Belarus’s potash sector: reasons and consequences of break-up with Uralkali

Belarus’s potash sector: reasons and consequences of break-up with Uralkali

Demand for potassium chloride kept improving throughout the second half of the 2000s for several reasons, including the steady growth in the world population, reduction in arable areas per capita, improvement in rations in developing countries resulting from increases in personal incomes, growth in biofuel output, and broader use of potash in the cultivation of various crops, such as corn, soybeans, palm oil, rice, and sugar cane.

However, the growing prices for potash can only partially be attributed to the increase in demand. Another crucial factor behind the hikes in prices was the high concentration of potash production and limitation of production by the oligopolists, which sought to maintain high prices.

Oligopolistic dilemma and divergence of interests of Belaruskali and Uralkali

The informal coordination of production volumes by BPC and Canpotex (which did exist, judging by the materials of the U.S. antitrust case) enabled the oligopolists to generate profits that were a lot higher than those possible in conditions of a genuine competition among numerous market players. However, cartels themselves are rather unstable institutions. The format for the engagement of cartel members calls for thorough coordination of the volume of output by all of the members (which normally envisages agreements on limitations of production) in order to maintain high prices. This pattern ensures the interest of all of the oligopolists in such kind of cooperation. At the same time, because each company is only concerned about its own benefit, high prices in the market tempt producers to cheat on their partners. Cartel members seek to secretly sell more than they originally agree, at lower prices, in order to maximize their own profits and expand their market share. This conduct by cartel members sometimes leads to a disintegration of the consortium. This is what happened to Belaruskali and Uralkali—the process culminated in the decision of the latter partner to exit the cartel in mid-2013.

There were two factors that encouraged Uralkali to break up with Belaruskali and leave BPC. First, Uralkali started suspecting its Belarusian partners of selling more potash than it had been agreed within the framework of the cartel. Second, Uralkali had a unique edge, which could have enabled it to eventually become markedly more profitable than Belaruskali. Tension between the two partners also kept increasing because Uralkali operated its own trader besides BPC, which enabled the Russian producer to sell only a part of its output via BPC. Agreements concerning redistribution of the export quota resulted in Belaruskali’s selling less potash than it would have been selling if Uralkali had been marketing all of its output through BPC.

The oligopolistic dilemma in the engagement between Belaruskali and Uralkali became especially tense, because the shareholders of BPC were guided by qualitatively different strategies. The Belarusian side represented by state-owned Belaruskali is primarily interested in effectively addressing the current challenges to the national economy, mainly the provision of foreign exchange proceeds for the country when it faces crises. For its part, privately-owned Uralkali seeks to maximize profits in the medium and long terms.

Belaruskali’s and Uralkali’s potash export to foreign markets, millions of net tonnes, and revenues, millions of U.S. dollars, in 2008–2014.

The discrepancies between the two companies became increasingly visible in 2012. First, Uralkali’s revenues (the Russian producer had completed its merger with Silvinit in the previous year) considerably exceeded those Belaruskali’s (see chart above). The reason was not only the redistribution of sales quotas within the framework of BPC in favor of Uralkali, but also the more flexible marketing system compared with that of Belaruskali. While Belaruskali exported all its products via BPC, the Russian company sold some of its output through its own trader, Uralkali Trading (UKT), whenever the market situation was favorable.

Second, Uralkali’s export through BPC fell because of Belarus’s economic difficulties. In the second half of 2012, Belarus was made to give up the lucrative business of exporting oil products refined from Russian crude oil while designating them as solvents and diluents, and the country’s foreign trade performance declined. Furthermore, demand for potash remained low in the world market. Therefore, seeking to improve its trade balance figures, the Belarusian administration resolved to increase the volume of sales at reduced prices.

Apparently, it was during that period (second half of 2012–early 2013) that the Belarusian side started selling some of Belaruskali’s products through traders other than BPC. The possibility was formalized by Decree No. 566 passed on 22 December 2012. Under the document, “the exclusive right of foreign trade in mineral or chemical potash fertilizers […] shall be exercised by OAO Belaruskali, ZAO BPC, and other organizations identified by the President of the Republic of Belarus”. It was the passing of the decree that the Board of Directors of Uralkali used to motivate its resolution of 30 July 2013 to discontinue export sales through BPC: “Based upon that decree, Belaruskali began shipping products beyond the framework of BPC. OAO Uralkali construed the move as a breach of the fundamental principle for cooperation and grounds for rechanneling export flows to its own trader”. The Belarusian side insisted, though, that despite Decree No. 566, Belaruskali kept supplying all of its products exclusively via BPC.

Uralkali’s game plan: making a proactive move

Why, then, did Uralkali make up its mind to withdraw from the cartel, being aware of the imminence of upcoming price falls?

First, pursuing its price-over-volume strategy, Uralkali started to gradually lose its share in the global market. The official annual review by Uralkali for the year 2013 reads: “despite the fact that the overall volume of the potash market expanded by 9% in the first half of 2013, Uralkali’s sales during the same period shrank in year-on-year terms, resulting from aggressive marketing policies by its competitors.” As a negative example, Uralkali’s Board of Directors cites the situation in Brazil, where the company was not selling its products with a view to maintaining high prices and where it ultimately lost a substantial portion of the local market. Uralkali’s executives draw the conclusion that “by keeping to the ‘price over volume’ strategy the company gradually yielded its share in the key markets to alternative suppliers throughout the first half of the year, which led to its overall 5-point reduction in its share”.

Second, in the medium term, potash prices would have lowered even if both potash consortiums — Canpotex and BPC — had been operating conscientiously, because new major producers of potassium chloride appeared in the market. The growing number of producers results in a heavier competition in any oligopoly. Over the last few years, a number of major mining companies started investing in potash projects, given the high prices recorded recently. Potash market analysts were predicting that “the prospective brownfield and greenfield mines pose a threat of overcapacity and oversupply in the market. Additionally, the entry of the three giant miners — Vale, BHP Billiton and potentially Rio Tinto — is set to change the potash game towards 2020”. However, in the new context, now that the East European cartel dissolved and world prices dropped, investors have had to revise their original optimistic business plans and freeze some of the projects that they already embarked on.

Third, by making use of the specific nature of BPC’s operation and the element of surprise, Uralkali gained new functional advantages. While Uralkali created its own sales network and trained sufficient number of top-ranked specialists, Belaruskali had to build its marketing network amid shortage of highly skilled sales professionals. Although formally it was the Belarusian side that controlled BPC (it got to appoint its CEO who was authorized to make decisions that could not be vetoed by Uralkali), many of BPC’s top managers were employees of the Russian producer. Once Uralkali made the move to end its venture with Belarus, they all submitted their resignations and left Belarus. The Belarusian company had to look for independent traders. In early August 2014, Belaruskali signed a framework agreement on joint sales of potash with Qatar’s Muntajat.

Performance by Belaruskali and Uralkali after the break-up of the cartel

According to Uralkali’s reports, the company’s share in the key potash markets expanded in the second half of 2013 (especially in Brazil and Asia), whereas during the first half of the year, it kept falling. The producer worked almost to its complete capacity starting August 2013, supplying approximately 1 million tonnes of potash on a monthly basis.

Quarterly export of potash fertilizers by Uralkali and Belaruskali in 2013–2014, millions of net tonnes

Export supplies by the two companies were almost equal during the first two quarters of 2013. After Uralkali exited BPC, a significant difference can be observed in export volumes by Belaruskali and Uralkali in the third and fourth quarters. While Uralkali was purposefully increasing sales in foreign markets, Belaruskali’s export shrank.

The activation of all of Belaruskali’s four mine groups became evidence that Uralkali’s volume-over-price strategy, which the Belarusian company was trying to oppose in the second half of 2013, was actually working. Belaruskali’s sales increased, because the best economically viable tactics were to maintain the producer’s market share and push up sales with a view to reaching a profit level that would be as close as possible to the one that the company had before the disintegration of the consortium, when the price-over-volume strategy prevailed in the market. Back in 2013, Uralkali was the one responsible for the slump in prices, whereas in 2014, it was Belaruskali that knocked down world prices by offering its products cheaper than its competitors and working to its full capacity.

Back in 2013, Uralkali was the one responsible for the slump in prices, whereas in 2014, it was Belaruskali that knocked down world prices by offering its products cheaper than its competitors and working to its full capacity. Uralkali’s CEO publicly voiced his discontent about Belaruskali’s offering potash fertilizers to China at reduced prices in 2014 and early 2015.

Volume of output by Uralkali and Belaruskali in 2009–2014. Note: the sharp increase in output by Uralkali in 2010 is due to its merger with Silvinit.

The year 2014 turned out to be bittersweet for Uralkali. On the one hand, the company managed to substantially increase its output in volume terms (to 12.1 million tonnes). It had planned to boost sales through expanding its sales operations in Brazil and Southeast Asia—Malaysia, Indonesia, Vietnam, and, to a lesser degree, to India, China, and the domestic market. Uralkali’s aggressive moves in Brazil and Southeast Asia made after the producer ceased its collaboration with Belaruskali evidenced the Russian company’s bare-fisted approach.

On the other hand, the year 2014 was shadowed by USD 631 million losses for Uralkali caused by the depreciation of the Russian ruble and a serious accident at the Solikamsk-2 mine, which accounts for approximately 20% of the company’s total capacity. It was also reported that the drop in Uralkali’s shares resulting from the accident may affect the principal shareholders (UralChem, Onexim), which may now have difficulties in servicing their loans originally taken against the security of Uralkali’s shares.

The available statistics for the year 2014 show that Belaruskali managed to adapt to the new environment quite successfully. Back in 2013, Uralkali was the one responsible for the slump in world prices, whereas in 2014, it was Belaruskali that was knocking down prices globally by offering its products cheaper than its competitors. In 2014, the Belarusian company reached its full capacity and put out 10.3 million tonnes of potassium chloride, of which 9.5 million tonnes were exported. Although the Russian producer reported more impressive performance indicators for 2014 (with the total output volume of 12.1 million tonnes and export of 10.4 million tonnes), Uralkali was affected by the combined natural and technological factor, namely, an accident at one of its principal mines. The producer has not fully recovered from the accident yet, and there is a chance that Uralkali’s production will fall further. Therefore, the original rational game plan by Uralkali worked only partially and for a limited period of time.