This is my working thesis/narrative of recent events, as well as how they will play out.

Sequence of events (more or less facts)

• There was tension in the BPC relationship – fights over allocation, pricing, that Uralkali was maintaining outside sales relationships but Belaruskali was exclusive.
• Belarus started cheating at some point and the cheating has continued.
• In December, BPC was undermined by decree by Belarus’ president which removed the exclusivity of BPC over Belarus exports. This obviously undermined the long term stability of the cartel arrangement and if unchallenged could be very bad for industry structure in the long run
• A few days ago, Uralkali essentially declared war on Belarus by throwing out the arrangement altogether (the nuclear option)
  • They sold 500K tons of potash to China, and “guided” to a price of $300 per ton in the latter half of 2013.
• Equity valuations has declined dramatically across the board. Uralkali is on the downgrade list by Moodys’ and S&P. Belarus sovereign bonds are dropping.
  • Interestingly, market consensus has in one fell swoop adjusted to about $300 as the LT price across the board.
• Since then, the CEO of Uralkali has incrementally talked down prices... to "maybe as low as $250" per ton. 

Backdrop (also more or less facts)

• Belarus’s macro is in bad shape. Chronic balance of payments problems; thin foreign exchange reserves; high inflation; dependence on Russia for both financial support and trade.
  • IMF and Russia had to bail them out with loans
  • Russian trade has fallen due to Ruble appreciation and Russian macro, putting tremendous pressure on Belarus
  • Russia is reluctant to extend more loans to Belarus. Belarus is asking for $2 billion USD.
  • Belarus has external dollar/Euro denominated debt that’s due in chunks over the next several years. I think there's over $3bn USD due this year alone, and similar amount next year. These are huge sums for this country.
• Potash is a critical source of income for Belarus. It’s one of the few sources of foreign exchange outside of trading with Russia. Belarus has less than 10mm people with very low per cap GDP.
  • The potential hit from Uralkali’s declaration of war is very substantial. At $$270-300 per ton, the hit would be $1billion USD, or nearly 2% of GDP
• Uralkali is not in peachy shape either.
  • The stock is down 33%.
  • After spending lots of money on buybacks in the past year, net debt has climbed by USD$2.5 billion since December.
  • The bonds are being downgraded

My interpretation (conjecture)

• Uralkali is catching Belarus at an exquisitely vulnerable time. This is the perfect time to punish transgressions and extract concessions.
  • Although Uralkali is hurting itself, its low cost position will stave off financial distress. For Belarus, the same cannot be said.
• The incentives are huge to reconcile from both parties, and in fact, from the entire ecosystem (including stakeholders like the Canadian government)
• Uralkali has been in talks to buy Belaruskali several times over the last few years, but Lukashenko keeps scotching the idea. This time around, given the much higher net debt at Uralkali, it doesn't feel like a pressure tactic to get Belarus to change their minds.
• Uralkali’s stated strategy (maximize profits by maximizing volumes) has very little chance of success, and they know it.
  • However, they have to be “credibly reckless” in this gambit
  • The price elasticity of potash is small. Look at the history of prices v volumes. The huge spike in prices has caused little demand destruction in recent years. This is very typical of commodities.
  • In such a market, increasing volumes is very unlikely to offset price drops. I calculate that if Baltic FOB prices drop to $270, Uralkali's per ton gross margins will fall to $160 from $290. After factoring corp expenses, 40% of EBIT is wiped out. A volume increase is unlikely to offset this.
  • Game theory tells you that when a cartel breaks down, all players have incentives to “dump”. Uralkali is unlikely to monopolize the (modest) volume increases in a price war. In fact, there is tremendous incentive for Canpotex to dump into key Asia markets which are traditionally reachably via Vancouver. It actually might be cheaper for Canpotex to reach some of these markets than Uralkali, which ships via very, very long rail hauls (or thru the Baltic).
  • Plus, this war is unlikely to stave off supply additions in the potash industry, unless prices stay very low forever. (Projects like Jansen aren’t “lost”. If potash prices rise, BHP will just go in there and complete it). Destroying economics of the industry just to DELAY new entrants is like fending off burglars by burning down your own house.
  • This is classic economics. Kerimov actually trained as an economist. He would know this.
• This entire situation was caused by the direct agency of one man – Kerimov. And what he has wrought and he can un-wright. Clearly, Belarus wants to reconcile. Even if he was stupid enough to embark on a "volume over price" plan for real, if EBIT falls enough, he can change course.
• The hard part is figuring out how long a resolution will take.
  • Belaruskali is essentially a sovereign. (It’s one of the most important economic entities in Belarus, with a “market value” of 40% of GDP, pre-crash).
  • Dealing with sovereigns are tricky, especially when there are geo-political dimensions at play
  • Where do the Kremlin’s interests lie? I can’t imagine that it wants to severely destabilize the Belarussian state… But the relationship there has deteriorated in recent years
• In various interviews, Uralkali has talked in recent days about its desire to set up a Swiss based trading cartel (presumably so that the trading company would not be under Belarussian law). It's unclear if that's their ultimate intention.

How Might I be wrong

• Unknown unknowns. This situation is like a stack of Russian dolls. It just goes deeper, and deeper, and deeper…
  • I personally believe that Occam’s Razor applies. But who knows?
• Why did Uralkali buy back one of its shareholder’s stakes in June for $1.3 billion? Why did one of the other shareholders sell for $1 billion in the open market, at the same time when Uralkali was conducting open market purchases?
  • There were signs of shareholder group tensions in Uralkali prior to now. There were 5 oligarchs involved… yeesh.
  • These issues can be interpreted in a variety of lights, ranging from good to sinister. Not sure how much you can parse the tea leaves without getting into tin foil hats.
  • To be fair though, the buyback program started in last Nov. Nesis started selling in late June. Although the buyback helped give liquidity, it's unlikely that was the play from the beginning. (If they wanted to solely give liquidity to Nesis, there are a lot easier ways to do it

• I think an argument can be made for downside protection for North American producers.
• North America is relatively geographically isolated. And there's little incentive for POT/MOS to dump into their home markets. Canada + US accounted for 40-45% of POT's revenues last year.
• Even if Uralkali/Belaruskali try to dump into the NA market, it will require huge transportation costs. US potash usage is concentrated in the grain belts of the upper mid west (and to a lesser extent, the high value crops of California). The uppermidwest in particular is difficult to penetrate from the sea. I'm not sure the netbacks are worth it. Brazil is a better target for them (which hurts K+S).
• If Uralkali tries to dump into North America, Canpotex has the power to absolutely crush Asian prices -- to below $250 per ton. The game theory gets complicated.
• I think it's quite possible for North American prices to diverge from Asian/Lat Am prices. This reminds me of the coal industry, which had large differentials between US, European, and Asia Pac prices (and still does). This is all owing to transportation issues. The potash industry could actually diverge more than coal, IMO.
• All this is a point in favor of Intrepid, owing to their location. I think Intripid MIGHT be able to support mine mouth prices significantly greater than the prevailing Baltic price. (I'm penciling in "normalized" EBITDA of about $130 million for Intrepid, assuming potash prices fall to $270-$300 in Europe and stays there).

When I look at valuations in the industry, I think this is a somewhat assymetric bet. I'm personally long IPI (thru options), and MOS (outright). I think POT will probably do well too, but I don't really know/care/like the Nitrogen business. Nitrogen prices have been dropping like a rock. If you are feeling good, I think long Uralkali (traded in London) will do well. K+S is the speculative bet. If the cartel reforms, the stock can close to doubling. But if the situation stays poor forever, K+S is pretty screwed... maybe 50+% downside?