By John Helmer in Moscow
Uralkali keeps the initiative as potash breaks $600.
A series of Russian government decisions this month, awarding new mining licences at a premium valuation; imposing export duties; and regulating the domestic price of fertilizers for the next five years has triggered fresh forecasts for the direction of Russian potash producers, now the price-setter for the global commodity trade.
The biggest test of the clout of the potash miners began a week ago, on March 12, when the federal mine licensing agency Rosnedra conducted an auction of licences in the Urals region for the mining of new potash reserves. One week later, and the first impression of decisiveness on the government’s part has begun to dissolve, with a fightback orchestrated by the leading producer and exporter, Uralkali.
The official announcement of the March 12 auction said that three licenses to mine potash reserves at the Verkhnekamskoye deposit, in Perm region, had been sold for a total of $2.35 billion. Global reserves of potash are concentrated in Russia, Belarus, and Canada, but all the Canadian deposits have been allocated long since. The Verkhnekamskoye field is one of the largest unmined sources of potash in the world, and the largest ever to be auctioned internationally. When and if mines open in about a decade, the field represents an estimated increase to global potash supplies of 9 to 10 million tonnes per annum. This is roughly equal to the total volume produced in 2007 by Russia’s lead producers, Uralkali and Silvinit combined
Although wishful interest in the bidding had been expressed at one time by the Canadians, Rio Tinto and BHP Billiton, the auction bidding was limited to domestic companies. Acron acquired Talitsky, with reserves estimated at 681 million tonnes, for R16.8 billion ($704 million). Silvinit won the license for Polovodovsky and two associated sites, with just over 3 billion tonnes of reserves, for R35.1 billion ($1.47 billion); and EuroChem’s Kovdorsky potash mining company won Palashersky and Balakhontsevsky, with 1 billion tonnes of silvinite and 500,000 tonnes of carnallite, for R4 billion ($ 171 million).
This looked to industry observers to be an upset, because Uralkali, the sector leader, declined to beat Silvinit’s price for the biggest of the reserves, Polovodovsky. Uralkali had entered the bidding with Russian oil producer, LUKoil, and earlier acquired oil prospecting rights in the same area. Silvinit joined the contest with a state-owned partner, Rosoboronexport. The appearance was of the two potash miners arming themselves differently, one commercially, one politically:
In the preliminaries, there was lobbying of Rosnmedra’s supervising minister, Yury Trutnev, the Minister of Natural Resources, who has been close to LUKoil since his days as the Perm region governor. Silvinit proposed a limit on open bidding, suggesting instead a state review of rival project plans and a state award.
Moscow industry analysts were skeptical that, even with state backing, Silvinit could afford the development cost of a new mine at Polovodovsky. Renaissance Capital reported that the Silvinit-Rosoboronexport project company, KMC “plan to build a 0.5mnt-capacity plant at Polovodovsky over the next two years, with a potential investment of $1.5bn. The volume of investments seems very high.” And that was before the bidding drove the acquisition price to $1.5 billion.
Alfa Bank analyst, Roydel Stewart, who had earlier forecast that Silvinit wasn’t politically powerful enough to ward off a takeover bid, commented on the auction outcome: “We were surprised that Uralkali did not win any licenses.”
Another Moscow analyst, Chris Weafer of UralSib Bank, claimed “the result of an auction again demonstrated that – at least in the so-called strategic industries – there is a very clear advantage in investing with the state.” But he acknowledged that forward correlations made Silvinit’s bid price a risky one. “The price paid was, to say the least, challenging, which gave some degree of relief to Uralkali investors. On one hand, in terms of long term growth prospects, this field was clearly a must win for both companies due to its huge reserve potential. On the other hand, the long-term potash price assumptions required to make this bid IRR positive are not far from the current potash prices. Such a high price (earlier estimates were for USD700-800 mn) assumes a long-term continuation of the current positive momentum in fertilizer prices – not a conservative assumption, but in our view not impossible either.”
Other Moscow sources downplayed the auction acquisition by Eurochem, noting that its site is of primary interest as an oil prospect. The sources add that Eurochem, owned by Andrei Melnichenko, is in the process of being sold to Gazprom, and the cost of the bid is likely to be part of price negotiations ongoing between Melnichenko and Gazprom executives. Price is one of the bones of their contention.
Uralkali CEO Vladislav Baumgertner has said that the prices paid by his competitors were unjustified by prevailing potash prices. Regarding the bid by Acron for Talitsky, Baumgertner said this “would bring a return on investment only if prices at the mine on potassium chloride increased fivefold relative to 2007 prices.”
Talitsky lies close to Uralkali’s existing operating area. The proximity is good for Uralkali, bad for Acron or Eurochem, Baumgertner said. “They have no infrastructure in this area whatsoever, they have no expertise in potash – and finding expertise in greenfield development of potash mines in Russia – where nobody has started a new mine in 20 years – will be very difficult,” Baumgertner notes.
Uralkali can afford to watch and wait. Based on its current licenses, Uralkali has large potash reserves sufficient for about 50 years of operations at 7 million tonnes of output per year. According to Uralkali management, development of new deposits would require significant financial and engineering resources and that the start up of the new mines could take from 7-10 years. In the meantime, Uralkali’s newest mine-5, still on the drawing board, is under feasibility study, with projected capacity of up to 4 million tonnes. The mine could reach full capacity by 2015, with total output reaching 11 million tonnes of product.
But it turns out that the bidding may not be over. A unit of the Rosoboronexport group, Oboronimpex owns the Russian titanium producer, VSMPO Avisma, which draws supplies of carnallite from the Perm potash mines. It was carnallite that was one of the strategic state interests in securing a Perm mining right for the future. But according to Moscow industry sources, VSMPO Avisma has said that it will not accept the $1.5 billion price which has been lodged for Polovodovsky. This move has triggered the threat that it would sell its 20% stake in the licence-holder, Kamskaya Gornaya Company (KGC), leaving Silvinit with a 45% stake, and Lanta, a small Moscow precious metals outfit, with 10%.
According to reports circulating in the press, Silvinit approved the ceiling bid price for the license with all its partners before the auction at a figure that was higher than the winning $1.5 billion bid. The reports also suggest that Silvinit may also come under internal pressure from 20% stakeholder, Madura Holding, Dmitri Rybolovlev’s company, which controls Uralkali. A shareholder revolt may be materializing to vote down the licence acquisition at the next Silvinit shareholder meeting. If that were to happen – or if the threat were serious enough for Silvinit’s controlling shareholders – the purchase could be blocked, and the license would then be transferred to the next highest bidder, Uralkali. A compromise arrangement between the two companies may be negotiable.
Baumgertner said last week that he favours a deal. “We are not discussing anything with them [Silvinit] at this point,” he said. “But we believe there are huge synergies between Silvinit and Uralkali. So it does make sense to merge the two companies.”
Without estimating the possibility of a reduced-price outcome for Verkhnekamskoye, Stewart of Alfa reports that Uralkali “avoided a set of high-risk investments that were not needed to increase shareholder value.” Stewart also argues that Uralkali can significantly increase its capacity without acquiring new licenses. “Additionally, the recent imposition of export duties and the possibility of other taxes on potash lessens the attractiveness of such a long term, expensive investment.”
Fresh government moves since the auction have been positive for Uralkali as potash leader. New customs duties have been introduced on exports of potash and other fertilizers, to deter export and hold down domestic prices for farmers. Contrary to expectation, the government has set a lower rate for potash exports than for nitrogen and complex fertilizers (which mix nitrogen, potash and phosphate). The duty for potash will be 5%; for the other fertilizers, 8.5%. This looks irrational to many industry observers, because complex and nitrogen fertilizers have lower profitability, and are subject to rising gas prices. About 3% of the 5 to 8.5% duty will be passed on to consumers through higher pricing of the Russian commodities.
It is also possible that a change of government posts, following the inauguration of President Dmitry Medvedev in May, may remove advocates for the duties.
Uralkali has also signed an agreement with the Federal Anti-monopoly Service (FAS) to regulate price growth in the domestic market. The deal will run for five years, and tie the movement of the domestic potash price to the lowest export price, adjusted for transportation and other export costs. Prices for agricultural users will be at least 30% lower than the price for domestic industrial users.
Export prices continue to accelerate upwards. The Belorussian Potash Company (BPC), which trades for Uralkali and Belaruskali, announced this week that prices for granular potash will move to $600-$610 per tonne, starting next month. Granular potash usually sells at a 15% premium to the standard MOP, but pulls the lower priced product in the same direction. The new price illustrates just how tight supply is in the current potash market, and how potent the Russians remain in driving price growth.