The slumping fertilizer industry is on the verge of a price war.
In the months since the recession took hold, the world's largest potash producers have coped by drastically slashing production, rather than lowering prices. But now cracks are starting to appear among the disciplined producers that had so far managed to keep prices near historic highs, despite weak demand.
Russian supplier Silvinit undercut its competitors by 26 per cent Friday to score a contract with India, leaving analysts to wonder whether the price break signals a widening split among companies desperate to start moving their inventories, or if it was a one-off motivated by Silvinit's shaky finances.
"It's fine to keep the prices up, but eventually these companies need to ask how many tonnes they are actually moving and whether that model is sustainable," said Erin FitzPatrick, Rabobank International assistant vice-president and industry analyst.
The contract with India is key because of the way the potash industry works. Large potash contracts are usually negotiated between brokers and foreign governments anxious to secure a predictable supply of fertilizer for their farmers.
Prices set in China, India and Brazil tend to dictate how much companies charge on the spot market to other customers.
The Silvinet deal has India paying $460 (U.S.) a tonne for 850,000 tonnes of potash for March delivery. Its rivals - including broker Canpotex Ltd., which negotiates on behalf of Potash Corp. of Saskatchewan Inc. , Agrium Inc. and Mosaic Co. - had set their prices near the $630 mark, which is close to the price India paid last year.
The Indian deal took many in the industry by surprise, especially considering that Canpotex signed a deal last Thursday with South Korea and Taiwan to secure shipments through the second half of the year for $700. It signed a similar deal with Japan last month.
"Potash pricing appears poised to rapidly crumble," Oppenheimer & Co. analyst Edward Yang said in a note to investors.
Prices for potash - which is used to prevent plant disease and make crops hardier - quadrupled in 2007 and 2008 to $1,000 as farmers around the world looked to meet the demand for food from emerging markets, as well as the demand for crops that could be used to produce biofuels.
The $1,000 price tag was treated not as a peak by industry watchers, however, but rather a base from which prices would inevitably climb. Prices are still at historically high levels, given that potash averaged $270 a tonne from 2003 to 2008.
The International Fertilizer Industry Association said farmers used 28.3 million tonnes of potash in 2007-08, but estimates they will only need 24.3 million tonnes for the 2009-10 planting season, as cash-strapped farmers gamble that they can go a season without adding nutrients to their soil and still achieve strong yields.
CIBC World Markets analyst Jacob Bout lowered his potash price target by 18 per cent yesterday to $490 from $600 a tonne to reflect the Indian deal, but cautioned that the settlement might have more to do with Silvinit's financial situation than global potash prices: The company took out a $3-billion loan last year and likely faces interest costs near $500-million this year.
"As a result, the lowering of our potash price assumption may be premature, and we will have to see where other producers settle," Mr. Bout said.
Signs of stress in the industry have been evident since last year, as producers held prices steady by slashing output. Potash Corp. alone has cut its production by 5.5 million tonnes since August. But in June, Europe's largest producer, K+S AG was the first major producer to openly lower its asking price, with a 20-per-cent drop, to $600 a tonne.
"Even if there are no sales, you need to pay the bills," Rabobank's Ms. FitzPatrick noted. "Eventually someone was going to step out and make a sale at a lower price."
The low price tied to the Indian deal makes it less likely that the companies such as Potash Corp., the world's largest producer, would be willing to sign on to longer-term contracts, instead turning to the spot market for flexibility.
"Silvinit's deal was disappointing and unnecessary, because it is quite likely India would have easily paid the higher price for potash," said Patricia Mohr, a commodities specialist at Scotia Capital. "Negotiations are under way with China, and I wouldn't be surprised if there wasn't a contract signed at all in 2009."
While using the spot market would make the companies more nimble, it also makes it difficult for analysts to set price targets for their shares.
Lower crop prices and "mixed messages from management on pricing strategies" have added to the difficulty, UBS analyst Joe Dewhurst said.
Potash Corp. has seen its shares fall 25 per cent since reporting that "fertilizer sales ground to a virtual halt" in its first quarter, cutting its profit by 45 per cent. The shares are 60 per cent lower than they were a year ago, when Potash Corp. was briefly the biggest component of the Toronto Stock Exchange. Second-quarter results are due next week.
"Everything is so speculative right now," Ms. FitzPatrick said. "Because prices have been so high in the last year, we're seeing some choppiness on the way down. I don't know if you can call it a bottom - we'll have to wait six months to find out."
Close: $42.90, up 70¢
Close: $42.46 (U.S.), up $1.33
Locking in prices
Analysts aren't willing to call Silvinit's $460-(U.S.)-a-tonne deal with India the bottom of the market, insisting they need to see what happens in China before determining if whether it's a permanent retreat from 2008's highs of $1,000 or a temporary dip.
Coal producers received unexpected good news in March when BHP Billiton Mitsubishi Alliance and Nippon Steel Corp. settled on a price of $128-$129 (U.S.) a tonne for coking coal for the 2009 Japanese fiscal year, above the levels of less than $100 a tonne that the market had feared early in the negotiations.
China is holding out for a better deal, but in May Japan's steel makers agreed to a 33-per-cent price cut. China was said to be after a 40-per-cent cut, threatening to turn to the spot market. Steve LadurantayeReport Typo/Error
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