A major U.S. investment bank following the potash sector sees a “ratcheting up” in the sector’s risk profile that may suggest a possible shift in market competition in the longer term.
In a recent report on its longer-term view of the potash market, New York-based Dahlman Rose and Co. admits to “major misgivings” about just assuming fertilizer market conditions seen from 2005 to the third quarter of 2008 will return anytime soon, even if one omits the “extreme run-up” seen in the first half of 2008.
The bank’s research coverage of the ag chem sector includes Saskatoon-based PotashCorp, Calgary’s Agrium and U.S. firms Mosaic Co., CF Industries and Intrepid Potash. And it says it’s “skeptical” about assuming potash players will be able to return to their 2007 peak sales volumes by 2011 or earlier.
“Forget the farmers’ dissatisfaction with their recent treatment by suppliers,” the company wrote, “we just do not see a catalyst, short of a major miss in grain production, driving demand back to those levels in that time frame.”
With that in mind, Dahlman Rose wrote, it remains “very concerned regarding the long-term status of the potash market and its ability to fully retain the power of its oligopolistic structure.”
An oligopoly refers to a situation in which a market sector has just a relatively tiny number of producers or sellers, thus limiting the level of competition. “In our view,” Dahlman Rose wrote, “the (potash) oligopoly’s discipline has formed the backbone for the group’s valuation.”
And if cracks do start to show in that structure, “farmers should be better off, because (such an event) is liable to create a better price trajectory than one might otherwise assume,” said Charles Neivert, managing director of Dahlman Rose’s agriculture and chemicals research division, in an interview.
Less market discipline among the industry’s players could mean a more competitive process in terms of farmers’ potash costs, he said, if another four, five, six or more players were to enter the market.
From the perspective of a provincial government such as Saskatchewan’s, which has previously relied heavily on resource revenues from its potash sector, “it might be a toss-up,” said Neivert, who until May 2009 led Morgan Stanley’s fertilizer chemical equity research practice.
If the province doesn’t change how it taxes the potash sector, it could come out better, worse or the same, he said. It’s possible, he said, that the province could get more value out of its potash supplies if even one more player were to take a position in that sector.
“Ill will” rising
“It is our sense that a far more gradual rebound in volume (except for the increase into 2010 from the exceptionally low demand of 2009) is in store for the market for at least the next two to three years,” Dahlman Rose wrote.
“As a result, we see little urgency from buyers to purchase product, unlike 2007 and 2008 when there was a fear of not being able to get potash.”
In that period, potash producers were “running flat out” without much near-term upside capacity capability, Dahlman Rose said. However, even assuming demand of 50 million tonnes in 2010 and that producers can clear out their “enormous” inventory, there remains “plenty of capacity upside.”
Among recent data that “significantly” raise Dahlman Rose’s concerns are the “stubbornly high” potash inventories of North American producers; Agrium and Vale advancing their plans for new capacity; lower pricing out of Brazil; and lower prices being paid for product by buyers such as Vietnam and Sri Lanka.
On top of those, the company noted events building over the past six to nine months, including the “escalation of customer ill-will toward producers,” inventories worldwide rising since the third quarter of 2008 to levels “well above the norm” and the politicizing of China’s potash negotiating team.
With those issues in mind, the company asked in its report, “is there the possibility that the disciplined oligopoly structure for potash and its ability to buffer pricing from supply/demand fundamentals may be weakening, in much the same way that OPEC’s hold on the oil markets was weakened following the 1980 price peak?”
Dahlman Rose said it would keep its “hold” rating on both PotashCorp and Denver-based Intrepid Potash, but “we note the ratcheting up of the risk profile.”