Mike Wilson, Agrium CEO
The potash mining industry could be about to get a whole lot scarier for investors who've bet on the price of the essential fertilizer ingredient going onward and upward indefinitely as world demand for food rises.
Profits in potash mining could be poised for wild swings in a downward direction if new companies that enter the business don't show supply discipline, warns a report by Toronto-based bond rater DBRS Ltd.
"DBRS expects potash market volatility to increase over the next few years," the firm said, adding that producers whose fertilizer product mix is most reliant on potash have the most to worry about.
"If the market structure of the industry changes and margins are driven down, the ratings of producers largely reliant on their potash businesses could be negatively impacted," it said.
Currently, much of the world's potash is marketed by two quasi cartel-like entities, Canpotex, a Canadian company that sells Saskatchewan production on behalf of Agrium Inc. , Mosaic Co. and Potash Corp. of Saskatchewan and a similar firm that handles output from Russia and Belarus.
This producer-friendly marketing arrangement "could well be challenged" by new companies entering the business, Ernie Lalonde, senior vice-president, mining, at DBRS, said in an interview.
Potash prices have more than doubled since 2007, leading producers to embark on huge capacity additions that could undermine future profitability.
Potash Corp. is in the midst of a program to double its capacity by 2015 from 2003 levels. Other majors that have announced capacity additions include Uralkali, K+S Aktiengesellschaft, Mosaic and Agrium. Meanwhile, a number of new entrants want to expand into the business including Vale SA BHP Billiton and Eurochem Mineral and Chemical Co.
BHP has previously said it won't join marketing groups and will try to maximize output.
"The key issue is this: How will the expected persistent demand growth for potash be balanced with potentially large supply additions in what has been to date a market historically dominated by a small number of players," DBRS said.
Additional output by new producers "may tip the balance and not allow the sort of price dynamics that we've seen historically in the potash industry," observes Robert Winslow, an analyst at National Bank Financial.
Mr. Winslow says increasing output, much of which comes on stream by 2015, is "a potential risk" to prices. "The tightness in the market may not be there to support higher fertilizer prices," he says.
The bright spot for the industry is that demand for potash will likely continue growing at its average historical rate of about 3 per cent a year in response to the rising global need for food.
Because potash mines are capital intensive and take years to develop, there could be temporary price spikes if new projects are delayed and demand continues to grow at projected rates, according to Mr. Lalonde.
Potash Corp., the leading Canadian producer, says it isn't worried. The company argues added supply will be needed to satiate the world's demand for crop nutrients. "The trend is that demand is going to grow and new supply will be needed to meet that demand," says Bill Johnson, a spokesman for the company.
But he cautioned that there will be ups and downs in the market along the way. "Will the growth in the fertilizer market be in a straight line? Probably not," he said.
A spokesman for Agrium declined to comment on the DBRS report.