Will the Ethanol Subsidy Stoppage Impact Potash?

By Leia Michele Toovey- Exclusive to Potash Investing News

In June, the US Senate voted 73-27 to remove ethanol subsidies. While the decision was largely motivated by America’s deficit problems, rising food costs were undoubtedly an underlying factor.

“We’re driving up food prices unnecessarily,” said Ken Powell, chief executive of General Mills in an interview with the Financial Times. “If corn prices go up, wheat goes up. It’s all linked.” Powell added that last year, General Mills had to pay twice as much for wheat and 30-40 percent more for corn and oats. The rising costs were absorbed by both General Mills and the consumer.

As soon as the announcement was made, corn prices declined 12 percent, retreating from record-highs. The shares of potash producers also dipped, Potash Corp (NYSE:POT) fell about 8 percent, posing the question- will a stoppage in ethanol subsidies impact the potash industry? Grain and potash prices are correlated, to the effect that high grain prices increase the incentive to apply fertilizer. If the subsidy would result in the prices of grains steeply correcting, then, possibly halting the subsidy would take a bite out of potash demand. Given the current economic climate, analysts expect that eliminating the subsidies will have a negligible, if any, impact on grain prices.

There are several significant factors involved in the run-up in grain prices including: increased speculation, population growth, shrinking arable land, and increased wealth in emerging economies. While the ethanol subsidies encouraged farmers to plant corn, and undoubtedly buoyed corn prices in the US, the overall strength in corn, and the prices of other grains, is not expected to simply evaporate if the subsidy is stopped. A big factor behind the rise in grains prices is population growth. The global population is expected to grow at an average annual rate of slightly less than 3 percent through 2014, at the same time, the amount of arable land in the world will decrease.  According to Potash Corporation of Saskatchewan, grain production has failed to meet consumption in seven of the past 11 years.

Another factor that is expected to support potash demand is the accumulation in wealth of the emerging markets. As countries such as Brazil, China, and India increase their fortunes, they shift from traditional rice and grain based diet to a high-protein diet. A high-protein diet requires more grain output from a given amount if land, and the best way to hike land output is to fertilize.

Despite the vote to cut subsidies, regulations around the globe to encourage the use of biofuels are another bullish factor for potash prices. The US is the largest ethanol producer and uses corn as a primary crop to produce ethanol. Asia uses palm for biofuel production, and Brazil produces ethanol mostly from sugarcane. Sugarcane consumes twice as much potash as corn.

Brazil is a prime example of where the global demand picture is going, in terms of crop growth and potash demand. Brazil started its profitable ethanol industry more than 30 years ago. Ethanol comprises about half of the gasoline consumed by cars in Brazil. More than half of Brazil’s sugarcane crop is used to produce ethanol, and rising demand for the fuel is expected to increase demand for sugar by almost 40 percent over the next five years.

The question remains as to whether or not stopping the subsidies will actually have any influence on ethanol demand. Considering the government mandate in which gasoline companies required to blend ethanol into their fuel, even if the subsidies are cut, fuel companies will still be required to blend a minimum of 12.6 billion gallons of ethanol into the gasoline pool this year under the federal Renewable Fuels Standard. Current output is running at less than 10 percent above that rate.

In the end, if the subsidies are actually halted, the net effect on potash will be limited. In a note to clients, TD Newcrest’s Paul D’Amico raised his recommendation on Potash Corp. to “buy” from “hold,” arguing that investors have overreacted to the ethanol news. “US Senate ethanol vote looks mostly ‘symbolic’ rather than indicative of big near-term changes,” he said. More importantly, the Renewable Fuels Standard mandate is unchanged. The fundamental near-term impact is nil to negligible in our view, but sentiment is likely to be negative as speculative positions in corn potentially decline.”

Another important consideration is that despite the unanimity of the Senate vote,  it is not guaranteed to be passed. Following the vote, the White House issued a statement saying it was against a full repeal of ethanol subsidies, indicating it could use its veto power if the amendment continued to advance in Congress. “We need reforms and a smarter biofuels program, but simply cutting off support for the industry isn’t the right approach,” said Agriculture Secretary Tom Vilsack. Supporters of continued federal spending for ethanol argue it is a leading source of alternative fuel that helps reduce US dependence on foreign oil. If the issue is still on the table near the 2012 elections, it will be a heated debate point.