Saturday, October 16, 2010

BHP to get shafted?



And now for something completely different. As you know, BHP is bidding for Canada's dominant potash producer, PotashCorp. On Saturday, the only other mooted bidder, Sinochem backed out. So the way is open for the Big Australian.

Or is it?

This blogger had a spare moment to peruse the Investment Canada Act and its National Security hurdles.

Not much is available beyond the conditions under which a National Security Review can take place. They are available here.

For the most part the Australian media has been nervously endorsing the likelihood of BHP winning regulatory approval. But, to be honest, this blogger will not be surprised if the Canadians squash the bid.

The rationale for doing so is quite straight forward. Food supply is a strategic issue for China. Potash is therefore a strategic commodity. And in the past, BHP has proved itself very capable of favouring profits over national security interests. Let me explain.

Take a look at the Conference Board of Canada's review of the bid. In it they describe the Potash market thus:
The global potash market has many of the characteristics of a traditional oligopoly market.For example, there are few players in the industry, with the Canadian, Russian, and Belarusproducers accounting for the vast majority of global trade. There are also high barriers toentry, with few large deposits of potash globally and high costs and long development timesto develop new mines. Finally, most of the large producer companies in the industry areprice setters, rather than price takers. Although potash producers do negotiate their sellingprices with their customers, they have considerable bargaining power given the limitednumber of players operating in the industry.

A distinctive feature of an oligopoly market is the interdependence of a few large firms,each of which has the ability to influence broad market conditions. Therefore competing firms must take into account the actions of the other market participants. In some situations, this can lead to various forms of collusion, such as passively allowing a market leader to set prices, which the smaller producers then adopt; or more active measures, such as seeking to increase prices by limiting production. At the other extreme, oligopolistic markets can be extremely competitive, with firms seeking to maximize market sharethrough aggressive price discounting. This situation is more common in markets with undifferentiated products and high levels of fixed costs, both of which characterize the global potash industry.

I'm not sure what school of business behaviour these analysts went to but the first rule of oligopoly business is NEVER drop your prices.

And that is not what BHP did in the iron ore market, even though it ramped production. Rather, BHP understands that strategic commodity markets do not work on the regular laws of supply and demand.

In regular markets if prices rise then demand falls, as well as vice versa. But in strategic commodity markets, where governments depend upon security of supply for legitimacy, the opposite happens. When prices rise, demand rises further because governments get spooked about security of supply. Stockpiling and strategic investment in production ensue.

It is for this reason that BHP broke the annual contract system that had served to balance the needs of buyers and sellers for fifty years in the iron ore market. Prices have been riding high ever since.

The Canadian potash producers sell through a similar annual contract system to the one BHP has just trashed in iron ore, using a single desk arrangement called Canpotex. BHP has already announced its intention to abandon Canpotex.

Just as it did in its iron manouvres, BHP is selling this idea as market friendly because it appears to be breaking up a cartel. But in reality, BHP is trading security of supply for higher prices. Of course, the customers - especially China - are royally pissed by the whole business.

This, you might say, is all fair enough. The Australian government didn't give a hoot and has been enjoying higher tax revenues ever since.

But the Australian government was happy to outsource its foreign policy to BHP. If you're a Canadian security analyst, and you're considering what's in the national interest, the notion of a foreign-domiciled firm poking an already dirty stick into your China relationship can't feel too comfortable at all. It is quite the rogue element you're introducing, and with vast other potential trade with China (already Canada's third highest export destination) and the need to diversify away from a huge US export dependency, sustained good relations are key.

The famously Presbyterian Canadians have already muted their human rights concerns and, who knows, they may seek to trade a favour.

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