BHP sees fertile ground in Russia's potash moves

BHP Billiton would be monitoring the byzantine manoeuvrings around Russian potash giant Uralkali closely, with the eventual outcome likely to have significant implications for the future structure of the potash industry that BHP still has ambitions to enter.

Earlier this week the $US575 billion Chinese state-owned enterprise, China Investment Corp, converted bonds issued by Uralkali that it held into a 12.5 per cent equity stake in the world’s biggest potash producer, giving it a stake valued at something north of $US2 billion.

CIC’s move comes as major changes in the ownership of Uralkali are afoot.

In July Uralkali stunned the potash sector by withdrawing from the decade-long marketing joint venture it had with Belarus’ Belaruskali.

That joint venture, which controlled about 43 per cent of global potash supply, formed an informal cartel with a similar Canadian marketing joint venture between Potash Corp, Mosaic and Agrium which accounted for a further 30 per cent or so of global supply.

Apart from triggering an immediate dive in prices because Uralkali, the low-cost producer with the most unused capacity in the sector, made it clear that in future it would prioritise volume over price, the decision to break away from the cartel produced a sharp political response.

Belarus jailed Uralkali’s chief executive, Vladislav Baumgertner, and demanded that the company’s largest shareholder, Suleiman Kerimov, sell his 22 per cent shareholding. It also issued a warrant for his arrest.

Kerimov, with two fellow Russian billionaires, controls about a third of Uralkali. It appears that all of their shares are now on the market with a host of interested parties circling. A number of Russian bidders, CIC and other Asian entities have reportedly expressed interest, although there is some scepticism that the Russians would allow any greater interest or influence to be held by the Chinese.

China is the biggest consumer of potash, accounting for about 10 per cent of global demand. It imports about 70 per cent of its potash requirements, which are growing rapidly in line with its rising living standards.

The longterm outlook for potash is very strong as the developing economies in Asia shift up the wealth and protein curves and the need to improve the productivity of arable land rises.

Uralkali has declared itself committed to its newly-independent stance and strategy, which it could afford to pursue because it has a substantial cost advantage over the other major producers. Its production costs are about $US60 a tonne and it has generated EBITDA margins of about 60 per cent. It has announced plans to lift production by a third over the next couple of years.

When it broke away from Belaruskali, it also announced a deal with a Chinese fertiliser company to supply about 10 per cent of China’s annual potash requirements. The CIC stake could further strengthen the relationship, potentially giving Uralkali a significant competitive advantage over the Canadian producers.

There appears to be an expectation in the industry that, once the dust settles and Uralkali’s share register has been restructured, the Russian cartel will be re-established and CIC’s shareholding will be of little strategic relevance other than as a listening post for the Chinese.

Whether that is the case or not in the longer term may depend on what BHP does.

BHP’s Andrew Mackenzie annoyed some BHP institutional shareholders earlier this year when, in announcing the group’s 2012-13 results, he also committed to a further $US2.6 billion of investment in its Jansen potash project in Canada over the next few years. Some of BHP’s shareholders want the group to halt all investment in new projects.

The investment will enable BHP to finish sinking production and service shafts and associated above-ground services and facilities at Jansen, preserving the option to give the $US13 billion or $US14 billion project a go ahead in a few years’ time. Jansen could be the world’s largest potash mine and among the lowest-cost.

The schism between Uralkali and Belaruskali, regardless of its outcome, is providing BHP with some valuable market intelligence because it gives an insight into how the market might behave if the price were set predominantly according to the supply-demand equation.

The potash price has fallen since Uralkali announced its split from Belaruskali, albeit nowhere near as much as it is expected to fall as Uralkali lifts production. Uralkali itself has predicted a $US100 a tonne decline to below $US300 a tonne.

BHP is committed, as it is across the range of commodities it produces, to market-clearing prices if it gives Jansen a go ahead.  The Uralkali moves provides some insight into where the price might head under its preferred market structure, whether or not the split from the cartels is sustained.

The CIC investment in Uralkali might also provide a different kind of encouragement.

Mackenzie has broadcast BHP’s interest in finding a partner for Jansen, both to share the expense and risk but also to establish a value for a project about which the market has some significant reservations.

A logical minority partner would be a major customer and China is clearly the most strategic and valuable market for potash.

Whether the Canadians, who prevented BHP from acquiring Potash Corp, would countenance a Chinese SOE holding an interest in a such a potentially strategic player within its industry is an open question but, like Uralkali, BHP would no doubt see some merit in trying to improve its eventual access to the Chinese market by creating an alliance or at least a relationship of some sort with the Chinese.

There’s plenty of time for BHP to sit back and watch events unfold within Uralkali, the cartels and the market.

The preliminary works at Jansen to which it has so far committed won’t be completed until 2017. It would take BHP at least a half-decade to ramp Jansen up to full production if and when it gained approval.

What it has done so far is to create a valuable, albeit expensive, option to give the project a go ahead in several years’ time, by which time it will have a far clearer picture of both the supply-side and the extent to which China’s demand has grown and is growing.

Jansen has always been a project geared towards the next decade and beyond rather than for the current market, which is convenient given the current state of flux in the sector.