Green Acres

According to the United Nations the world’s population will increase by more than 50 percent between 2000 and 2050, from 6.1 to 9.2 billion people.

Feeding people is already a major challenge. But, contrary to popular belief, the biggest challenge isn’t growth in the numbers of mouths to feed but upgrading the diet.

Economic growth in developing nations is behind a change in global diets of epic proportions, the likes of which the world hasn’t seen since the Agricultural Revolution of the 18th and 19th centuries. As consumers’ disposable incomes rise, their diets tend to become more diverse and meat consumption tends to increase.

Source: Food & Agriculture Organization of the United Nations

The average Chinese consumer’s total daily calorie intake has risen gradually since 1965. However, the more dramatic trend visible here is the change in the composition of these calories. The intake of basic cereals such as rice has declined, while meat, fruits and vegetables have all become vital components of the Chinese diet.

From an agricultural standpoint, this shift presents a problem. Meat, fruits and vegetables are far more agriculturally intensive products than rice and other cereals.

It takes 7 kilograms (15.4 pounds) of feed grain to produce 1 kg (2.2 lb) of beef; 4 kg (8.8 lb) of grain to produce 1 kg of pork; and 2 kg (4.4 lb) of grain to make 1 kg of poultry.  As consumers eat more meat, there’s a huge multiplier effect–demand for producing grains for feed goes up by a multiple of the increase in meat consumption.

According to estimates by the US Dept of Agriculture (USDA) and other international agricultural organizations, total global demand for grains is likely to triple from its 1960 level by 2020. Much of that jump is due to indirect grain consumption as a livestock feed.

Supply is also a major issue. As countries like China develop and urban areas grow, there’s less land available for cultivation. A growing shortage of water also has an impact–parts of China, for example, once suitable for cultivating crops are now little more than deserts with insufficient water to support much plant life.

According to estimates by the Food & Agriculture Organization of the United Nations (FAO), there were more than 0.5 hectares (1.24 acres) of arable land per person globally in 1950. Today the figure is closer to 0.22 hectares, and by 2020 it’s going to fall to 0.2 hectares, less than half its 1950 level.

Simply put, the world’s farmers will need to grow more food to feed more people using less land. The global agricultural challenge is every bit as acute as meeting exploding demand for energy.

Agriculture is no longer the low-tech activity it was 20 years ago. Meeting the global boom in demand will require the adoption of best-practice farming methods worldwide and increasing use of advanced gene technologies to boost yields per acre and protect against crop failure.

Another implication is that to make the widespread adoption of advanced farming technologies economically feasible, the prices for all sorts of agricultural commodities will continue to rise.

There are several different investment angles, including agricultural services, supplies and technology firms and, of course, actual producers. I’ll focus on one of the most crucial agricultural markets of all: fertilizers.

The Big Three

Crops remove certain nutrients from soil over time and if that process goes unchecked, yields per acre will drop precipitously. To replace those nutrients farmers fertilize their soil. The amount and types of fertilizer used depend to a great extent on varying soil conditions in different parts of the world as well as the type of crops being cultivated.

There are three main types of fertilizer at use in the world today: potassium chloride (potash), phosphate and nitrogen.

Potassium chloride is mined from ore deposits created when oceans and seas dried up millions of years ago. With the passage of time, most of the world’s ores have been covered by earth and are now located deep underground.

To create potash that’s used on crops, the potassium chloride is separated from impurities such as salt and then dried and prepared into either solid pellets or a liquid product.

The largest producers of potash in the world, based in Canada, Russia and Belarus, account for about two-thirds of total global output. Because there are only a handful of global producers, about 80 percent of global potash supply is traded across international borders.

Fruits and vegetables account for nearly one-quarter of global potash consumption. Corn and rice are also big potash consumers accounting for a further 28 percent of the global market combined.

Phosphate is also mined from underground ore bodies created from ancient sea life. Typically, phosphate fertilizer is combined with ammonia to produce solid fertilizers known as DAP and MAP. Sulphur mainly derived from oil and natural gas refining/processing is a key raw material for converting phosphate rock into usable fertilizer.

As with potash, production of phosphate is concentrated in a handful of countries. China is the largest producer, followed by the US and Morocco. The latter is the largest exporter in the world because the US and China consume most of their domestic phosphate production in their domestic agricultural sector.

Because the big producers of phosphate also tend to be the big consumers, only 20 percent of global phosphate supplies move across international borders. The crops hungriest for phosphate include: fruits and vegetables (18 percent of total demand), wheat (16 percent), corn (12 percent), and rice (12 percent).

Nitrogen is the most common element in the air; however, plants rarely make direct use of atmospheric nitrogen. Nitrogen-based fertilizer is made from ammonia that is synthesized from natural gas. In fact, natural gas accounts for as much as 90 percent of the cost of making ammonia.

Urea is the most common form of nitrogen fertilizer accounting for about half the world market. And most nitrogen fertilizer isn’t traded but is used near where it’s produced. The biggest crops for nitrogen fertilizer are corn, rice, and wheat that account for half of total global nitrogen use worldwide.

Given soaring demand for agricultural commodities and the need to grow more crops on less land, farmers the world over are focused on yield, the amount of crop they can grow per acre of land. Because proper fertilization is among the most important factors determining yield, demand for all three types of fertilizer has been on the rise generally in recent years and that trend is likely to continue.

The other side of the equation is, of course, fertilizer supply. Two of the three main fertilizers are mined commodities with relatively limited geographic availability. And check out the table below.

Source: Potash Corp of Saskatchewan

It can take as long as seven years to bring a new potash construction plant on stream, and building a mining and processing facility costs upward of USD2.6 billion. That means that as demand for potash rises, supply can only adjust gradually to that demand.

In order for a USD2.6 billion investment in a plant to be worthwhile, potash prices would have to remain relatively high and stable. Although phosphate and nitrogen fertilizers are a bit less intensive in terms of investment and time, it’s certainly not a simple matter to increase fertilizer output quickly to meet demand.

Constrained supply and rising demand can mean only one thing: rising prices.

Source: Bloomberg

This chart shows prices for Canadian potash on the export market in US dollars per metric ton. As you can see, prices rose more than four-fold between mid-2007 and late 2008, early 2009 amid an extraordinarily tight market for the nutrient. Since then, prices have fallen sharply and stand at about half their peak level.

But the recent slump is a short-term hiccup, not a long-term cause for alarm. In fact, weakness in potash and other fertilizer prices has helped to push down stocks involved in fertilizer production, giving investors an outstanding entry point.

How to Play It

The near-term weakness in fertilizer prices and related stocks has its roots in the financial crisis and Great Recession. Soybean prices fell from above USD16 per bushel to below USD8 from late June 2008 through year’s end. And corn prices plummeted from around USD7.50 per bushel in mid-2008 to less than USD3.

Deteriorating agricultural commodity prices made farmers cautious on spending. One of the ways they cut costs was simply to apply less fertilizer than they normally would, relying on residual nutrients from prior year’s applications to feed crops.

Fertilizer distributors also stopped buying new inventory of fertilizer from the producers and simply sold down their inventory to bare-bones levels. Some took a significant hit on their inventories as prices on unsold stocks of fertilizer deteriorated, forcing write-downs.

But relying on nutrients in the soil is, at best, a short-term solution. Failure to apply fertilizer will depress yields immediately, and the problem only gets worse as each new crop will take more of the remaining nutrients from the soil.

The collapse in overall demand for fertilizer in late 2008 and early 2009 represents not demand destruction but demand deferral. Ultimately farmers will have to start applying more fertilizer to their crops.

Meanwhile, the fertilizer dealers that act as middlemen between producers and farmers are also low on inventory as they flushed their stocks after last year’s severe demand collapse.

To further complicate matters, the US corn harvest is the latest since the mid-1980s this year.

Source: US Dept of Agriculture

The US is the world’s largest producer of corn and corn is the key end-market for most fertilizer used in the US. Corn alone accounts for close to half the potash used in the US in a given year, more than triple its closest competitor, soybeans.

The USDA estimates that this year’s corn crop will be the second-largest on record, a true bumper crop. However, it’s also the latest crop in over two decades.

In the US, corn is typically planted in April and May and harvested in October and November.  As the chart above shows, roughly 20 percent of the US corn crop had been harvested by October 25, up from 17 percent the week before.

Last year at this time 38 percent of the crop had been harvested; the five-year average is closer to 60 percent. This presents a problem for the fertilizer industry. Typically, potash and other fertilizers would be applied to the ground after the corn crop is harvested but before the winter frost sets in.

The problem this year is that that won’t leave much of a window–the Thanksgiving holiday (November 26) is the unofficial last day of the fertilizer season, and the harvest is likely to extend well into mid-November.

That means a lot of the demand for fertilizer that would normally fall in the fourth quarter will be deferred into 2010, ahead of the spring planting season in April. Farmers will be looking to apply fertilizer in March or April next year ahead of planting.

This sets up the potential for a real supply squeeze into early 2010. Crop prices are improving–corn and soybean prices have rallied in recent weeks, and futures expiring late in 2010 indicate expectations for better pricing ahead. Improving farm economics will mean that farmers are able to spend more.

At the same time, dealers of fertilizers have ultra-low stocks and farmers will need to replace a lot of nutrients in the soil. Not only did farmers under-apply fertilizer last year but they’re also seeing a record crop–the bigger the crop, the more nutrients it pulls from the soil. And finally, fertilizer normally applied late in 2009 will undoubtedly get deferred into 2010.

Right now most farmers appear convinced that the fertilizer producers have plenty of inventory to meet their needs. But in a big rush for supply early next year as farmers want to apply fertilizer and dealers want to restock their inventories could quickly put upside pressure on prices.

And the US isn’t the only game in town. Brazilian farmers also under-applied fertilizer last year. In Brazil, a big soybean harvest should begin in March, and the planting and harvest season for sugar cane begins in April/May. In China, the rice planting/harvesting season begins in March as well.

Given all that deferred demand I’m looking for fertilizer consumption to come back with a vengeance in early 2010, pushing prices higher in the first half of the year.

Potash Corp of Saskatchewan (TSX: POT, NYSE: POT) has exposure to all three major fertilizers but, as its name suggests, it’s truly dominant in potash. The company controls nearly a quarter of the world’s total potash mining and production capacity and is by far the largest player in this market.

In light of the trends I noted above, total global potash demand is expected to surge back above 50 million metric tons in 2010 after slumping below 40 million in 2009. That would put potash consumption back at average levels from 2004 to 2008.

In addition, shipments from producers are likely to be larger than consumption because dealers will want to restock bare bones inventories. In its quarterly conference call on October 22, Potash noted that inventories are extremely low all over the world.

However, management highlighted Brazil; at the beginning of this year the country had 1.8 million metric tons on potash in inventory, but that figure will likely end the year closer to 300 thousand metric tons. And Malaysia and Indonesia, which began the year with high stocks, are now essentially out of potash.

And China essentially withdrew from the market in 2009. Potash Corp expects the Middle Kingdom will need at least 8 million to 9 million metric tons of imports next year to avoid a major hit to crop yields. With the government trying to encourage rural development, it’s likely China will buy the fertilizer it needs.

Potash Corp is the most exposed major fertilizer company to this big resurgence in demand.

Potash Corp should also be applauded for its discipline and expansion potential. The company has a long-term strategy of shuttering production facilities as needed to match demand. The company actually cut its own output by two-thirds in the third quarter due to weak demand and pricing for potash.

This move allowed it to maintain relatively high margins on the tons it did sell and undoubtedly helped to arrest what would have otherwise been a much larger slide in prices and a bigger build in global inventories.

It takes billions of dollars and as long as seven years to bring a new greenfield potash facility onstream. But Potash Corp has the ability to build more capacity on its existing sites, a so-called brownfield development.  This costs a small fraction of new greenfield capacity and can be built in far less time.

Potash Corp plans to increase its total capacity from around 12 million metric tons per year in 2010 to 18 million by the middle of the coming decade, primarily via brownfield expansions. That means that Potash Corp would control more than a third of the global market, making it an even more dominant player.

While potash is the company’s most important market, it also has a roughly 5 percent share of the phosphate market globally and 2 percent in nitrogen.   These markets are far more fragmented than the market for potash; the company is actually the third largest producer of both commodities despite that seemingly low market share.

Potash is likely to be the most supply-constrained fertilizer market near term, and Potash Corp is the dominant producer. Buy Potash Corp of Saskatchewan under USD105.

Elliott H. Gue is associate editor of New World 3.0, editor of Personal Finance and The Energy Strategist, and co-editor of MLP Profits. Go to to sign up for his free e-zines.

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