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After a tough five years, the price of agricultural
potash is rebounding. Demand for fertilizer is on the rise in China, Brazil
and the United States, and mining firms are rushing to find new sources of
the pink potassium salts. In this exclusive interview with The
Energy Report, Fadi
Benjamin, mining analyst with Northern Securities Co., shares his top picks
in the junior space and talks about the pros and cons facing entrants in an
industry dominated by a handful of seniors.
The Energy
Report: Fadi, the International
Fertilizer Industry Association is reporting
that the fertilizer market is on the mend, with demand for potash rising 3.7%
per year. Today, U.S. potash prices are at about $575 per metric ton (mt), compared with $380/mt last
year. What caused the upswing?
Fadi
Benjamin: Let's look at what caused the potash crash: Back in
2008–2009, potash prices had risen to almost $1,000/mt,
driven by Chinese demand. Crop prices were relatively low at $3.50 corn,
$10.25 soy and $4.44 wheat. Farmers around the world retaliated as they could
not justify the economics of these high potash prices and low crop prices.
Many farmers, particularly in North America, took a "potash
holiday." They stopped applying the mineral to cropland for a couple of
years. The holiday was possible because crops do not consume all of the
fertilizer immediately, and the remainder stays in the soil as a reserve. But
now, all around the globe, the potash content in soils is too low. The demand
for potash has returned, and crop prices have significantly increased. We are
now in a world of $7.90 spot corn prices, $16.65 spot soy and $8.89 spot
wheat. It may take two to three years of aggressive potash application for
North American soils to reach 2008 soil levels.
TER:
Will the predicted slowdown of growth in China and other developing countries
impact the outlook for potash?
FB:
Slowdown or not, people need to eat. Population is on the rise in developing
countries, including China and India. There is a push to grow more crops, to
utilize more of the arable land, to improve yields and to raise cattle for
meat. Agriculture requires potash.
TER:
Which countries and regions are the largest potash consumers, and which are
the largest producers? Is there a regional or global synergy between networks
of production and consumption?
FB:
Canada and Russia are the two largest potash producers. India, China, Brazil
and the United States are the largest consumers. There are synergies in the
form of two marketing organizations. One, Canpotex,
represents North American producers, and the other, Belarusian Potash Co.,
represents Russian producers. Russia and Canada are the gorillas in the
potash cage. They ship potash around the globe, especially to China, India
and Brazil, the areas of greatest need.
TER:
Saskatchewan holds about 40% of the world's known potash reserves. Should
investors look first to Canada for potash production? Which countries are
delivering the most bang for the potash investor's
buck?
FB:
Junior potash miners are quite active in Africa, which is rich in resource
commodities. Companies looking for potash in eastern Africa, specifically
Ethiopia, include Allana Potash Corp. (AAA:TSX; ALLRF:OTCQX) and Ethiopian Potash Corp. (FED:TSX.V;
FED.WT:TSX.V). Companies exploring for potash in western Africa
include Elemental Minerals Ltd. (ELM:TSX; ELM:ASX) and MagIndustries Corp. (MAA:TSX).
There are a number of explorers in Brazil, including Rio Verde Minerals Development
Corp. (RVD:TSX) and Verde Potash (NPK:TSX).
But even in highly developed Saskatchewan investors will find a spectrum of
companies, from early-stage developers to those that are fairly advanced and
in search of financing to build a mine.
TER: Do
you have any names in that space?
FB: Western Potash Corp. (WPX:TSX.V) is the most
advanced junior potash company in Saskatchewan. Before Western Potash even
had a feasibility study of its Milestone project in hand, it had pushed the
bar high enough to attract the interest of a Chinese strategic investor, China BlueChemical
Ltd. (CBC:HK:3983).
TER:
Your firm, Northern Securities, recently lowered the target price on Western
Potash from CA$3.30 to CA$2.30. Why? Are you still bullish on the company?
FB:
China Blue withdrew at the last minute, so we lowered the target price.
Western Potash had been working with China Blue as a potential partner for at
least a year. China Blue did six months of research and due diligence. For
reasons that have not been disclosed to Western Potash's management, the
parent company of China Blue did not approve the deal. But we know the
Chinese did not find an issue with the project itself, or the negotiations
would not have gone so far.
TER:
Western Potash recently signed a deal to purchase city wastewater for use at
Milestone.
FB: That
is one reason we are bullish on Western. First and foremost, Milestone is an
excellent deposit. Now, low-cost water for solution mining is available as
well, through Western Potash's agreement with the city of Regina. The
Milestone grades are conducive for low operating costs, and Western Potash
has access to low-cost natural gas from Canadian shale gas producers. From a
logistical standpoint, Western Potash is nicely connected to rail
infrastructure and to ports in Vancouver.
TER: You
mentioned Elemental Minerals, which is developing a project in the Republic
of Congo. What is the news on that front?
FB:
Elemental Minerals is a world-class deposit and our top pick from a project
standpoint. In the Congo, Elemental Minerals has discovered the Hangingwall Seam, which contains a potash deposit of the
highest grade—almost 50% potassium chloride. It is also a very shallow
and scalable deposit. The potash horizons are at 260 meters below surface
with a resource size of over 1 billion mt. And due
to the low cost of natural gas in the Congo, the project has a low capital
expenditure (capex). The existing infrastructure of
ports and roads in the Congo is a key advantage for Elemental Minerals, and
the company has a logistical advantage with easy access to ocean freighting
to Brazil, one of the fastest-growing agricultural markets in the world.
Brazil's demand for potash is growing annually at a rate of nearly 4%.
TER: The
Hangingwall Seam is sylvinite-bearing.
Can you talk about how sylvinite and carnallite affect potash grades?
FB: Not
all potash is the same. Two types of minerals produce the chemical compound
known as potash: Sylvinite is a mixture of
potassium chloride and salt. Carnallite is a
potassium magnesium chloride. Carnallite is, at
best, considered an impurity. It tends to dissolve in water a lot more easily
than sylvinite, but it takes energy and time to
break the magnesium element out of the brine. Potash producers generally seek
sylvinite and avoid carnallite.
Carnallite is only sought out for mining in
countries where there is no sylvinite.
TER:
What kind of potash is being mined in Ethiopia, and what are the prospects
for junior miners there?
FB: Allana Potash and Ethiopian Potash are looking for sylvinite. However, their sylvinite
layers sit on top of carnallite, so solution mining
in these deposits brings along the carnallite, too.
One cannot selectively mine for the sylvinite in
these seams. Producers have to liberate the potassium chloride from the brine
mixture.
Furthermore,
Ethiopia-based deposits lack infrastructure support. They sit in a desert far
from roads and rail lines, and water is difficult to come by. Allana Potash is drilling wells to find water. Juniors in
Saskatchewan and the Congo are not exposed to the same lack-of-water risk.
Allana
Potash stands out from the pack in Ethiopia; the company has the better
position. Recently, Ethiopian Potash has tried to restructure and reorganize
itself. In addition, BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK) has announced
that it is not conducting any more exploration at its Ethiopian potash
project. This exit brings a bit of uncertainty to the potash zone in eastern
Africa.
TER: BHP
Billiton has been buying up junior potash producers. Is that good or bad for
investors in the junior space?
FB: BHP
has been buying juniors since 2007, including Anglo Potash Ltd. and Athabasca
Potash Inc. Those were purchases of land more than anything else; no
feasibility studies or well-defined projects. The purchases allowed BHP to
put forward a plan for its Jansen project, which is one of the world's
largest potash mines, in Saskatchewan. The buying spree created a lift for
the junior space. New entrants came in, hoping that large mining companies
such as BHP, Rio Tinto Plc
(RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCPK),
and Vale S.A. (VALE:NYSE),
would scoop up juniors.
However, the
large mining companies have decided not to overpay, especially after the
failed takeover of PotashCorp. (POT:TSX;
POT:NYSE) by BHP. Consequently, sovereign entities from China
and a large consortium of potash buyers from India have been coming to
Saskatchewan looking at juniors' assets. The drawback for juniors is that
these new acquirers are not mining companies. They tend to do a lot of due
diligence and are slow at making decisions. Juniors must be prepared for a
long ride with these guys before a deal is made.
TER:
Does Northern Securities have target prices for junior potash firms that have
caught its eye?
FB: We
like Elemental Minerals for a target price of CA$2.70. The thesis for Elemental
Minerals is its access to Brazil. In addition, its high-grade deposit is
close to the surface, which allows for lower capex
and operating costs. We like Western Potash at a target price of CA$2.40. The
story there is an advanced Saskatchewan play. Plus, we have recently
initiated play on Rio Verde Minerals, which is a Brazilian phosphate and
potash exploration company. It is going for potash in northern Brazil's Sergipe Basin. We have a target of CA$0.52 for Rio Verde.
TER:
What is the Brazilian government's attitude toward potash mining in its own
backyard?
FB:
Brazil is very supportive of domestic potash and phosphate exploration. As a
matter of fact, it has given Vale, which is a Brazilian company and the
second-largest mining company in the world, a mandate to find more fertilizer
for consumption in Brazil. The government is good at removing red tape
surrounding permits and licenses.
TER:
What is the ratio of production cost to market price for potash?
FB:
There is a spectrum of operating costs. For example, the current market price
is $575/mt. For Western Potash, one might assume
$63/mt of operating costs, almost half of which is
the cost of natural gas. Because this a solution mine,
Western needs to heat the brine to precipitate the potash. It assumed $6 per
million British thermal units (MMBtu) in operating
costs. But at today's prices, natural gas is less than $4/MMBtu.
Western's operating costs are now lower than its assumptions.
TER:
That sounds positive.
FB:
Indeed. Let's look at the operating costs for Elemental Minerals: also $63/mt, not including port operations. If it decides to build
and operate a port, we can figure operating costs at about $70/mt. That is a very nice margin.
TER:
What other costs constraints are there?
FB: The
other factors for cost include freight, because most of the deposits are not
where the markets are, and that could range anywhere from $60–100/mt. The majority of these plays require a royalty.
Depending on how a mine is financed, there may be a minority interest. And
taxes must be covered.
TER:
Approximately what kind of internal rate of return could one expect from a
$575/mt price?
FB:
Anywhere in the low 20s after taxes. The beauty of potash is in the high
margins. However, there is also a high capex. For
Western Potash and Elemental Minerals, we are looking at multibillion-dollar
projects.
TER:
What will be the likely effect on junior firms of U.S. Interior Secretary Ken
Salazar's proposal to create oil- and gas-drilling islands in areas of the
American Southwest, where potash can also be mined?
FB:
Companies are looking for potash in areas of Utah and New Mexico. Inevitably,
they overlap with oil and gas producers in those areas. This has been
contentious. The new rules give junior potash companies a more defined idea
of what they should expect when exploring for a deposit.
TER: The
complaint was that oil and gas companies were harming the potash reserves in
areas where the deposit layers coincided.
FB: The
oil and gas layer does not have to be in the same layer as the potash. More
than likely, the two are in separate layers. However, if you are developing
an underground potash mine near oil and gas reserves, fracking
and horizontal drilling can interfere with the potash mining operation. The
idea of the proposed rule is to create a buffer zone around the potash
deposits.
TER: Are
there any other junior companies that you would like to draw our attention
to?
FB: Potash
is only one aspect of the fertilizer space. The other nutrient is phosphate.
And phosphate is also in high demand. Currently the production of phosphate
rock is dominated by Morocco. Most North American phosphate companies either
have their own mines or buy rock from Morocco. We cover a company called Stonegate Agricom
Ltd. (ST:TSX). Its Paris
Hills Phosphate Rock Project in Idaho is one of the highest-grade phosphate
deposits in the United States. We think it is very attractive, because with
high phosphate fertilizer usage and demand in the United States, Stonegate Agricom will be able
to save on costs. Freight costs will obviously see savings, but the company
also might be able to get ore out of the ground for
less than it costs to buy phosphate rock from Morocco.
TER:
That sounds promising. Do you have a target price on Stonegate
Agricom?
FB: Our
target price on Stonegate Agricom
is CA$1.65.
TER: Are
you looking at Stonegate Agricom
as a takeover candidate?
FB: One
aspect of the thesis is that Stonegate could become
a takeover candidate for any of the big fertilizer producers. It could also
attract a strategic investor or a mining firm that wants to exploit the
resource. It is very promising as a takeover target. But it can also stand on
its own. Paris Hills should cost about $250 million to put into production;
such a cost is not difficult to cover for certain types of strategic
partners.
TER:
Paris Hills is a shallow deposit. How does that affect operating costs?
FB:
Shallowness lowers operating costs, because a shaft is not needed. It is a
continuous mining operation, similar to mining coal. The only drawback is
that most of the phosphate mines in the U.S. are surface open-pit mines.
There isn't much knowledge with regard to mining for phosphate underground. Stonegate Agricom has brought
mine managers on board who have strong backgrounds in underground mining for
coal and soft rock.
TER:
Great, Fadi. Thanks.
FB:
Thank you.
Fadi
Benjamin is a mining analyst with Northern Securities Co.,
an investment bank based in Canada. He worked at Stifel
Nicolaus & Co. in equity research, and at Wardrop Engineering (now Tetra Tech WEI Inc.) as a
project engineer. He is a graduate of the Rotman
School of Management at the University of Toronto and the University of
Colorado, Boulder.
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DISCLOSURE:
1) Peter Byrne of The Energy Report conducted
this interview. He personally and/or his family own shares of the following
companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: Allana Potash Corp. and Verde Potash. Interviews are
edited for clarity.
3) Fadi Benjamin: I personally and/or my family
and/or Northern Securities Co. own shares of the following companies
mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this
interview: None. I was not paid by Streetwise Reports for participating in
this interview.
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Energy Report
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