Page 2 of 2 Kremlin's potash war picks its prisoners
By John Helmer
The Chinese win with this strategy in the short term because potash will cost them $200 less per tonne. In the medium term, they will gain on their equity investment if Uralkali successfully pressures Belarus into conceding control of Belaruskali to the Kremlin. In the long term, the Chinese might find themselves financing the enlarged potash monopoly for a stake of better than 12.5%.
How many insiders can fit inside the Kremlin wall? This June, six weeks before the strategic change, Mutsoev sold out his 6.4% stake back to Uralkali for $1.3 billion. At the time, Alexander Voloshin, once a mouthpiece for Boris Yeltsin and currently
chairman of the Uralkali board, claimed Mutsoev was selling his shares because "he wants to focus on public service". Could Voloshin have been as blind, deaf and dumb as that sounds in retrospect? Or was he in on the scheme agreed with the state banks and with their Kremlin supervisors that Mutsoev would start his new focus on public service by sharing the multi-million dollar profit the insiders were guaranteeing?
Mutsoev wasn't the only one - Nesis was also heading for the door. He had started by buying 13.2% of Uralkali during the elimination of Rybolovlev and Silivinit - a "warehousing operation" for him, an associate acknowledged at the time, with the understanding that he would be allowed to sell out slowly. By August of 2012, Nesis was down to 9.9%; by April of 2013 he was holding just 5.1%. That too was sold out by July 26, according to a statement by Uralkali, when Nesis's appointee on the board stepped down.
Nesis and Uralkali agreed to say his exit had been "in several small stakes on and off the market, with buyers representing several portfolio investors." Like Mutsoev, Nesis was also engaged in public service, according to the Uralkail statement, since "the funds received from the sale of shares will be used to finance projects in railway transportation."
According to a spokesman for Nesis, the timing of his share sale and the collapse of the potash cartel is a "coincidence". Nesis's spokesman Nikolai Dobrinov used that word with his tongue firmly planted in his cheek. Nesis and Mutsoev have been insiders for several years, so there was almost certainly a prior obligation on the part of Uralkali to buy them out at an agreed profit margin, protecting their outlay risk if the market changed, or if they could not find an open market, arm's length buyer for their shares. Nesis started earlier than Mutsoev; he may have made the larger profit.
But if implementing the Kremlin strategy for the potash sector - devised originally by Igor Sechin when he was deputy prime minister in charge of resources and decided Rybolovlev had to be replaced - is public service, then that's exactly what Mutsoev and Nesis have been fortunate to serve.
No source close to them, or to Kerimov and Voloshin, believes they have acted without advance agreement with the Kremlin. Without that, the state banks holding Uralkali shares as collateral for the company's borrowings, as well as Kerimov's, would have followed the July 30 announcement with margin calls.
That hasn't happened. Their shared strategy to leave the BPC has now triggered a 47% decline of Uralkali's share price from this year's peak; it has taken down with it the share prices of all other potash producers, including K+S, the German multi-fertilizer group in which Melnichenko holds the largest stake. About half of Uralkali's market capitalization, or $11 billion of shareholder value, has been lost.
At K+S the value burn has been 3.7 billion euros (US$4.9 billion). In April, K+S announced it was delaying the start of a new potash mine in Canada, replacing its dwindling mines in Germany, because the Canadian costs had risen substantially. But the delay would be temporary, K+S also claimed, because it was forecasting no global increase in the volume of potash for sale, and thus relatively stability for the potash price.
According to the K+S claims, it planned to invest in an extra 3 to 4 million tonnes of potash capacity; hang on to its 10% share in the global market; and earn "a 15 percent premium on the cost of capital before taxes", according to its chief executive, Norbert Steiner.
Through three Bermuda front companies, 9.88% of K+S is owned by Melnichenko, and he is K+S's largest shareholder. Since last week's Uralkali move, he has lost 365 million euros in current stock value. But that's only the start. If the Germans thought Melnichenko was their fixer in Russia, their early warning on their eastern front, they appear to have made a bad mistake. If the potash crisis was deliberately triggered by the Kremlin, on terms allowing some of the Russian stakeholders in Uralkali to escape with profit, is Melnichenko the biggest of the Russian losers? Or did he too strike an accommodation with the Kremlin in advance?
Uralkali's move to stop cooperating with Belaruskali and increase annual production to 13 million tonnes next year from 10.5 million may reduce prices to less than $300 a tonne, according to Uralkali's chief executive Baumgertner. That would be at least 25% below the latest contract price for China and the lowest since January 2010.
At that price level, Melnichenko and Eurochem cannot start mining potash without making losses. As these two charts of the potash price show, the first for one year past, and the second for the previous seven years, it will be ruinous for Melnichenko and Eurochem if they bring their two new Russian mines onstream, and allow K+S to do the same in Canada, at the same time as Kerimov uses his new market power to force the potash price back to its historical level.
That, say Moscow's institutional analysts, will have an immediate financial impact on Uralkali's position with its banks. Uralkali's loans totaled just over $4 billion on December 31, 2012, according to the company's annual financial report. The banks are not identified, but are believed to be led by the Russian state lenders. Reporting by Moscow financial institutions indicates that by June 30, the debt was $4.9 billion.
The picture for Eurochem is much worse. According to its 2012 annual report, it has been counting on besting Uralkali to become the leading producer in Russia of saleable "nutrient capacity". This and other presentations have indicated a forecast of more than $1 billion in annual revenues from the potash mines, once they are operational. However, if the potash price drops below $300 per tonne, analysts are calculating that compared to the revenue projections, the company will lose about $1.8 billion.
In short, it will be losing more money on potash than it has been counting on taking in sales - more money than it says it has invested to earn at one of its Russian mine projects. What happens then?
If Melnichenko doesn't produce potash at the Verkhnekamshoye and Gremyachinskoye mines by the 2014 deadlines in their license agreements with the Russian government, will Melnichenko be able to negotiate an extension of the deadlines? Or will he face the same ultimatum Sechin gave Rybolovlev in 2009 - sell out, or be taken over? Given what Uralkali has already done to the potash price, the market price of Melnichenko's exit from the potash sector will be much less profitable than Rybolovlev's.
The Rencap analysis of Uralkali's future since the July 30 announcement is positive towards Uralkali because "potash prices of around $300/t make nearly all greenfield and brownfield potash projects IRR [investment rate of return] negative and may force some marginal producers to idle operations. The reduced potash supply in the future may support potash prices later this decade, while Uralkali's new strategy may help maximize its market share." Eurochem, which isn't covered by the institutions because it remains unlisted, is one of the apparent victims.
Non-Russian bank lenders to the potash sector, who aren't in on VTB's and Sberbank's deal, appear to have worked this out. For that reason, they are now getting ready to raise their price for the abrupt increase in risk in lending to Melnichenko and Eurochem which has materialized.
According to one report last week,
EuroChem has sent out a request to banks for a soft target of $1bn, with banks asked to provide $100m-$150m each. The margin on the five-year unsecured deal is 180bp [basis points]. This price has proven contentious among lenders as it is the same that the firm paid in 2011 for its secured pre-export finance facility. At least two of EuroChem's relationship banks have decided not to lend to the firm on this deal because of the pricing. Last week [before July 30], one of the banks from the senior group told EuroWeek that they were not lending a top ticket this time around, citing the low pricing as the reason. Instead, the bank has returned to EuroChem with an offer of a much-reduced ticket, as a way of keeping the relationship open. But now another bank - also a senior lender on the 2011 PXF [Pre-Export Finance] - has told EuroWeek that it is dropping out altogether.
Several days before the July 30 shock, EuroWeek's sources among the Eurochem bank syndicate were admitting their reluctance to lend at Melnichenko's proposed interest rate. Whether there is a price at which the remaining members of the syndicate will lend now remains to be tested by Eurochem's negotiators over the next few days.
This is why Torin, Melnichenko's spokesman, is so tight-lipped. When Eurochem issued its annual report for 2012, it acknowledged the "threats" facing its potash strategy: "Prolonged, significantly worse-than-expected market conditions could negatively affect EuroChem's ability to continue financing these investment projects ... Significant capacity additions resulting in oversupply in the industry."
So Torin was asked: "At a potash price of between $200 and $300 per tonne, Eurochem's previous statements regarding its two new potash mines in Russia, and its projects in Kazakhstan, suggest that these projects will be uneconomical, if not loss-making. Is that correct? What action does Eurochem intend in relation to its capital spending on the Gremyachinskoye and Verkhnekamshoye mines? Do you intend to delay commissioning these and the Kazakh projects until potash prices stabilize again above $400? Does Eurochem intend to prioritize the nitrogenous fertilizer segment of its business as a result of the changes in the potash market?"
No reply, not even an acknowledgement of receipt.
To this, Uralkali has already issued its response. "Consolidation", said chief executive Baumgertner in Moscow this morning, "is the logical step when the price falls to the level of marginal producers."
John Helmer has been a Moscow-based correspondent since 1989, specializing in the coverage of Russian business.
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