BHP left in a pickle with potash assets

BHP Billiton appears to have dodged a bullet in its failed $US40 billion attempt to buy Canada's PotashCorp a few years back.

The cartel arrangement that has artificially constrained supply in the international potash market has just been turned on its head, with one of the main members, Russian producer Uralkali, staging a breakaway and threatening to increase supply.

The potash market is now in disarray, leaving questions over the value of BHP's investment in its own greenfields potash development, Jansen, also in Canada.

The move by the Russian company to exit the cosy position inside the Belarus Potash Corporation cartel appears to have taken everyone by surprise. Shares in the three Canadian members of the second potash cartel, Canpotex, went into free fall - including PotashCorp, whose stock plunged 25 per cent.

In just a day the economics of the industry have changed. Pricing certainty has disappeared in the short to medium term and the remaining alliances will come under pressure.

Against this backdrop BHP's recently minted chief executive, Andrew Mackenzie, has to assess whether, or how much more, the company is willing to invest in Jansen. Until this week there had been hints that BHP, which has already invested $US2 billion in preliminary development work, was on the cusp of making a decision on whether to step up the project development, move the gear stick into neutral or tick the box for a fully fledged $US12 billion development.

Any suggestions the project, along with its substantial reserves, could be sold seem unlikely as prices for potash assets will have dived. At the very least a decision on Jansen will have to be postponed until the dust settles and the true market dynamics for this industry emerge.

Potash was one of the two big capital projects of the previous BHP chief, Marius Kloppers. His reign over the world's largest mining company was characterised by big bets - including an unsuccessful attempt to take over Rio Tinto, a $US20 billion foray into US shale oil and gas, and the tilt at PotashCorp. This was a period of unprecedented strength in commodity prices and BHP's aggressive growth drive was a match.

Mackenzie is operating in a different environment and with a different agenda, including scaling back expenditure and new projects and boosting cash flow through asset sales. While he has spoken recently about potash potentially becoming BHP's fifth pillar - to add to iron ore, coal, copper and oil/gas - investors were not expecting the board to approve the increase to full-scale development and production in the near term. The more likely scenario was pre-approval capex of less than $US1 billion being pumped in over the next couple of years.

But now perhaps even this level of investment is optimistic. The reality is that BHP is standing flatfooted as it assesses the events of this week. It started its romance with potash 10 years ago and won't be making any rash decisions to walk away. It is clearly taking a long-term view on a commodity that is vital in servicing the needs for food production for decades ahead.

It is all about the supply/demand curve and in a market that has been artificial to date it is hard to get a read on where the price should naturally fall. While the two cartels have been holding back supply, they have perversely also been investing in brownfield developments to expand capacity. The breakaway Uralkali has plans to boost sales from 10.5 million tonnes this year to 14 million tonnes in 2015, which is a sizeable capacity boost to a market that sits at 50 million to 55 million tonnes.

Uralkali's chief executive, Vladislav Baumgertner, thinks that following its defection from the cartel, potash prices could fall from about $US400 a tonne to about $US300 - a price that is clearly acceptable given its lower production costs.

Meanwhile, the spot price of potash has halved over the past couple of years, along with PotashCorp's share price, which is now close to the level it was before BHP's failed takeover bid.

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