Western Potash Corp - ready to take off?

It is common to witness weak commodity prices during periods of global economic slow down. Less affected by such slow downs is the agriculture business. After all, food items need to be produced and crop yields need to be increased regardless of economic woes. Consequently, investors continue to remain loyal to companies that provide exposure to the agriculture sector.

Potash is the singular commodity that has continued to hold its value amidst the economic crisis because the underlying fundamentals of this key nutrient remain strong and intact. The Potash industry is expected to be supply-challenged for at least the next five years as demand continues to rise globally. Not surprisingly, given potash price resistance, potash prices and share prices of companies that provide exposure to them have recently been on the rise.

Our attention thus goes to Western Potash Corp (TSX.V: WPX, Frankfurt: AHE). The Company has three potash exploration permits in Southwest Manitoba located along the Saskatchewan border covering 1000 km² adjoining two potash deposits with an estimated 1 billion tonnes of potash. In addition, the company was also granted 50,000 hectares of Saskatchewan exploration permits and applied for an additional 150,000 hectares in Southern Manitoba.  Recent 2D seismic data and drilling results have confirmed the continuation and presence of the salt beds that host potash mineralization throughout the Company’s property.

If one seeks comfort in the availability of producing mines in the neighbourhood, WPX assets are in close proximity Potash Corp.’s (PCS) Rocanville potash mine. Rocanville is one of the lowest-cost potash production facilities in the world and has a capacity of 3.0 million tonnes KCl. WPX assets also border BHP Billiton’s Potash Lease and Agrium’s Exploration permits along the Manitoba border.

 

While WPX indeed has its own competitive edge over its peers, much of its investment case rests on potash fundamentals, which is driven by the agriculture super-cycle. Over 90% of global potash production is used as fertilizer to assist farmers to grow crops. Potash fertilizer is essential for plant growth and there is no substitute.  The rising proportion of affluent population in fast growing economies such as China and India is driving the demand not only for more food, but also for better quality, high protein food such as meat.  PotashCorp (PSC) estimates that a third of each new dollar earned by people in these countries is spent on food, particularly protein rich food such as meat.

General population growth and rising incomes have resulted in over 170 million tonnes of additional meat being consumed per annum globally in the last 40 years. Much of the growth has actually come from the developing world. For instance, growth in meat consumption in developed countries during this period has been 5-6% per annum compared to just 2% per annum in developed countries, a trend that is expected to continue.

 

 
To produce meat you have to feed animals grain – lots of it.  This is significant for the potash industry, because it takes several kilograms of grain to produce just one kilogram of meat.  As such, more grain will need to be grown on the world’s limited arable land acreage which is declining on a per capita basis as the global population increases and urbanization gathers pace.  Basically, every acre of arable land will need to become more productive. Farmers therefore are required to fertilize at scientifically recommended levels, a practice yet to be followed by the developing world.

 

Although not as profound as the change in dietary habits of the developing world to the agriculture super-cycle, the growing popularity of bio-fuels such as ethanol has also contributed to the increase in grain and oilseed demand. Corn is the main feedstock for ethanol production. In 2005, around 1.6 billion bushels, or 14 percent of the US corn crop was used in ethanol production.  By 2007, 30 percent, or 4.3 billion bushels is expected to be used for ethanol production. From a global perspective, world ethanol production has increased threefold over the past six years. As bio-fuels emerge as an alternative to expensive fossil fuels, fertilizer use to increase grain and oilseed yields is expected to drive potash prices to even higher levels.

In addition to rising food and ethanol consumption, potash fundamentals are underpinned by the constant need to increase crop yields in the face of declining arable land. Of the earth's 57 million square miles of land, approximately 8 million square miles are currently arable. Due to deforestation arable land is lost at the rate of about 40,000 square miles a year. The role of fertilizer gains more eloquence against this backdrop as the limited arable land requires all the help to increase crop yields.

So what makes WPX unique and an attractive investment? Overwhelmingly positive is the location of its properties in proximity to industry leaders such as PCS. Manitoba deposits encompass a combined resource of nearly one billion tonnes of ore grading 21.0-25.4% potash (with an estimated in situ value of $40 billion). The U.S. border is a mere 55 km to the south of Western Potash, providing easy access to the world's largest potash market. Following the recent financing rounds, WPX is well financed and has over $35 million cash resources.

In addition to the news flow from its development and exploration endeavours, more news is expected from WPX as it is on the look out for acquisition opportunities. Such opportunities may well be on the way, as the current financial turmoil has left several companies short of funds.  

On the back of rising demand potash prices have been making new highs. China, which signs annual price contracts, settled for 2008 contracts with both BPC (Belarussian Potash Company, the export company owned by Belaruskali of Belarus and Uralkali of Russia) and Canpotex (the export company owned by all Saskatchewan potash producers namely PotashCorp, Mosaic and Agrium), at $575 per tonne. This marks a staggering $400 per tonne increase from $175 per tonne in 2007 in Vancouver. (This is what happens when only 7 companies control 85% of the world’s production)  Canpotex has also concluded its annual contract negotiations with India at $625 per tonne. Japan signed a 6 month contract in November 09 for $900.00 per tonne.
 
If economics are so attractive, what stops companies building new potash mines? The main challenge is the lack of mineable potash deposits. Potash is only produced in 12 countries around the globe and consumed in over 160.  Saskatchewan, accounts for over 50% of the world’s mineable reserves and 37% of capacity. Other places where potash deposits can be found are in Russia, Belarus, Argentina, Brazil and Chile. 

Higher potash prices are expected to continue as the yearly supply growth lags behind the demand growth. The current annual demand growth at 3-4% is equivalent to almost a new 2 million tonne mine.  The industry has high entry barriers such as limited availability of quality mineable ore bodies around the world and high capital requirement to develop new mines.  WPX is in an enviable position having secured good properties in established potash regions with cash to finance expansions. There aren’t too many investment opportunities in the sector. WPX clearly is one such rare opportunity.