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By John Helmer in Moscow

Uralkali (ticker URKA:RU), once Russia’s fastest-rising potash miner, continues to wait nervously under the Damocles Sword of a government ruling, which may put the company, or its controlling shareholder, Dmitry Rybolovlev, out of business. Still, Moscow investor sentiment firmed last week, lifting the miner’s London and Moscow-listed share price by 24% to $1.28, after seven months of steep decline. Current market capitalization of the company is $2.7 billion. At last June’s peak, it was $31 billion.

The Deputy Minister for Natural Resources, Semyon Levi, held a meeting last Thursday, February 12, in Moscow to review estimates of the bill for costs compensation and liabilities facing Uralkali from the subsidence and loss of Mine-1 at Berezniki, in the Perm region. The collapse and loss of the mine occurred in October 2006. revival of government claims against Uralkali began, apparently on the initiative of Deputy Prime Minister Igor Sechin, in October 2008.

Hints from Prime Minister Vladimir Putin, Sechin and others suggests they have in mind to dispose of Rybolovlev, and reorganize Uralkali under the control of Vyacheslav Kantor, who currently controls the nitrogen fertilizer producer and exporter, Acron. For reasons of either their personal security or comfort, both Rybolovlev and Kantor prefer to live in Geneva, and run their Russian operations from there.

This Russian scheming is taking place against a background of serious drought in northern China, affecting the wheat crop. Chinese press reports this month, and a report on February 13 by Merrill Lynch, suggest that the drought may cut China’s wheat production at harvest this year by 13%, compared to last year — or about 15 million tonnes. Henan, Hebei, and Shandong are the provinces hardest hit so far by the lack of rainfall. The winter crop (planted in August, harvested in May) is more important than the crop planted in the spring, and it is the one currently suffering from drought. If the spring rains fail next month, then the drought is likely to hurt both crops.

Chinese farmers do not add fertilizer to rain-starved soil. However, they do increase the volume of fertilizers to less afflicted fields, in order to increase their harvest payoff. And so, with ample grain in national reserve to stave off a wheat price increase, and the Beijing government’s reluctance to import wheat, the impact of this drought on farmers is likely to be increased demand from China for fertilizer to apply to fields unaffected by water loss, thereby improving both yields and farmer income. According to Merrill Lynch analysts in Hong Kong, “since 1987, fertilizer demand in China grew on average 7.9% in drought years, more than double the 3.2% average in non-drought years. As a result, we believe that the chance of a significant pick up in fertilizer demand is high.” This means more imports from Russia — and rising fertilizer prices.

Russian exporters to China say it is too early for them to confirm a pickup in export orders from China; the spring period, starting next month, will be decisive for rainfall, and for fertilizer imports. Since Chinese demand is one of the drivers of the global potash price, and this in turn sustains the share price of Uralkali, the farm troubles in China may provide a windfall for the Russian exporter. That is, if Uralkali can survive the ill-wind blowing from the Kremlin.

Government officials say the latest session on Uralkali’s future was closed, and they decline to give any account of what happened. This silence was interpreted by the Moscow market as positive for Uralkali, whose share price immediately jumped 16% on the absence of news last Friday.

The closed-door session followed a detailed public statement a few days earlier, on February 6, by Levi’s superior, Minister Yury Trutnev. Trutnev made his remarks at a press conference at Berezniki.

Ministry sources confirm that the government has decided that an additional 2.5 km-section of rail track in Berezniki, costing another Rb2.3 billion ($64 million), is no longer required, as the sinkhole has stabilized, and is no longer expected to expand.

Trutnev also said further feasibility studies are required before the extended 53-km railroad bypass can be budgeted for completion. The track, which is already in construction by the state-owned Russian Railways Company (RZD), has been reported to cost about Rb13 billion ($361 million), and forms a large part of the potential liability facing Uralkali, since Rostekhnadzor (Federal Service for Environmental, Technological and Nuclear Supervision) completed its report last month on the losses and liability for the October 2006 subsidence.

Trutnev has been close to controlling shareholder Rybolovlev in the past, when Trutnev was Mayor of Perm City and then Governor of Perm Region, before his appointment as the federal mines minister in March 2004. In his latest remarks, Trutnev said there are no international precedents for making a potash miner liable for loss of potash reserves due to the type of geological anomaly and incident that caused the subsidence and flooding at Mine-1.

In its initial post-incident report in 2006, Rostekhnadzor had reviewed the circumstances, and held Uralkali harmless for the mine collapse. Then, on October 29 last, following an order from Deputy Prime Minister Sechin, Rostekhnadzor opened a new investigation. Its report, leaked last month, claimed that, with timely geological surveys and early-warning measures, Uralkali “could have taken measures to prevent” the incident. The company disputes this, but has proposed several schemes of compensation for the direct, non-reserve losses, which the government continues to consider.

Rostekhnadzor’s report issued a series of estimates and recommendations, but left to Sechin the decision on Uralkali’s liability.Two estimates of reserve losses were reported — a minimum of $706 million and a maximum of $2.372 billion. Adding the mineral extraction tax that was lost to the federal government, and the two potential reserve-loss totals, for which Uralkali may be held liable, are $723 million and $2.5 billion. If Uralkali is levied the full infrastructure and rail cost, plus a reserve loss charge, the company is thus facing from $1.3 billion to $3 billion in government-imposed charges.

Trutnev said on February 6 that a final decision on this issue would be made by the end of this month. This was misreported in Moscow with a deadline for an announcement by Sechin of February 15. Government sources say that no such deadline exists. They also say that Levi’s meeting of officials this week will not make the final decision, but will continue to assess cost and budget estimates, as well as compensation proposals from Uralkali and other fertilizer and mining operations in the area.

Trutnev was asked at his Berezniki conference to say who is “guilty”, and responded that this can only be judged in court. Media reports miisunderstood the answer, according to ministry sources. They have told Minesite “nobody is going to court this time — everything will be decided by the [Rostekhnadzor] commission.” Sources close to Trutnev and Levi say that they have agreed to levy no more than Rb2.5 billion ($70 million) in additional costs and charges on Uralkali — an amount which would leave the company still firmly under Rybolovlev’s control.

A report by Anna Kupriyanova at Uralsib Bank in Moscow warns that “we believe a positive solution to the conflict is unlikely and see a high risk of Uralkali losing some assets or facing a change in ownership (to finance the penalty), as the fine may be significant enough to force the company to seek external financial support from the State. We also see significant risks for minorities, including valuation and squeeze-out risks, as well as other potential risks associated with a change of Uralkali’s business structure (particularly, changes in the organization of its export trading operations or domestic supplies).”

Uralkali officials are making no comment on the situation. They remain in waiting mode for Sechin’s decision. The latter’s office doesn’t respond to questions.

Sechin’s colleague in charge of the farm sector, First Deputy Prime Minister Victor Zubkov, is also playing coy — this week with Russia’s nitrogen fertilizer producers and exporters. A public warning from himthat he may reinstate the export duties recently lifted on nitrogen fertilizers will be tested by the domestic industry in the run-up to a cabinet session scheduled for March 5.

For the time being, Zubkov will neither reiterate hiswarning, nor defend his assessment of the domestic price movement for fertilizers.

In a statement released to a state news agency last week, Zubkovreportedly said that the government may reintroduce export duties, if the fertilizer producers do not reduce the domestic prices of their products “in accordance with the agreements entered into.” Zubkov was referring to last month’s decision by the government to cancel from February 1 the 8.5% export duty imposed in April of 2008 on nitrogen fertilizers. The duty was due to expire on March 31. Duty levels of 5% for exports of potash fertilizer and 6.5% for phosphates and sulphur remain in force for another month and a half. These measures were taken by Zubkov to encourage the producers to sell to domestic consumers, instead of export to the higher-priced global markets.

Zubkov, whose remarks were reportedly made in a telephone conference with regional grain procurement and farm supply officials, claimedthe fertilizer producers had promised not to raise their prices if the export duties were lifted. but he and his spokesmen refuse to answer questions, referringthem to the government press office. The spokesmen there refer back to Zubkov’s office, thereby refusing to respond without exactly saying so. A discussion of the farm sector ahead of spring planting and harvest planning has been scheduled for a cabinet meeting on March 5, but Zubkov will not confirm even the date.

The potash and phosphate producers decline to comment, because they say their products are still under the export duty regime.

The Russian Union of Fertilizer Produces, an industry lobby group, say they have been surprised by Zubkov’s claims. They claim that in January they delivered 295,000 tonnes of fertilizers to the farm sector, up 186% on January of 2008. They add that the price was 15% to 20 % below the level reported to the government in November, and well in line with the earlier agreement with Zubkov. Because of falling demand and falling prices, both domestically and in the export markets, the fertilizer producers had lobbied Zubkov for early relief of the export duties, as they were adding to the downward pressure on sales revenues. At the start of this month, according to the association, the state statistics agency Gosstat was reporting that domestic fertilizer prices were 50% below the level of the Zubkov agreement of last year.

Industry analyst Mikhail Frolov of the Finam investment house in Moscow says that the price decline to December 31 was followed by a lift in prices during January, and that traders, rather than producers, may have been responsible. Domestic end-users in Russia cannot buy fertilizers directly from the plants, without going through trade intermediaries.

The producers are considering despatching a letter to Zubkov to explain that the January increase has not lifted prices above the agreed level. “It is unlogical to bring back export duties now,”commented Frolov, “when the times are so tough, and it won’t drop prices anyway.”

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