Gensource Potash, Rather than BHP, May End Up Breaking the Oligopoly

In 2007, CEO Bill Doyle of PotashCorp (now Nutrien) told investors that building a potash mine was so complex and expensive that only a few could be built – and that he planned to build most of them. By 2012 we were tracking 117 proposed projects and no investor believed that barriers to entry were meaningful. In 2016, PotashCorp lost its independence after a big decline in the stock. But now, in 2019, we know that Bill Doyle was more right than wrong – of the 117 projects we were tracking back then, less than handful have been built, and almost all of those by existing industry players. Even mighty BHP Group hasn’t produced any meaningful potash from the very deep hole it dug.

Nutrien’s most recent potash project, Vanscoy was completed in 2016, substantially over budget; we estimate final total cost of at least $2,300/ton. Eurochem is thought to be more than $1 billion over budget with its projects, and still not producing meaningful output. Uralkali built a new mine, but doesn’t appear to be shipping much more than it did before (another mine is said to be having significant water problems). At today’s ~$320/ST price of potash, earning an acceptable return on these most recent projects will be tough, and there are now very few producers or new entrants talking in any credible way about incremental new capacity.

But one new entrant looks not only credible, but potentially more disruptive than even BHP. Gensource (TSXV:GSP) has developed a “modular” potash production process that it says can deliver 250,000+ tons per year of potash production for about $1,000/ton. If Gensource can deliver, the days of massive spending on huge potash assets may soon be over – and along with it, the oligopoly power of a handful of producers who tightly control supply chains.

The Gensource team is not new to the potash industry. CEO Mike Ferguson led the PotashOne’s Legacy project – the only greenfield potash project in North America in several decades (now owned by K+S). CFO Rob Theoret has been involved in potash and mining finance in Saskatchewan for most of his career. What makes the Gensource approach so compelling is that the technology itself is nothing new, but the business model addresses some of the biggest shortcomings in the industry structure. Gensource uses a form of solution mining that has been used since the 1960s. It uses directional drilling techniques common in a wide range of other mining and extraction businesses.

Gensource’s production facilities don’t generate salt tailings, use substantially less fresh water than solution mines, need no evaporation ponds – in fact, there is relatively little ecological impact at all at surface level. That means a much lower bar for permitting; with so little above-ground impact, a Gensource module is classified as a “non-development project”, so it requires no (expensive and time consuming) environmental impact assessment. And indeed, above ground a Gensource facility is arguably a relatively simple, low-impact manufacturing model.

Below ground, selective dissolution means that potash (as KCl) is precipitated out of the brine solution while regular salt (NaCL) remains in solution, and is re-injected into the caverns. On its designed scale of ~250,000+ MT/yr of KCl, Gensource believes that its cost of production will be competitive with some of Canada’s lowest cost traditional mines – with far lower capital and fixed costs.

Gensource does not plan to be an open market seller. Instead, it will build its production modules on a direct-to-customer basis, with offtake agreements put in place before construction begins. With production increments of ~250KMT, rather than the 2-5MMT for a traditional potash mine, Gensource can easily work with large distributors and dealers who currently have seen the number of large potash selling companies shrinking as the big producers get bigger and more powerful. As Gensource proves out its concept with its first project, we expect the number of interested offtake partners to expand quickly, and to potentially include export market buyers as well (the initial plan, however, is to produce granular, for the U.S. domestic market).

A direct-sales relationship with a bulk buyer would mean that Gensource can sell FOB mine – substantial advantage for a smaller producer, which should lead to stronger netbacks with lower risk. The kind of buyer that Gensource is looking for already has extensive logistical operations, and can get better terms and carrier treatment than Gensource could. Gensource is currently working on two potential first projects, with two different potash buyers, with potential to arrange financing and be ready to break ground by spring 2020. That would put first production at the end of 2021 or early 2022. Given the relatively small project size, we would not expect any meaningful negative market impact in terms of pricing.

So how disruptive would Gensource’s success actually be? First, let’s consider the impact on the value of existing traditional potash assets. Nutrien is currently positioned as the only major source of incremental potash thought to be available at modest cost, thanks to the substantial idle capacity it already has, and the brownfield economics it would enjoy in expanding. At a recent investor day, Nutrien expressed confidence that it can help keep market pricing stable thanks to its large controlling. Yet even at today’s prices, Gensource’s project IRRs look attractive. For large buyers of potash who are perhaps less enthusiastic about Nutrien’s ability to control market pricing, Gensource may be an avenue to regaining negotiating leverage. Offtake partners may well choose to take equity in a project, given what looks like attractive economics.

When BHP made its ham-handed and ultimately unsuccessful attempt to acquire PotashCorp in 2010, it spoke of “breaking the cartel”, but was unable to explain how it would make building a multi-billion dollar potash mine the market didn’t need make economic sense after it had pushed market prices down to cash cost. A decade later, the market is still waiting for an explanation, and we don’t see Jansen as likely to become economic over the next half decade or longer. If Gensource is successful, it may well succeed where BHP has failed. The massive cost of large scale potash mines would no longer represent a meaningful barrier to entry – and might in fact become a significant competitive disadvantage.

So how much of a threat does Gensource represent to the existing producers? At least two industry players have indicated that a potential Gensource partner has been told that its access to potash from one of the North American majors will be cut off if it supports Gensource (through an offtake agreement). That sort of threat of anticompetitive behavior appears to be quite common in ag inputs lately – we are hearing of it in other areas where new entrants are introducing technology to businesses that have amassed substantial market power but have been short on innovation or efficiency. In some cases, those threats may well succeed in stopping the new entrants, but in potash, and particularly if Gensource can prove out its approach commercially with its first project, it may actually embolden customers to move more aggressively to promote and secure this potential new source of North American supply. That is testament to the frustration buyers have even at today’s potash prices, with the significant and ongoing decline in the number of suppliers thanks to M&A both within North America and elsewhere.

Mark Connelly, Analyst at Stephens

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