Thursday, January 7, 2010

BHP Billiton (BHP) Forges Ahead with Plans to Develop Their Own Potash Reserves

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This is quite an interesting development as mining giant BHP Billiton (BHP) has been mentioned often as a suitor for one of the few, huge potash miners.  Instead it appears (for now at least) the company is going to strike out on its own to develop potash assets.  As long time readers know, a potash mine takes a LONG time and a LOT of money to develop [Nov 16, 2007: Potash Expands Mine for $2 Billion]... money is not an issue for BHP since they are a huge company with a deep war chest, but it will take quite a few years to build out the infrastructure and get up and running since these are virgin mine sites. 

This does have the potential to change the structure of the potash sector long term, which until now could be described as an oligarchy.  Or BHP could simply make itself the oligarch by not only developing its own potash sites, but combining that with a purchase of one of the few major producers in the world.  (although the time to do that was 1 year ago when prices were a fraction of what they are now)

Ironically at the moment we own both BHP and the largest potash producer... so for our purposes it's a bit of a moot point which way this develops.  However, for all those who love to run up fertilizer stocks by dropping a rumor on the Street combined with buying a slew of call options to indicate "something is up" (a fun hedge fund game) - if BHP is intent on simply becoming a competitor rather than an acquirer, that is one less company to continuously throw out there to the financial media as a potential buyer of said assets.  That won't mean the hedgies won't keep playing the game...

Via Fortune:
  • Everyone who eats food should encourage mining giant BHP Billiton to forge ahead with plans to develop what could become the world's biggest mine of potash, the potassium-rich substance that is a vital fertilizer for farmers worldwide.  BHP Billiton is drilling test shafts and doing other preliminary work on a site in Saskatchewan, Canada, called Jansen. BHP Chief Executive Marius Kloppers has spoken excitedly about potash as a great diversifier for the Anglo-Australian giant's iron ore-heavy mining portfolio.
  • This is frightful news for the oligopoly of Russian and Canadian potash producers, which have controlled 70% of world production for decades, and which have been working together, a la the OPEC oil cartel, to keep prices high amid crimped demand.  (that last phrase is a bit "over the top" and revisionist, considering potash prices were in the basement just 5 years ago)
  • Back in 2008, amid global food shortages, spot prices for potash reached $1,000 (trebling Potash Corp.'s income to $3.5 billion in 2008). [Apr 23, 2008: Potash Hits $1000 on Spot Market] It was those high prices that attracted BHP to the industry. Potash stocks were the darlings of day traders then. Shares of most producers have since fallen by half, with fewer pops like the one seen over the last few sessions.
  • Traders will likely bid 'em up again later this month when Canpotex, the Canadian producers trade group, finalizes its annual supply deal with China. Charles Neivert, a veteran analyst with Dahlman Rose in New York, says any price higher than $350 a ton and volumes of more than 750,000 tons would be very bullish--in the short term.
  • In the years to come, look for the earnings and valuations of the potash oligopolists to fade as BHP becomes king of the fertilizer heap. (again that is a bit of a generalization - it all depends on how much demand there is and how much supply BHP can bring online)
Wall Street nowadays considers next week "long term" so fussing over a project that won't even begin until 2011, and will take 2-4 years to get up to speed is quite laughable.  As a true long term investor it's important to know, but considering 60-70% of all volume in the markets these days are based on 1/5000ths of a millisecond high frequency trading - this sort of news only applies to humans.  And only a small subset of humans who still look out past a few days or weeks.  
  • Though a final investment decision on Jansen won't come until 2011, analysts like Neivert consider the mine a certainty. BHP is likely to invest $3 billion in the mine, which could be generating 8 million tons of potash a year by 2022. Potash Corp. has annual capacity of more than 15 million tons and Mosaic roughly 10 million tons.
  • Neivert believes BHP's entry will shake up the potash market, potentially driving down prices that have already plunged 60% from their 2008 peak.
8 million tons would be impressive, making BHP almost as important as Mosaic (MOS).  But first we have to see if this is the true ability of the mining site and second we have to see what demand will be in the coming decade (I expect far higher) as an increasingly crowded Earth, with less and less arable land struggles with food production.  That said, it does change the game even if its 5-7M tons of capacity.  Just not yet.
  • Unlike the oligopoly producers, it is BHP's custom to own low-cost, high-volume mines, then operate them at full capacity. If prices get low, other more marginal producers will be forced to cut unprofitable volumes first. Really, $350 a ton is still a very good price; potash went for $100 a ton in 2004.
Now unlike some of the generalizations above, that point above BHP's style of operation is much more relevant and interesting.
  • Don't tell that to Potash Corp. Chief Executive William Doyle, who has repeatedly stated his belief that farmers need to get used to paying high prices for potash because it is key to preventing worldwide food shortages. In an effort to keep prices from plunging even more, producers have reduced production, laid off workers and refused to cut prices further despite mounting inventories. Farm groups have sued the potash producers for collusion, so far unsuccessfully. Even though fertilizer costs farmers just pennies per bushel, it adds up.
More on the rumors that "financial engineers" like to spread to help make their quarter...
  • Last year the rumor was that BHP ($50 billion in annual revenues) was looking to buy Potash Corp., Mosaic, or Intrepid Potash outright. Forget about it. Even though their shares are half what they were in 2008, investors are still banking on unreasonably high potash prices--making these companies too pricey for BHP to take over. "Their sense of the value of their product may have gotten out of line," says Neivert.
It also appears one of the other mining giants Vale (VALE) is getting into the game; the irony being that many of us consider the mining giants (BHP Billiton, Vale, and Rio Tinto) to be oligarchs themselves!
  • BHP isn't the only oligopoly-buster out there. Brazilian mining giant Vale do Rio Doce is developing a potash mine in Argentina.
  • And China, which sees food security as an issue of national importance, has indicated it will work to double its own domestic potash supplies to as much as 8 million tons per year within a decade (it currently uses roughly 10 million tons a year). "To keep the country stable," says Neivert, "food is a huge issue." (not quite so easy for China to do, it is not like a plant where they can just build 500 of them; they need to have access to actual potash mines - of which there appear to be only so many worldwide)
Long BHP Billiton, Potash in fund; no personal position

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