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Killing potash cartel could very well backfire

Cartels are supposed to be illegal, anti-competitive beasts that don't really work in the long run. But tell that to OPEC - the Organization of Petroleum Exporting Countries - which was founded in Baghdad 50 years ago this week and seems in rude health in spite of endless predictions of its demise.

The evidence: $75 (U.S.) oil even though demand dropped in 2008 and 2009 and half the world remains mired in recession or is sputtering along with anemic growth rates.

To be sure, OPEC has had years, even decades, when it looked like a goner. In the late 1990s, oil prices collapsed - the low was about $11 a barrel - as the cartel lost control of the market. It has been a marvel of discipline since then, plugging the holes in leaky member countries and setting a Goldilocks price, neither too high nor too low.

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Which brings us to Potash and potash. Potash Corp. markets and exports potash, a key fertilizer ingredient, through a cartel called Canpotex that it owns with two other like-minded companies. Formed in 1970, Canpotex has done a credible job of adjusting exports to meet demand, generally avoiding wild price swings (except during the food crisis of 2007 and 2008) and building a transportation structure to get 8 to 9 million tonnes of potash a year to buyers around the world. The Saskatchewan government, secure in the knowledge that more or less stable prices lead to more or less stable royalty flows, adores grubby little Canpotex.

Then along came BHP Billiton CEO Marius Kloppers and his $38.6-billion (U.S.) hostile offer for Potash Corp. Mr. Kloppers is a miner, not an investor or a commodities trader. If you had any doubts about his status, note that he revealed at the onset that BHP and Canpotex were not really compatible.

Potash Corp. is the world's biggest fertilizer maker and its exit from Canpotex would surely kill the cartel, a scenario that does not sit well in Regina. Mr. Kloppers has since backed down on his threat. The message now is that BHP, Canpotex and the Saskatchewan government would eventually reach some sort of agreement that would make all sides happy. Translation: BHP, the world's biggest mining company, will get its way, though it might take a few years.

Mr. Kloppers's threat to rip the belly out of Canpotex should have come as no surprise. The trouble is, his instincts might be wrong. When you have the delicious luxury of being a price setter, the Microsoft of fertilizer, why do you want to become a price taker?

On a certain level, the kill-Canpotex threat is admirable. Cartels by nature are designed to please the producer, not the consumer. In theory, prices would fall the moment the cartel is disbanded, just like OPEC effectively vanished in the 1990s when many of its members ignored production quotas and flooded the market with oil. Eliminating Canpotex should translate into cheaper fertilizer prices to grow more grain to feed more cows to make more hamburgers. The Big Mac could be re-launched as the Big Marius in BHP's honour.

Mr. Kloppers didn't say specifically why he would ditch Canpotex, but we can figure it out. BHP in good part owes its formidable success to low costs, achieved through tight cost controls, generally high-grade deposits and the penchant to run mines flat out, or close to it, all the better to max out the efficiency quotient. In other words, if Canpotex didn't exist, BHP could open the potash spigot and squeeze the competition in Russia and Belarus. It would then gain some of their market share.

BHP, like rival Rio Tinto, went to market-based pricing on Australian iron ore sales and it seems to have worked beautifully. Until last year, iron ore contracts were negotiated annually. Now they're based on quarterly spot market prices. The change made iron ore profits soar for both companies.

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The flaw in Mr. Kloppers's reasoning? Market-based pricing works best, of course, when the market is rising, which is the case for iron ore and may be the case for potash as global agriculture markets recover and food demand rises with growing populations. But all bets are off in a falling market, and the crash of 2008 and 2009 shows that commodities can sink like lead life jackets overnight. And when they do, wouldn't a handy little cartel be nice to moderate the fall? BHP shareholders might like that, even if Mr. Kloppers thinks Canpotex runs against BHP's corporate DNA.

There would be another benefit to maintaining the price-setting mechanism - it would keep the Saskatchewan government happy. To the government, potash and the predictable royalties it produces isn't just guck in the ground, it's lifeblood.

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