Uralkali Stuns The Potash Market: The New Era Begins

| About: Uralkali Jsc (URALL)

In a move that has stunned the markets, the world's largest potash producer, Uralkali (OTC:URALL), announced Tuesday that it has decided to stop its export sales through Belarusian Potash Company ("BPC") and will direct all export volumes through Uralkali Trading owing to breach of discipline by Belaruskali, which has made a number of deliveries outside BPC.

Vladislav Baumgertner, Uralkali CEO, said in a statement:

Unfortunately, we should state that our cooperation with our Belarusian partners within BPC framework has come to a deadlock. It has always been Uralkali's position that export activities of both producers should go through the unified sales network. This fundamental principle of partnership was violated by the Decree No.566 issued by the Belarusian President on 22 December 2012, which cancelled the exclusive right of BPC to export Belarusian potash. Following the issue of the Decree, Belaruskali has made a number of deliveries outside BPC.

We have repeatedly informed our Belarusian partners that such actions were unacceptable and they have ultimately destroyed the fundamentals of our prolonged fruitful cooperation. In this situation we have to re-direct our export deliveries through our own trader.

The Russian potash producer is moving from a price-over-volumes strategy to a volumes-over-price strategy. The company, after changing trading policy, now plans to boost production to 10.5 million tons in 2013 and 13.5 million tons in 2014.

Uralkali now intends to focus on gaining market share by running production at full capacity. The company's shocking move effectively brings about a transformation of the entire potash industry, shifting it away from what has been a de facto duopoly led by BPC and Canada's Canpotex.

"Uralkali's announcement completely turns the global potash market upside down," said Elena Sakhnova, a VTB Capital analyst in Moscow. "If previously global potash producers were acting like an oligopoly, working with the rule that benefited higher potash prices over shipped volumes, now the market will be fully competitive."

Our Take

The potash industry is clearly heading towards higher production levels and we believe the substantial overcapacity will likely result in prices falling to marginal cost of production. With Uralkali's new volume over price policy combined with weak fundamentals in the key growth regions, prices are likely to further deteriorate in 2H13 and 2014. Uralkali itself anticipates the potash prices to fall below $300 per ton, which is at least 25% below the most recent Chinese contracts settled at $400 per ton and the lowest since January 2010.

It is unlikely that Canpotex producers, including Potash Corp. (NYSE:POT), Mosaic (NYSE:MOS), and Agrium (NYSE:AGU), will take a wait and see approach at the expense of sacrificing volume and market share losses. We believe these Canadian potash exporters, which have been investing in expanding their own potash capacity, will likely follow suit, and the end result would be a supply-disciplined industry and the beginning of a new era. However, since Uralkali is the lowest cost producer, the new era is likely to hurt global producers more than Uralkali. The Russian company has a production cost of $62 per ton, compared to more than $100 per ton for North American producers.

The market has responded heavily to the news and shares of the global potash producers are down more than 25%. By noon shares of POT were down as much as 24% and according to Bloomberg, 8 million shares changed hands, making it POT's heaviest day of trading in nearly 3 years.

The discipline enforced by the cartel-like marketing organizations had always made the potash market very unique and attractive but Uralkali's move undermines exactly that. Going forward, small independent producers will likely face both pricing and volumes pressure from large competitors and the new era of lower prices not only signifies competition but also consolidation and M&A activity.

We recently published articles on both POT and MOS. We had a buy rating on both these stocks, but this surprising move by Uralkali changes everything and we are putting our ratings under review. This is one of those occasions when the whole industry changes overnight. As of now we have neutral ratings on both these stocks.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.