Taking a notch out of BHP’s fifth pillar

BHP has decided to trim its spending on the Jansen potash project in Canada as it reins in boom-time capital investment plans, but argues that will not affect the longer term development of the project.

BHP Billiton’s decision to trim planned spending on its Jansen potash project in Canada is, at face value, at odds with the glowing contemporaneous commentary about the group’s prospective ‘’fifth pillar’’ in today’s quarterly report.

Despite the big cutbacks to its investment program as part of Andrew Mackenzie’s attacks on costs and capital intensity, BHP had budgeted to spend $800 million on Jansen this financial year as part of a $US2.6 billion investment ahead of any full-scale go ahead for a project whose capital costs have been estimated at around $US13 billion to $US14 billion.

Today BHP said spending on Jansen this financial year was now expected to be about 25 per cent, or $US200 million, lower than the previous guidance as it sought to ‘’modulate’’ the pace of development and ‘’time our entrance to meet market demand, thereby maximising shareholder returns’’.

The cut-back in spending means the access and production shafts BHP is sinking at Jansen will no longer be completed in their original timeframe but BHP said this would not affect either its budget or longer-term plans for the project.

Jansen,  if it gets an eventual go ahead, would take four or five years of construction before it started and then a decade to ramp up to full production – BHP said that on its current projections for market demand the mine could ramp-up to its theoretical design capacity of about 10 Mpta in the decade beyond 2020.

BHP continues to believe that Jansen is the best undeveloped potash resource in the world, among the lowest-cost once fully developed and that it could ‘’underpin a potential fifth pillar’’ of the group, sitting alongside its core iron ore, coal, petroleum and copper businesses.

The reduced spending on Jansen coincided with an outbreak of speculation in Canada that BHP might have a second crack at Potash Corp. Under Marius Kloppers BHP made a $US40 billion bid for Potash Corp in 2010 that was blocked by the Canadian Government.

There have been some big changes in circumstances since that bid failed. Bill Doyle, CEO of Potash Corp for nearly a decade and a half, played a pivotal role in galvanising opposition to the bid. He retires mid-year to be replaced by former Inmet Mining CEO, Jochen Tilk.

BHP has continued to invest and employ heavily in the Saskatchewan province while Potash Corp has been reducing production and shedding employees, which gives it somewhat stronger recognition and credibility within the province and Canada than it had in 2010.

More particularly – and this argues heavily against a bid – the market has changed, with potash prices down almost 30 per cent, or about $US100 a tonne, last year and massively below where they were in 2010.

Capacity has been withdrawn – Potash Corp itself has slashed production – and continues to be withdrawn after a break-up of the Russian potash cartel, a marketing joint venture between Russia’s Uralkali and Belarus’ Belaruskali, saw Uralkali prioritise volumes over price (which Doyle, the leader of the North American potash cartel, has described as ‘’probably the single dumbest thing that I’ve ever seen’’.)

While Uralkali lifted its global market share from 17 per cent to 23 per cent last year and it operated its mines at full capacity, its earnings fell 58 per cent as its average export price fell 28 per cent to $US268 a tonne.

Despite the fact that demand for potash continues to grow at its long-term average of about three per cent a year and demand did appear to improve towards the end of last year, there is an increasing amount of capacity on the sidelines.

Given the long lead time for Jansen to be brought into production and then ramp up to full production Mackenzie won’t be particularly concerned about the state of the current market but the Uralkali move has provided a better insight into the fundamentals of a market where there is now a strong element of market-related pricing where previously the price was manipulated by the Russian and North American cartels.

The longer term outlook for demand is what attracts BHP to potash. As developing economies push up the wealth curve their demand for protein – and for fertilisers in circumstances where there are limitations on the availability of arable land – ought to rise strongly.

There is, however, no rush to invest urgently and heavily against that prospect at a time when BHP and its peers are far more focused introspectively on lowering boom-inflated cost bases and reining in previously profligate capital investment programs.

That, incidentally, argues against a bid for Potash Corp. BHP was prepared to bid $US40 billion for Potash Corp when potash was trading at nearly $US400 a tonne (having almost touched $US900 a tonne in 2009).

Today Potash Corp’s market capitalisation is just under $US30 billion, implying that a bid would have to be pitched at a very similar level to the 2010 bid to succeed – BHP would be paying the same amount for a group producing significantly less and getting a significantly lower price for what it does produce.

It is extremely doubtful that Mackenzie, his chairman Jac Nasser or BHP shareholders would even contemplate a major acquisition of anything in the current environment of lower commodity prices, uncertainty about the near term demand for commodities from China, the wider question marks over the European and US economies and shareholder demands for a better share of returns.

In any event, like Jansen, Potash Corp is an option that doesn’t have to be exercised in the near term, if ever. If either were to be exercised, it would be better to do so within more stable settings for commodities generally and potash in particular.

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