A state-owned Chinese fertilizer company has signed a 10-year potash supply agreement with Prospect Global Resources Inc, guaranteeing China a steady flow of the crucial fertilizer and helping it partially sidestep multinational suppliers.
The deal with Sichuan Chemical Industry Holding (Group) Co SICHAD.UL, worth more than $2 billion, is part of a Chinese trend to partner with small mining companies hungry for capital to develop their land.
Potash is one of the most-important fertilizers for farmers to apply, after nitrogen and phosphate.
"In China we've got a key customer who is really motivated by national food-security issues," said Devon Archer, the Prospect director who helped negotiate the deal. "And securing our first customer was really a breakthrough moment for Prospect."
Prospect's mine in Holbrook, Ariz., is estimated to have the largest potash reserves in the United States with nearly 40 years of supply, but the company has yet to obtain financing or regulatory permits to develop it. The mine is not expected to open until at least 2015.
The Denver-based company, which launched an initial public offering in July and has a market cap of roughly $160 million, can now use the agreement to secure financing to develop the mine. Archer declined to discuss funding amounts or potential financiers, but similar-sized projects have cost more than $1 billion to develop.
China has inked similar contracts with rare earth and uranium miners around the world. With the Prospect deal, the world's largest consumer of potash locks in some of its supply needs ahead of the once-in-a-decade change in Chinese leadership next month.
China has been aggressively negotiating for lower potash prices with Canpotex Ltd, the marketing agency that sells Canadian potash. Canpotex, owned by Potash Corp, Mosaic Co, and Agrium Inc, is one of the world's largest potash exporters.
So far neither Canpotex nor China has been able to agree on a price, and a deal isn't expected until the end of 2012 or early 2013. The Prospect deal gives China some leverage in negotiations as it will be less reliant on Canpotex for supply.
China buys potash through contracts that are generally renewed annually at prices used as a benchmark for spot sales. The country consumes more than 9 million tonnes of potash per year.
At current market prices, the Prospect deal is worth roughly $2.4 billion.
Archer, the Prospect director, declined to discuss the specific price per tonne in the China contract, though he said it was "very competitive and based off the world price."
North American prices at the Port of Vancouver, the main Canadian port for potash exports, hovered under $500 per tonne in September, according to market data released by Potash Corp last week.
China paid $470 per tonne under previous contracts with Canpotex and wants to pay less in future contracts, according to Lazard Capital Markets analyst Edlain Rodriguez.
The Holbrook mine is expected to produce 2 million tonnes of potash annually when online, and China will take at least 500,000 tonnes of potash each year for ten years.
China, which produces some potash domestically but not enough to meet demand, has been buying more than 1 million tonnes of potash each year from Canpotex. It has signed supply deals in the past with producers in Belarus for roughly 500,000 tonnes.
In the contract with Prospect, China has the option to buy more potash, and the company is negotiating with other potential buyers for the remaining potash that will be produced, Archer said.
Prospect plans to hire roughly 700 workers to run the 90,000 acre site in eastern Arizona.
Unlike most potash mines, Prospect's Holbrook mine is relatively close to the surface with reserves roughly 800 feet to 2,000 feet deep.
The mine also is located in the warm Arizona climate, whereas most other potash reserves are in cooler climates in Canada or Russia. Given that Prospect has yet to open the mine, it's not clear what its cost per tonne to produce will be, though the company will have to do less digging.
For instance, Mosaic's Esterhazy mine in Saskatchewan, the world's largest potash mine, is roughly 3,700 feet deep.
Mosaic had to freeze an underground lake and drill through the ice just to reach its potash reserves.
"What we do have at Prospect, which is most important, is the geology," said Archer.