Ed Lotterman: Lessons from a potash cartel’s collapse

August 9, 2013 

Optimists say that every cloud has a silver lining, and it isn’t hard to find one in the recent potash industry upheaval that sent the stock of several fertilizer producers down by a fourth.

What is bad for them is great news for U.S. farmers, who will see the price of this important crop fertilizer fall sharply for the next growing season.

Moreover, while a lower share price stemming from reduced profitability may be bad for shareholders, executives and other headquarters employees, it isn’t necessarily bad news for production employees at these companies’ potash mines. Lower prices will mean somewhat greater overall potash consumption, and that will translate into more jobs or more overtime hours for production workers.

For teaching economists, it is a great real-world example of the operations of a cartel, an artificial combination of two or more players, companies or countries, so they can act as a monopolist. This involves limiting output so as to drive up price. The structure of demand is such that this means higher profits; the positive effect of the higher prices at the corporate level outweighs the negative effect of smaller quantities sold.

But there are always internal tensions within cartels, whether it’s the multistate Organization of the Petroleum Exporting Countries or the Belarus-Russian potash cartel, the collapse of which last month provoked the drastic sell-off of stock for every potash producer (there aren’t many).

First, let’s review a little introductory microeconomics: For a market economy to be efficient, certain conditions need to be met, including having many buyers and many sellers for any product. When these conditions are true, the market price will be optimal for society in terms of efficient use of available resources and satisfaction of people’s needs from those resources.

If, however, there is just one seller, or only a few, the resulting price is neither optimal nor efficient. A monopolist can drive prices higher by limiting the amount sold. The exact amount that maximizes profits also depends on the cost of producing additional units of the good in question.

If a group of producers band together to act as one, as in a cartel, they can achieve the same result.

In the late 1800s, U.S. companies formed cartels using the specific legal ploy of putting a controlling interest in all the participating companies into a trust. Hence, in our country we speak of “antitrust” policies, while the rest of the world says “competition policy.”

Cartels increase the profits of producers at the expense of consumers.

But there are inherent internal tensions. If production is to be decreased, and it must be to drive up prices, then which producers have to cut back and by how much?

It would have been illegal for any U.S. company to participate in the cartel to the point of divvying up sales in our country with competitors. However, such firms do participate in a venture, Canpotex, that deals with export sales from Canadian mines.

The quasi-cartel acts “to maximize producer returns” by jointly marketing potash outside of the United States and Canada. Because it does not sell fertilizer itself as a group in these countries, even though its member companies do, it does not violate U.S. or Canadian competition laws.

But one can be sure that this entity took the actions of the Belarus-Russian concern into account in shaping its own policies. Moreover, the actions of an export coalition like this inevitably have some feedback into their home markets when the product is an internationally-traded homogeneous commodity, even if there is no violation of domestic law.

The Belarus-based cartel had less than a third of world production. Yet by cutting back its own production, it was able to drive up price, with most of the benefits flowing to non-stinting outsiders. This is the same situation that Saudi Arabia has often faced within OPEC.

So now one of the two companies has bailed on the agreement, and the cartel has collapsed. So have prices and so has the stock in major potash producers. The initial fall in market value for these firms came to some $13 billion.

Financial markets often overshoot in their reaction to bad news. A 25 percent drop on the first day does not mean that the stock will be low a month later.

Also understand that even before the potash price drop touched off by this news, the cost of the fertilizer to farmers, adjusted for inflation, was well below where it was 35 years ago when I was still buying it. Like many other primary commodities, it has gotten cheaper in real terms in recent decades. So the ability of the cartel to drive up prices was limited.

However, the prices of corn, wheat, soybeans, alfalfa and other potash-using crops also have increased much more slowly than the rate of general inflation. The ratio of the price of the fertilizer to the price of the crops it helps produce has not favored farmers. So this drop in price, even if it lasts for only a season or two, is good news for them.

China and India, two large potash importers, are jokers in the deck. If their economies slow markedly, resulting import reductions would further push prices down, and with them the stock price of producers like Mosaic, which has benefitted greatly from the commodity price boom engendered by these two countries. But no one knows for sure what will happen for them, nor how much fertilizer imports would drop as their economies slow. All indications are that fertilizers would not be affected as much as iron ore, for example.

All this is not earthshaking, at least if you don’t own a lot of stock in a potash producer and need to sell it soon. But it is an excellent case study of basic economics.

Economist Edward Lotterman teaches and writes in St. Paul, Minn. Write him at ed@edlotterman.com.

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