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This is a transcript of episode six of the Down to Agribusiness podcast. Visit the show page here.


China settles its potash contracts – what does this mean for the global potash market?

Luke Hutson

Welcome to episode six of the Down to Agribusiness podcast. This is the first of Fertecon’s podcasts on the fertilizer markets and, in this podcast, we look at the big news of the potash market and that’s the settling of China’s import volumes for the remainder of 2017. I’m Luke Hutson, Head of Urea and Nitrates Analysis here at Fertecon and, I’m happy to say, I’m joined here by Daniel Fletcher-Manuel, who is our potash analyst. Today we’re going to discuss what these contracts mean for the industry, why they matter as much as they seemingly do and what the future holds for this type of supply mechanism.

So, hi Dan. Firstly, can you just explain what we mean when we’re referring to the Chinese and Indian potash contracts?

Daniel Fletcher-Manuel
Hi Luke, yes sure. So, in the potash industry there are three major ways of buying product, that’s spot, tender or contract. So, spot purchasing is essentially where a buyer might survey the supply side of the market and speak to loads of suppliers, get quotes on whatever it is that they’re looking to buy and make the purchasing decision based on that data, which is made available to them on what we call a spot basis. So, it’s literally person wants a product, go to the buyer, find a vessel and bring it to the port of destination.

Tender is a very similar way of purchasing but, what it allows you to do is, at least in theory, it allows you to identify the lowest possible bid. So, in this case, suppliers will submit a bid and in the tender request it normally says your lowest offer and then the buyer will make a decision based on these sealed envelopes which come through to them, which is the lowest bid and then they follow the same process as spot. They secure a vessel and they bring the products to port of destination.

What we’re talking about today and is especially important in potash, more so than other fertilizer materials, is contract. That is where both suppliers and buyers negotiate a fixed price for the product that they’re buying and selling and a fixed volume over a period of time. So, that could be six months, that could be twelve months, sometimes in Europe that’s quarterly. That is a very potash specific way of buying. I think they only do it in sulphur and a couple of other smaller markets, but, in potash, as we’ll touch on soon, it’s one of the most important pricing mechanisms in the industry.

Luke
It’s interesting because, obviously, I cover the nitrogen market and there aren’t any equivalents really to that. Just for those listeners who maybe aren’t so familiar with this form of contract, I guess a similarity is if you have a mortgage and so you can either go for a fixed contract on your interest payments or you can go on a variable one. Obviously, there’s risk there isn’t there Dan that, if you go for the variable, sometimes that’s like the equivalent of a spot price, you might be paying higher than if you’d gone for a contract or a fixed price? So, it’s very important.

I mean, it’s interesting because, I remember, that India used to buy a lot of DAP, Diammonium Phosphate, on contracts, six-month contracts. It was back in about 2010-2011 that, in the end, suppliers were less keen to offer longer term contracts because they knew that there would be some price volatility. So, that practice, I believe, has now ended and India doesn’t buy any of its DAP on longer term contract.

Now, it terms of the Indian and Chinese importers, why do they agree to fix for such long periods? I mean, don’t they stand to lose out in case there is price volatility?

Daniel
I mean, yes. They do. They stand to lose out if prices decrease to a price which is lower than the one which they have negotiated and fixed for that period of time and some years, actually, they’ll do much better. They’ll find that the price has rocketed between them setting the contract and, you know, the end of that contract period and, if they’d purchased on a spot basis, they would’ve had to pay a much higher annual average price.

I think, for China and India, it’s really important to look at the historical nature of this supply mechanism and keep in mind that both of these markets, they have huge global economies and huge populations, which need to be fed. So, for them, fixing in, specifically a volume of potash, and that’s in an environment or a framework where food security is, obviously, a huge political objective, that is the main priority and, historically, it’s been about fixing a volume. So, on that basis, the price that India and China pay might be slightly higher and it might not be too much of a concern to their domestic industry because, for them, the priority is volumes.

On the supply side, and we’ll touch on this a bit later I guess, it’s a bit more contentious in modern times, but, historically, the objective was to secure 20% or 30% of their annual production volumes in contracts. As you can imagine, if you’re a mining company, having almost a third of your production capacity already accounted for, already sold and a price based on that, really allows you to plan for the rest of the year and it helps you to-, certainly helps with your stakeholder and investor sentiment. So, for them, there’s that incentive. It’s also worth remembering that we’re dealing with fertilizer, we’re dealing with agriculture and it takes, you know, one El Nino, it takes a hurricane in the corn belt or it takes a prolonged period of rain in Europe and you could see demand for potash decrease substantially. So, having that fixed volume in place for suppliers, is an attractive element of the contract setting.

Luke
Also, Dan, the volumes that are coming, I imagine some of them are going into MPK production, is that correct?

Daniel
Yes. Mostly, they do. That’s right. Most of the products go into secondary fertilizer. That’s MPK or maybe potassium sulphate.

Luke
So, therefore, the requirement there is, obviously, a regularity of shipments, so that production for the MPK can continue without disruption. I guess that’s part of it, isn’t it?

Daniel
Absolutely, ensuring the pipeline, or the raw material supply pipeline, is full and, therefore, they’re able to get that MPK production in place. Don’t forget, that’s ultimately what goes on the soil and that’s ultimately what grows the crops and, ultimately, that is what drives food security. That is the main objective.

Luke
Okay. Then when I-, I suppose, I remember when I was looking at the market, quite often people said that the Chinese contract price sets the floor for the industry. Again, just for those listeners who maybe aren’t quite so familiar with the terminology, if we say ‘sets the floor price’, we mean the lowest price. Is that still the case, Dan?

Daniel
Yes, in theory it is and, I suppose, the context of that is that the global spot market, and that’s 80% of the global potash market, they really do look to China and the price that the Chinese contract settles at, for direction for the price that they will pay. So, we see periods of real certainty versus uncertainty in terms of buy side sentiment and the strongest way to send a message to buyers is by fixing the contract price, A, early and, B, in a way that provides direction. Whether that’s higher or lower, it provides buyers with a level of confidence in their own purchasing decision. So, it’s definitely regarded by buyers and by stakeholders in the industry as the pivotal moment in the potash year.

Luke
Shall we just put some numbers on it then? So, what was the Chinese contract price settled at and for what was the time period and the volumes that we’ve got so far?

Daniel
Sure, so, price was settled in early July at $230 CFR, so, that’s an $11 increase on the previous contract which was settled. This is the second year in a row where the contract has been settled in July and covered tonnage per shipment between July and December, so making it a second half-yearly contract, a second half of the year contract. So, the tonnage covered is obviously for H2 shipments. Suppliers tend to fix the price first, that tends to be the real headline in the industry that people talk about and that is the main priority. So, we saw Uralkali fix the price. Uralkali is yet to announce specific volumes, under that contract, but they will in the next week or two. Canpotex quickly followed, that’s the Canadian export marketing company. They quickly followed Uralkali’s example. Fixed at the same price $230 CFR and they have committed 1.4 million tonnes of potash under that second half contract. We just need to wait for the Belarusians and some of the smaller participants, who will fix at the same price and they will fix, no doubt, very similar volumes, somewhere between 1.2 and maybe 1.6 million tonnes, like the major guys.

Luke
I see. So, will we then see another round of negotiations, if this is for July to December, do I take it that in say November, December time, we’ll have another round of negotiations for a new price for the first half of 2018?

Daniel
So, in theory, yes. It’s a relatively recent development that the Chinese contracts have stopped being annual. That happened last year and it happened this year and they were the result of quite prolonged negotiations in 2016, and that was an unusually long length of time for negotiations to take, you know, six months, seven months, very long for the industry. It’s repeated itself this year. The analyst in me is, sort of, spotting a trend emerging, which is the Chinese importers are very savvy in showing that they have more than sufficient sea-port inventory through the close of the calendar year into the new year and that means that they don’t really need to settle a contract until much later on in the year. If you bear in mind that China is also a huge domestic potash producer, they also carry domestic potash inventories, you can sometimes see, and we saw this in H1 this year and in H1 last year, that there could be between 5 and 6 million tonnes, half of the annual demand, sitting between sea-port and domestic channel inventories.

So, the Chinese importers are becoming very smart at leveraging the supply demand balance in their favour and that has resulted in us seeing a bi-annual contract. So, I would suspect that, actually, what we’ll see next year is a repeat of this year, which is shipments under the contract that have just been settled will go through until the end of the year. There will be some delays because it’s settled quite late and they will probably be shipped right the way through to Q1 next year. Then, no doubt, we’ll see a contract settled for H2 2018 shipments in late spring, early summer 2018. I think that’s how it’s more likely to play out. We’re seeing a real change.

Luke
Interesting. So, in a changing, sort of, environment like this, am I correct in saying that some suppliers were, shall we say, a little bit frustrated with this year’s Chinese settlement?

Daniel
Yes and that does always happen. You’ll always find that whichever supplier agrees the contract price first, you’ll find a little chorus behind them saying, ‘That’s too low, we could’ve held out, we could’ve got a higher price.’ So, that’s not surprising but, I guess, this year is a little bit unique in the sense that the $11 increase in the CFR price, is a good headline for the industry. It is good for suppliers to have that headline, but, it’s really worth mentioning that freight costs, in the last year, have increased. So, actually, when you net back from this CFR price to Vancouver FOB or Baltic FOB, actually, that price increase isn’t represented in FOB net backs. That margin is effectively consumed by higher freight costs. So, for some suppliers, they are frustrated because they’re making the same margin on this contract that they were in their previous years, so they’re not getting the full benefit.

Luke
I see. I mean, so, in a way, we’ve got an $11, as you say, headline increase but, from a suppliers’ perspective, does this really mean anything?

Daniel
Well, not a great deal, other than the fact that there is a ricochet effect. I touched on buyer side sentiment and the impact that settling this contract has on other buyers and so, what this does is, it sends a really clear message to importers in Brazil, in the US, in Europe and South East Asia and it says to them, ‘Hey, the market is going up. This is a bullish environment. Prices are firming.’ It really emboldens them in seeking higher prices in these markets. So, they’ll get higher margins and they’ll achieve high CFR prices in these spot markets off the back of the higher CFR price in China, but, from the CFR price increase in China specifically, they’re not going to get much of a margin increase.

Luke
I see. Then, in a way, just staying with China before we move to India, you’ve mentioned about the potash demand, largely driven by that political need for food security and, obviously, that’s behind the supply mechanism that we’re describing. How do you expect Chinese demand to change over the coming years and how might these changes affect the need for these contracts?

Daniel
Yes. That’s interesting. That’s two pretty contentious sub-questions because Chinese demand is a huge source of debate right now for the industry. For some numbers, in recent years, Chinese imports have been between 15% and 20% of global MOP demand. That being said, Chinese potash demand is so high that importers only actually account for 50%, maybe 60%, of its demand and the balances met through domestic production. To put a number on that, total Chinese demand is anywhere between eleven and sixteen million tonnes in the last five years. That’s eleven and sixteen million tonnes in an industry where global demand has been 51 to 65 million tonnes in the last five years. So, that’s 22% to 25% of global demand coming from China. That’s why it’s so important.

Luke
So, just to be clear there Dan, we’re talking MOP, aren’t we? Muriate of potash?

Daniel
Yes. That’s right. Yes. So, MOP. I guess why this is contentious, is that there’s some disagreement in the industry as to how this huge source of demand might change over the coming ten years. I suppose this has really started in 2014, right at the end of 2014, when the Chinese government announced a policy which was to limit nitrogen and phosphate chemical fertilizer consumption. Specifically, limit that growth rate to what they call ‘0% growth rate’. The objective there was resource use efficiency but really the driver was to maximise farmer incomes. Now, obviously, in that policy, they don’t talk specifically about potash but, as we mentioned earlier, most of the potash that goes into China, is actually made into MPKs and consumed and applied through MPKs.

So, we at Fertecon, have taken the position that, if you achieve a 0% growth rate in nitrogen and phosphate, without going through a process of quite substantial reformulation...from MPKs all the way through China, we would expect a similar movement in potash consumption. So, that means that we have a slightly less optimistic forecast for Chinese demand growth, when it comes to K2O, than some of the major potash suppliers.

Now, this is important because the Chinese government is also incentivising domestic Chinese companies in developing potash resources off-shore and, so, the objective is, from the Chinese government, to become increasingly self-sufficient. Not just in terms of the end agricultural products but also in terms of the in parts and potash is crucial here, because they are so dependent, you know, half their requirement comes from imports. So, you’ve got to think about that supply demand balance. If they’re going to be consuming less of global production and, also, they’re going to be playing a bigger role in off-shore production and bringing that product back into China.

How much leverage do the major exporters today, Canpotex, Uralkali in Russia and BPC in Belarus, have to try and say, ‘you really ought to fix a volume with us’? My view is that if demand growth does begin to taper off and if we do see Chinese companies expanding resources, developing resources off-shore and selling that back to China, there’s not much of a need for Chinese importers to fix a contact. So, there’s a lot of ifs, buts and maybes but that is certainly one scenario that I’m looking at very closely.

Luke
Okay, great. Well that’s something to follow and I’ve no doubt you cover some of this in your potash outlook. Let’s just quickly get to the present though because, obviously, we’ve got India, which are still to settle their potash contract. Can you just give us a very quick overview of what’s the situation today and what might be a likely price, I guess?

Daniel
Yes. I mean, that one is a little bit more straightforward. Typically, in your settles after China, the rule of thumb is that they tend to settle at about a $10 increase to the Chinese price. That’s driven by the fact that there’s normally a slightly higher freight cost into India and they also add on to that 180 days credit, which is part of their contract terms, and that might add a couple of dollars on in terms of the cost to the supplier. So, normally, it’s about $10 more. They tend to settle contracts within a couple of weeks or a month or so of the Chinese contract and I would very much expect that to be the case this year. So, to put that in a headline, that would mean Indian contract probably in the next fortnight or so. The price on the previous contract is 227 so, anything between 235 and 245 CFR seems really likely.

Luke
I see. Will that be for six months as well?

Daniel
No, so, India settles on an annual basis. Mostly, they settle on the 1st April. Contracts go from the 1st April to the 31st March, so 1st April 2016 to 31st March 2017, however, last year that was delayed, as they wanted to secure a much lower price than perhaps they would have earlier on in the year. They ended up settling in the summer and that’s why we’re seeing the contracts settle in July, not April. I’m not sure if that will continue. We might see this contract cover up until the end of March next year, that seems quite likely, but it may be another twelve-month contract from July. Mostly likely, it will be for a year.

Luke
Okay, great. Well, thanks very much, Dan, for your time today. I think, you know, that’s been really useful and we’ll try and catch up again once India has settled and we can review the, let’s call it the potash landscape, after that time. So, thanks very much, again, Dan.

Daniel
Excellent. Thank you.

Luke
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