Legacy behind PotashCorp’s drive for K+S
There is one word on the minds of potash industry executives at the moment — Legacy.
The mine, 1,500 metres below Canada’s prairies, is the reason behind PotashCorp’s €7.8bn offer for its smaller German rival K+S,
Expected to enter production in the summer of 2016, Legacy is the first “greenfield” potash development in Saskatchewan in almost 40 years. The K+S project threatens to bring more of the vital fertiliser ingredient into an already challenged market.
“The main rationale for the acquisition appears to be to prevent K+S’s Legacy from disrupting market prices as it adds capacity to the already over-supplied global and north American markets,” says Jeremy Redenius, analyst at Bernstein Research.
For many years potash enjoyed stable prices due to the power of two production cartels — Belarus Potash Corporation representing Uralkali and Belaruskali and Canpotex, comprised of PotashCorp, Mosaic and Agrium.
However, supplier “discipline” started to break down in 2013 after high prices led to weak demand in China and India, culminating in Uralkali breaking away from BPC. The result has been aggressive marketing from Belaruskali, undercutting its rivals.
Pent up demand returned in 2014, but some of the leading players, who previously prioritised the commodity price ahead of market share and so restrained production when needed, are now fighting for customers.
“The market has fundamentally changed in the last couple of years,” says Lisa Smith at Integer Research.
Last year, Canada’s share of the international potash trade fell to 34 per cent, down from 37 per cent in 2013, while Russia‘s rose to 20 per cent from 16 per cent and Belarus jumped to 19 per cent from 15 per cent, according to data from the International Trade Centre in Switzerland.
PotashCorp clearly feels the need to control future supplies.
In May this year, Jochen Tilk, PotashCorp’s chief executive, told an investor conference in May that he wanted to see Legacy to join Canpotex once the mine started running. “Yes it can [join Canpotex], and I think it will,” he said.
One of the biggest issues Legacy presents is the pressure it will bring to bear on the US market, where prices are currently at a premium to other markets.
The large Canadian players which once dominated the US market, are now seeing increased competition from foreign companies including Belaruskali.
And there is little doubt that it will become the key target market for Legacy. “The US market will come under increasing competitive pressure, and Legacy will be competing in a key market with PotashCorp and others,” says Ms Smith.
The dilema faced by PotashCorp is twofold. In order make the K+S acquisition work in terms of return on capital, the potash price will need to be about $355 a tonne.
But if Legacy falls under the control of PotashCorp and prices stabilise at about $355, this will encourage more capacity, including BHP Billiton’s Jansen mine [see sidebar].
“It’s a Catch-22,” says Mr Redenius.
BHP can economically justify bringing its Jansen mine online at near to $350 a tonne and this in turn would ensure “overcapacity and lower prices in the long run,” Mr Redenius adds.
Over a longer horizon, PotashCorp’s purchase of K+S will not resolve the overcapacity in the potash industry. Even if BHP fails to bring Jansen online, the industry will see more new mines coming online over the next few years.
Russia’s Eurochem will have two mines coming online with total production capacity of 8.3m tonnes, while Mag Industries’ Mengo mine in the Republic of Congo and Turkmenhimiya’s Garlyk mine in Turkmenistan are due to launch over the next two years with capacity of 1.2m and 1.4m tonnes respectively.
Some of these projects, including Legacy, have relatively high costs and do not offer economic returns at current potash price levels. However, many are underway and are highly likely to proceed to completion.
Some institutional investors have expressed their scepticism about the efficacy of PotashCorp’s offer. As one mining executive says: “A company’s ability to control market prices is very limited.”