Markets: Questioning BHP's persistence on potash

As a BHP Billiton Ltd shareholder would you prefer a capital return equivalent or a long-term commitment to potash?

With over $US6 billion sitting on its balance sheet, BHP has to do something with the cash, but an investment in potash in the current market is a questionable strategy.

The only comfort BHP shareholders can harvest from the pursuit of the potash project Jansen in Canada is it looks like the alternative – an acquisition of New York Stock Exchange-listed fertiliser maker The Mosaic Co – is on ice. Mining magnates don’t have the best record when it comes to acquisitions – remember Rio Tinto’s disastrous $US38 billion purchase of aluminium miner Alcan in 2007.

BHP has committed to invest a further $US2.6 billion in the massive Jansen project on the basis the long-term outlook for potash is compelling. With Jansen not tipped to be producing until 2020, there is much time for the potash market to adversely change even further. If potash prices fall to $US300 per tonne or even lower, the value Jansen will deliver to shareholders becomes even less.

In addition to what has already been spent, the total committed to the project is now at $US3.8 billion. The amount looks trivial given BHP has a market capitalisation close to $190 billion, but it appears an extreme commitment in light of the events unfolding around potash.

While the pursuit of potash would provide additional diversification for BHP, it is surprising chief executive Andrew Mackenzie has made this decision in the current environment. In a time where BHP’s core commodity prices have fallen, it certainly doesn’t hurt to consider diversifying the portfolio but timing and choice are perplexing.

BHP can certainly afford the project, but it is a completely separate thought to be confident over the long-term value to shareholders the project can deliver.

Commodity prices have proven to be volatile and unpredictable. In 2007 the iron ore spot price was $US190 per tonne. Today it is $US138. No one expected that iron ore would be trading lower than the 2007 price – or that it would hit a low of $US87 not so long ago. As we know, commodity prices drive share prices.

There are no fundamentals to suggest potash won’t suffer a similar fate.

With Jansen not tipped to generate revenue until 2020, there is a long time for the potash market to change. Support for the price of potash over the longer term includes increasing food consumption and logically, an increased demand for potash. However, the question is not over agricultural demand but rather the actual price of potash. Taking bets on the future price of commodities is risky business.

Committing to a potash project so soon after the major cartel supporting the price has broken up just doesn’t make sense. BHP could delay the investment decision until there is more clarity on how potash prices will be affected. Potash miner Potash Corp of Saskatchewan (which BHP tried to buy in 2010) has been pushed down 21 per cent since news the potash cartel was breaking up. Evidently the market isn’t positive on the immediate outlook.

If BHP has nothing else to spend its cash on in the short term it wouldn’t be a bad idea to give some money back to shareholders. An off-market buy-back or special dividend spring to mind.