Why Potash Producers Should Be Worried About This Development

Rio Tinto's entry into potash market would put pressure on prices and margins.

Jul 8, 2014 at 11:39AM

Potash prices tumbled last year following the breakup of the Belarusian Potash Company (BPC), which led to a bearish outlook for the potash market. The major concern was that prices would drop below $300 per ton, hurting the margins of major producers. However, the outlook for the potash market has improved since the start of this year as prices have remained resilient.

Indeed, last month, the outlook improved even further as Uralkali, which was responsible for the breakup of the Belarusian Potash Company, announced a production cut to support prices. But just as potash producers such as Potash Corp. (NYSE:POT) were growing in confidence, Rio Tinto (NYSE:RIO) and its partner announced that they would be moving forward with their potash project in Canada. Rio's entry into the potash market would put pressure on prices, albeit in the long-term. Still, the development is likely to worry potash producers.

Improved outlook for potash market
When Uralkali broke up its joint venture with Belarus last year, the biggest fear was that potash prices would drop below $300 per ton. Uralkali had walked out of the joint venture to increase its market share. While potash prices fell sharply after the breakup of BPC, they never fell below $300 per ton.

In fact, prices have been resilient. As I noted in an article back in April, Uralkali this year signed agreements with Chinese and Indian customers to sell potash at prices above $300 per ton. Canpotex also signed agreements to sell at prices above $300 per ton. Indeed, as I noted back then, the agreements meant that potash prices had a floor and ended a great deal of uncertainty over prices.

The outlook for potash market improved even more last month after Uralkali cut its production target for the year by around 8% in order to support prices. The company lowered its production target from 12 million tons to 11 million tons. Uralkali's CEO Dmitry Osipov noted that the company will continue to consider market conditions when weighing production levels.

Uralkali's surprise production cut proved that despite the breakup of one of the cartels operating in the potash market, producers were sensitive about prices.

The improved outlook even prompted Potash Corp. to rescind its previously announced layoff notices at its Penobsquis, New Brunswick facility. The company noted that given the ongoing tightness in the granular potash market, the temporary extension in operations will allow continued production from the Penobsquis mine. Not surprisingly, Potash Corp. shares have done well so far this year, gaining more than 14% year to date.

Rio's entry a worry
Just as the outlook for the potash market was turning robust, Rio Tinto and Russia's Acron OAO said that they are moving ahead with the development of the Albany potash prospect in Saskatchewan. In a statement released late last month, Acron said that the project area consisted of 1.4 billion tons of inferred resources, with recoverable amount at 329 million tons. According to Acron, the next steps for the project include continuation of environmental assessment and the pre-feasibility study.

Rio's rival and mining giant BHP Billiton (NYSE:BHP) also intends to enter the potash market. After failing to acquire Potash Corp., BHP Billiton invested in the Jansen project in Canada. The Jansen project is much larger than Rio's potash project in Canada. However, BHP has delayed production until at least 2020.

Rio's project is also not expected to come online in the near term, which would be a relief for potash producers. However, the entry of mining giants such as Rio and BHP Billiton is a major worry for producers in the long term as it will put pressure on prices and margins.

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Varun Chandan Arora has no position in any stocks mentioned. The Motley Fool owns shares of PotashCorp. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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