UBS Investment Research Australian Resources Weekly Potash 101  Potash overview Potash is a generic term used to describe a variety of mined minerals and manufactured chemicals that contain potassium. It is one of the three important nutrients to plants besides nitrogen and phosphorous. Potassium chloride (KCl) also known as muriate of potash (MOP), is the most important potash product and is primarily used in fertilisers (more than 95%).  Potash production process KCl ore deposits located deep underground is predominantly mined using conventional mining techniques. Solution mining is also used in a number of cases but this process is more energy- and cost-intensive solution mining. Using a flotation process, common salt and clay particles are removed, the brine solution is dried, and the dried potash is then sized by screening.  Potash demand supply Regionally, potash demand is driven by developing and populous economies o f China, Brazil, India, Indonesia and Malaysia. Supply is concentrated on a regional as well as corporate level; six countries account for about 95% of the global potash trade and six producers account for 63% of global capacity. Long-term outlook looks positive as the minerals have no substitute and we believe potash use will become much less discretionary over time in order to maintain soil fertility.  Global mining companies have shown interest in potash Several global mining companies have shown interest in the sector with BHP developing a green-field project in Saskatchewan (potential start-up in 2015 o r later) and Vale buying Rio’s Argentine project (Potasio Rio Colorado) earlier i n the year. Yara and Salt Lake Potash are our preferred potash plays. Global Equity Research Australia Mining & Metals Sector Comment 13 November 2009 www.ubs.com/investmentresearch Glyn Lawcock A nalyst glyn.lawcock@ubs.com +61-2-9324 3675 Tom Price A nalyst tom.price@ubs.com +612 9324 2189 Jo Battershill A nalyst jo.battershill@ubs.com +61-2-9324 2834 Mark Busuttil A nalyst mark.busuttil@ubs.com +61-2-9324 3623 Daniel Morgan A nalyst daniel.morgan@ubs.com +61-2-9324 3844 Chart 1: Stock price movement of potash equities in the last three months 80 90 100 110 120 130 140 150 12-Aug-09 19-Aug-09 26-Aug-09 2-Sep-09 9-Sep-09 16-Sep-09 23-Sep-09 30-Sep-09 7-Oct-09 14-Oct-09 21-Oct-09 28-Oct-09 4-Nov-09 11-Nov-09 POT.N MOS.N ICL.TA YAR.OL URKAq.L AGU.N Potash equities rose mid-Oct due to reports of probable corporate activity in the industry Source: UBS This report has been prepared by UBS Securities Australia Ltd ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 17. UBS does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. ab Australian Resources Weekly 13 November 2009 UBS 2 Potash overview Potash is a generic term used to describe a variety of mined minerals and manufactured chemicals that contain potassium. The main potash products are potassium chloride (sylvite), potassium magnesium chloride (carnallite), potassium magnesium sulphate (langbeinite), potassium sulphate, and potassium nitrate. Potassium chloride (KCl) also known as muriate of potash (MOP), is the most important potash product. Potassium is one of the three important nutrients to plants besides nitrogen and phosphorous in that order. The main use of potash is in fertilisers (more than 95%). Besides fertilisers, the mineral is also used in home usage (feed supplements) and industrial production (glass, ceramics, soaps etc.). Potash helps vital functioning of various processes in plants (and animals) and improves crop yields. Some of the important functions of potash fertilisers are: — Enhances water retention; — Aids in photosynthesis; — Increases root growth, and — Develops resistance to (plant) diseases. Potash vs Nitrogen & Phosphates Nitrogen finds the widest application as fertilisers followed by phosphate and potash as shown in the table below. Each of the three nutrients has different long-term attractiveness. Potash has the most concentrated industry structure, the least amount of raw material volatility, and the greatest barriers to entry from a resource, time, and cost standpoint. Nitrogen has the most fragmented industry structure and the greatest raw material volatility as natural gas comprises 75% of the cash cost of production. Phosphates rank between nitrogen and potash in terms of raw material volatility and industry fragmentation but like potash, phosphate is an industrial mineral and the quality and life of the producer’s reserve is the key driver of competitive position. Chart 2: Usage of various fertiliser nutrients – Nitrogen, phosphate and potash Year Ended Acreage Acres Receiving (%) App. Rates (lbs/acre) Nutrient Use (000s tons) Nutrient Use (000s tons) 30-Jun (000s) N P2O5 K2O N P2O5 K2O N P2O5 K2O Total N P2O5 K2O Total Corn 2005 81800 96 81 65 138 58 83 5,410 1,922 2,212 9,544 44% 41% 43% 43% 2006 78300 96 78 64 137 59 84 5,149 1,802 2,105 9,055 43% 40% 44% 43% 2007 93500 96 78 64 138 60 85 6,171 2,188 2,543 10,902 47% 48% 50% 48% 2008 86000 96 77 63 132 55 80 5,449 1,821 2,167 9,437 43% 42% 45% 43% 2009E 87000 96 75 55 128 49 65 5,324 1,582 1,555 8,462 44% 43% 50% 45% Wheat 2005 57200 88 61 25 66 34 45 1,661 593 322 2,576 13% 13% 6% 12% 2006 57300 85 65 19 65 32 28 1,583 596 152 2,331 13% 13% 3% 11% 2007 60500 85 65 20 67 33 28 1,723 649 166 2,538 13% 14% 3% 11% 2008 63100 85 64 20 68 32 28 1,824 646 180 2,649 14% 15% 4% 12% 2009E 59800 85 63 15 60 29 25 1,525 546 112 2,183 13% 15% 4% 12% Soybeans 2005 72100 17 25 30 23 49 82 141 442 887 1,469 1% 2% 17% 7% 2006 75500 18 23 25 16 46 80 109 399 755 1,263 1% 2% 16% 6% 2007 64700 18 24 30 16 49 84 90 377 810 1,277 0% 2% 16% 6% 2008 75700 18 23 25 17 48 80 116 418 757 1,291 1% 2% 16% 6% 2009E 77700 18 23 20 16 43 65 112 381 505 998 1% 2% 16% 5% Source: USDA, Fertecon, and UBS estimates Australian Resources Weekly 13 November 2009 UBS 3 Geology The most abundant mineral in potash commercial deposits is Sylvite (KCI). Sylvite together with halite form the common potash ore called Sylvinite. Like other ore deposits, potash ore deposits are differentiated on the basis of tonnage and minable K20 grades. Large potash deposits are primarily of marine origin as sea water contains sodium and potassium. With the effect of evaporation and other geological changes over a period of time, these potash ore deposits are formed. Most of the potash deposits across the world are of these marine evaporite sequences. The largest and most minable potash deposits are located in Saskatchewan, Canada. Potash deposits occur in beds of sediments at depths ranging from 1000 m (3,200 ft.) to 3000 m (10,000 ft.) below the surface and tend to have a thickness from 2.7 m (9 ft.) to 23.5 m (77.6 ft.). Potash Production Potassium chloride (KCl), ore deposits located deep underground is predominantly mined using conventional mining techniques (approximately 80 percent of global capacity). Solution mining is also used in a number of cases but this process is more energy- and cost-intensive solution mining. In limited circumstances, potash can be harvested from salt lakes or seas also. Conventional underground dry-shaft mining methods are utilized in mines up to depths of 1100 m (3500 ft.) whereas solution mining methods are used to extract potash from deeper depths. Conventional Mining: Ore is extracted from potash deposits by electrically operated mining machines and conveyed to the surface where it is crushed. Using a flotation process, common salt and clay particles are removed, the brine solution is dried, and the dried potash is then sized by screening. The resultant coarse grade product is ready for distribution. Fine particles remaining from the screening process are compacted into sheets which are then crushed and screened to particle sizes suitable for blending. Figure 1: Simple potash production process Source: Potash Corp, UBS Australian Resources Weekly 13 November 2009 UBS 4 Solution Mining: Solution mining is used for deeper deposits or when conventional underground mines become flooded and unworkable. Water is injected as a brine (a salt and water solution) in the mine to dissolve potash and salt and later pumped to an evaporation pond. As the liquid cools, the potash and salt crystals settle to the bottom of the pond. The cool brine is then heated and re-injected into the mine to start dissolving potash again. The remaining potash in the ponds is removed with floating dredges and pumped to the mill. Cost of production Chart 3 shows the breakdown of potash production costs for PotashCorp. As per PotashCorp, about 70% of their production cost is variable, which gives them flexibility to increase or decrease production to meet demand. Production costs are affected by geological conditions; ore thickness, consistency and continuity; ore depth and K2O content; energy costs; the level of mill recovery; operational capacity and degree of automation. Potash demand supply overview Demand side Fertilizers account for approximately 95% of the potash demand. Demand for fertilizers in turn comes from food production requirements. Demand in potash is driven by developing and populous economies of China, Brazil, India, Indonesia and Malaysia. The following two factors have lead to increased potash demand Q Rising world population along with rising levels of income have led to demand for better diets which leads to demand for more food production. Use of high quality fertilisers for better crop yields has also led to increased potash use. Q Potash demand has also increased indirectly due to a trend toward bio fuels usage – crops like corn, sugarcane, soybean, oil seeds are used in biofuel production where better fertilisers is being used to increase crop yield. In June, the International Fertilizer Association (IFA) projected a 4.8% decline in global fertilizer consumption for 2008/09. By nutrient the IFA expected an NPK decline of 1.5%, 6.3%, and 14.3%, respectively. IFA also projected a 3.5% rebound in global fertilizer consumption in 2009/10. By nutrient, IFA expected a 2.5% increase in N, 5.2% increase in P, and a 4.7% increase in K. The following charts show nutrient-wise demand growth in fertilisers and also potash consumption trends over the years in key markets. Chart 3: Prod’n cost composition -2008 22% 21% 14% 13% 13% 17% Supplies Labor Royalties/taxes Energy D&A Other Source: PotashCorp Australian Resources Weekly 13 November 2009 UBS 5 Chart 4: Global fertilizer demand Chart 5: KCI consumption trend in key markets 0 50000 100000 150000 200000 81/82 85/86 89/90 93/94 97/98 01/02 05/06 09/10E N P K Source: IFA, UBS estimates Source: Fertecon, IFA Supply Side Potash is produced in only about 12 countries (with consumption in about 160 countries); 87% of the world’s aggregate potash production is concentrated in six countries (Canada, Russia, Belarus, Germany, Israel and Jordan). Indeed these six countries accounted for more than 95% of the global potash trade in 2008. Canada and Former Soviet Union (FSU) countries account for approximately three-fourths of total potash exports. Biggest producers of potash are not the significant consumers of the mineral instead the biggest consumers are the leading importers of potash. Total potash production for 2008 was around 54kt of KCI with exports at about 41kt of KCI as per Natural Resources Canada. PotashCorp is the largest producer of potash followed by Mosaic and Belaruskali. Similar to regional concentration, potash production is concentrated at corporate level also. Three Canadian and three FSU producers account for 63% of global capacity. The owners of another 25% of global capacity (including Kali und Salz (K+S), Israel Chemical (ICL), and Arab Potash (APC)) tend to follow the pricing lead set by the market leaders. Historically, Canpotex, an exclusive offshore marketing company, owned by PotashCorp, Mosaic and Agrium to handle potash sales globally for Saskatchewan potash producers, has been the most disciplined export marketer. Due to a concentrated industry, potash producers are able to exhibit production discipline. In the last year, leading producers announced cutbacks to bring market stability with total global curtailments expected to approach 20Mt in 2009, versus nameplate capacity of 65Mt. The recent economic downturn and tightness in credit markets has led to delays or cancellations of many potential new expansion projects. With few exceptions, we expect most capacity growth between now and 2015 will come from debottlenecks and brownfield expansions by existing producers. We estimate existing Canadian and FSU producers will account for 41% and 18%, respectively, of the likely increase in potash capacity between 2008 and 2015. Several small- and medium-sized brine-based projects in China will account for 17% of global capacity expansions through 2015, or 3.2Mt on a KCl equivalent Chart 6: Potash exporting regions 40% 18% 16% 10% 7% 4% 5% Canada Russia Belarus Germany Israel Jordan Others Source: Fertecon Australian Resources Weekly 13 November 2009 UBS 6 basis. Our totals assume several more speculative greenfield projects will not be completed over the next five years, including those announced for Congo, Laos, Argentina, and Russia. We expect global potash capacity to increase from the current 65,000Mt to approximately 79,100Mt in 2011. Market Balance The following chart shows the regional demand supply gap across the globe. Asia and Latin America have the largest demand supply gap as they are not meaningful potash producers. Figure 2: Country-wise production and demand for potash Source: Fertecon, PotashCorp We remain positive on the long-term outlook of the mineral as we believe potash use will become much less discretionary over time in order to maintain soil fertility. The current slowdown is likely to curtail capacity development in an oligopolistic industry. We forecast a 12% rebound in potash consumption in 2010 as growers replenish nutrients depleted by his year’s crop. We, however, are cautious in our demand expectations and do not expect demand to return to 2007 levels as forecasted by PotashCorp. Our 2010 estimate for global potash demand of 47 mm mt KCL is below Potash Corp’s estimate of 50-55mm mt. The following table shows our volume assumptions. Table 1: Potash Price/Volume Assumptions for 2009-11 000 mt KCL 2007 2008 2009E 2010E 2011E Global Potash: Consumption 52.8 48.2 42 47 52.9 Shipments 59.4 56.7 37.4 50.8 56.8 Capacity 62.5 64.7 66.4 73.3 79.1 Source: Fertecon, PotashCorp, UBS estimates (as on Oct 2, 09) Australian Resources Weekly 13 November 2009 UBS 7 Prices Potash products are mostly sold on an annual contract basis. As with many other commodities, annual price settlements with China are typically considered to be the benchmark contract price for they year. Canpotex leads the negotiation for Canadian potash producers. A relatively small amount of potash is also sold in the spot market. For spot prices, Canadian potash is referenced to standard grade KCI Vancouver spot prices. The following table shows the change in Canpotex’s annual potash price settlement changes with China. Table 2: Potash price change in Canpotex’s annual contracts with Chinese buyers ($ per metric ton FOB Vancouver) Price Change Contract Yea r FOB Vancouver ($ /mt ) Comment 2000 None China’s purchase price (i.e., Canpotex’s selling price) was largely unchanged for many years prior to 2000. 2001 None 2002 None 2003 None 2004 $3 2005 $40 2006 $25 Agreement in July 2006 following protracted negotiations. Price increase was in effect for balance of 2006 only 2007 $5 Price increase lagged world market price by approximately $30-$40/mt 2008 $400 2009E ($140-$145) UBS Securities estimate of required price change for India – equivalent price. Source: Industry sources and UBS estimates Current price settlement In July this year, an Indian firm achieved a delivered price of $460 per metric ton, a decline of $165/mt versus the prior year contract price of $625/mt. Import demand appears to have fallen well below recent historical levels from virtually all major offshore markets in 2009, with the exception of India. The above contracted prices are not seen as market bottom by either US or international buyers, who have instead chosen to wait to see if China achieves a lower price. We estimate that a Chinese contract price freight-equalized to the Indian contract price would equate to an FOB Vancouver price of $430-$435/mt, a decline of ($140-$145/mt) from the 2008 contract price. Current expectations are for the Chinese contract to settle just under $400/mt fob Vancouver or $35 below the equivalent Indian contract price. Australian Resources Weekly 13 November 2009 UBS 8 Chart 7: Potash domestic prices still settling following year- long buyers strike (US$ per short ton) Chart 8: International pricing down from 2H 2008 peaks (US$ per metric ton) 0 200 400 600 800 1000 1 Q 05 3Q 05 1Q 06 3Q 0 6 1Q 07 3Q 07 1 Q 08 3Q 08 1Q 09 3Q0 9 E Cornbelt price Sask list price 150 300 450 600 750 900 1050 Jan-07 Jul Jan-08 Jul Jan-09 Jul 165 325 485 645 805 965 1,125 Asia Brazil China Corn Belt Source: Green Markets Source: Green Markets, FMB, and UBS estimates Investment View Belaruskali (state-controlled and not in the table), Silvinit and Uralkali are some of the largest pure play potash producers whereas PotashCorp, Mosaic, Agrium and Israeli Chemicals have potash as major part of their production. The table below provides our global potash comps. We prefer Yara and Salt Lake for potash exposure. Further, Yara appears to be an inexpensive stock based on our FY10 and FY 11 earnings estimates. We are Neutral on CF Industries which appears to be the least expensive stock in our coverage on the basis of forward EV/EBITDA multiple. Table 3: Global potash exposure Company Ticker Rating Mkt Cap Price Target Price Upside / Downside PE EV/EBITDA USD Local Local 2009E 2010E 2011E 2009E 2010E 2011E Potash Corp POT.N Neutral (CBE) 30,092.11 101.72 95 -6.6% 41.9 15.6 11.2 23.5 10.2 7.3 Mosaic MOS.N Neutral 23,109.41 51.78 52 0.4% 18.2 20.7 13.8 10.1 11.3 7.4 Israel Chem ICL.TA Neutral (CBE) 16,611.50 48.16 46 -4.5% 21.5 14.0 12.1 15.6 10.6 8.8 Yara YAR.OL Buy 10,280.60 198.6 240 20.8% 23.1 8.4 7.7 13.7 5.0 4.4 Uralkali URKAq.L Neutral 10,205.75 4.86 4 -17.7% 26.6 19.3 12.4 16.8 12.5 8.3 Agrium Inc. AGU.N Neutral (CBE) 8,290.26 52.47 50 -4.7% 22.0 10.1 7.6 9.0 5.2 4.5 Salt Lake 000792.SZ Buy 6,109.23 54.33 65 19.6% 37.7 23.0 18.1 19.4 12.2 9.8 CF Industries CF.N Neutral (CBE) 4,532.88 79.72 82 2.9% 10.6 12.3 8.0 4.2 5.0 3.5 Terra TRA.N Neutral 3,670.06 36.69 37 0.8% 16.9 14.1 18.6 6.7 6.2 7.4 Sinofert 0297.HK Sell 3,600.56 3.98 3.78 -5.0% 26.2 26.4 16.6 23.9 15.4 9.6 Intrepid Potash IPI.N Neutral 1,952.96 26.02 25 -3.9% 33.0 17.4 11.8 15.8 8.4 5.1 Source: UBS estimates (Prices as on November 11 for Nth American stocks and Nov 12 for Asian stocks) Several global mining companies have shown interest in the sector; BHP is developing a greenfield project in Saskatchewan with potential start-up in 2015 or later and Vale bought Rio’s Argentine project (Potasio Rio Colorado) earlier in the year. Vale also appears to be looking at additional production opportunities in Brazil. Australian Resources Weekly 13 November 2009 UBS 9 Potash Industry The charts below show major producers and consumers of potash and also the industrial reserves of the mineral. Chart 9: Potash Reserves, 2008 Chart 10: Potash production region-wise, 2008 48% 19% 8% 8% 6% Canada Russia Belarus Germany Jordan Israel Brazil United States Other countries 32% 19% 14% 10% 7% Canada Russia Belarus Germany Israel China United States Jordan Others Chart 11: Potash production company-wise, 2008 Chart 12: Potash uses 15% 15% 13% 11% 8% 8% 8% 8% 5% 4% 3% 2% POT MOS Belaruskali K+S China Uralkali Silv init ICL Arab Potash Agrium Intrepid Other 95% 5% Fertilizers Others Chart 13: Avg annual consumption by country (07-08 avg, 000mt, K2O basis) Chart 14: Global potash imports (% mt 2008 imports by country, K2O basis) India, 2,800 Brazil, 4,000 China, 6,500 A ll other, 10,900 Indonesia / Malaysia, 2,000 US, 5,400 United States 18% China 13% India 11% Malaysia 4% Brazil 16% France 3% Other 32% Indonesia 3% Source: USGS, Fertecon, UBS. NOTE: One ton of Potash is approximately 60% K2O content by weight (1 million metric tons of potash equals 600,000 metric tons K2O). Australian Resources Weekly 13 November 2009 UBS 10 Weekly share price movement Chart 15: Weekly price changes -0.1% 0.6% 2.0% 2.5% 3.4% 3.4% 4.2% 4.3% 4.9% 5.3% 6.0% 6.4% 6.6% 6.7% 6.9% 7.2% 8.1% 8.5% 9.1% 9.2% 10 . 6 % 11.1% 11.6 % 11. 9 % 12 . 7 % 13 .3 % 13 . 8 % 15 . 9 % 17 .8 % 25.6% -27.2% 70.6% 5.0% 27.6% 114.0% 20.1% 110.9% 13 3 .0 % 61.0% 7.2% 130.0% 2.1% 97.3% 10 . 3 % 57.9% 12 . 4 % 59.5% -8.2% 14 . 3 % 34.6% 29.9% -50% -25% 0% 25% 50% 75% 100% 125% 150% FLX MRE ERA ILU PDN S&P/ASX 200 GCL CEY ASX 200 Resources WSA KZL BHP AWC FMG PEM RIO MCC WHC PNA GBG MMX CNA OZL AND MGX NCM IVA LGL DOM AVO WEEKLY YTD Source: IRESS Markets recovered during the week, with the S&P/ASX200 resources index gaining 3.4% w/w, while the broader S&P/ASX200 index gained 3.4%. RIO continued to outperform BHP, with both gaining w/w. Gold stocks again were the best performing stocks w/w, with the Au price passing through US$1,100/oz. FLX was the worst performing stock during the week, with the share price continuing to trade with reference to the bid. 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Morgan A nalyst daniel.morgan @ubs. com +6 1-2 -9 324 3844 Chart 1: Stock price movement of potash equities in the last three months 80 90 100 110 120 130 140 150 12-Aug-09 19-Aug-09 26-Aug-09 2-Sep-09 9-Sep-09 16-Sep-09 23-Sep-09 30-Sep-09 7-Oct-09 14-Oct-09 21-Oct-09 28-Oct-09 4-Nov-09 11-Nov-09 POT.N MOS.N ICL.TA YAR.OL URKAq.L AGU.N Potash. 150 300 450 600 750 900 1050 1200 1350 Dec-94 Nov -9 6 Oct-98 Sep-00 Aug-02 Jul-04 Jun-06 May -0 8 0 5 10 15 20 25 30 35 40 Sn Price Sn Stocks KtUS¢/lb 30 60 90 120 150 180 210 Dec-94 Nov -9 6 Oct-98 Sep-00 Aug-02 Jul-04 Jun-06 May -0 8 -2 20 20 260 500 740 980 1220 1460 1700 Zn