maandag 26 augustus 2013

Allana Potash Nearing Construction Financing

Following the news on July 30, 2013, that Russia’s OAO Uralkali was abandoning Belarusian Potash Co., a joint venture with rival Belaruskali of Belarus, the whole potash industry's stock market fell around 20%. Two cartels, Canpotex (PotashCorp, Mosaic and Intrepid) and BPC (Uralkali and Belaruskali), which control 40% and 30% of the potash market, would split up into three cartels: Canpotex, Uralkali and Belaruskali.

Uralkali said it would be focusing on production volume, which means they would sell more potash following the breakup of the cartel. As a result the capacity will grow on this news. The question is, how should investors play this news? Should they buy the dip in potash stocks or sell out?

Today, a month after this news, we already see that potash prices have fallen 5% just recently. Prices for spot shipments of the crop nutrient from Port Metro Vancouver recently slipped $20 (U.S.) to less than $400 a tonne, while there are preliminary signs of market softness elsewhere, including slightly discounted potash prices on rail shipments to China. So, it looks like potash prices are indeed softening.

We know that demand is still growing as potash deliveries are dependent on population growth in the Asian world and that number is still growing at a rate of around 5% per annum. If we bring this number down to world population growth, we have a growth rate of 1.1% per annum. Demand for potash is pretty inelastic, so it could be that some years demand will be higher due to lower potash prices, while other years will have less demand due to high potash prices. Overall, the demand side looks positive. According to Green Markets, a fertilizer industry information provider, demand will increase 26% to 66 million tons. Now let's look at the supply side.

Chart 1: Potash Delivery Vs. Population Growth
The potash industry is having a pretty high capacity utilization rate of around 80% (not as high as compared to a typical 90% capacity utilization rate in the mining industry), but let's say there is overcapacity at the moment. As capacity is set to grow due to the breakup of the cartel, we could see falling potash prices. At this moment, the marginal cost of potash production is around $280/tonne. So we could see potash prices fall another 30% to this level due to an increase in supply. It is estimated that supply will go to 96.5 million metric tonnes by 2017, according to Green Markets.

A good metric to predict potash prices is to look at the capacity utilization trends. The capacity utilization rate is a leading indicator for future inflation. When capacity utilization goes up, we can expect a similer increase in price in about a year from now. We can use this theory to predict potash prices.

Chart 2 gives the potash capacity utilization projection. As you can see, the capacity utilization plunged from 90% in 2007 to 50% in 2009. This corresponded with a drop in potash price from $870/tonne in 2009 to $312/tonne in 2010, exactly a one year lag as predicted by this correlation between capacity utilization and prices.

If we then look at what is happening in 2013, we see that the capacity utilization rate is pretty flat, so I don't expect any huge movements in price in the coming years, but prices could certainly soften to around marginal cost of production. If we look at the Green Market numbers, we would get 66 million tonnes and 96.5 million tonnes by 2017. That's a capacity utilization of around 70%. This really isn't all too bad, considering the plunge to 50% in 2009. Also consider that many of the mines won't come into production at the current price of $400/tonne.
Chart 3: Potash Price (KCL)
The conclusion is that this breakup in the BPC cartel can definitely lower potash prices to around $300/tonne. If you know this will happen, you should invest only in those projects that are low cost. Many development projects need at least a $400/tonne potash price to be economically viable, according to Patricia Mohr, vice-president and commodity market specialist at Bank of Nova Scotia. Knowing that potash prices could go lower than this level, I would be very wary about development companies. Investors should look at low cost producers that are fully funded.

One of my favourite plays was Allana Potash (ALLRF.PK) and it is still my favourite. I have written about this company a year ago. Even though Allana Potash has declined since then (together with the whole commodity market and mining industry), the news gets better and better. Allana Potash's valuations have only improved and the company has all the ingredients to make it into a producing mine.

Read about Allana Potash here.

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