other major growing regions due to lower applications as we've just discussed.
We've had as Bill indicated a pre-look at lower application rates in Brazil and Argentina and we're hearing Argentina could be as low as 33 million to 34 million tons of beans and we're already hearing of lower yields in Indonesia and Malaysia because of lower K applications. If you go back to the pick year, we consumed 4.8 million tons of K20.
This year, we're saying it's going to be as low as 3.5, so we're planting 25 million more acres of corn and using 3.5 million tons of K20. So it really does not compute. We do anticipate some impact. We pulled off really five great corn crops in a row. I think the average yield the last five years is 152 and right now the USDA is forecasting an above trend line yield or a trend line yield of 157 bushels.
So with K it also allows the other nutrients to interact a lot better. You have better nitrogen use efficiency, so I just don't see how we can yield what we've seen in the last five years with this kind of fertility, this kind of consumption this year. And as Bill indicated, around the world, we're already starting to see the impact of lower fertility and that's primarily two of all three nutrients.
We have a web question from Eric and I'll ask Bill to read that now.
The question is, Kerry Industries commented that they expect that nitrogen demand for the spring season in North America to exceed domestic production and imports by on million tons resulting in a significant drawdown in inventories. Consequently they are expecting solid demand to refill the channel in the back half of 2009. Do you share this view or do you believe weak industrial markets will offset fertilizer demand?
I would say that we share the view with them on nitrogen. You do have some offset with the weaker industrial markets but we don't think we'll really rebound until 2010, but certainly the ag market is going to be very strong in the second half of 2009 as we said, the channels across the board are empty.
Your next question comes from Paul D'Amico – TD Newcrest.
Paul D'Amico – TD Newcrest
On the EPS guidance, it's obviously heavily back end weighted with respect to the potash volumes and granted Q2 looks better than Q1 but Q3 and Q4 have to be very strong. In terms of the geographic split just in exposure not in terms of actual tonnage, the geographic split expected, is it expected to be normal in the second half of the year, i.e. the five million tons you talked about China imports, is Campatex market share expected to be the same as what it's been in the past?
What I'd tell you is that Campatex will have a stronger second half than normal, but boy the first half was terrible. And I would say really the same thing for our domestic business. Here we are in the April, and just to give you an idea of how paralyzed the situation has been, I think we shipped our entire entitlement to Campatex on the first day of the month of April.
So that's pretty skinny. So what I'm saying is that for the second half of the year, you're going to see a very strong rebound. Normally we have a strong first half of the year in Campatex and then it tends to lighten towards the end of the year, but it's going to be the reverse this year and when you see China, India, Brazil, Indonesia, Malaysia, Campatex just sold yesterday into Thailand, Taiwan, $750 equivalent potash. So we're seeing these orders come in and there's going to be a race to the finish line here in 2009.
Your next question comes from [D.J. Dupont – Citi]
[D.J. Dupont – Citi]
I was hoping to get some color on inventories and volumes. Can you tell us what is your sense of available inventories in China and in the dealer channel in the U.S. and related to that, based on your view of inventories, I guess you guided to potash volumes of six million tons in '09. Where do you see that number going in 2010?
Our belief is at the current time China has three million tons of inventory total system wide of MOP. Two million tons is normal inventory for China. We were seeing a million tons a month go out the door in February, March, slowed down a little bit in April on the first three weeks here of April, but they expect to come back in May.
So you start thinking about two million tons, that's why the time frame of EFA negotiations for the Chinese contract, they're not going to buy the material until they need it. We know that. It's the reason why we're so patient with these negotiations each and every year. I think we're very close to having normal inventory restored and I think that's why you'll see more negotiating activity as we get to the EFA meeting at the end of May.
In terms of the U.S., on a fertilizer year basis North American potash sales July through March are down 45%, around three million tons and if you carry that out through June as dealers and distributors continue to destock, that number could go as high as 60% between four and five million tons.
So we think there may be a case or two where people carry over inventory but we would think that a 35% decline in consumption at dealer/distributor inventory should be fairly low by year end and probably empty in a lot of regions of the country. Producer inventory at the end of March was 3.3 million tons. That was 42% above last year.
Talking about the 2010 outlook, obviously we're in no position to give you any firm numbers at the current time, but that being said, if you think about Campatex shipments alone, Campatex shipped 9,400,000 tons in 2008 and we're forecasting 6 million tons this year, down abut 37%. If you start thinking about just one country, China, China in 2007 consumed 11 million tons. In 2008, 7.4 million. In 2009, we think the consumption is going to be up even though the imports will be the same, as I said 5 million tons, we think consumption is going to be about 9.5 million tons in 2009.
But then in 2010, because they've got to rebound consumption up, that consumption could be 12 million tons or more in 2010, and so that's just one market to give you an indication of how quickly this thing turns and why we have to be ready to go and have the systems in place to take the lions share of the growth which we think we will.
That one market, and we have a pretty good handle on that market shows a pretty exciting 2010 ahead of us. We've got the pain largely behind us with this downturn. It's been like a pregnancy almost, nine months and the baby is about ready to be born, so then we'll get on with raising it.
Your next question comes from Mark Gulley – Soleil – Gulley.
Mark Gulley – Soleil – Gulley
I had a question regarding U.S. application rates. To what extent do you think that the over application of P&K in prior years may be responsible for the under application this year and therefore at least for U.S. growers, you just commented on China, for U.S. growers there will be no catch up going forward?
I think for some farmers they do maintain the soil bank at pretty decent levels. If you're a smart farmer, if you think for example right now, phosphate and nitrogen are really cheap again, so if I was a farmer, I'd think about building my N&P levels up because it's cheap. But if you look at it from a scientific point of view, if you think about the analysis that we've done through the International Planned Nutrition Institute, what they're saying is that in phosphate and potash, U.S. soils and soil test results about 40% of the total U.S. soils are under applied in P&K right now.
And so we know there are a lot of people that are minding the soil bank this year just because that psychological reason I talked about and thinking that this market is going to change. Some of the farmers don't understand the potash business or the phosphate business, fertilizer business at all.
Of course some are people that are running the companies don't understand the fertilizer business very well, so I don't blame that on farmers. But when you look at the scientific proof, it would say that U.S. soils are on the downside of application rates under applied when you see 40% of the soils testing under.
Your next question comes from Robert Koort – Goldman Sachs.
Robert Koort – Goldman Sachs
I think you gave some numbers on Chinese consumption. I think you said it was down like 30% potash consumption in '08 yet their corn production, I'm sure about the other products they had record production. So I guess what I'm getting at is you made a case earlier that you know quite emphatically that if you don't put on potash there's going to be a day of reckoning, yet maybe in the short run they haven't seen that. So what changes that behavior? Do we have to get a dramatic yield penalty and then similarly in the U.S. what's going to give the dealers incentive to refill those bins this summer before they know whether their U.S. customers have seen a similar yield penalty.
What I'd say about China is, there is no question China has been mining the soil bank. You're right they did have a really good crop in 2008 as did the world. But they have been mining nutrients there which they recognize. They've already clearly recognized that that's been going on in 2008 and 2009.
I think you could easily see yield penalty this year in China and I think you're going to see it, we've already seen it in Argentina and Brazil and I think you're going to see it in the U.S., and I think you're going to see it in many, many other areas. 2009 crop year, crop production is going to be off of the records and you could see dramatically higher prices going into this fall.
I think the U.S. farmers are very astute. They realize the yield they've taken off the last five years. They know what's going on around the world. They've seen lower yields, as I mentioned earlier in South America and now we're starting to see in it Indonesia and Malaysia. I think that as you go into the summer months, again with record [inaudible] in great shape, they're going to see much lower nitrogen and phosphate prices, potash prices, so their total fertilizer spend will actually be less year over year.
And if you look at the return over variable costs, it may be the best economics they've seen in the history of the business. So we are very confident in the second half of the year.
Your next question comes from Brian MacArthur – UBS Securities.
Brian MacArthur – UBS Securities
I want to go back to the freight question because obviously your freight, the railways aren't very happy that you're not moving anything and now we're going to talk about maybe if things rebound you're going to move a lot in the back half of the year. Do you think you still have the capacity to move everything and how does it actually work when you get these very low volumes? Are there penalties on that rail contract or is it just a linear function where you move a certain number of tons and you pay a certain amount per ton.
We do have the freight and terminal capacity, protection freight and terminal capacity to meet any needs that are out there. While we're shut back and continue to be shut back we can turn the spigot on pretty quick. The relationship we have with the railroads and in terms of export for Campatex, we have a really great long term relationship with CP Rail and they understand that our business doesn't always work like clockwork but over the long term, they benefit greatly from having the Campatex relationship. We don't see a jump up in freight rates as a result.
They understand that they're going to get this business back here in the second half of 2009 and believe me, I know my friend Fred Green is really looking forward to a wonderful volume year in 2010 and we're going to give it to him.
Your next question comes from Michael Picken – Cleveland Research.
Michael Picken – Cleveland Research
I wanted to go into the liquidity issue both from the perspective of some of the dealers in some overseas market as well as kind of the position of some of your international potash competitors, particularly the Russians. You talked this morning about some of the Brazilian dealers being forced to liquidate some of their fertilizer inventories down there. I'm wondering what type of position they're going to be heading into this fall. Not the farmers, the dealers specifically. And then your estimate for where the Russians are and how long they might be willing to continue to lower operating rates before they might come back to ramp up productions.
The Russians, the latest reports, I saw one earlier this week that Belarus was down in the first quarter 60% reduction in production. We have seen reports also saying that Euro and [Sylvanit] are down similar levels. It fits when you think about that number globally of 12 million tons, it's coming from other places as well.
If you think about our reduction, 3.5 million this year and then with the strike last year which was about 800,000, that's 4.3 million of the 12 million comes from Potash Corporation and so the rest of it comes from all the other players.
And you know it's in their own self interest to do it. Clearly you can't be jamming material into a non existent market without significant price ramifications which is what we've seen in phosphate and nitrogen.
In terms of Brazil, I'll have David talk on North American liquidity, but in terms of Brazil I was just down there a couple of weeks ago in early April, and we think a lot of the problems in terms of liquidity are coming to a close now as the inventory that these customers of ours had is being moved. They haven't re-ordered, a lot of them.
We did see some movement but a lot of these customers, there are many in Brazil are now moving the inventory that they had in place and are gaining liquidity as they go so we're already seeing EDC, which is the Export Development Corporation Canada, renewing credit to many of these customers so we'll be in shape for the second half of 2009 and we'll be ready to ship when they place their order.
So we don't see a problem in Brazil due to liquidity and I would say as we go around the world, China we don't see any liquidity problems there. India, the question is the subsidy in India. They're going through an election right now for the next few weeks. It's a month long election process. I don't see India really coming off that subsidy any time soon.
It certainly wouldn't be a cut off. They might reduce, I think logically if they reduce 10% a year for 10 years subsidy, that would probably been a smart approach but they never seemed to have done that. The subsidy just keeps growing in India.
But Southeast Asia is market oriented. You have good palm oil prices there. Across the board we don't really see any liquidity problems.
In North America as I mentioned on the previous call if you look at net farm income its a record the last four out five years. The balance sheet of the farmer from a debt to equity standpoint is down to 10%. If you look at the forward markets for corn, December '09 to 2010, it's $4.00 to $4.25, $4.35. Beans are $9.00 to $9.35. If you look at fertility costs in the second half of the year as I mentioned, return on variable costs, I think the farmer is in great shape from a liquidity standpoint and we don't see any issues. there.
In terms of our customers, they too have had very good years. Most of them are in very good financial shape. Most of them too though have taken some pretty significant write downs on phosphate and nitrogen they purchased last summer, and they've been taking those write downs here in the fourth quarter, first quarter of this year.
But I think for the most part they're all ion very good financial shape from the Anderson's in Ohio to CHS in Minneapolis and my good friend Al Philips in Charleston, South Carolina. They all have a lot of cash and they're going to be in business we think for a long time.
Your next question comes from [Mark Connelly – Stern Agee]
[Mark Connelly – Stern Agee]
You've pointed out that in the past governments have ignored declining stocks to use for a decade at a time and you mentioned the G8 comments and I look at Brazil and I say okay, the credit situation may be clearing there but Brazil certainly didn't move aggressively to solve the problem quickly and China and India don't seem to be in much of a hurry. So I look at this and say couldn't we be in for a period where we have unusually high volatility in grain prices over the next couple of years because we get a lot of talk and we don't get a lot of action?
I think you're right on the button. I think you're going to see much higher grain prices and commodity prices. This whole world food crisis, all the attention that was brought on by the press to this issue just about a year ago, which totally went away because of the financial crisis, and as I said to many of you the reason it went away was not real, it was just the attention span of the world can only handle one crisis at a time.
But the real crisis is the food crisis and there's just no question that we're going to come upon much higher grain prices as we come out of this global recession and ag is going to be one of the first to come out because you just can't get away from the fact that you have to plant a crop everywhere in the world at a minimum of twice per year, northern hemisphere, southern hemisphere.
Many of those countries like in China where you have three or four crops, Taiwan where you have five crops a year, with a burgeoning population all the fundamentals that have been in place are still there. The global economic crisis is only a slow down in that food equation and you're going to see, anyone looking at the long term understand this.
We've got to make sure in our business that we don't make short term decisions that would jeopardize the potash needed to be able to grow this crop. And that's why we're so committed to our program, to our strategy and why we think the Potash Corporation is going to be a big part of the answer to the food crisis.
Before we finish up I would just like to remind everybody that we have an upcoming analyst meeting at the Art Institute of Chicago. That's on May 20. Registration and details are available on the home page of our web site and we really hope you're able to join us.
Thank you. If you have any further questions, please don't hesitate to call us. Have a great day.
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