By Steve Halabura
Here is an investment thesis I’ve heard this summer: fertilizers, and by association, potash, is heavily oversold, thus discrediting any claims that fertilizer shortages will create opportunities for production expansions in the near to medium term.
Wrong!
How can I say this given the drop in potash prices and poorer than expected share price performance of the fertilizer majors over the past year?
Hear me out on this.
I am most likely to hear the “potash is oversold” thesis from my contacts in the investment community, who are not investing directly in the sector, like a pure potash production company would do, but into the equity markets within which those same producers are listed. The big potash producers are integrated fertilizer producers, so they hang their performance upon nitrogen and phosphate, alongside potash.
Because the title of this publication is The Potash Producer and not The Nitrogen Producer or The Phosphate Producer, I will not delve into some of the deeper aspects of why nitrogen prices have been a serious drag on fertilizer companies over the past year; however, I will dive a bit deeper into potash as a pure fertilizer play.
While the sector has underperformed compared to 2022, what I am disputing is whether this can be taken as a proxy of the future of the potash sector. Therefore, let me propose an antithesis: the underlying potash market supply and demand is not properly accounted for in what we see reflected in the performance of potash producers share prices. I base this upon several factors:
- While market performance in 2023 is down from 2022, it is still much better than 2021.
- Most of the big producers are not pure potash plays.
- Equity markets reflect corporate, not operational initiatives.
- Market disruptions abound.
- Addition to new production capacity is hampered by larger macroeconomic impacts.
While all five points have validity, the key point is this: while 2023 is not as good as 2022, it is better than 2021, and most definitely better than the production and price performance over the past decade.
What do I base this claim upon?
I have said this many times before: the best public source of information about the health of the global potash sector is from the Province of Saskatchewan (Check it out yourself, here is the link: https://dashboard.saskatchewan.ca/business-economy/business-industry-trade/mineral-sales#by-commodity-tab). Please note one peculiarity about the data I am about to present – the province reports its production and sales in “tonnes K2O equivalent”, not KCl or product tonnes. If you want to think in terms of product tonnes, just divide the tonnes K2O by 0.6317.
Let’s begin with potash production, beginning with a comparison of the month of June 2021 to June 2022. In 2021, mines produced 1,074,048 tonnes, while in June 2022 those same mines produced 1,331,314 tonnes, an increase of 24 per cent. June 2023 saw production of 953,622 tonnes, which is a 28 per cent drop from 2022. However, compared to 2021, 2023 production was down by only 11 per cent. Comparing year-to-date numbers for 2023 to 2021, production is down only 9.5 per cent.
The next comparison is potash sales. Comparing the month of June 2021 to June 2022, 2021 potash sales were $580 million, while in June 2022 sales were $2 billion, an increase of 250 per cent. June 2023 saw sales of $615 million, which is a 70 per cent drop from 2022. However, compared to 2021, 2023 sales are up by six per cent. It’s even better when we compare the year-to-date numbers for 2023 compared to 2021, as sales are up 106 per cent.
Last, let’s look at realized price. The month of June 2021 compared to June 2022 saw a realized price of $540 per K2O tonne in 2021 compared to $1,527 per K2O tonne in 2022, an increase of 183 per cent. June 2023 saw a realized price of $645 per K2O tonne, which is a 58 per cent drop from 2022. However, compared to 2021, 2023’s realized price is up 19 per cent, and on a year-to-date basis, 2023’s realized price is up 128 per cent.
What do I make of this? Yes, 2023 when compared to 2022 is disappointing, but when 2023 is compared to 2021, it’s doing pretty good! Let’s take a broader look at the question of pricing and production.
The above charts look back 12 years and they show some interesting trends.
Annual production since 2011 show steady growth of about 550,000 tonnes per year, which by my calculation is about 3.9 per cent annual growth per year. There is a decline in production from 2022 to 2023; however, I would attribute this to demand destruction forcing production cutbacks, as well as difficulties in shipping potash from Canadian ports due to labour strikes. Note that 2022 saw no production spike, which I attribute to the inability of current producers to expand production. Hence, Nutrien’s announcement last year to expand production capability and in turn, its retraction in August 2023.
If we look at the price chart, the overall price trend was downward until 2020, when prices began to rise. Clearly the 2022 price is a spike that, in my opinion, was induced by several geopolitical factors, but when compared to the long-term trend, 2023 is dramatically higher than the preceding decade trend.
What can we take away from this analysis? Here are my conclusions:
First, the geopolitical forces that buffeted the potash sector in 2022 and in 2023 may have had little long-term effect on production, and it’s reasonable to conclude that demand growth will continue to be between 2.5 per cent and 4.5 per cent per annum, depending upon who is your market guru.
Second, the price spike of 2022 demonstrates to me that potash is very sensitive to farmgate price, and if prices rise above a certain level, then demand will be curtailed. The lesson to be learned is that any future enterprise with the ambition of entering the potash production space must be focused upon two operational imperatives: first, low capital expenditure for mine installation, and second, low operating expense. The only way to achieve these imperatives will be by deploying smaller, technologically advanced mines, and brownfield expansions of existing operations. A good example is Mosaic’s announcement in August that it intends to reopen its shuttered Colonsay underground mine – it’s far cheaper to reopen an old mine than it is to build a new mine from scratch.
Third, a short-term outlook may work in the public markets, but it is the wrong way to look at investments in potash. My experience is that the average investment-backed oil project may have a lifespan of 10 to 20 years, but a Saskatchewan potash mine? Try 75+ years. Mosaic’s Esterhazy K1 and K2 mines had an effective life of about 60 years, and their abandonment was the result of brine inflows, not ore depletion.
Fourth, geopolitical considerations have significant impacts upon potash supply and demand; however, underlying these influences, there is a real and steady growth in demand for potash. Population growth, food insecurity, and climate change will have far greater impact over the next several decades than anything else.
‘Nuff said …
