24 July 2017
While safely driving productivity gains and executing low-risk, high-return latent capacity projects is the core of what we do, we must also develop options for the future to grow shareholder value over the long-term. We have an option in Canada to develop a potash mine that could support attractive shareholder returns over decades. We’re excited to have this option in our portfolio, and there are many ways we can realise value from it. Above all else, we would only proceed if it passed our strict investment hurdles and was in the best interests of our shareholders.
In the first episode of our potash series, we concluded that the combination of population growth, changing diets and the need for cultivated soils to support higher and higher crop yields indicates a long-term trend of steady demand growth for many decades – an attractive prospect for any commodity producer. But demand is only half the story. In this second episode, we focus on the supply side of the potash market.
Potash minerals are extracted from underground deposits or from natural brines and then processed into potash fertilisers. Over 70% of global potassium chloride capacity is based on conventional underground mining. The remainder comes from solution mining and the processing of natural brines.
The natural occurrences of potash suitable for fertiliser production are geographically quite scarce, but there are a number of very large deposits. Over 60% of potassium chloride production today comes from the Prairie Evaporite in Saskatchewan, the Verkhnekamskoye deposit in Russia’s Urals region and the Starobin deposit in southern Belarus.
In the 156 years since the world’s first potash mine opened in Staẞfurt, Germany, in 1861, the industry has faced excess capacity on multiple occasions, just as it does today. The opening of the Canadian basin in the 1960s and 1970s produced one such period, as did the collapse of the USSR in the 1990s, with output from Russia and Belarus being re-directed to the international market.
The latter episode resulted in a lengthy period of minimal investment through the 1990s and early 2000s, which eventually led to the market tightening and contributed to a bull run in potash prices from 2003 to 2008. The end of this run coincided with what has become known as the “Global Food Price Crisis” of 2007-08. Somewhat overshadowed by the Global Financial Crisis that soon followed, the 2007-08 period highlighted what can happen when strong demand emerges after a sustained period of weak investment in new capacity.
Potash producers responded to this boom with major investments in capacity expansion. In the 10 years to 2016, the industry added nearly 27 million tonnes of annual “nameplate” capacity, but sales volumes did not rise to the same degree1. Moreover, while the period of brownfield expansion may now be coming to an end, greenfield supply will also come on-stream over the next five years. That indicates that over-capacity in the industry, which has already contributed to potash prices slipping to their lowest levels in a decade, is likely to get worse before it gets better. That will put further pressure on higher-cost incumbents and some of the industry structures that have evolved over time.
Although the near-term outlook may be sombre, we expect to see the peak of over-supply occurring within the next few years. Positive underlying demand fundamentals, assisted by affordable pricing, should see consumption catch up to capacity in the 2020s. The exact timing of the market returning to balance is uncertain. It will depend upon a multitude of factors on both the demand and supply side, including the capacity utilisation rates of existing operations. As the market progressively balances we expect prices to improve and the need for additional greenfield supply to re-appear. The potash market is one where patience will be rewarded.
We do not anticipate that a “pinch-point” like the one that contributed to a major spike in prices in the mid-2000s will emerge. What would have to happen to get there again? Well, a lot of the new capacity in the pipeline would need to fail to reach production – either for economic or technical reasons – and at the same time demand in large markets, like India and China, would need to outstrip our expectations.
Alternatively, what would have to happen to keep prices around their current levels in the long-run? First of all, huge improvements in productivity would be required to substantially lower the projected costs of adding the new supply that is required to balance the market. Secondly, the exchange rates of the countries that house the major producing basins – the Canadian dollar and the rubles of Russia and Belarus – would have to remain at their currently weakened levels. In the case of Russia, that would require oil and gas prices to remain depressed, and sanctions on the rest of the economy to remain in place for the long term. As we have argued here before, the fundamentals of the oil market make that unlikely. And if energy prices were to rise, then the Canadian dollar is also likely to make gains. Thirdly, uneconomic capacity would have to stay in the market well beyond the traditional “stickiness” seen during commodity price downturns. In our minds, that combination of factors – huge industry wide productivity gains, bottom-of-cycle exchange rates and the presence of excess capacity ad infinitum – are most unlikely to persist individually, let alone co-occur indefinitely. In other words, it may take some time for potash prices to recover, but today’s prices are not sustainable given the need for the industry to grow with demand over the long-term2.
2. CRU’s estimate of real long run marginal cost is US$412/t (2036) versus a free-on-board Vancouver Standard Muriate of Potash (sMOP) average price of around US$218/t as of late June, 2017 [Source: Fertecon].