China's Potash Hypocrisy

By Stephen D. Simpson, CFA | September 16, 2010 AAA

If nothing else, China has chutzpah. China's government put out a statement early on Wednesday indicating that it was paying "close attention" to the possibility that BHP Billiton (NYSE:BHP) would succeed in its bid to acquire Canadian fertilizer giant Potash (NYSE:POT). In mentioning that a so-called BHP potash monopoly would "harm global interests" and that prices are already "unbearable" for Chinese farmers, it would seem that this is a not-so-subtle shot across the bow for not only BHP, but perhaps Canada as well.

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Given that BHP Billiton has a significant stake in Chinese potash company China Sinofert, China actually does have some influence in this process and could certainly apply pressure to BHP through that investment. Moreover, there is still the possibility that a Chinese investment fund or company could make a competing bid for Potash - even as large Chinese companies seem reluctant to commit to much interest in such a move.

Do As We Say, Not As We Do
The irony in China complaining about a potential monopoly comes from the government's own efforts over the past decade to lock up more and more resource assets for its own companies. China's government has shown no hesitation in using national resources to secure favorable access for energy companies like China Petroleum and Chemical Corp (NYSE:SNP), PetroChina (NYSE:PTR) and CNOOC (NYSE:CEO), as well as metals companies like Baosteel, Jianxi Copper and Chalco (NYSE:ACH).

China's government has facilitated this on multiple fronts. First, it is pretty clear that the government has been, at a minimum, highly supportive of its large banks lending money to resource companies to acquire businesses and assets. More blatantly, the government has also given all manner of aid to developing countries, including military aid, to grease the skids for favorable development deals for Chinese companies.

Perhaps the best-known example is in China's policy towards rare earth elements. A surprisingly large percentage of the world's rare earth elements are sourced from China, and these are critical components in a variety of modern devices, including batteries, motors, optoelectroncs, and so on. Recently, the Chinese government has been making more and more noise about restricting the export of these metals - a clear threat, then, to a variety of companies and industries around the world and perhaps a boon to Chinese companies like BYD (Nasdaq:BYDDY).

The Bottom Line - Adapt Or Else
Ultimately, China's moves to lock up resources like rare earth elements will likely prove futile. Companies like Rio Tinto (NYSE:RTP) and Lynas (Nasdaq:LYSDY) will develop resources outside of China's control, and users like Hitachi (NYSE:HIT) will re-engineer products to reduce the rare earth content.

Likewise, a monopoly in potash will only go so far. If China truly sees its food security threatened by potash prices, the government will allocate resources towards finding alternative supplies. Moreover, it seems safe to assume that China would likewise devote resources towards alternative fertilizers or perhaps become even bigger customers for engineered crop seeds from DuPont (NYSE:DD) or Syngenta (NYSE:SYT) that require less fertilizer.

All in all, expect China to stomp its feet and make some noise, but for the ultimate fate of Potash to be a matter of the shareholders' interests. Although there may be some risk of tit-for-tat retaliation if China sees this as a move to threaten its agricultural sector, the reality is that China understands the monopoly game as well as anyone and certainly understands the logic of BHP's efforts to do this deal. (For more, see Investing In China.)

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