Brett Owens is a leading on income investing; the editor of the industry-leading Contrarian Outlook ...
Fertile Ground for Potash
08/20/2009 1:40 pm EST
There's just one more big customer negotiation standing between Potash of Saskatchewan (NYSE: POT) and a bottom for potash prices. Unfortunately for anyone hoping for a quick fix, that customer is China, and the Chinese are likely to take their time striking a deal.
In its second-quarter earnings report, Potash said that it projected a turnaround in global fertilizer demand in the second half of the year. Since then, other fertilizer companies such as Agrium (AGU) have made the same prediction.
I think the fertilizer companies have a pretty good handle on future volume, that is, they know how much fertilizer is stockpiled, how many farmers have been cutting back on how much fertilizer they use, and how much longer lower levels of application can go on before it cuts into yields.
(Owning Potash of Saskatchewan also allows you to ride along with the Canadian dollar, or Loonie. For more on that, see my August 6 post, “The world’s greatest currency? Canada’s Loonie gets my vote.”)
What no one knows at this point is what price those future tons of fertilizer will sell for. The consensus just a few weeks ago was that the price set in recent negotiations with India put in a bottom. But China, the world's largest buyer of potash fertilizer, now looks to be aiming to lower the price some more.
Exactly how much more? No one is sure, although the best guess is that while China is looking for a lower price than the $460 a metric ton that India agreed to pay for potash, the price won't be a whole lot lower. Maybe somewhere around $439 a metric ton, which domestic producers are currently getting for potash in China.
As long as the price is not punitively lower, simply removing the uncertainly should cause the stocks in the sector to rally.
Demand for potash fertilizer has collapsed in China, and with it, the country's need for imports. Potash imports hit a record 9.4 million metric tons in 2007 and then dropped to just 5 million tons in 2008. In the first half of 2009, imports dropped even more to an annual rate of just 3.4 million tons.
But because potash use by China's farmers fell even faster, the country has built up a huge stockpile of about 6.8 million tons at the beginning of 2009. Do the math: China has 6.8 million tons in stockpiles, it produces about 3 million tons domestically, and total consumption is running at about 7 million tons. Do you see a reason for China to settle quickly at a higher price?
The two things potash companies have in their favor are: 1) The size of China's stockpiles, and 2) The country's desire to buy more while the price is low in order to save on future imports. Forcing down the price too much hurts China's domestic producers and reduces the value of the country's existing stockpile. Letting negotiations drag on too long limits China's chance to buy big now while global prices are low.
The guess by Wall Street fertilizer analysts is that the final deal will be at $400 to $460 a ton and that a deal isn't likely before the end of the third quarter of 2009.
(Full disclosure: I own shares of Potash of Saskatchewan in my personal portfolio.)
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