The Mining Report: Ding Xuedong, chairman of the
$650-billion ($650B) China Investment Corp. (CIC), wrote in the Financial
Times June 17 that the CIC is "keen to invest more across the entire
value chain" of the agriculture sector. What does this mean for Chinese
and world food supply?
John Chu: It could be very
big, not just for China but for the world. We're going to see some
significant investments from CIC in agriculture and into regions that have
seriously lacked funding. China has already been investing in African
farmland, which should increase food supply and alleviate some of the recent
pressures we've seen. Last year, China bought Smithfield Foods, America's
largest pork producer, and Chinese state-owned entities have invested in egg
production as well.
In 7 of the last 12 years, crop demand has exceeded
supply. This has led to higher food prices across the globe.
TMR: Can we expect food prices to continue to increase?
JC: Yes. Developing countries are becoming richer, which leads to
greater demand for beef, chicken and pork, which in turn leads to greater
demand for cereals and grains.
TMR: Ding Xuedong also said that the CIC is "keen to work with
the right partners to invest in greenfield projects." Can we then expect
major Chinese investment in the Western fertilizer sector, as we have seen
with oil and gas and the purchase of Smithfield?
JC: I'm a little skeptical about that. China is now the world's
number one nitrogen producer, with four times as much capacity as Russia. And
China is also number one in phosphate fertilizer production. The only area
where it's actually lacking is potash. It does have some domestic reserves in
the Qinghai
Salt Lake Potash Company Ltd. (000792:SZSE). Once that ramps up to full
capacity, it can probably meet 40% of China's domestic needs.
CIC has just made investments in Uralkali
(URKA:RTS; URKA:MCX; URKA:LSE), a Russian potash player, and has an
equity stake in PotashCorp. (POT:TSX; POT:NYSE). But given how weak the
markets are now, China is not likely in a big hurry to make any further major
potash investments anytime soon.
TMR: What is the projected growth of the fertilizer sector, and can
supply keep up with demand?
JC: Potash has the strongest growth. This is driven by China, India
and Brazil, which have considerable upside potential in potash demand.
Historically, 5-to-10-year projections for annual potash demand growth have
been in the 3�5%
range. But that growth will come from a lower base, given how weak demand was
last year.
Phosphate comes next, with a 2�4%
annual growth forecast. Nitrogen comes last, in the 1�3% range, but it's always had the most stable
and predictable growth. Currently, we've probably got excess supply for most
of the fertilizers, and demand has been a bit choppy considering the sharp
run-up in prices over the last several years. Some of the major buyers are
playing a cat-and-mouse game, not necessarily following through with what
they've ordered in the past, to try to keep prices down a bit. So supply now
meets demand, but over the longer-term we expect that demand should catch up
and require new capacity coming on-line.
TMR: Will the rapidly growing world population lead to the benefits
of the green revolution topping out?
JC: Probably not. There's so much unused arable land in such places
as Russia, Brazil and Africa. Significant new investment will be required,
but technologies such as new seeds and GPS systems and techniques such as
proper fertilizer balance cannot help but contribute to higher food yields
and production growth. To give one example, U.S. corn yields are expected to
potentially hit a new record high, and the U.S. is a mature corn growing
region.
TMR: How much corn is used for biodiesel?
JC: Upward of 40% of U.S.-produced corn is used for ethanol. Some
of the byproduct can be used for feed, so on a net basis it's probably around
25%.
TMR: Does this mean edible corn shortages and higher prices?
JC: It has led to shortages and higher prices, but typically in the
agriculture sector, higher spot prices lead to a supply response. I mentioned
the record U.S. corn harvest. The Chinese situation is similar, and Ukraine
and Brazil are stepping up as well.
TMR: To what extent is phosphate production dominated by North
African and Middle Eastern suppliers?
JC: Production of the fertilizers that farmers use is dominated by
China, Russia and the U.S. Africa and the Middle East control about 75% of
the production of phosphate rock, which is the raw material.
TMR: Could this be considered a strategic problem?
JC: Not quite yet. There is more than sufficient reserve out there.
But that region is beginning to get into added value, and that could raise
prices for phosphate rock.
TMR: Which phosphate project in that region most interests you?
JC: There is one company that we don't officially cover, so I can
only give general observations. That company is Allana
Potash Corp. (AAA:TSX; ALLRF:OTCQX), which has the Danakil project in
Ethiopia. The company has published a bankable feasibility study, and now
it's just a matter of securing funding. This is the biggest hurdle for junior
fertilizer projects. Danakil's capital expenditures (capex) seem manageable
at around $650 million ($650M). Allana has a key partner in Israel Chemicals
Ltd. (ICL:TASE), a top-seven global potash producer, which has a 16% equity
stake and an offtake agreement.
Allana also has support from some global development banks and foresees
commercial production by the second half of 2016. We think the company is in
a good spot, especially given the potential of supplying to India, a
top-three potash importing country with a lot of upside demand. Allana is
definitely seeing support from the Ethiopian government, and infrastructure
is being built to support the project. This is a company investors should be
looking at.
TMR: Danakil's infrastructure is dependent upon the construction of
a port in Djibouti, correct?
JC: The Djibouti port and the rail lines to support it are part of
the plan to get Danakil up to a million tons annually, and even expanding
that. The Chinese are involved in this.
TMR: How do you rate Allana's management?
JC: Very knowledgeable, with a lot of experience in the agriculture
space. Allana's management also understands capital markets, which is
critical.
TMR: How do you rate the prospects for the current North American
producers?
JC: They're all in a good position now because the North American
fertilizer market across the board is very strong. On the nitrogen side,
prices favor Agrium Inc. (AGU:NYSE; AGU:TSX), but, overall, shale gas
has helped change many North American players from high-cost to low-cost
producers. North American demand remains strong, which is good for
PotashCorp, as is the potential for greater demand from China and India.
The global fertilizer market is tightening up. Uralkali and Belaruskali
(its Belarus equivalent) had formed a marketing arm, which some people like
to call a cartel. Along with Canpotex, which is the North American version of
that, composed of PotashCorp, Agrium and The Mosaic Co. (MOS:NYSE), they
controlled about 65�75%
of world potash supply, and their focus was always on price over volume.
Uralkali announced a year ago it was walking away from its partnership.
That's when potash prices plunged. Now, however, we hear that Uralkali and
Belaruskali could resume some sort of working arrangement, which would
restrict supply and raise prices.
TMR: Is being a North American fertilizer producer advantageous?
JC: It is because the home market is a mature one without many
swings in consumption, unlike developing markets such as Brazil, China and
India. And the North American producers have good access from the East Coast
and West Coast to serve those developing markets.
TMR: What is your favorite North American phosphate project?
JC: Arianne Phosphate Inc. (DAN:TSX.V; DRRSF:OTCBB; JE9N:FSE)
and its Lac � Paul
project in Quebec. We like its management, and we've been impressed with how
far it has moved this project along. This is a large, igneous project.
TMR: What's the significance of that?
JC: There are two types of phosphate deposits: sedimentary and
igneous. Igneous is rarer but results in higher phosphate content, up to 40%
or more. Sedimentary deposits typically result in phosphate content in the 25�35% range. Higher content
means higher purity and value.
TMR: Arianne announced July 16 a TraMan Inferred mineral resource
estimate of 146 million tons at 5.3% P205. What's the significance of that?
JC: It's good news, but the deposit was pretty big already. In
other words, Arianne has firmed up its resources. North America has two or
three existing phosphate rock mines expected to come to an end of their mine
lives in the next 5�10
years. This gives confidence to potential phosphate fertilizer producers that
they can source phosphate rock from a company like Arianne.
TMR: What is Arianne's path to production?
JC: Probably by the second half of 2018. The major hurdle is, once
again, securing funding. With a capex of over $1B, the question is whether
Arianne can raise this money by itself or whether it will seek a partner.
TMR: How does Arianne stand with regard to infrastructure?
JC: It will have rail access to a port. Quebec has always been
helpful in this respect, so I don't expect infrastructure to be a problem.
TMR: Where does Arianne stand with regard to possible offtake
partners?
JC: There are several potential partners. One is Agrium, whose
Kapuskasing mine in Ontario closed earlier this year, forcing it to source
its phosphate rock from Morocco. Mosaic would be another candidate, as some
of its phosphate rock mines in Florida are expected to be shuttered in five
years or so.
TMR: Given its capex, is Arianne a possible takeover target?
JC: Quite possibly.
TMR: Which other North American project can we talk about?
JC: IC Potash Corp. (ICP:TSX; ICPTF:OTCQX) and its Ochoa
deposit in New Mexico. This is a niche project, taking a mineral called
polyhalite and converting that into potassium sulfate (SOP). This product has
little chlorine in it and so it is used on higher-value crops such as fruits,
vegetables and tobacco. We think Ochoa is really interesting because many of
the major potash players don't play in this space, believing it too small a
market for them. SOP pricing has held up quite well over the last year,
whereas potash prices in general are down around 20�25%. This should serve IC quite well.
TMR: What's Ochoa's capex?
JC: $1.02B. IC has partnered with Yara
International (YARIY:OTCPK), perhaps the largest nitrogen player in the
world. Yara is looking to branch out, so it has taken an equity stake and
signed an offtake agreement.
TMR: IC claims to have demonstrated an SOP production model that
will lower costs by up to 50%. What does this involve?
JC: It's not a new technology. It is a traditional process:
grinding, separation, extraction and granulation. The difference is that IC
is applying it for the first time to this particular mineral. It has tested
it and has seen good results.
IC has one of the strongest management teams we've seen in the junior
fertilizer space. COO Randy Foote used to work for Intrepid Potash Inc.
(IPI:NYSE). And IC's technical team, some of whom have worked for BHP
Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK), is probably the strongest in the
industry.
TMR: Ochoa's 90,000 acres require federal prospecting permits and
State of New Mexico mining leases. Is this a mining-friendly jurisdiction?
JC: New Mexico is a mining friendly state and a potash producing
state. We don't expect any issues there.
TMR: Are there any other interesting potash projects in the Western
Hemisphere?
JC: I would highlight Verde
Potash (NPK:TSX) and its Cerrado Verde project in Brazil. Brazil imports
most of its potash, and is one of the top-three fastest-growing potash
markets in the world. This gives Verde a tremendous advantage in
transportation and everything else. In addition, the Brazilian government has
promoted potash self-sufficiency for some time, and Verde is obviously well
placed to benefit from that.
TMR: Cerrado Verde's capex is only $114M.
JC: It is a pilot project, overseen by the Brazilian Development
Bank (BNDES), with 90% of the cost being funded by the Brazilian government.
This pilot project is phase one of a much larger project.
TMR: It will produce thermal potash. Is this particularly suited to
Brazil?
JC: Thermal potash has a lower potash content than some of the
other potash products. It has unique characteristics, such as a slow release
into the soil. This is particularly good for sugar cane, coffee and other
crops specific to Brazil. It also contains lime and other micronutrients that
the Brazilian soil needs. Thermal potash has a history in Brazil and will not
be anything new to local consumers.
TMR: What's Cerrado Verde's path to production?
JC: We don't have a timeframe, but given its modest size�330,000 tons (330 Kt) per
year�it can get to
production a lot faster than some of the larger projects we've discussed.
TMR: Is there advantage to being small and nimble in this space?
JC: I think there is. Verde believes that going into production
quickly with a low capex will generate cash flow, prove management's ability
to execute and the viability of its overall plan, and thereby induce further
investment for phases two and three. Cerrado Verde should be attractive to
investors who are somewhat risk averse.
TMR: Does the Brazilian government expect to be repaid for its
investment, or is it considering an equity position?
JC: My understanding is that there is a loan component that must be
repaid, but that's several years down the road. Part of the loan could be
forgiven.
TMR: You wanted to bring readers' attention to an agricultural
company that is not involved in fertilizer.
JC: That would be Input Capital Corp. (INP:TSX.V). Its initial public
offering was last year. The company has a new idea: giving loans to canola
farmers to help fund their working capital. In exchange, Input receives an
interest in each farmer's canola crop. For example, it may give $2M to a
farmer for what is effectively 1.5 Kt of canola per year over a six-year
period, with a floor price for the grain set in advance.
This is a fascinating concept, considering that Canada is the world's
leading canola producer. The potential market is quite large. Canadian grain
farmers were squeezed by the extraordinarily cold winter of 2014. This
resulted in rail delays whereby farmers weren't able to monetize their crops.
They sat in storage bins, temporary storage bags or on the field waiting for
delivery. This created some havoc in the agriculture space in general.
Equipment companies saw their sales fall because the farmers didn't have the
cash. Nonetheless, the farmers still had loans to repay, and this triggered
higher interest rates. As a result, farmers are looking at nontraditional
ways to fund expansion plans and working capital needs.
TMR: What does Input's new idea offer investors?
JC: It gives investors good exposure to agriculture with limited
downside risk.
TMR: The streaming model in silver and gold has been enormously
successful. How much of this have we seen in agricultural commodities?
JC: Input is the first publicly listed agricultural streaming
company. Shares were floated at $1.60 and have since risen to $2.61. So we
know there is investor interest; investors have seen the success of companies
streaming other commodities. That said, I think there are investors waiting
to see how well Input executes.
Input offers a quicker return. If you invest in Input, every year you get
crops. It doesn't have to be canola. For example, a farmer facing a supply
shortfall in canola can repay Input in other crops. I wouldn't be surprised
should other companies pop up to follow Input's lead.
TMR: The company closed a bought-deal offering of $46M on July 18.
This was oversubscribed by $6M, which indicates a fair degree of
institutional confidence, correct?
JC: The financing confirms that Input is seeing more interest from
farmers seeking to engage in streaming contracts. The company said in its
last quarterly result that the pipeline of potential customers looks strong,
having been boosted by the rail delays and attendant problems. We believe
that when Input begins to deploy its new capital to further streaming
contracts, this will further improve investor confidence.
TMR: To sum up, how do you rate the investor prospects for the
fertilizer sector as opposed to other commodities?
JC: There are a limited number of players in this sector compared
to other commodities. The fertilizer sector boasts bellwether companies that
offer good yields and demonstrate consistent growth. This makes them a pretty
safe harbor for investors.
In talking to investors we have heard that many have switched from other
basic-material commodities to fertilizer companies because farmers need to
use fertilizers year in and year out. This offers stability and explains why
the fertilizer sector has held up reasonably well year-to-date despite the
recent somewhat soft fertilizer market globally.
TMR: John, thank you for your time and your insights.
John Chu, CFA, is managing director of
Agri-Industry Institutional Equity Research at AltaCorp Capital Inc. He was
previously senior vice president in agriculture and industrials research at
Mackie Research Capital and also worked for Scotia Capital and HSBC
Securities. He holds a Bachelor of Arts with Honors in economics from Queens
University and a Master of Business Administration from the University of
Western Ontario.
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DISCLOSURE:
1) Kevin Michael Grace conducted this interview for Streetwise Reports LLC,
publisher of The Gold Report, The Energy Report, The Life Sciences Report
and The Mining Report, and provides services to Streetwise Reports as
an independent contractor. He owns, or his family owns, shares of the
following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of
Streetwise Reports: Arianne Phosphate Inc. Streetwise Reports does not accept
stock in exchange for its services.
3) John Chu: I own, or my family owns, shares of the following companies
mentioned in this interview: None. I personally am, or my family is, paid by
the following companies mentioned in this interview: None. AltaCorp Capital
is a market maker for the following companies mentioned in this interview:
Allana Potash Corp. and Agrium Inc. AltaCorp Capital was involved in an
equity financing for Input Capital Corp. I was not paid by Streetwise Reports
for participating in this interview. Comments and opinions expressed are my
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