And then the world’s largest miner, BHP Billiton, made its bid for PotashCorp, the world’s largest producer of the mainly fertiliser product, potash. There’s a lot that makes this deal interesting. Firstly, there’s the question of how the demand for this product is set to explode over the next few years. Secondly, there is the issue of cartels. The potash industry has its own version of OPEC, but that could be about to change. Then there are global politics; PotashCorp sits centre stage over a territorial dispute in the Western Sahara. And then there’s China; will she really sit back and let this one pan out?

The characters and the background:

BHP Billiton is both the largest Australian company and the world’s largest miner by market capitalisation. It was formed in 2001 with the merger of Broken Hill Proprietary Company (BHP) and the Anglo-Dutch Billiton plc. It is headed by Marius Kloppers. A couple of years ago, the company dominated the headlines with its attempt to buy out mining rival Rio Tinto. Rio resisted the deal, then China came on the scene and attempted to buy the smaller company, until finally RIO and BHP settled for a joint venture, much to China’s fury.

PotashCorp is a Canadian company, based in Saskatoon, Saskatchewan. It is the world’s largest producer of potash, also known as potassium carbonate, which is largely used as a fertiliser. It is typically extracted from mines buried around 3,000 feet down. The company was founded in 1975 by the Saskatchewan government. The company went public in 1989 and ceased to be under any form of state control in 1990.

Potash is mined across the world. The largest reserves are in Canada, followed by Russia, Belarus and Germany. China is the sixth largest producer, although its production is around one-fifth of total production in Canada. PotashCorp has around 22 per cent of the potash market.

Potash and the cartel

PotashCorp reckons that once it became a private company, it learnt to rise above the wings of the market. So the Canadian giant, along with other, smaller potash producers agreed to collectively reduce output in anticipation of falling annual demand, and to increase output when demand was expected to rise. In this sense it operates in a cartel, much like OPEC, which tries to remove the volatility out of the price of potash.

This strategy has been only partially successful, because whereas in 2008 potash was going for around $1,000 a tonne, right now the price is around $374.

The cartel, by attempting to control the price of potash, may have enabled the more inefficient producers of the product to stay in business during the hard times. Whether this is a good or a bad thing depends on your own philosophical leaning. The cartel has been responsible for artificially pumping up the price at a time of global hardship. On the other hand, by doing so it has maintained global capacity so that the industry is better able to meet demand when the cycle rotates and demand for the product begins to rise.

BHP has vowed to end the cartel if it gains control of the company. PotashCorp boss Bill Doyle said of the BHP plan: “To blindly produce without regard for the market place has been proven to be a bankrupt strategy more than once.”

The future of potash

You don’t need a Nobel prize to work out why potash is a product which has outstanding prospects. The world’s population is set to grow from 6.8bn to 9.4bn over the next 40 years. This will clearly lead to a rise in the demand for food. Working on the assumption that globalisation will lead to significant rises in living standards, the demand for meat will grow even more rapidly than the global population. But meat production requires crops to feed livestock. It is known that far more crops are required to feed us humans via meat, than if we consumed the crops directly. In short, vegetarians use up less natural resources than carnivores. So the combination of the rise in population with the per capita rise in meat consumption will lead to a huge increase in the demand for food. But, at the same time, the supply of land is fixed. So the only way the rising demand will be met will be via more efficient food production. In the developed world, use of soil fertiliser is well advanced, but across much of the developing world there is great scope to increase production via better use of fertiliser. This is especially true in Africa.

 

The offer

BHP has offered $39bn for PotashCorp, which is the equivalent of $130 a share. But PotashCorp has retorted that two years ago its share price was $240. It is holding out for a much bigger offer. No one expects the initial BHP bid to be successful; it is clearly an opening gambit. The BHP offer represented a 16 per cent premium on the PotashCorp share price on 16 August, but the share price has risen by 30 per cent since, indicating that markets are expecting a much higher offer.

BHP itself is valued at around $200bn. For as long as its bid for PotashCorp is less than 25 per cent of its market cap, it won’t need to gain shareholders’ approval for the deal. BHP is due to reveal its results today, and markets expect to see net income of around $13.3bn for the year to 30 June.

 

The suitors

Bill Doyle told the FT there is a “large universe” of potential bidders for the company. Reuters reported him as saying: “If there was one good thing about the low-ball offer that BHP put in, it shined an incredibly bright spotlight on the value that is PotashCorp.”

Other likely candidates for putting in bids include the Brazilian firm Vale and Aluminum Corp of China Ltd (Chalco).

But a bid from either of these two companies, especially the Chinese firm, will be deeply contentious in Canada. By contrast, polls taken in the home media suggest the local population are quite relaxed about a BHP takeover. After all, the potash deposits are where they are. It matters not what nationality the company is that owns PotashCorp, the mining will still occur in Saskatoon.

Another potential bidder is Rio Tinto, although last week its boss Tom Albanese told Bloomberg: “I’m not a farmer. I’m a miner.” This was a slightly odd comment. After all, potash is extracted from mines.

 

The cycle

Despite the potash cartel’s attempt to control the price of this good, the story of potash has been a pretty good example of the way the market cycle operates. The price shot up during the boom, and crashed during the recession. If potash production is anything like oil, the cycle is supported, because when the price is high investment in capacity takes place; this leads to greater capacity which in turn can mean supply exceeds demand so price falls, and investment in capacity drops off until capacity falls below demand and then the cycle begins again.

There are no prizes for guessing that the price of potash will rocket over the next few years.

However, there are other issues here. It is possible that as demand grows, and prices go up, we will find other superior or cheaper alternatives to potash. Maybe, for example, greater use of genetically modified crops will make the use of fertilisers less important.

© Investment & Business News 2013