With potash prices deflating around the globe like stale party balloons, one might expect to see Potash Corp (POT) adopt a more humble tone in the earnings release Thursday morning. If history is any guide this seems unlikely. POT has firmly opposed potash price cuts for some time now, suggesting that this would not stimulate demand in a meaningful way and would only erode future margins. For the last few years this strategy seemed to work well, and the potash oligopoly succeeded in keeping prices high to spur record profits. The global financial crisis however changed all of this. Despite numerous studies that indicate potash application (even at high prices) makes strong economic sense, farmers have collectively thumbed their noses at the potash producers and have decided to take their chances with lower application rates. Demand has fallen off a cliff with some estimates indicating that potash consumption will be down about 30% this year. And now, whether desperate to generate revenues to satisfy financial obligations or merely attempt to resurrect moribund demand, producers are rushing to cut prices and grab a part of this smaller market (i.e. Silvinit). The fallacy of POT’s strategy has been exposed, as a supposedly inelastic demand for potash, an essential plant nutrient, has been shown to be surprisingly elastic in the near term. Farmers are choosing to forgo potash application and are instead attempting to “mine” the soil. The effects of this large scale experiment remain to be seen. While potash in soil likely can be mined for a year or two, over the longer term soil nutrients will need to be replaced. The problem for investors is that the effects of this experiment likely won’t show up until the 2010 harvest. As a case in point, the USDA makes no mention of the possibility of lower yields due to reduced fertilizer application rates in their latest crop reports, citing weather instead as the probable catalyst. With the Midwestern crop season shaping up far better than it was even a few weeks ago (as reflected in the corn, wheat and soy recent price drops), this suggests that yields could hold up this year and cause farmers to conclude that their experiment was indeed successful.
Longer term for potash it is a race against new capacity. As with any industry, nothing spurs new competition like record profits. Others with access to capital have discovered that potash can be a very profitable business. Whether recent speculation on Vale and MOS or BHP and POT turns out to be true, it is highly probable that we will see more investments by majors in the potash industry.
An era of “stronger for longer” potash pricing has also awaken the sleeping bears in the form of major sovereign users of potash. They have woken up to the realization that ceding control of a vital nutrient such as potash to foreign controlled corporations doesn’t make for good business or political sense, and they too have entered the race to develop new capacity. Two unspecified Chinese national companies have recently announced joint ventures/investments in junior potash companies (AAA-TSXV, MAA-TSXV), as a sign of the shifting balance of power in the industry.
Clearly POT feels threatened by these developments and wants to continue to be the “box” on the potash investment industry. For the first time in recent memory Potash Corp has dedicated an entire presentation slide in the latest investor presentation as to why greenfield potash mines don’t make good economic sense.
The POT earnings call will prove interesting to say the least, with the host of available issues up for discussion. Humility is likely to be the only thing not on the menu.
Disclosure: No positions.