02/09/2010 - 00:00

Questions aplenty over BHP’s Potash push

02/09/2010 - 00:00

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BHP Billiton’s $US40bn offer for a Canadian fertiliser maker has a few pundits scratching their heads.

IF you believe BHP Billiton it makes sense to spend $US40 billion buying control of a Canadian fertiliser maker. But, if you look behind the spin there are ‘logic holes’ that might be saying more about Australia and BHP Billiton’s ‘problem’ with excess cash than an expansion opportunity.

On the table is an all-cash offer for Potash Corporation of Saskatchewan, a company that controls about 20 per cent of the global market in potassium oxide, an important fertiliser seen as a key ingredient in boosting world food production.

BHP Billiton’s official line is that it will add value to the Canadian business through its skills in mining and transporting bulk materials, and in an ability to extract maximum value by changing the way potash is sold – switching from the current long-term contract arrangement to shorter-term, market-linked, pricing – much as it has done in iron ore.

So far, so good. Now look behind the timing, location, and nature of the potash business, which critics argue fits BHP Billiton like King Kong trying on a pair of Tony Abbott’s budgie smugglers.

• The timing of the bid is curious, coming as BHP Billiton’s attempt to merge its Western Australian iron ore operations with those of Rio Tinto run aground with most of the world’s anti-monopoly authorities.

• The location of the investment is equally curious, and perhaps the latest example of a mining company shifting funds offshore to avoid Australia and its anti-mining tax policies.

• The potash business itself can be extremely cyclical and BHP Billiton has worked hard to avoid exposure to cyclical metals, with its dislike of nickel on prominent display at the mothballed Ravensthorpe mine, and in regular reports of the entire nickel division being for sale.

There are other reasons to question the timing and price of the Potash bid, not least being that BHP Billiton has previously said that it did not want to get too big too quickly in potash, preferring to grow its own business to get a greater understanding of how it worked.

It is entirely possible that BHP Billiton is reading the signals about global demand for food better than anyone else, and that it knows enough about potash to put $US40 billion at risk.

But that possibility flies in the face of the fact that potassium is the world’s seventh most common element and while it is mined in only 12 countries (and used in 150) it is one of those materials that has never been high on anyone’s exploration list – but might be soon if demand really is about to take off as BHP Billiton appears to be indicating.

Then there is the question of supply, price, and capacity utilisation. World demand is currently being comfortably met with capacity utilisation running at 70 per cent – meaning abundant spare capacity if demand does suddenly jump.

Market analysis by the investment bank UBS claims that demand for potash will rise by 43 per cent between 2008 and 2020 – but supply will rise by 50 per cent, and that the price is likely to rise slowly from the current $US340 a tonne to $US400/t by 2013 – and still be at $US400/t in 2020.

Interesting as BHP Billiton’s bid for Potash Corporation is, it is hard to ignore the curious timing (the Rio merger-door closes, the Potash door opens), the location (anywhere but Australia for spare cash), and the cyclical nature of a business exposed to agricultural risks.

All that is before asking questions about the conflict between management needing to do something with the surplus cash being generated by copper and iron ore profits, and shareholders asking why not return it to them rather than put it at risk in a new business adventure – as BHP Billiton has done in the past.

Solid gold

GOLD is back on the lips of top investment advisers, with the US economic recovery sputtering and fear rising of an outbreak of inflation, as governments around the world resort to printing more money to try and kick-start their economies.

The latest convert is Gerard Minack, head of global developed market strategy at the investment bank, Morgan Stanley.

Mr Minack’s thesis is based on a belief that the US will do whatever it takes to avoid to disaster that is deflation, even if it means risking a dramatic break-out of inflation.

Deflation, which is what ails Japan, is a condition of falling prices whereby no-one is confident in buying (or investing) because the price tomorrow will be cheaper than today. Inflation is the opposite, which means people rush to buy to beat the price rise.

According to Mr Minack’s latest analysis, the $US has failed for the best part of a century to keep pace with inflation. He reckons a 1913 $US is now worth US4c.

Gold, however, has tracked inflation and, while not in complete harmony, there is a long-term record of gold being a rock-solid investment in the face of an inflationary break-out, which is what the US could unleash in a desperate bid to revive its economy.

To complete his argument, Mr Minack quotes from a speech by US central bank boss Ben Bernanke, who famously said: “By increasing the number of dollars in circulation, or even by credibly threatening to do so, the US government can also reduce the value of the dollar in terms of goods and services, which is the equivalent of raising the prices in dollars of those goods and services.”

We have been warned.

Ructions over rates

THE flipside, and a very nasty flipside of an inflation outbreak, is that the preferred central bank control mechanism is to raise interest rates, something we have seen over the past 12 months in Australia, but which could be much worse in Europe and the US.

In the most disturbing interest rate comment for some time, the British personal finance adviser Moneyfacts is tipping a home loan mortgage rate of 14 per cent within two years, caused by a combination of inflation and banks focusing on repaying their own debts to government rather than wanting to do business with home buyers.

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“Statistics are no substitute for judgment.”

Henry Clay

 

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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