Why Potash is Disappointing Investors

The world's population is over 7.8Bn and set to grow to 9.7Bn by 2050. How are we going to feed everyone? Based on our weekly show with Fergus Cullen – better known as Trader Ferg – this week we talk about why Potash is critical to solving our problem. 

"Potash is hugely capital intensive initially so creates its own moat against new entrants. And once in production, It's actually highly profitable."

Despite a promising macro outlook, potash has consistently proved a less worthwhile investment compared to other natural resource industries, even offshore drilling or coal.

We explain why potash's oligopoly and market oversupply are hampering success in the industry. 

Potash: Market Overview

Potash is a source of water-soluble potassium, one of the most important agricultural nutrients, alongside nitrogen and phosphorus. Roughly, 62 million tonnes of potash are mined per year, with 95% of supply being used in the manufacture of fertilisers.

Potash production is dominated by Canada, Belarus, Russia, and China, in that order, with Canada providing 31.6% of the world's current supply.

Fields deficient in potassium typically see lower yields, poorer water retention, and increased damage from disease and pests. And unlike many commodities, potash is completely irreplaceable as it is the only viable source of water-soluble potassium for use in fertiliser.

The Two Main Types of Potash: 

Muriate of Potash (MOP) – The more widely used variety which constitutes roughly 90% of the potash market. MOP contains chlorine meaning it can only be used to fertilise crops that are chlorine-resistant. It is generally used for staple crops like rice, maize, and wheat. Of the two types, MOP is significantly cheaper, costing roughly $220/t (per tonne).

Sulphate of Potash (SOP) – The lesser-used variety, making up just 10% of the market. SOP does not contain chlorine making it suitable for vegetables, fruits, and tree nuts, which are typically chlorine intolerant. SOP is far more expensive than MOP, costing between $400-500/t.

The Macro

For Cullen, the only way is up for potash given the estimated global population growth of 2 billion over the next 3 decades. The outlook is simple, the more people there are the greater the demand.

Regardless of cost people need to eat, it is perhaps one of the few constants we can expect over the next few decades. This very basic fact underpins Fergus’ view that this is:

“a pretty bullet-proof growth curve”

With a decreasing ratio of arable land per person, the need for fertiliser will increase. Soaring food demand and reduced farmland will inevitably require greater levels of production, and one of the primary tools for increasing production is fertilisers, like potash.

Cullen cites that demand for MOP is expected to have an annual growth rate of 1-2%, while SOP is predicted to double that with between 4-5% growth annually.

This effect is further compounded, particularly for SOP, by the rise of standards of living across the developing world, which will fuel demand for higher quality, more nutrient-dense foodstuffs. 

The macro outlook is simple – a growing population with higher standards of living will require more, and greater quality food from a smaller proportion of arable land, resulting in increasing demand for fertilisers, in this case potash.

The MOP Oligopoly

The potash industry is dominated by a handful of major players, with just five companies controlling over 70% of global production:

• Nutrien (TSE:NTR) is the single biggest potash producer in the world accounting for over 22% of the market. The Saskatoon-based company is also the largest agricultural phosphorus producer, cornering two of the three major fertiliser nutrients. Nutrien was created in 2018 by the merger of PotashCorp and Agrium, two, already significant potash firms.
• Belarusian state-owned Belaruskali is the second-largest potash company, the firm also constitutes the largest single tax-payer in the Eastern European nation and accounts for just under 14% of the global market.
• The Mosaic Company (NYSE:MOS), is the other major potash producer in North America, based in Tampa, Florida. It is the largest firm of its kind in the US and accounts for 13.3% of the global potash market. While significantly smaller than Nutrien, together the companies account for well over a third of the world’s supply.
• Uralkali (MOEX:URKA) makes up the same proportion of the market as Mosaic, with 13.3%. The company's projects are centred in the Perm Krai in the Ural Mountains and reported sales of 9.8 million tonnes of potash in 2019. 
• K+S (ETR:SDF), based in Kassel, Germany. The company is Europe’s largest supplier of potash and holds a market share of 8.6%.

The primary reason for this oligopoly is the enormous capital requirements to enter the market, with individual production facilities costing billions of dollars. This is then compounded by the low operating costs which enable the five largest firms to drive down prices to make newcomers to the industry uneconomical.

The industry is also estimated to be 25-30% oversupplied, keeping the prices, particularly of MOP, low.

BHP (ASE:BHP) and the Jansen Project

A prime example of the difficulties presented in entering the potash market is BHP’s Jansen project.

The project, based in Saskatchewan, Canada, covers roughly 9,600km2  and once completed is estimated to increase the global potash supply by 15%. So far, BHP has spent $4.5 billion, with an estimated $1.2 billion outstanding for the completion of the project.

Further expansions, up to 3 more, costing $4 billion each, could increase the global supply by 30%.

Despite being 86% completed, progress has halted as BHP waits for the price of potash to improve. The combination of the oligopoly and increasing an already significant market oversupply has halted a project so close to completion, demonstrating the immense difficulties for newcomers to the potash space.

MOP Verdict

Ultimately, Cullen doesn’t believe that its worthwhile to invest in these major MOP companies for 3 main reasons:

1. These firms are expensive, with both Nutrien and Mosaic trading at 10x their EBITDA, it makes far more sense to invest in cheaper markets like coal which generally sees 2-3x EBITDA.
2. The dividends are easily outmatched by other industries, Cullen cites the coal industry again with several firms, he discussed in this article, offering 10% dividend on investments, whereas the potash majors are offering between 3-4%.
3. With BHPs Jansen project close to completion the already oversupplied market will see an extra 15% (potentially rising to 30%) on top of global supply, which will constrain opportunities in the sector for years to come.

SOP Innovations

For Cullen, the SOP market is far more interesting, however, he stresses that gains in this space hinge on a 4-5% annual demand increase combined with a lethargic supply, which is by no means guaranteed.  

A key reason for the high price of SOP is the methods of production, in particular, the Mannheim process, which accounts for 43% of global supply. 

The Mannheim process extracts SOP from MOP, by heating it at roughly 700oC and then adding hydrochloric acid, resulting in operating costs of $450/t. The Mannheim process is particularly popular in China, which produces over half of the global SOP supply.

Several minors in the SOP space are extracting SOP directly from salt lakes, which dramatically reduces the operating costs, down to as low as $200-300/t, making these companies far more competitive. The process also boasts a 62% reduction of CO2 compared to the Mannheim process.

Cullen highlights 3 Australian firms promoting this method:

Agrimin (ASX:AMN)

Agrimin claims that, once in production, they will be the lowest-cost producer of SOP, outside of Africa. They are estimating that their Lake Mackay Potash Project will cost just $159/t to produce. Having completed their DFS (Definitive Feasibility Study) they are reporting an IRR (Internal Rate of Return) of 21% and a post-tax NPV (Net Present Value) of US$655 million. The Lake Mackay Project is also estimated to hold roughly 4x the reserves of Salt Lake Potash’s Lake Way Project and Kalium Lakes’ Beyondie Lake Project.

The company is also doing exploratory studies at their Auld Lake Project, which has indicated some of the highest in-situ SOP grades from an Australian salt lake.

Salt Lake Potash (ASX:SO4)

With their initial Lake Way project 81% complete in late January, Salt Lake Potash are close to entering production. As expansion could also see extraction from a further 10 salt lakes. The company is currently expecting operating costs of $205/t and has already secured off-take agreements amounting to 224,000t per year.

Salt Lake has also projected an IRR of 28% and a post-tax NPV of $335 million.  

Kalium Lakes (ASX:KLL)

Kalium Lakes is predicting operating costs at between $178-208/t and has secured an off-take agreement with German potash company K+S. Despite falling behind on early targets of entering production in January 2020 the company is now expected to start in September 2021.

They have estimated an IRR of 16.5 and a pot-tax NPV of $242 million. 

Fergus’ SOP Verdict

Despite dramatically lower operating costs, Cullen doesn’t see these firms being “huge winners unless something really happens in the market”, they are instead “reasonable cash flow businesses that’ll re-rate”.

Cullen is limiting his involvement in the industry, only considering a feeler position in Agrimin, the least developed of the 3 Australian firms.

“I wanted some brilliant take away, some hidden gem here, but no”

Instead, Cullen is focusing on offshore oil drillers, tankers, uranium, and coal.