A major new scenario

We look in this issue how well the leading fertilizer companies are performing financially. (Financial performance – a slow return of confidence, p18.) The short answer is not too badly. Most producers managed to withstand the worst effects of the credit crunch and collapse in demand to return to profitability by the fourth quarter of 2009. That positive momentum continued in the first quarter of 2010.
Another manifestation of the improved financial climate is the resurgence of merger and acquisition activity, marked by the final resolution of the long-running battle for control of Terra. Financial analysts love a good M&A battle and they have been salivating at the thought that such activity will accelerate during the course of the year. They believe that the nitrogen sector is particularly ripe for consolidation, as fragmentation is much greater. Some analysts have been eager to suggest the names of the companies that are thought to be susceptible to take-over bids, but their speculative writings have so far turned into nothing concrete.
Of much greater interest to all market observers has been the intense interest that leading mining companies have begun to manifest in fertilizer raw materials. BHP Billiton’s acquisition of the junior mining company Athabasca Potash was concluded in January 2010 at $323 million – a sum that was seen as small beer for this, the world’s largest mineral resource company. BHP Billiton previously picked up the potash assets in Argentina and Canada that Rio Tinto had briefly held. Having sloughed off other under-performing assets, including the White Elephant of the Ravensthorpe nickel project, BHP Billiton had been widely expected to withdraw from the potash sector - one which it should be noted has yet to yield the group a single dollar of revenue.
BHP Billiton’s recent capital market presentations have placed potash to the forefront of the group’s development strategies, and the company has declared that “to create a world-class potash business will require more than a single mine.” The Jansen project is the most advanced project in BHP’s potash development portfolio and BHPhas indicated that the neighbouring greenfield projects at Boulder and Young, Saskatchewan are waiting in the wings to proceed with development. “Potash is strategically important for BHP Billiton, offering the group an avenue for significant growth and further diversification by commodity, customer and geography,” said one BHP president.
Brazilian mining group Vale has issued a similar declaration of strategic intent. Its fast-expanding fertilizer commitments embrace both the potash and phosphate sectors. The group’s chief financial officer, Fabio Barbosa, said in August 2009 that Vale’s ambition was to become a major force in the phosphates and fertilizer sector, and its interests went “further than just mining.” The subsequent months proved a veritable whirlwind as Vale spent over $5 billion in acquiring fertilizer assets, including gaining a majority stake in Fosfertil, Brazil’s largest producer. “Carnaval has come early to Brazil this year,” commented a Financial Times editorial (14 February 2010).
Vale’s rapid advance was seen as partly the result of prodding from President Luiz Inácio Lula da Silva, who had berated the country’s hitherto fragmented (and partly foreign-owned) fertilizer industry for being slow to exploit the country’s mineral reserves and raise self-sufficiency. It is clear that President Lula had the Chinese model in mind: within barely a decade, China had transformed its nitrogen and phosphate fertilizer sector from being one reliant mainly on imports to become an exporter with a global-market impact.
The FT observed that President Lula had previously exerted pressure on Vale to invest in the Brazilian steel industry in order to reduce the risk of Brazil exporting all of its iron ore output to Brazil and in consequence would have to import Chinese steel. The FT questioned whether Vale’s sudden foray into downstream fertilizers was a rational move for a company whose core activity had been iron ore or another response to political bidding. It noted that the government still retained a 40% golden share in Vale and speculated whether the Vale move was part of an official strategy to strengthen Brazil’s role as a global fertilizer producer. Vale meanwhile insists that its investment in fertilizer and associated raw material assets is market-driven, and notes that analysts are unanimous in indentifying the sector as one offering consistent long-term growth.
The Financial Times seems to have accepted Vale’s wisdom in that respect, noting also that “previous Vale bets on coal and nickel have paid off.”
The costs of entry into fertilizers and associated raw materials is high. Expect to pay around $3 billion to bring a new potash mine into production and between $1-1.5 billion for new nitrogen and phosphate facilities. This has not deterred a large number of junior mining companies from proposing new developments around the world, including such locations as offshore Namibia, Ethiopia and the Democratic Republic of Congo. These companies had announced their projects in the heady days of escalating commodity prices in 2007 and early 2008. Despite the subsequent poor climate for investment, the junior minors have not gone away: most of their projects report continuing progress with exploratory drilling programmes and feasibility studies.
Established potash and phosphate producers may view the junior miners as upstarts, as was evidenced at the recent BMO Capital Markets fertilizer conference. BMO itself noted that ”financing commitments have not materialised for any of the leading potash projects managed by the junior developers.” Representing the established potash producers, Bill Doyle swatted away any notion of intensified competition from the wave of new projects, whether promoted by a major or a junior: “People ask us about our competitors, but they are not producing,” he said. “So they are not competitors. No-one knows more about building potash capacity than we do, and we are not too worried.”
A major new scenario for fertilizers and raw materials? Or just a group of financial analysts getting over-excited? Let us return to the issue one year hence.