A Million Eggs and One Basket: Omelet Anyone?

In my earlier post I presented the upside of the Sask government’s attempts to manage the price of potash and utilize the resulting revenues for 20% of the provincial government’s revenue in the coming year. If it works as expected, this will likely be a significant turning point in the province’s economic development. Unfortunately, things don’t always work as expected.

As I said elsewhere, this is a gamble. There are several reasons why the people of Saskatchewan may not win this gamble. I’ll try and present a few of them.

First, the consumers of potash generally rely on credit to finance their purchases. The current state of credit markets makes demand uncertain at best. This problem will, hopefully, only be temporary. The current provincial government has actually acknowledged this and is banking credit markets returning to “normal” by the fall.

The second major risk is linked to the exchange rate. Like most commodities potash is generally priced in US dollars. This means a low value of the exchange rate is beneficial to the Saskatchewan government. The lower the exchange rate, the more Canadian dollars potash will generate. Even if the world price of potash remains unchanged a rise in the US/CAD exchange rate will mean missing the target CAD price. It seems likely the Canadian dollar will rise in value over the next year as the Fed continues quantitative easing. This is a significant risk in my opinion.

The remaining risks relate to a simple fact. Potash is not an essential input into the farming process every season. Farmers can often defer application to another season or year. This provides a number of ways in which the revenue targets may not be met. First and foremost, the price maintenance may be too successful. By keeping the price high potash when the ability to pay for the output of farmers is low, farmers may reduce costs to meet their own revenue targets. Farmers could reduce applications or not apply at all. So the price prediction may be accurate, but the quantity prediction may not be.

Weather may also play an important factor. If the spring or fall are atypically wet, farmers may not be able to get on the fields, meaning application cannot take place, meaning low demand for potash. Again, the price may be maintained at the expense of quantity.

There is also the possibility that processors of potash, particularly in China, are sitting on large inventories of both raw material and finished product. This would mean they would be able to defer major purchases of the raw material in hopes of a lower price in the future.

The quantity issue is likely to be a short run phenomenon only. The increase in yields with application is too great to allow farmers to avoid purchases indefinitely. The drop in demand will mean difficulty in meeting budget targets and will likely have very large short run political implications. It could work in essentially the same manner as a strike, with each side attempting to “starve” the other into submission.

Putting all of your eggs in one basket is a gamble. Losing this gamble will require the current government to either; cut spending, increase taxes, or run a deficit. All three options have political implications for the party in power and more importantly implications for the people of Saskatchewan. None of the implications are positive and I don’t think potash omelets are likely to be popular. Cross your fingers.