Potash Pricing Floor Doesn't Signal a Recovery

The recent potash deals with China provided the market some hope for a floor in pricing, but investors shouldn't confuse that with a recovery. The pricing for potash slumped during 2013 due to a disagreement between the Belarusian partners of Belaruskali and OAO Uralkali. The high margins afforded North American potash producers were smashed, sending shares of PotashCorp  (NYSE: POT  ) , Mosaic (NYSE: MOS  ) , and Intrepid Potash (NYSE: IPI  ) down to multi-year lows.

Last week, agreements from both Canpotex (the North American marketing partnership between Potash, Mosaic, and Agrium) and Uralkali were for 700,000 metric tons of potash in the first half of 2014 at market prices. Canpotex didn't disclose the price, while Uralkali accepted a settlement of $305 per metric ton. The pricing possibly provides for a global floor for potash prices, but it in no way indicates any recovery in pricing.

Without indications of a full repair of the Belarusian marketing relationship, it will be impossible to increase prices back to the levels of $400 per metric ton from prior years. Also, it seems unlikely that prime buyers in China and India will support a return to higher prices -- especially considering all of the domestic producers continued to generate solid margins and profits, suggesting the market doesn't need higher prices to survive.

Important deal
The Canpotex deal with China is important considering the recent news back in Oct. that Russia had taken a 73% market share in the Chinese market. Uralkali's market share surged from only 26% back in May. A willingness by Uralkali to lower potash prices to grab Chinese market share makes it a concern that Canpotex got this deal based on bottom basement pricing. The lack of disclosure regarding pricing adds to that concern. The deal is important unless Canpotex is engaging in a pricing race to the bottom.

Still inflated margins
The biggest long-term problem with investing in potash stocks remains the inflated margins due to the marketing arrangements. Even at these lower potash settlement prices for the first half of 2014 with the Chinese, the prices mostly matched the spot market since the July breakup of the Belarusian partners. In that scenario, PotashCorp, Mosaic, and Intrepid Potash all generated what most users of the fertilizer would still consider large profits.

In fact, both PotashCorp and Intrepid Potash undertook cost reductions in order to maintain high margins in the face of declining prices. Could this be a never-ending race to the bottom?

Intrepid Potash recently undertook a plan to reduce annual costs by $15 million, or nearly 5% of revenues. For the first nine months of 2013, Intrepid Potash had costs per ton sold of $253 compared to a net realized sales price of $363 per ton.

PotashCorp recently reduced its workforce by a substantial 18% in order to achieve a 2016 targeted reduction of $20 to $30 per ton. During the third quarter, potash contributed margins of $148 per ton. Based on stable prices, PotashCorp would command huge margins of $170 per ton in a few years.

Mosaic generated $133 gross profit per ton, or a 35% gross margin. Potash isn't nearly as important to Mosaic considering it obtains 75% of revenue from phosphates, but during the third quarter gross profits were roughly equal between the two fertilizers.

Bottom line
The recent potash deals with the Chinese brought the markets hope that a market floor had been reached. Unfortunately for investors, the still-inflated potash margins bring into question whether the market will ever recover. The current climate isn't supportive enough of the potash marketing cartels to warrant further investments at this time. Investing in PotashCorp, Mosaic, and Intrepid Potash requires trust in a relationship between Belarus and Russia, which doesn't make for a solid long-term plan.

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