Global Value Investors Limited

Level 5 261 George Street Sydney NSW 2000

PO Box H104 Australia Square Sydney NSW 1215

www.gvi.com.au
Ph +61 2 8222 1100 Fax +61 2 8222 1199

The Potash Industry and why BHP wants in

Daniel Fitzgerald, Senior Equities Analyst – GVI

BHP’s US$39bn bid for Potash Corp of Saskatchewan, currently the world’s largest proposed acquisition,
is very topical and has clearly brought everyone’s attention to the potash market. So why might BHP be
interested in such a market and what is the long-term growth profile like for the industry? Before we
answer these questions we should probably start at the beginning and look at the background of potash.

What is Potash?

Potash or potassium carbonate is a salt-like mineral which is mined for use primarily in fertilizer
production. It is one of three key fertilizer “macro nutrients” that are essential for healthy soil and plant
growth. It is generally used in combination with two other macro nutrients (nitrogen and phosphorus) to
produce a range of fertilizers that are used depending on the soil type. There is annual repeat demand
for such fertilizers each year as nutrients are depleted from the soil with the harvesting of crops.

Potassium is essential to the workings of every living plant cell, plays an important role in plants water
utilization and also helps regulate the rate of photosynthesis. It also helps grow strong stalks, protects
from extreme temperatures, provides more ability of the plant to fight stress and extends the shelf life
of agricultural products. Importantly, there is no substitute to potash.

World potash consumption by crop can be seen in the chart below with wheat, fruit / veg, rice and
maize accounting for the majority of consumption. Potash ore reserves have been identified in 21
countries world-wide and currently the economic extraction of potash is limited to only 12 countries
(Russia and Canada mainly). Most countries rely on imports to satisfy demand and it is imported by
more than 100 countries world-wide.

Potash Consumption by Crop Potash Production and Sales by Region

World Potash Consumption

Sugar Crops
Cotton
3%
5%
Other oil seeds Wheat
6% 23%

Oil palm
9%

Soybean
5% Fruit & Veg
9%

Other coarse grains Rice

16% 9%

Maize
15%

Page | 1
 Global Value Investors Limited

Level 5 261 George Street Sydney NSW 2000

PO Box H104 Australia Square Sydney NSW 1215

www.gvi.com.au
Ph +61 2 8222 1100 Fax +61 2 8222 1199

The Potash Market and why BHP wants in…

Demand for fertilizer and potash is to be relatively strong going forward. The UN Food and Agriculture
Organisation (FAO) estimates that the total world demand for agricultural products will be 60% higher in
2030 than it is today with over 85% of this additional demand to come from developing countries1.
Industry expects medium term demand for Potash to be in the region of 3-5% with significant growth
potential in emerging agricultural markets such as Brazil, Argentina, China and Ukraine given under
application historically in these markets.

Agricultural Potash Consumption by Region

So what else is driving this demand growth? There are 2 main drivers - first, a growing world population.
The UN estimates population growth of ~1% out to 2050 and this means more demand for food, feed
and fibre. Secondly, the ‘wealth effect’. Higher living standards, especially from Asia increases demand
for food and especially for meat. Meat consumption in South America, Asia and Africa are significantly
below that of Western Europe and the US and as such there is significant potential for further growth.
Also, growth in meat consumption means a disproportionate increase in grain and feed demand as it
takes many multiple kilograms of grain to produce a kilogram of meat2.

1
“Fertiliser’s Role in World Food Production” The Fertiliser Institute (Potash Corp’s website) p.2
2
K+S presentation , Dresdner Kleinwort German Investment Seminar, NY 13-14 Jan 2009

Page | 2
 Global Value Investors Limited

Level 5 261 George Street Sydney NSW 2000

PO Box H104 Australia Square Sydney NSW 1215

www.gvi.com.au
Ph +61 2 8222 1100 Fax +61 2 8222 1199

Meat Consumption per Capita Yields of Cereals in Selected Regions

China, remains one of the largest net importers of potash, despite a producing a reasonable volume per
year. Demand growth has been strong historically with 10% compound growth over the past 20 years3.
Its needs are set to increase as urban growth shrinks arable land and the country looks to increase crop
yields to feed an increasingly affluent population. Currently the country is using about 7 per cent of
global arable land to feed about 20 per cent of the world population4 and as such yield and proper
fertilization remain key.

Other demand drivers which support a positive demand scenario for fertilizers are the increased use of
bio-fuels (especially in the US and Brazil) and the high current soft commodity prices which are
supported by low inventories in some crops.

In terms of the supply of Potash, the industry is relatively consolidated with the top 6 producers
controlling over 75% of the overall market. However, it is actually even more consolidated than market
share data might suggest as the Russian and North American companies both market as collective
organizations (‘BPC’ in the case of Russia and ‘Canpotex’ for the North American Companies) and as
such, these two organizations represent over two thirds of the global marketed volumes. In terms of
new capacity coming online over the next 5 years, the majority of the new capacity is to come from
North American and the Russian producers and as such the relative position of these producers will
strengthen further. It should also be noted that potash mines have very long lead times with a
greenfield mine, estimated to take up to 7 years to complete. Also, new mines are expensive, with a
new two million tonne mine estimated to cost a minimum of US$2bn. These factors are a barrier to
entry for new competitors.

3
FT “China’s fertilizer needs in view” L.Hook, August 25 2010, page 14
4
ibid

Page | 3
 Global Value Investors Limited

Level 5 261 George Street Sydney NSW 2000

PO Box H104 Australia Square Sydney NSW 1215

www.gvi.com.au
Ph +61 2 8222 1100 Fax +61 2 8222 1199

Source: Fertecon, Public Filings, PotashCorp

BHP is not the only company looking at consolidating the potash space. The Russian producers (Uralkali
and Silvinet) are potentially looking to merge their operations to create a strong global player (would
make them world #2) and they are also talking to the Belarussian potash producer (Belaruskali) about a
three way tie-up. If this were to go ahead this would create the largest potash producer in the world
with around one third of the overall market.

Why Potash Corp and why now?

Potash Corp is a tier 1 asset - it is the world’s largest potash producer by capacity with a market share of
approximately 23%. It is one of the lowest cost producers, has vast reserves and has the largest
potential for growth going forward with capacity set to increase by ~50% by 2015, accounting for over
half of all new global capacity growth in that time. BHP understandably has fairly stringent acquisition
criteria and Potash Corp meets those criteria in that it is a market leader, is low cost/high return, is
expandable and is export orientated (especially to emerging markets). Potash assets are also scarce, of
the listed companies globally only two have an open register and could be acquired- Potash Corp and
the German producer K+S (which GVI owns). The rest of the listed companies have either blocking
stakes, government ownership or are in difficult mining jurisdictions (Russia).

In terms of the timing, one could argue that the market is changing quite quickly given the
aforementioned consolidation and as such BHP is somewhat being forced to act if they want to be a
meaningful player in the short-medium term. Whilst BHP has Potash assets these are not to be fully
operational until 2018 and even then the company would be likely to have only a marginal market share.
If BHP wants to be a meaningful player in the potash space, Potash Corp is the logical fit. The bid itself is

Page | 4
 Global Value Investors Limited

Level 5 261 George Street Sydney NSW 2000

PO Box H104 Australia Square Sydney NSW 1215

www.gvi.com.au
Ph +61 2 8222 1100 Fax +61 2 8222 1199

well timed with the potash market normalizing after a downturn in 2009 and volumes have recovered
sharply. The issue is price and what BHP are prepared to pay for such an asset. The market price of
Potash Corp currently indicates that the market anticipates a higher bid and certainly the negative
reaction of the directors of Potash Corp, suggest that to be successful, a higher bid is needed.

Whilst GVI is not a direct shareholders of Potash Corp or BHP, we are getting exposure to the potash
market through our exposure to K+S, Western Europe’s largest producer. If Potash Corp is taken over by
BHP, K+S will be the last available company of meaningful size that can realistically be acquired in the
potash industry. Interestingly, the company is already of interest with a Russian investor having taken a
15% stake in the company.

Conclusion

In short, we remain positive on the potash market as the long-term dynamics are favourable. Demand
should remain robust supported by population growth, a rising wealth effect and increased usage in
emerging markets. Combined with that, supply is consolidated and new mines are expensive and have
long-lead times. At present there are no ways to invest in potash on the Australian share market.

Why GVI owns K&S

GVI seeks to own businesses that have strong business models, excellent management and are priced
attractively. K+S demonstrates all of these factors and was identified as one with a high exposure to the
positive dynamics in the potash market. K+S will continue to generate very strong cash flows going
forward as well as growing earnings and dividends over time. The company is now one of two
companies globally that is available to be purchased and further interest in potash assets remains highly
likely, especially from those countries which are short potash (Brazil and China). We see much further
upside to the K+S share price and as such are happy shareholders given the scarce nature of their assets.

Page | 5