Potash Corporation of Saskatchewan's (POT) CEO Jochen Tilk on Q2 2016 Results - Earnings Call Transcript

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Potash Corporation of Saskatchewan, Inc. (POT) Q2 2016 Earnings Conference Call July 28, 2016 1:00 PM ET

Executives

Denita Stann – Senior Vice President, Investor and Public Relations

Jochen Tilk – President and Chief Executive Officer

Stephen Dowdle – President-PCS Sales

Wayne Brownlee – Executive Vice President and Chief Financial Officer

Mark Fracchia – President

Raef Sully – President-PCS Nitrogen and Phosphate

Analysts

Mark Connelly – CLSA

Vincent Andrews – Morgan Stanley

Jeff Zekauskas – JPMorgan

PJ Juvekar – Citigroup

Ben Isaacson – Scotiabank

Jacob Bout – CIBC

Adam Samuelson – Goldman Sachs

Chris Parkinson – Credit Suisse

Joel Jackson – BMO Capital Markets

Yonah Weisz – HSBC

Don Carson – Susquehanna Financial

Steven Byrne – Bank of America

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Potash Corp. Second Quarter 2016 Earnings Conference Call. At this time, all call-in participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions] I would like to remind everyone that this conference call is being recorded on Thursday, July 28, 2016 at 1'O PM Eastern.

I will now turn the conference over to Denita Stann, Senior Vice President, Investor and Public Relations. Please go ahead.

Denita Stann

Thank you, Joe. Good afternoon, everyone, and thank you for joining us. Welcome to our second quarter earnings call. In the room with us today we have Jochen Tilk, our President and CEO; Wayne Brownlee, our Executive Vice President and Chief Financial Officer; Stephen Dowdle, President of PCS Sales; Mark Fracchia, President of PCS Potash; Raef Sully, President of PCS Nitrogen and Phosphate; and Joe Podwika, Senior Vice President and General Counsel.

I'd like to welcome all those who are listening in and remind people that we are live on our website. I would also like to remind everyone that today's call may include forward-looking statements. Such statements are given as of the date of this call and involve risks and uncertainties. A number of factors and assumptions were applied in the formulation of these statements and actual results could differ materially.

For additional information with respect to forward-looking statements, factors and assumptions, we direct you to our news release and our most recent Form 10-K. Also, today's news release, which is posted on our website, includes a reconciliation of certain non-IFRS financial measures to their most directly comparable IFRS measures.

I'll now turn the call over to Jochen for some comments, and then we'll go to questions.

Jochen Tilk

Thank you, Danita. Good afternoon and thank you for joining us for our call. We appreciate the opportunity to discuss our second quarter performance and what we see ahead for our company. Second quarter and year-to-date results for all three nutrients reflected muted global demand and competitive pressures.

Demand in North America and Latin America was relatively strong, but key Asian markets are limited delivers throughout the second quarter because of the late contract negotiations in China and India. Lower prices and offshore potash sales volumes contributed to weaker second quarter and first half earnings of $0.14 per share and $0.23 per share. Included in these results were certain notable charges of $0.04 share during the quarter and $0.11 per year-to-date related to the suspension of our Picadilly Mine in New Brunswick, the termination of the Prince Rupert port option by Canpotex and adjusted asset retirement obligations because of lower interest rates.

Canpotex’s exit from Prince Rupert British Columbia resulted in a one-time reduction of our offshore netbacks by $26 per ton. The decision to exit, Prince Rupert was partially supported by the availability of storage and loading capacity at the Port of St. John in New Brunswick, following Potash Corp’s recent announcement regarding the Picadilly mine suspension. While the difficult nutrient environment weighed on our earnings, we are able to offset some of the impact to reduce costs from the optimization of production to our lowest cost Saskatchewan facilities. Our cash costs for Potash were $72 per ton in the quarter, a 15% decline relative to the previous quarter excluding the New Brunswick severance.

In nitrogen, lower global energy costs and increase in capacity push prices markedly lower than the prior year more than offsetting lower production cost. And phosphate weaker demand of pricing as well as negative adjustments to inventory and our asset retirement obligations kept gross margins for the quarter and first six months well below the last year's comparables.

Looking at the reminder of 2016, we expect Potash sales volumes of 8.3 million tons to 8.8 million tons and gross margins of $400 million to $600 million. In nitrogen and phosphate, we anticipate gross margins in the range of $400 million to $550 million. We now expect earnings of $0.40 to $0.55 per share.

While our annual results weighed down by the first half, we see a more constructive environment moving forward. In recent weeks, we have seen new Potash contract settlements in India and China providing a reminder of the importance of our products and the reality that purchases inevitably resumes. While Canpotex is still in the midst of final negotiations with its Chinese customers, volume commitments with Indian customers have been made for the next three months and Canpotex’s anticipated shipments to both of these markets to begin in the weeks ahead.

With China and India beginning to take deliveries, the uncertainty that weighed on market sentiments is lifting and a recovery is beginning. This is also evident in Brazil with $5 to $10 per ton price increases have recently taken hold. We also see the potential for higher prices in the United States following completion of summer fill deliveries. Our recently announced summer fill program stated a price increase of $20 per ton for orders after August 5th.

Importantly, we believe lower inventories and a more normalized demand environment bodes well for 2017. We expect global Potash demand next year to be in the range of 61 million ton to 64 million tons. Experience is telling us that that a rebound in demand is to norm following a year of later than normal contract settlements and the late purchasing. We have also looked carefully at the specific factors in each key region and believe that they also support a recovering 2017.

In China, a delayed contract settlement and lower inventories are expected to shift demand into next year. We continue to see strong underlying consumption growth trends in this market, including an incremental shift to more bulk blends and compound fertilizers. Importantly, Canpotex has grown its customer base in this market and now serves a diverse group of customers that produce these products. For 2017, we see growth and anticipated total demand of 14 million tons to 15 million tons in China.

In India, recently announced reductions in farm retail prices for Potash are expected to support consumption growth in 2017. With lower retail prices and strong economic need, we anticipate deliveries will go to 4.7 million tons to 5.2 million tons next year.

In Brazil and other Latin American countries, demand is expected to remain robust. With highly supported domestic crop economics we expect growth in planted acreage and application rates will drive an increase in Potash demand next year. For 2017, we estimate total deliveries in the range of 11.5 million tons to 12 million tons. In North America, Potash affordability is expected to be compelling even if this year’s harvest keeps crop prices at current or slightly lower levels. We believe the strong value proposition along with the requirement to replenish nutrients following a large harvest will help support modest demand for growth next year and expect shipments of 9.3 million tons to 9.8 million tons.

In Southeast Asia, we expect improved weather and healthy farmer economics to support high deliveries, relative to 2016 when drier conditions limited demand for many plantations. This was also a region whereby a caution in 2016 was elevated, given the late contracts in other standard grade markets. With this dynamic not expected to repeat in 2017, we anticipate shipments of 8.8 million tons to 9.3 million tons next year. We also anticipate modest growth in Africa and FSU and Central Europe to further support global demand.

When we look at the supply side in Potash, outside of our own expansion at Rocanville, we see only modestly higher global operation capability next year. This incremental capability comes primarily from other existing producers in North America as well as some ramp up tons from K+S Legacy project, although recent announcements may delay the ramp up.

On the strategic side, we support Canpotex’s cautious approach to the Chinese and Indian markets, committing volumes only through the remainder of 2016. As recently announced contract prices, we believe some producers are now selling into these markets at a loss or thin margin, which we believe is not sustainable and another factor that may support improved pricing in 2017.

We've demonstrated our strategic approach over the past 12 months by taking meaningful steps to align our operating capability with expected market conditions and to reduce costs. This included a suspension of 2 million tons of Potash capacity in New Brunswick earlier this year as well as production curtailments in Saskatchewan. These operational decisions have helped to restore greater balance to the markets and importantly reduce our Potash operating costs.

We expect to lower product production cost further next year as Rocanville reaches its full capability. We're nearing the final phase of construction and we’ll begin ramp up later this year. We're excited about the progress at Rocanville and look forward to the Canpotex proving run in the first quarter of 2017. We estimate that this will increase our Canpotex allocation to approximately 56% beginning in the second half of 2017.

Regarding the dividend, despite recent evidence that prices have stabilized, we intend to take the prudent approach to protect our balance sheet and realign our quarterly dividend to $0.10 per share beginning with the declaration of our fourth quarter dividend in September. With customer sentiment improving and announced industry shutdowns, we anticipate a more supported potash environment through the balance of the year and with affordability and the need to replenish soil nutrients, we see an improved environment in 2017.

Thank you for your time and we look forward to taking your questions.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, we will now conduct the question-and-answer session. [Operator Instructions] Your first question comes from Mark Connelly with CLSA. Please go ahead.

Mark Connelly

Thank you. Does the new dividend level imply that your board might be thinking that over the next year or so stock buybacks might be a better discretionary use of cash than the big divided was?

Jochen Tilk

Good afternoon, Mark. No. This was really looking our balance sheet and the current market situation as I said, we're optimistic given the recent evidence, but we thought it was proven to really to look at our balance sheet and protect it. And so, this is not a tradeoff dividend versus another way of returning capital, this is simply responding to market conditions at this point in time.

Mark Connelly

But, if the market does start to turn up, would you be advocating an increase in the dividend?

Jochen Tilk

Yes. Well, if market conditions pickup Mark, that would be a great problem to have or will be a great problem to have. So, I think, we'll make that call at that point of time.

Mark Connelly

Fair enough. Thank you.

Jochen Tilk

Thanks Mark.

Operator

The next question is form Vincent Andrews with Morgan Stanley. Please go ahead.

Vincent Andrews

Thanks. Jochen, could you just help us understand, it seems like you're taking a harder line with China and India, but was there ever any thought about just not selling at all to them this year at these netbacks and trying to taking even harder line and what were the pros and cons of that thought process?

Jochen Tilk

Thanks and good afternoon Vincent. So, I’ll sum up the Canpotex strategy as announced and as we communicate in different contexts, that we'll sell product throughout the remainder of the year, throughout 2016 that we take a cautious approach and not want it to spillover. So, that's the essence of it, because we believe that makes more sense and makes a lot of sense for Canpotex. The more detailed approach is really a negotiating strategy that Canpotex executes, but in India we're committed to – Canpotex is committed through October now, so that's the next three months. In China, negotiations are ongoing, they are actually ongoing as we speak and we'll see what comes out of it, but the approach there really is to commit only throughout the end of 2016.

Vincent Andrews

And do you think you have a mechanism in place now to renegotiate these sort of short term contracts quickly or if you done in India as of October when will you start renegotiating for November deliveries there?

Jochen Tilk

We don't know. I mean we can't answer that, but is really with the objective. We think that marketing are tightening. We've seen certainly some changes in Brazil now in the range and of course our expectations that 2017, and the way we characterize it is would be low inventories and good demand that prices on the spot will pick up. And we think that's a better representation of prices at the beginning of 2017 and that's what we think contract negotiations ought to be based on. How that works out we'll have to see, but it certainly a position strategy that we have taken that Canpotex is representing.

Vincent Andrews

Thank you very much.

Jochen Tilk

Thank you.

Operator

The next question is from Jeff Zekauskas with JPMorgan. Please go ahead.

Jeff Zekauskas

Thanks very much. Your net-backs in North America improved nicely in the second quarter versus the first quarter, is that because prices went up or was it that your costs went down?

Jochen Tilk

Yes.

Jeff Zekauskas

Netbacks were better?

Jochen Tilk

We'll do. Good afternoon, Jeff. I’ll take what happened and then I'll turn it over to Steve and then he can explain the details.

So it's a calculation because we reserve rebate of provision in the account, we're making accrual in a volatile market because we don't know really what direction things are going. And if we do better than we think, those accruals are going back into it and increase our net backs and this is exactly what happened. We did a little better than we thought. We have made those accruals because of volatility and then they have come back into the netbacks. Stephen, anything you want to add to this?

Stephen Dowdle

Yes, the only thing I would add, it would be, particularly in quarters that are straddling in-season demand and that certainly happens between Q1 and Q2, it also happens between Q3 and Q4. Q1 and Q2, you have the spring demand in Q3 and Q4, you have the fall application season demand. And I think a better – the best representation is not so much to focus on the changes from Q1 to Q2, but more to look at the first half realizations because at the end of the second quarter, the seasons are over and everything is trued up, and those are very accurate representations of what's happening in the market.

And we clean out any of these accruals by the end of last…

Stephen Dowdle

That's correct.

Jeff Zekauskas

Okay, great. Thank you so much.

Stephen Dowdle

Did that answer your question, Jeff?

Jeff Zekauskas

Yes, it did.

Stephen Dowdle

Thanks.

Operator

The next question is from PJ Juvekar with Citigroup. Please go ahead.

PJ Juvekar

Yes. Hi. You have shutdown your New Brunswick mine earlier, and then you also had some recent curtailments in your capacity, instead, why couldn't you delay the Rocanville will start-up and maybe save some start-up costs? Thank you.

Jochen Tilk

Yes. PJ, thanks for that question. So if there's an operation component and there's obviously a strategic component let me just say on the operational side we've made the preparations we've been fielding Rocanville for many years and we're literally in the final stages. We expect the hoist to start turning somewhere around November 15 so it's coming rapidly. We've commissioned pretty much all the other components so operationally we have advanced and I can tell you that we have spent to this point most of the capital or at least a minimum committed most of the capital that is necessary to prepare for Canpotex run and those preparation actually go on for almost a year or so.

So that's one of the instance we are we're so far advanced that operationally we have made most of these commitments now. On the strategic side and I volunteer that part of it we certainly mindful Rocanville is a large mine, it's a large Canpotex run and strategically we'll look at it very carefully to ensure that it's very consistent with our strategic approach that we outlined many times. So we have flexibility we've got five operations in Saskatchewan so we have some flexibility how we can mange that as we focus on the Rocanville run but our strategy by doing so it's consistent the way we look at supply and demand.

PJ Juvekar

Thank you.

Jochen Tilk

Thanks P.J.

Operator

The next question is from Ben Isaacson with Scotiabank. Please go ahead.

Carl Chen

Hi. this is Carl Chen stepping in for Ben. Thank you for taking my question. Can you please talk a little bit about the your estimate of the inventory level for key potash consumption regions currently and how long do you think this entire destocking cycle will last?

Jochen Tilk

So, I'd say they're lower, and then probably as general as they are and we know of course at the beginning of 2017 when we go region-by-region we know they will be lower in China that's our anticipation would be low – and somewhat lower in India relatively lower in U.S. So, Stephen, I don't know if you want to walk through every jurisdiction and every geography,

Stephen Dowdle

Well they are lower Carl and of course the reason being of the lack of engagement with around the world or people waiting for China and India contract markets to settle out. So, as that was happening inventories were drawn down. And what we have seen here in North America is the same phenomena and as the season was ending what happened in dealer warehouses was the last truckload was sold about 50 times. So, we have ended the spring season with extremely happy pipeline at the dealer level. And which is I think one reason why we've gotten thus far a very good response into our summer-fill program, because the anticipated demand coming up in the fall is expected to be quite robust and there is certainly a need to start refilling that, that supply pipeline.

Carl Chen

Great. Thank you.

Wayne Brownlee

Thanks, thanks Carl. I mentioned that it will be – I think interesting to see us as volumes are written up in China and because there is obviously a desire to reconcile what’s really in inventory at different parts and sum that up and there is some challenges to really get that number down because of visibility, but I think the momentum and the engagement that’s happened on these two contract markets will give us some understanding visibility how much – how much inventory there really is, and they will be able to have a better reconciliation for 2017. I mean that's certainly be something that we are quite interested in to see.

Carl Chen

Perfect. Thank you.

Wayne Brownlee

Thanks, Carl.

Operator

The next question is from Jacob Bout with CIBC. Please go ahead.

Jacob Bout

Good afternoon. Another Rocanville question here. So, as Rocanville ramps, does it make sense to put some of these higher cost mines on care and maintenance. So, thinking of going from maybe five mines to three mines perhaps shutting down Cory and Patience Lake, and then producing some of that industrial product say at Rocanville. Is that possible and what would that cost be or to do that, the type of work?

Stephen Dowdle

Good afternoon, Jacob. So, let me start with the whole point of portfolio, I'll say, I'll call it portfolio optimization and we've done that quite a bit, obviously our decision to suspend New Brunswick was part of that, to optimize our portfolio. Your point is well taken, it's right on, I mean it's an obvious point, but important to bring out well, is there another ship, what if we're all can get it. So, I'll give you a couple of parameters and I'll frame it, that we haven't made final decisions on that, because we are looking at that in the context of what we see in 2017, what we think demand and supply is in operating capability. And then we'll conclude on how we manage that portfolio of our Saskatchewan operations most efficiently.

So, no decision has been made, but the point is understood our objective is – of course to bring our operating cost down as low as we can, and that suggests that Rocanville should run close to its capacity because it does have the lowest operating cost and economy of scale. We have a couple of options, what we’ve done traditionally where we take inventory shutdowns if needed at several of our operations and optimize that with the optimal number of employees and balance to what their operating capability is.

And there is certainly another step that you could contemplate it, as you suggest that well, maybe you look at the cost scenario. So we're looking at all of that, as you would expect, but we have not made a decision on how that final operating scenario would look like.

In terms of cost, without making any reference because we haven’t made a decision but in New Brunswick, I think gave you – an example of what that involves. It’s a very, very difficult step. We take that very seriously because our employees are on top of the priority list but we went to that and we publish what the financial impact of that was and I think that’s a good proxy of what that would be.

Jacob Bout

Thank you.

Stephen Dowdle

Thanks, Jacob.

Operator

The next question is from Adam Samuelson with Goldman Sachs. Please go ahead.

Adam Samuelson

Yes, thanks. Good afternoon. Maybe on the 2017 demand view, it would seem like especially in South America and possibly in India there’s an assumption of inventory restock on the part of some customers. It was not obvious underlying demand is actually growing that fast. Is that true? And along the same lines, can you talk about your own inventory levels and your own production levels over the balance of the year? You built a little bit more inventory again this quarter, kind of what operating rates we should think about for the balance of 2016?

Stephen Dowdle

Yes, there’s some inventory restocking involved, particularly if you stock very low, but obviously we look at what the average level is and expect that people restock to that appropriate one. So, some of that will happen and our objective is that it does notice escalate, so it becomes more of a point of negotiation rather than through inventory necessary to operate the facilities. As to our own inventory, just to understand your question, your question is what are inventories at our mining operations, at our facilities?

Adam Samuelson

Well, your Company owned inventories, your production exceeded sales for three quarters in a row. I’d put your Company on inventories somewhere around 1.5 million tons right now.

Stephen Dowdle

Yes.

Adam Samuelson

Can you talk about kind of the production rates in the back half of the year? Because it’s not obvious you’re actually going to be drawing those down significantly.

Jochen Tilk

Yes, we can, so Mark, I want to comment a bit on our production inventories at our operations and what our rates will be.

Mark Fracchia

Right, currently our inventories are very manageable at each of our operations. We of course have two of our facilities, Lanigan and Allan, still in the summer maintenance shutdowns, and they will be coming out of those shutdowns at the end of this month, but during this time they’ve been able to drop down inventories nicely at both facilities so we see ourselves in pretty good shape in terms of the back half of the year and we foresee at this stage being able to run the operations certainly at their production capability to that back half of the year. But of course it depends on how we end up the year and looking ahead into 2017, what our inventories are like as we head into the Canpotex run but at this stage it certainly looks like we could operate all of our facilities at their production capability.

Jochen Tilk

And particularly in the second half, we expect to move a lot of volume, just for reasons of seasonality, but also because volumes will go to India and China with Canpotex and quite a bit of volume to Brazil into the season and then the tender season starts in southeast Asia, Malaysia and Indonesia. So a lot of volume will move out of production inventories in Saskatchewan in the second half of the year. Well this half.

Adam Samuelson

All right. Thank you.

Operator

The next question is from Chris Parkinson with Credit Suisse. Please go ahead.

Chris Parkinson

Perfect, thank you very much. Just given the degree of the Chinese demand that’s already been met during the first half as well as recent contracts through the balance of the year, how should we think about overall Canpotex volumes in 2016, and what are the general puts and takes we should think about for China and India specifically? And then also any quick assessment on your ability to capture the New Brunswick tons that were previously being sold outside of North America would be greatly appreciated, thank you.

Stephen Dowdle

Well, you asked – I'm trying to take notes here. I think you asked four questions.

Chris Parkinson

Sorry about that.

Stephen Dowdle

No, no. You want to go through them take your time. I just want to make sure we don't miss them.

Denita Stann

Yes, Chinese demand for the first and second half was that what you were asking for, Chris.

Stephen Dowdle

Yes.

Chris Parkinson

So if you look at, I guess the first half imports, they're around 3.3 million tons, and then the recent contracts, I guess were around for just short of two million tons. And then so what's the expectation for the second half there?

Jochen Tilk

Yes, absolutely. Steve, you want to talk about what we anticipate in the second half of China?

Stephen Dowdle

It’s difficult to talk too specifically about that right now, because all those contracts haven’t been settled yet, and there is still under negotiation, so what we seen is through the first half we've seen a slight decline in some of the cross-boarder rail traffic. So we do expect the sea born deliveries, are going to be pretty robust during the second half. But to talk too specifically about it, we'd really have to wait and see what volumes are committed by the various suppliers to come up with an overall estimate. But in general, for the consumption demand in China in 2016, we came off a very strong year in China in 2015. We think that consumption will be down about a million, million and a half tons maybe in 2016 overall, but we also see and are anticipating a rebound in consumption in China in 2017.

Mark Fracchia

One interesting aspect in both India and China will be what the supply chain can actually deliver because we do anticipate that China and India are signing up significant volumes in part to catch up certainly for the year, it will be down but if it’s down 20%, or 25%, or 30% not sure, but it will be loaded towards the second half of the year and of course we all have to now look at our supply chain and our ability to deliver. And it will be interesting to see whether or not physically those volumes that will be signed up can actually be delivered in a time frame. It's going to be quite a strain in demand on the industry.

To your question on the ability to recapture New Brunswick, they were sold outside of North America. I’d say we have captured them. They were brought into Canpotex. As you may recall, we have received an allotment of 700,000 tons that went into the Canpotex allocations, so our number went up slightly to 51.6% for that. Obviously, we now only receive revenue for 50% of the tons sold to customers, but there are high net back tons to us because the operating cost in Saskatchewan is so much lower. So at the end we did recapture those tons and customers because they are now with Canpotex and they are serviced by Canpotex.

In fact as an addendum one of our senior executives has been [indiscernible] one of our executive – sorry, manager has been seconded [ph] to Canpotex to facilitate. And she’s there now and ensures that that customer base that was serviced to New Brunswick is now properly serviced through Canpotex.

Chris Parkinson

That’s a very good color. Thank you very much.

Mark Fracchia

Thank you.

Operator

The next question is from Joel Jackson with BMO Capital Markets. Please go ahead.

Joel Jackson

Hi good afternoon. I thought I'd go back to your 2017 demand forecast, because it is notable, and maybe talk about what looks like two, or two of your main assumptions which are, again, India and China. Could you give a little more color? You seem to think that the lower MOP retail price had been established in the recent weeks in India will lead to a million ton increase in demand in India. Can you give a little tangible evidence why you think that’s going to be the case?

And then the second part would be in China, you have a slide in your deck where you talk about historically in years of late China to potash contracts, global shipments have gone up in the prior year. But that same slide, actually in three years have gone up, in two years they've gone down, and inventories are high and Chinese domestic production is higher. So just want to get a little more of your thinking around those two assumptions, thanks.

Mark Fracchia

Yes I think China, Joel good afternoon first. Joel, China is our assumption is that we’ve looked at it from two points. One is bit more first principal look at the market in general what we know and what we think comparing the cost demand and assessing that. And we do have some visibility, because we know what the customer base is for Canpotex and the interest and as we stated previously there is an increased shift to NTK compound fertilizers, bulk fertilizers. And Canpotex now has a fairly diverse customer base in China that buys potash for the purpose of lending an NPK. And that’s a growing industry. So that’s kind of one of the data points and first principle that we extrapolated how we see 2017.

Of course the other one is inventory. I mean inevitably just physically we believe it will be possible to start 2017 with the same high inventory that the year started. We know that in 2015 a lot of volume, a lot of products, a lot of the optionality was actually ended up in inventories and then the late negotiation.

So that’s just physically is unlikely to happen because volume can’t be shift to those levers. The historic experience that suggests that after a lower year there is a strong year I think it was really meant to demonstrate that, when there is inventory drawdown and the year starts with lower inventory, it's more likely that the consecutive year has a high demand which is really just saying that there has to be some adjustment.

Jochen Tilk

Thanks. Anymore on that Stephen.

Stephen Dowdle

And I would add and you mentioned India and we’ve certainly been waiting for this development for quite some time. There’s been a necessity to readjust the subsidy scheme in India, because the scheme as it was for the last several years, it was very much favoring urea consumption. And there was a growing concern in India over the imbalance in the use of NP&K in favor of urea. And this is a significant step that the government has made to decrease the maximum retail price for phosphate and for potash. And there has been a growing realization amongst the fertilizer companies, the ergonomists that having such an imbalanced use of nutrients is very detrimental to Indian agriculture and also to the soils in India.

And you've seen, for example our shortfall in the sugar production in India, you've seen sugar prices increase significantly on the world markets and this is one crop that is very sensitive to potash efficiency. And we think that this adjustment in the subsidies is representing a real effort on the part of the Indian government to try and correct this imbalance used in nutrients.

So we're quite optimistic that, this is really going to translate into significant real growth in Potash demand in India.

Operator

The next question is from Yonah Weisz with HSBC. Please go ahead.

Yonah Weisz

Hi, yes, and good afternoon. A question about the whole contract mechanism, I mean during the first half of 2016, China did succeed to import around 3.2 million tons. About 1.5 came from Russia, Canpotex I think under around 0.5 million tons. After this arduous process, after all of the uncertainty, why would you continue with half year contracts? Why don’t you just try to abandon that and sell direct to buyers, like Russia seems have done over the past six months?

Jochen Tilk

Well, in China is a contract market. Whether or not we like that it's not our choice. They have opted to negotiate it through a buying committee. So that is their call. Now the price is set by the buying committee once a contract has been negotiated. Now as a supply, you may choose not to follow, but that's not – it's not up to us to make that call. What we can do is we can sell to different customers and we have done that. We started to diverse that, Canpotex I should say. Canpotex has diversified its customer base and that's based on demand, it’s just a growing industry in China, it's being growing rapidly on the NPK fund.

So, it's not a choice one or the other, it's a mechanism that is set out for China. What we endeavor to do for this year is to say fine so there's hardly any time left 2016. So, we'll look at volumes, but we don't intend to have that spillover into the following year, so that there is a clear line. And in 2017 there’s more visibility in the market, there will be more spot settlements that are there in South America, in the U.S. and there are additional data points and that we'll see. But it’s not just solely our choice to say we can move this to a spot market.

Yonah Weisz

Thanks.

Operator

The next question is from Don Carson with Susquehanna Financial. Please go ahead.

Don Carson

Just had a question on your nitrogen outlook. You've taken down your guidance for the year, prices have obviously come down considerably. So where do you see U.S. Gulf Coast, urea price troughing? Do you think we're there yet? And at current prices, can you justify any additional U.S. debottlenecks from a return on capital standpoint? And just wondering how profitable is Trinidad at these price levels?

Jochen Tilk

It's a very good question. First one, and we can go around here in our management group, but we obviously don't know, on both urea and ammonia. We would hope that we've reached bottom, but we've seen recent tamper settlements in ammonia are still trending downwards.

So, we observe the market. We know it's a highly competitive market. There is additional capacity and the input costs as low as ever in terms of natural gas. So, now, we have great operations that's offsetting that, but in terms of direction. So, on that first part, Stephen, Raef, our President, showing any further offering where we think urea and ammonia going.

Stephen Dowdle

These are in the most volatile markets or nutrients in our space, the nitrogen product. So very difficult to predict, it's kind of mugs game to try and predict the prices in these markets. And really it's primarily a function of natural gas energy costs. And that there’s certainly demand; there’s no question about that, but it's a very, very competitive market. And what is particularly putting pressure on the market in United States is the new capacity that's coming on stream here in the second half of this year, and that's been anticipated and it’s being priced into the market, and it will probably continue to pressure the market for the next few months.

Jochen Tilk

Thanks, Stephen. Turn it over to Raef a little bit because I think the debottlenecking question is a really good one, but as an International we look at that on a case-by-case basis. So we look at every project from a point of rate of return, and Raef and his team would look at these opportunities whether they're smaller ones or they're in the $100 million plus range. If there is a rate of return of course that’s a decision point, you either pursue it or reconsider it. Question of course is what price deck do you put in there what the long-term prices. And that's an assumption that we make in similar to the discussion we just had. We look at that and extrapolate. So on your question doesn't make sense or not, it really depends what the rate of return of any of those project is, and what price deck we put in to get to those. Raef, I don’t know if you want to add anything to that process.

Raef Sully

I think they are both excellent answers.

Jochen Tilk

Thank you. On Trinidad ammonia your third question, yes, it is profitable at this point, but your point is well taken. Trinidad has – as we all know has higher gas costs and there’s gas curtailment. And that put some – puts those operations into a disadvantage to the domestic one. However, Trinidad – that produce some urea and that produce merchant ammonia and there are other markets. And what we do is, we shipping to the U.S., but we're also looking at some high net stock markets to mitigate that.

Raef Sully

Well, I was just going to add of course the gas cost we pay that is in tied to global ammonia and at the moment it's actually approximately paying for gas down there is quite competitive with domestic U.S. markets.

Jochen Tilk

And we're looking at parts in world where there are opportunities to ship ammonia other than U.S. because we know and full anticipate that the ammonia import in U.S. which is currently about 5 million tons will decrease inevitably and so for us. And we're a big importer of Trinidad ammonia into the U.S. So, we're looking at that in the near-term to mid-term.

Don Carson

Okay. Thank you.

Jochen Tilk

Thanks.

Operator

The next question comes from John Roberts with UBS. Please go ahead.

John Roberts

Thank you. On Slide 14 on your guidance, I think your income from equity investments is the same as it was last quarter? Why is it that – isn’t going down as well?

Jochen Tilk

Wayne, our CFO can answer that question.

Wayne Brownlee

Well, I think in part it’s buffered by the earnings in SQF and they're benefiting from strong lithium prices. So, it's basically pro rata share.

John Roberts

Okay. So, the improvement in lithium offsets all of the fertilizer weakness that you'd have across your equities?

Wayne Brownlee

Yes. If you take a look at SQM, you'll see that the earnings have hung in there reasonably well.

John Roberts

Okay, thank you.

Jochen Tilk

I think also in the potassium nitrate, which has been somewhat more protected in the specialty markets. So, it’s same for lithium and potassium nitrate.

Operator

The next question is from Steven Byrne with Bank of America. Please go ahead.

Steven Byrne

Yes, thank you. Your expectations for shipments to China are no different than they were in January. I'm just curious as to what maybe has changed in your – in the mix since January? Do you see may be more domestic production or more railed product from Russia that still gives you confidence in the same total shipment level for the year even though half the year is over and there hasn't been a contract with Canpotex?

Jochen Tilk

Yes, very perceptive Steven. We actually started low at the beginning of the year. When we put our guidance together and reflected on that we were well aware of the level of inventory. We had thought that maybe there is a contract settlement in December to get momentum going, but then we anticipated that it would be a pretty long contract negotiations. For being entirely transparent, we certainly didn't anticipate that negotiations would be ongoing, in fact they still are. Only think from what we know in the two parties have reached settlement.

So we anticipated that was incorporated in the assumption and we may not have anticipated that in going on for that long. And we are now actually reasonably confident that there is a bit of catch up, I think said, if China is down year-over-year, by 20% to 30% thereabout that means still a lot of volume would have to move in the second half, so that we feel quite comfortable on the guidance from the beginning into China.

Steven Byrne

And what's your outlook for domestic production in China in your 2017 forecast?

Jochen Tilk

Well, let me just – we’ll look at that, I can – I want to give you the most acceptant, we didn’t list that here.

Denita Stann

Yes.

Jochen Tilk

Yes. I have to get back to you on that, obviously we have 50% so, in the range of $7 million, but that's just…

Steven Byrne

Okay.

Jochen Tilk

I want to give you the one that we have so…

Steven Byrne

That's fine. That's fine. And just one last one, do you have a strategy to defend your market share position in the U.S. in 2017 in potash given a new entrance, starting up?

Jochen Tilk

Yes. I am going to answer the first question because somebody flip me note, its 7.4 million tons are our estimate of domestic production in China. On the second question, I will turn it over to Stephen on whether or not we have any…

Stephen Dowdle

Well, we do. We certainly have a sales strategy in the domestic market and we have been pursuing it when it largely revolves around making sure that we have the capability to be a very reliable supplier in a market where our customers are very risk adverse. And we have seen that not just in North America, but around the world where you have just in timeline mentality. So, that places an extra burden on producer like ourselves to make sure we have the distribution capabilities to be able to play a role and gain a market share that we are targeting and certainly in North America we’ve just launched a new distribution center in Hammond Indiana, which we think will prove to be very useful for us to operate in this kind of risk adverse environment, and we intend to drive as much advantage from that as possible.

Steven Byrne

Thank you.

Jochen Tilk

Thanks, very much.

Operator

The next question from Sandy Klugman with Vertical Research Partners. Please go ahead.

Sandy Klugman

Good afternoon. Well, the follow-up on nitrogen, could you comment on what your expectations are for demand in your industrial end markets. And then similarly how do you see the outlooks for industrial and feed markets impacting demand for high grade merchant asset in your phosphate segment?

Jochen Tilk

Yes, good afternoon, Sandy. Good questions. Stephen on the industrial?

Stephen Dowdle

Well, the industrial market has been under pressure. We just for example, you may have seen one of our ammonia customers at Augusta vibrant as announced, but they’re shutting down their capital active facility due to the market conditions in the capital active market, primarily driven by Chinese production. So there is certainly some pressure in some aspects, but on the other hand in other sectors, in the DEF, for example, we’re seeing quite significant growth.

So, our strategy at our nitrogen operations is to try and run them full out and we have product flexibility in order to do that, we’ve seen in the ammonium nitrate market certainly with the coal industry suffering some significant setbacks we’ve seen demand for ammonium nitrate falloff. But we are moving those products and moving that molecule into products whether they would be fertilizer products are DEF or other products to trying to make adjustments. We may not be able to make every single adjustment in the real short-term, but we are confident that we will be able to make the adjustments that are required in order to run these plants that maximum efficiency.

Jochen Tilk

And you know, you had a second part to your question on the feed. So obviously another product that’s been on the pressure, there’s been a fair amount of imports into the U.S. that came from Europe from Russia, and are competing with U.S. domestically produce treat products and we’re in that situation I mean they are not compete with and we did lose market share.

As a result of that and just, as you know we make the asset in white springs one of our phosphate plants that we deliver to produce the feed in and we have to rethink that as well. And it’s the same adjustment that we make in the industrial product. We look at it and say, okay, where can that industrial super phosphoric acid blackspar, where can it go instead of feed? Can we put into a granular and maybe make mapped out, so it’s an adjustment. We think those markets will be on the pressure and impact.

It’s just a reality of the more competitive polar market. Fortunately we have a fair amount of flexibility to respond to that, and look, if we can shift our products into another direction and our plans are fairly flexible. They have opportunities to shift from some wet products into dry products and then we can respond and see if there are better netback opportunities.

Sandy Klugman

Thank you.

Jochen Tilk

Thanks.

Operator

The next question is from Steve Hansen with Raymond James. Please go ahead.

Steve Hansen

Yes, hi guys, thanks a lot. Just a follow-up to the prior question on the China contract mechanism. Given the obvious challenges that the repeated stalemate seem to present here, I’m just curious, how does Potash at Canpotex adjust its go to market strategy over a longer period of time, let’s say five plus years, ten years, to try and mitigate this impact, or are you effectively just stuck with it? Thanks.

Jochen Tilk

Yes, I think it’s a similar question to the prior one in terms of, what are we seeing, will that now shift? And to be honest we don’t really know. We just think that there is an opportunity for better mechanism that the contract is either negotiated for the appropriate time frame at the right time. We have and I’m stating the obvious but we found the first half 2016 was obviously very challenging for us because we had to adjust to the fact that there will be no shipments of India into China and then they are all loaded into the second half, which puts a ton of strain and it’s not a good way of operating.

I think that’s well understood. And our intention is to move whatever we can do to make it a more harmonized more balanced a way of being able to shift and deliver and not being stuck in negotiation, that somewhat in our opinion artificially causes our operations really to go to difficult times.

And so that’s the objective. And as I said before, whether that translates into more timely negotiations, whether that translates in a different form, we don’t know, we’ll see but our objective is just to make those points hurt, make them in a fair way and see how they translate into the different format.

Denita Stann

We’ll have time for just one more question.

Operator

Thank you. The next question is from Matthew Korn with Barclays. Please go ahead.

Matthew Korn

Good day, everybody. Thanks for the time, I appreciate the chance. Couple things very quickly. First, the message out of the first quarter on potash demand from you and your peers was, look, things are very slow right now, flows are slow, but once we get these contracts in place, buyers will return to the market. The first question would be, one, have you seen concrete signs that that is in fact is occurring?

If so, which countries in particular are starting ringing the marketing desk more often? And then second, following up on the phosphate question that was just asked, just want to confirm, there were no operational issues or anything at the plants that limited volumes this quarter? This was –this decline of 500,000 tons was purely demand driven? Thanks.

Jochen Tilk

Yes. To your first question, yes, we do and in fact we’ve seen in the last couple of weeks that there’s been an uptake, a pickup in demand. And that’s not a coincidence. In U.S. we’ve come out with a semi-fit program following the Southwestern Conference, there was no program. Our people were out there, we listened very, very carefully with our customer spot. And there was apprehension because people didn’t know and still don’t know perhaps what direction price were taking.

So we understood why people were reluctant to take inventory at the time when there was no seasonal demand. The semi-fit program has come out and we don’t being able to quantify right now, I mean that wouldn’t be possible. And it’s still quite a ways to go, but we’ve seen good response so that gives us optimism and faith in confidence that – and what the message really is that prices have stabilized. You don’t have to worry about further deterioration. We think on the contrary, and we’ve expressed our confidence that we see that – we say the price will go up after August, 5 for order after August 5.

Looking at other markets India and in China, I can’t speak to the specific negotiations that Canpotex is holding right now. They are taking place, so that would not be appropriate, but I can qualify that there is significant interest in volumes. That at the moment those negotiations have started and that’s not a surprise. I mean a lot of companies in China been waiting to ensure the products, we knew that they – they were not able to meet their production targets, because they didn’t have input, they come to us and say can we sign up now. And so we see good demand, same in India, we see good demand in that one. So yes, the answer is, there are good signs and as I said I can’t – I don’t want to quantify right now would not be appropriate, but its positive signs.

To your second question yes, the issue was that we had not delivered as much black spar into our feed production because of competitive environment that I mentioned and were not able to reroute that asset as quickly as we needed. So now we’re looking at it. So that was related to demand but not operational issues.

Denita Stann

Right, thanks for your question, Matthew. And thank you everyone for joining us today. If you have any questions, please don’t hesitate to give us a call at the office. Have a great day.

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