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Potash Power Plays: Rio Tinto’s Big Blunder

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“I have no spur to prick the sides of my intent, but only vaulting ambition, which o’erleaps itself, and falls on th’other…” (William Shakespeare in Macbeth, Act I, Scene VII)

The vaulting ambition of Rio Tinto plc (ADR) (NYSE:RIO) (LON:RIO) to become a global potash producing powerhouse has been thrown an unexpected curveball. And it’s one that could prove hugely embarrassing for one of the world’s biggest and most successful mining companies. I’m talking about a serious strategic blunder that may also prove to be an absolute godsend to its tiniest rival.  

While recently investigating potential M&A synergies between several aspiring new market entrants in Saskatchewan’s multi-billion dollar potash mining business, I made a startling discovery. And unfortunately for Rio Tinto plc (ADR) (NYSE:RIO) (LON:RIO) and its Russian joint venture partner, JSC Acron (London Stock Exchange: AKRN), it’s a shocking oversight. In fact, it’s one that may seriously complicate plans to commercialize what’s being hailed by the Russian fertilizer giant as a “massive” potash find that is “world-class.”

I’m referring to the KP405 potash permit in southern Saskatchewan, which Rio Tinto plc (ADR) (NYSE:RIO) (LON:RIO) recently upgraded to a “Tier One” status (see Rio’s Strategic Report 2013, page 36). This is big-league mining industry parlance for a project that exhibits the preliminary potential to become a large, profitable mine.

According to JSC Acron’s North-American subsidiary, North Atlantic Potash Inc., the KP405 deposit boasts the prospect of producing around three million tons of potash per year. This represents annual revenues of nearly a billion dollars – even in a deflated marketplace from which potash prices are expected to rebound strongly within the next few years.

So what’s the problem with this seemingly rosy picture for Rio Tinto plc (ADR) (NYSE:RIO) (LON:RIO) — the project operator at KP405? It’s the fact that some of its potash riches belong to someone else. Specifically, some of the KP405 land holdings are messily intermingled with land leases owned by the company’s next-door neighbor, Western Potash Corp. (TSX: WPX).

As a small Vancouver-based potash development company, Western Potash has already made great strides in its quest to build a world-class potash mine at its Milestone project, which adjoins the KP405 project. A prospectively 2.8-million-ton-a-year mine, Milestone shares many favorable geological features with the KP405 deposit.  However, it also appears to be up to twice the size of KP405. By comparison, KP405 has an inferred resource of 1.4 billion tons of potash.

Now that Milestone has been given a provisional green light by the Saskatchewan government to begin building a mine, Western Potash Corp. (TSE:WPX) has attracted some financial backing ($33 million) from a state-owned Chinese fertilizer manufacturer, China BlueChemical Ltd. (HKG:3983) (OTCMKTS:CBLUF). But it’s going to take a lot more money – up to $3 billion – to build the mine. And China BlueChemical isn’t the only deep-pocketed player that covets Milestone because of its strategic value and its money-making prospects.

This is what makes the ties (both literal and figurative) between Western Potash Corp. (TSE:WPX) and Rio Tinto plc (ADR) (NYSE:RIO) (LON:RIO) become all the more interesting. Whereas KP405’s footprint does not overlap onto the Milestone property, the reverse cannot be said. In order for KP405 to be fully developed, Rio Tinto has to deal with a checkerboard of land claims that are intermingled with ones owned by Western Potash. In other words, there appears to be no easy way of building a mine at KP405 without encompassing Western Potash’s peripheral leases.

For the sake of brevity, I won’t delve at this time into the reasons why Rio Tinto plc (ADR) (NYSE:RIO) (LON:RIO) made the seemingly oblivious blunder of staking around a patchwork quilt of claims that are owned by a rival company, albeit a relatively tiny one with a market capitalization of only about $125 million. Suffice to say, it’s now a matter of public record (as illustrated by the following map that I compiled with data available in the public domain):

It’s also synergistic that both the adjoining Milestone and KP405 deposits are deep-seated, which means that these are similarly suited to solution-extraction mining techniques, which are far less capital intensive than conventional mining methods. This involves injecting large amounts of heated salt water into an underground mine to dissolve the potash, which is then pumped to the surface.

Now here is where the story gets especially interesting. Western Potash Corp. (TSE:WPX) has already secured a long-term water supply to make this kind of mining even possible, whereas Rio Tinto plc (ADR) (NYSE:RIO) (LON:RIO) hasn’t. For more on this see my previous articles entitled “Bidding War on Western Potash on the Horizon?” and “Primed to Build a World-Class Potash Mine”.

Thus, it would make a lot of sense for Rio Tinto plc (ADR) (NYSE:RIO) (LON:RIO) to gobble up Western Potash – at least from the standpoint of having the assurance of being able to access a crucial water supply. As matters stand, Rio Tinto plc (ADR) (NYSE:RIO) (LON:RIO) may face considerable political opposition from competing stakeholders (including aboriginal First Nations communities) in its quest to obtain massive amounts of water for decades to come from a nearby source, which would likely be the Buffalo Pound Lake.

Needless to say, such a strategic acquisition would also solve Rio Tinto plc (ADR) (NYSE:RIO) (LON:RIO)’s conundrum as to how to develop the KP405 deposit without interfering with Western Potash’s land holdings that are intermingled with the KP405 property leases.

It would also offer Rio Tinto an expedited entry into the potash mining business since Milestone could be commercialized within a couple of years, whereas KP405 is lagging far behind in the developmental curve. Hence, it would take considerably longer for KP405 to be commissioned. And there is still no assurance that the project will overcome all the technical, logistical, environmental and governmental challenges it still faces before it can be validated as a viable business proposition.

None of these realities are lost on the investment community, which has fueled considerable speculation in the news media lately that Rio Tinto may yet gobble up Western Potash by way of a takeover. Or it may instead opt to finance Milestone as an alternative means of buying into this world-class project, while also paving the way for KP405 to become a sister mine. Together, both mines could eventually produce in excess of six million tons of potash per annum.

Some of the M&A buzz surrounding Western Potash and Rio Tinto became all the more palpable last week with the venerable Australian national newspaper, The Australian, reporting the following in an article entitled “Rio Keen to Make Potash Plunge” on March 22, 2014:

“Rio’s find has sparked speculation it could bid for, or form a joint venture with, Canada’s Western Potash Corp. (TSE:WPX), which has neighbouring ground. With a market value of just $C125m ($124m), it would be no trouble for Rio to swallow, giving it access to the company’s Milestone project, which is next to KP405 and has a resource twice the size. Milestone is a similar size to the mine proposed at KP405 and is expected to cost $C3bn, but it is more advanced and has better access to water, which could be shared. 

Meanwhile, Rio Tinto is keeping its cards close to its chest. David Ovington, a company investor relations spokesperson, did not get back to me with a comment about his company’s intentions regarding Western Potash when I contacted him earlier this week. And I find that to be very intriguing.

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Neither Rockstone Research nor the author was compensated or instructed by any of the companies mentioned herein to produce or publish this content. However, the author holds shares of Western Potash Corp. and therefore would financially benefit from volume and price appreciation, whereas it is noted that the author has not sold any shares of Western Potash Corp. since first reporting on the company and does not plan to do so in the next weeks. Please read the full disclaimer on www.rockstone-research – none of this content is to be construed as an “investment advice” as this article is intended for information use only and the author is not a registered investment advisor.

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