If you want to know whether Potash Corp. of Saskatchewan still has a target on its back, don't look at the markets or the financial news. Watch the provincial government.
Potash Corp. shares sold off last week on poor earnings and also after BHP Billiton surprised investors by buying Athabasca Potash. The resource giant had already announced a plan to spend another couple hundred million developing its existing potash resource in the province. Investors figure the deep-pocketed BHP will just build its own division from scratch instead of buying one of the big players, whether it be Potash Corp., Mosaic or Agrium.
I think that might be wrong. I think BHP is arguably just as much in the hunt if not more so. If it's not Potash Corp., it's Mosaic or Agrium. But someone will get taken out and relatively soon, is my inflation-adjusted two cents worth.
When it was a provincial crown corporation, Potash Corp. was a dog, losing $100-million a year. They brought in a CEO named Chuck Childers who figured out that Potash Corp. was to potash what Saudi Arabia is to oil: the swing producer with a disproportionate influence on production and, therefore, on prices. Mr. Childers imposed discipline on producers because he wielded a big stick. Comply or die, basically. And they did more or less, helping Potash Corp. swing to nine-figure profits.
As I argued in this space in October, Potash Corp. had an opportunity to play the cartel leader again in 2007-08 when prices were going through the roof. It had spare capacity and could have cranked up production to moderate pricing. It chose not to and prices soared to as high as $1,000 (U.S.) a tonne. The company earned an astonishing $11 a share in 2008.
This rich success had three effects. First, it alienated customers who, contrary to what some investors think, don't have to replenish their soil nutrients every year. They can skip a year or two or more and indeed are doing so (I heard from some farmers after my previous column). Eventually of course they will have to stock up, but only when the economics make sense. But there may be less of a rush than some investors think.
The second inconvenience was that the huge profits Potash and others made attracted covetous glances from others, including BHP Billiton. High returns on equity attract competition. And that's what is happening to the potash industry.
There are eight advanced greenfield projects under way and about 20 early stage greenfield projects (greenfield meaning from scratch), according to CIBC World Markets. And that's not counting expansion plans at existing facilities. That means more competition down the road.
And the third effect was that potash revenues to the Saskatchewan government fell off a cliff. The last budget had a $1.8-billion hole in it because royalties from potash sales evaporated. That's a shocking 20 per cent shortfall.
So how does this portend a takeover? Simple. BHP is run by shrewd people. They want to be No. 1 or No. 2 in their endeavours. Spending half a billion bucks on potash resources in Saskatchewan isn't going to get them there. They'd love to own Potash Corp. and I'd guess the parties have had informal discussions.
That's one incentive to buy a producer. A bigger one is this: Ultimately, the province controls the potash industry in Saskatchewan. While the province is interested in development, its incentive lies in a balance of higher prices and development. I doubt it wants to see rampant potash production that could hurt prices. It's not like Alberta, which can afford to encourage unbridled oil sands production because it won't affect prices.
It's the government that decides, through royalty and tax regimes and environmental permitting what greenfield projects go through. And after a nearly $2-billion shock, I don't think it's in any mood to allow prices to collapse again.
In other words, I don't think the province will be fast-tracking new potash developments. In fact, the recent changes to the potash production tax were cosmetic, amounting to an incentive to add a few office jobs. There's some evidence.
If the province makes it hard for new players to start mining, the scarcity value of the big boys goes up. Potash Corp. is at the top of the list.