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Is It Wise for Rio Tinto to Join the Potash Game?

Potash prices remain under pressure following a steep drop in 2013, but this isn't stopping Rio Tinto (NYSE: RIO  ) . The mining giant is continuing the development of the Albany potash project in Canada together with the Russian fertilizer producer Acron. With this move, Rio Tinto joins another diversified miner, BHP Billiton (NYSE: BHP  ) in an effort to expand in potash. Is the space getting crowded?

Betting on growth of the world's population
The UN projects the world population will grow from 7.2 billion in 2013 to 8.1 billion in 2025 and 9.6 billion in 2050. All those "extra" people will need food. At the same time, the quantity of land for farming won't increase at such a pace. Thus, land productivity will have to rise, which will drive demand for fertilizers.

However, the world's population growth has yet to translate into higher potash prices. Potash Corp. (NYSE: POT  ) and Mosaic (NYSE: MOS  ) have already felt the consequences of lower pricing. Potash Corp.'s average realized potash priced dropped 31% in just a year, and drove revenue 20% lower despite higher sales. Mosaic's revenue drop was smaller, helped by the company's big exposure to the phosphate market, which was under less pressure. No wonder Mosaic was happy to acquire CF Industries' phosphate business this year, and continues its participation in the phosphate project in Saudi Arabia, which has just gotten a $5 billion financing deal from a group of banks.

The growth of demand itself does not guarantee higher prices, because the supply situation matters as well. On this front, a lot of new potash could come from BHP Billiton's Jansen mine when it finally starts production. BHP Billiton has taken a cautious approach on the gigantic project because of the current pricing softness, but chances are the threat of this new huge player on the potash field will be evident by the end of this decade.

Will potash fit into Rio Tinto's business?
Currently, the iron ore segment dominates Rio Tinto's revenue and earnings. The company is also a large producer of aluminum, copper, and coal. Rio Tinto's smallest segment by revenue is diamonds and minerals. The company was trying to sell the diamonds business last year, but it dropped the plan because of low pricing. A diversification into potash seems like a sound strategy if Rio Tinto will be able to keep the project's costs at bay.

There's still no info regarding the capital spending that will be needed to develop Rio Tinto's potash mine. However, one can assume this will not be an easy journey given BHP Billiton's experience with the Jansen mine. Apart from current price softness, the emergence of two big deposits at the same time could have a shocking effect on markets.

What's more, population growth does not necessarily translate into an equal rise in fertilizer demand. There could be many obstacles to the growth of fertilizer usage, even if a certain country needs it. The situation in India, where the tough situation with government subsidies has curbed fertilizer demand, is a vivid example.

How Rio Tinto will be spending money at its new potash project is of utmost importance. A phased approach is preferred in current conditions, as there is a possibility of burying a lot of money into the mine only to realize that the market is still oversupplied.

Bottom line
Rio Tinto's move into potash is interesting. The company follows BHP Billiton's steps. However, BHP's route has not been easy and straightforward, and this is what could await Rio Tinto.

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Vladimir Zernov

Vladimir Zernov believes that fundamental analysis works best with energy and materials stocks and covers them on Motley Fool.

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9/1/2015 2:16 PM
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