AG-The Modernization of the BRICs

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Canaccord Adams is the global capital markets group of Canaccord Capital Inc. (CCI : TSX|AIM)

The recommendations and opinions expressed in this Investment Research accurately reflect the Investment Analyst’s personal,independent and objective views about any and all the Designated Investments and Relevant Issuers discussed herein. For importantinformation, please see the Important Disclosures section in the appendix of this document or visithttp://www.canaccordadams.com/research/Disclosure.htm.

9 July 2008 2008-071

Keith Carpenter, MBA, CFA

416.869.7325

[email protected]

Neal Gilmer, MBA

416.869.7294

[email protected]

InsideGlobal Macro Overview 3

Political Overview 8Industrialization of the BRICCountries 20

Wealth 34

Arable Land 36

Global Weather Patterns 47

Agriculture Sub-sectors 61

Final Thoughts 132

Companies 133

Comparables 227

Agriculture

The Modernization of the BRICsFeeding and fuelling the New Industrial Age

We believe that Brazil, Russia, India, and China (BRIC) are entering into an

industrialized age that is likely to have a profound impact on the planet, ranging from a

dramatic shift in global demographics, to an awakened demand for more expensive

goods, services and infrastructure. As the BRIC countries continue to industrialize, the

developed world is readying a supply response, largely driven by macro-economic

variables that have already impacted underlying commodity prices. We do not believe

this is a short-term cyclical bull market in commodities; rather we see a sustained and

secular demand trend. We favour companies with exposure to these underlying macro-

economic trends that also possess an experienced management team and sound

financial models.

This report has three broad sections. The first aims to provide a macro overview

wherein we highlight significant global trends that are likely to lead to higher sustained

commodity prices and drive demand for more expensive goods, services and

infrastructure. For instance, the rapid industrialization of the BRIC countries has led to

higher disposable per-capita incomes in those countries and, consequently, higher rates

of consumption. The second section of this report discusses the agriculture sub-sectors,such as grains and feed, fuel, fertilizers and water and their impact on agriculture and

commodity markets globally.

Finally, with this report we hereby initiate coverage on the following:

· Agrium (AGU : TSX : C$99.22 | BUY, C$160.00)

· Athabasca Potash Inc. (API : TSX : C$7.57 | HOLD, C$9.50)

· MagIndustries Corp. (MAA : TSX-V : C$3.15 | BUY, C$8.50)

· PhosCan Chemical Corp. (FOS : TSX-V : C$1.75 | BUY, C$3.20)

· Potash Corporation of Saskatchewan Inc. (POT : TSX : C$211.25 | BUY, Target

C$425.00)

· Potash One Inc. (KCL : TSX : C$4.29 | SPECULATIVE BUY, Target C$7.75)

· The Mosaic Company (MOS : NYSE : US$129.43 | BUY, Target US$210.00)



2

The Modernization of the BRICs 9 July 2008

Table of ContentsGlobal Macro Overview...........................................................................................................3

Political Overview....................................................................................................................8

Industrialization of the BRIC Countries................................................................................20

Wealth....................................................................................................................................34

Arable Land ...........................................................................................................................36

Global Weather Patterns ......................................................................................................47

Agriculture Sub-sectors.........................................................................................................61

Feed ..................................................................................................................................61

Fuel ...................................................................................................................................77

Equipment ........................................................................................................................88

Infrastructure....................................................................................................................95

Bio Engineering .............................................................................................................103

Fertilizers ....................................................................................................................... 109

Agriculture Technology.................................................................................................. 125

Final Thoughts.................................................................................................................... 132

Potash Corporation of Saskatchewan Inc............................................................................... 133

The Mosaic Company......................................................................................................... 146

Agrium................................................................................................................................. 159

MagIndustries Corp............................................................................................................172

PhosCan Chemical Corp. ................................................................................................... 189

Potash One Inc................................................................................................................... 203

Athabasca Potash Inc. ....................................................................................................... 216Comparables. ..................................................................................................................... 227



3

9 July 2008 The Modernization of the BRICs

GLOBAL MACRO OVERVIEW

While the shortages of energy and oil have dominated the headlines in recent months, the

impact of agricultural shortfalls is proving to be of equal, if not greater significance. After

years of stability, food prices are experiencing high volatility. For instance, wheat in the

U.S. (hard red spring) was priced at about US$5 per bushel in May 2007, but by February

2008 had jumped to a high of US$16, until falling back to the US$10-15 range where it

currently trades. In addition, several global trends may also affect dietary patterns, such as

urbanization and the aging of the global populace, of which higher food prices are a

consequence.

Recently, government attention has been focused on recapitalizing the banking and

financial services sector after the sub-prime crisis resulted in significant losses. The

Blackstone Group recently received US$3 billion from China’s sovereign fund. Morgan

Stanley and Citibank have also received capital. The agricultural sector globally is also

capital intensive and, given the significant increase in the prices of agricultural

commodities, sovereign funds have already begun to invest in agriculture to counter the

supply shortfall in agricultural commodities.

POPULATION

The technological advancements of the previous century greatly improved agricultural

productivity and, along with further developments in medicine, helped to propel population

growth at an incredible rate of 1.7% annually, from 2.6 billion people worldwide in 1950 to

6.6 billion in 2007. The US Census Bureau forecasts that by 2050 our numbers will total

9.2 billion, representing an annual growth of 0.8%. In 2007, the working population (15 to

65 years of age) made up 65% of the total population; however, that number is expected to

decline to 62% by 2050. This is primarily due to improvements in life expectancy, and

while people older than 65 years comprised 7.5% of the world population in 2007, by 2050

that number is expected to increase significantly to 16.8%. The world is getting older, quiteliterally, while its workforce in comparison is beginning to shrink.

Figure 1: Age structure, world population, for the years 2007 and 2050

2007

400 200 0 200 400

0-4

'10-14

20-24

30-34

40-44

50-54

60-64

70-74

80+

A g e g r o u p

In million

Male Female

2050

400 200 0 200 400

0-4

'10-14

20-24

30-34

40-44

50-54

60-64

70-74

80+

A g e g r o u p

In million

Male Female

Source: United States Census Bureau

People older than 65 years of age comprise7.5% of the world

population today, whichis expected to increase

to 16.8% by 2050.



4


It is also helpful to examine world population in terms of developed and developing

countries. Currently, the developed world represents about 19% of the total population,

and is expected to grow at 0.1% annually until 2050. On the other hand, population in the

so-called developing countries is expected to grow annually at a significantly-higher rate of

0.9%, with Africa on trend to post an incredible 1.8%. Resources are already considerably

constrained in the developing world. Population growth is expected to further strain

economic development as it increases the ratio of dependent children to working adults

and compels families to spend more on essentials such as food, clothing and housing, and

less on education, infrastructure and other similar investments required to enhance

economic growth. In addition to further constraining the food and water supply, larger

populations more severely impact natural resources, such as forest land for housing and

agricultural requirements, which leads to increases in land erosion, and ultimately to

climate change and global warming.

In Figure 2, we compare the age structure of an African country (Nigeria), a BRIC country

(China), and a developed country (the United States). The U.S. has the highest proportion

of people older than 65 years of age, followed by China and then Nigeria. China has the

lowest proportion of people who are younger than 15 years of age, driven by the Chinese

government’s one-child (planned birth) policy, which was introduced in 1979. Now cyclingthrough its first generation of enforcement, the effects of the government’s one-child policy

have been exaggerated by China’s cultural proclivity to favor male children; the result of

which has produced an atypical male-to-female ratio in China. Currently, the nation’s sex

ratio is 943 females per 1,000 males as compared to 986 for the world and 1,034 for the

U.S. This gender imbalance is now proving a source of concern for policy makers in China.

The most striking observation about Nigeria is that 42% of the population is younger than

15 years of age.

Figure 2: Age structure, 2007

Nigeria

15 10 5 0 5 10 15

0- 4

10- 14

20-24

30-34

40-44

50- 54

60-64

70- 74

80+

In million

M ale Female

China

80 60 40 20 0 20 40 60 80

0- 4

10- 14

20-24

30-34

40-44

50- 54

60-64

70- 74

80+

A g e g r o u p

Inmillion

Male Female

US

16 12 8 4 0 4 8 12

0- 4

10-14

20-24

30-34

40-44

50-54

60-64

70-74

80+

Inmillion

Male Female

Source: United States Census Bureau

Aging and urbanization

Activity levels decline with age, which results in lower food demand per capita as

compared to a population boasting a younger demographic mix. Studies have also shown



5


that the types of foods consumed also shift with age, with elderly people typically

consuming less animal products (protein rich) and more fruits and vegetables than their

younger counterparts. Consequently, it follows then that the composition of a population’s

relative age will affect the demand of foodstuffs significantly; and as the number of people

older than 65 years of age increases from 7.5% currently to a forecasted 16.8% of the

world population by 2050, the planet could experience a dramatic shift in the demand for

agricultural products as well.

In addition, an aging society may find it more difficult to adjust to the demands placed on

its food supply, especially in non-urban geographies that typically rely on smaller, localized

farming cooperatives to maintain agricultural supply. Older farmers tend to shift to crops

that are less labour-intensive or stop farming altogether. Such farmers may find it difficult

to adjust to technological changes and may be less willing to adopt new methods of

production, which can also lead to a decline in agricultural production.

Over the last five decades the planet has experienced rapid urbanization, and

approximately half the world’s population now lives in an urban environment. This figure

is up from about 29% in 1950, and is expected to increase to 70% by 2050. The primary

reason for this dramatic change is the unprecedented urbanization of the less-developed

regions of the world. The urban population in less-developed regions was 0.31 billion in

1950. The corresponding figure in 2007 was 2.38 billion, representing annualized growth

of 4.1%.

It is projected that those living in an urban environment will increase from 3.3 billion in

2007 to 6.4 billion in 2050 and, as stated, a majority of this growth will come from less-

developed regions.1 Asia will be the major contributor, adding 1.8 billion people to urban

regions, followed by Africa (0.9 billion) and Latin America and the Caribbean (0.2 billion).

Figure 3: Urban world population, 1950-2050

0

1

2

3

4

5

6

7

1950 1975 2007 2025 2050

P o p u l a t i o n ( i n b i l l i o n s )

Urban Rural

Source: United Nations Department of Economics and Social Affairs/Population Division

1 The developed regions stated here include North America, Europe, Australia, New Zealand andJapan. The rest of the world is considered less developed. (Source: United Nations World UrbanizationProspects Report , 2007).



6


Figure 4: Urban population for more developed and less developed regions, 1950-2050

0

1

2

3

4

5

6

1950 1975 2007 2025 2050

P o p u l a t i o n ( i n b i l l i o n s

)

More developed region, Urban population More developed region, Rural population

Less developed region, Urban population Less developed region, Rural population

Source: United Nations Department of Economics and Social Affairs/Population Division

At the same time, the rural population is expected to plateau at 3.5 billion in the next 10

years and to decline to 2.8 billion by 2050. In more developed countries, rural population

accounted for 47% of the total population in 1950 and has been in decline ever since.

The impact of urbanization on agriculture

Urbanization can lead to the replacement of rural staple crops (grown locally) with

marketed staple cereals and processed foods. Urbanites typically spend most of their

waking hours away from the home in, for example, an office or factory setting, or in

commute to and from work. Urban life increases the opportunity cost of time for activities

such as the preparation of meals; people living in an urban environment, as a

consequence, tend to consume more convenient “off-the-shelf” processed foods. A

significant proportion of the calorie intake of an urban consumer is derived from fats and

sweeteners, which can ultimately lead to the consumption of more calories than justified by

their energy needs.

70% of the world population is expected tolive in urban areas by

2050.



7


Figure 5: Changes in dietary consumption with urbanization in 180 countries

Source: FAOSTAT

In terms of our dietary habits, the most significant impact of urbanization is the increase in

the consumption of meat products, which acts as a catalyst for the industrialization of

livestock production. Such large-scale production often leads to the degradation of arable

lands with the increased risk of soil and water contamination. Additionally, urban

expansion also reduces the availability of local arable land, placing further strain on the

supply of locally-grown agricultural products. It also draws labour away from agricultural

activity to other sectors of the economy, thereby reducing the resources available to farm

production.



8


POLITICAL OVERVIEW

In this section, we intend to provide an overview of the political and economic environment

of the so-called BRIC countries.

CHINA

The Communist Party of China (CPC) has been in power since the establishment of the

People’s Republic of China in 1949. Under the early years of communist rule, the country

was all but closed to external investments and private participation until 1978, when the

country opened its doors to the outside world and began to commit itself to additional

economic reforms. The country is still in the midst of this transitional phase, and continues

to move from a system of public ownership toward the large-scale privatization of

“unprofitable” state-owned enterprises. In 2006, the private sector contributed 65% to the

GDP and employed over 500 million people.

Figure 6: Foreign direct investment, China

7569

72

61

54

9%

-4%

18%

13%

0.05%

0

20

40

60

80

2003 2004 2005 2006 2007

F D I i n f l o w s ( i n U S $ b i l l i o n )

-10%

0%

10%

20%

30%

40%

A n n u a l i z e d F D I g r o w t h

Source: UNCTAD, World Investment Report 2007

Real GDP growth in 2007 was 11.4%, which compares to the global average of 5.2%.

However, The Economist Intelligence Unit (EIU) expects this figure to begin to “fall” to

9.8% in 2008 and to moderate further to 9.0% in 2009, primarily due to slowing export

growth. However, its significant trade surplus is expected to keep China’s current-account

balance in a healthy position. With the highest foreign reserves in the world, estimated at

US$1,528 billion, and external debt of US$363 billion (as of 2007), China has the highest

positive current-account balance of over US$1,000 billion among all countries globally.

Additionally, with the 2008 Olympic Games at hand, the government expects to showcase

its recent achievements to the world and, in doing so, perhaps provide the country an

impetus to its service exports. The Games are also expected to further drive an inflow of foreign investments, which totaled US$75 billion in 2007.

Owing to its large population and rapid economic growth, China’s current infrastructure is

under tremendous strain. In response, the government has significantly increased its

transport development spending. For the 2006-2010 period, the Chinese government has

allocated US$200 billion for the development of rail infrastructure alone. The total length

of toll expressway, which stood at 53,600 kilometres in 2007, is expected to increase to

70,000 kilometres by 2020.

China has the highest foreign exchangereserves globally, at

US$1,528 billion.



9


In 2007, the industrial sector contributed 49.2% to GDP and represents the largest share of

China’s economy; this is followed by the service sector and the agriculture sector, which

contributed 39.1% and 11.7%, respectively. Historically, agriculture has been an important

part of the National Program and, to enhance its competitiveness within the international

market, large scale investments have been made to modernize its agricultural

infrastructure. In 2008, the central budget allocated approximately US$84 billion for

farmers, agriculture and development of rural areas, representing a 36% increase from the

previous year. To provide further assistance, in 2006 the government abolished the

Agriculture Tax, which had been in place in China for centuries and, at the time of its

expiration, was estimated to be US$4.7 billion in direct taxation and over US$9 billion in

other fees.

Figure 7: China’s GDP growth

7,736

3,242

2,7742,303

1,9371,6481,454 11.4%

11.1%10.4%10.1%10.0%

0

2,000

4,000

6,000

8,000

2002 2003 2004 2005 2006 2007 2012E

N o m i n a l G D P ( U S D b i l l i o n )

0%

10%

20%

30%

40%

50%

R e a l G D P G r o w t h

CAGR

9.0%

Source: The Economist Intelligence Unit (EIU)

In its endeavor to encourage farmers and foster growth within the agriculture sector, the

government introduced subsidies to help meet the increasing costs of agricultural supplies.

In 2007, comprehensive direct subsidies to farmers stood at US$5.6 billion as compared to

US$3.2 billion in 2006. Additional measures to increase internal crop production include

funding for research to develop crop and livestock varieties with improved quality and

yields; providing subsidies on the purchase of high-quality seeds and agricultural

machinery; limiting the increase in fertilizer prices paid by farmers; and providing

preferential loans for the construction of water-saving irrigation and water control

projects, field irrigation, drainage works, and rural drinking water projects. The

government is also enforcing strict rules regarding the conversion and sale of arable land

for non-agricultural use.

Double-digit economic growth has also increased the demand for energy in China. China is

the second largest consumer of oil after the U.S. and the third largest importer of oil after

the U.S. and Japan. It is also the largest producer and consumer of coal, although many of

its coal reserves are yet to be developed. However, China’s growing demand for energy hasforced the government to look for alternatives to coal and oil. In 2007, Chinese energy

officials agreed to purchase five nuclear reactors from Western companies. The Three

Gorges Dam hydroelectric facility, deemed to be the world’s largest hydroelectric project by

total capacity (22,500 MW), is also expected to become fully operational by 2011.

China is also actively developing its biofuel production capability, and is targeting an

annual production capacity of 2 million tons of ethanol by 2010 and 10 million tons by

2020. During 2006, 1.3 tons of fuel was produced by four, mainly corn-based, ethanol



10


projects. Nearly 4 million hectares of land in different regions are being used to raise oil-

bearing seeds with an expected fruit output of 4 million tons which can be used as raw

material for biofuel. However, cognizant of the increasing domestic demand for food, China

has banned the use of grains for the production of biofuel. The government is planning to

cultivate biofuel forests in the uninhabited mountain areas to save existing farm land and

provide the local people in these regions with additional employment and income

opportunities.

INDIA

India is a parliamentary democracy, with institutions similar to the democratic systems in

the UK. The last general elections in 2004 resulted in a fractured mandate and led to a

coalition between the Congress and the Left parties to form the government. The

government is now focused on the next general elections scheduled in 2009, and its 2008

budget included several populist measures such as loan waivers for farmers of

approximately US$15 billion, lower income tax rates and higher spending on the social

sector. This is expected to adversely affect the fiscal deficit in 2009. The Central Bank

remains focused on controlling inflation, especially the prices of essential agricultural

commodities.

Figure 8: India’s GDP growth

2,644

1,147

927809

698594507

8.7%9.7%9.2%8.3%8.4%

3.8%0

1,000

2,000

3,000

2002 2003 2004 2005 2006 2007 2012E


0%

10%

20%

30%

40%

50%


CAGR

7.6%

Source: EIU

India’s GDP exhibited growth of 9.4% in 2006-2007 making it the second-fastest growing

economy worldwide and the EIU forecasts that GDP growth is expected to decline

marginally to 7-8% over the next four years. The country currently has foreign currency

reserves of US$294 billion and external debt of US$138 billion. A debt servicing ratio of

7.3% makes India a moderately-indebted country. In 2006, the services sector contributed

55% of the GDP, followed by industry at 28% and agriculture at 18%. An interesting

observation here is that in spite of the modest contribution by the agriculture sector (at18% of GDP), agriculture provides for the livelihood of almost 60% of India’s workforce;

per capita income in this sector is low and a significant section of the farming community

struggles to earn a decent living. In comparison, the Indian Information Technology (IT)

industry generated revenues of US$50 billion in 2006 or 5.4% of the GDP and has been

growing annually at 30% over the last 10 years. One aspect that is hurting Indian exports

currently is the fact that the Indian rupee appreciated by 11% against the US dollar in

2007, eroding the margins of export-oriented industries such as IT, the offshoring and

outsourcing services industry (or BPO), textiles, and gems and jewelry.

India has been growing at a high rate of over 8%

since 2003.



11


In recent years the government has announced several initiatives intended to assist

farmers, such as providing a minimum support price for essential food crops including

wheat, rice and sugar cane irrespective of market conditions. The government also

maintains sufficient stocks of these food crops to meet demand-supply gaps. Another

recent initiative is a nationwide subsidized public distribution system for essential

commodities, primarily for the economically weaker sections of society. However, this

public distribution system has been receiving negative coverage of late, including charges

of inefficiencies and corrupt practices, and now even at the federal level there is an

understanding that an overhaul of the system is most likely unavoidable. Apart from these

measures, the government also regularly announces initiatives for financial support and

easy credit to the farming community for technological and equipment upgrades,

irrigation, pest management systems, fertilizers, and cold storage.

In terms of biofuels, 5% ethanol-blended automobile fuel has been introduced by the

government on a pilot basis. This ethanol is produced from molasses, a waste product of

sugar processing. Similarly, biodiesel is being used on a pilot basis, and the current policy

envisages that biodiesel will meet 20% of the nation’s diesel requirement by 2012. India

imported US$52 billion of petroleum and oil products from April 2006 to February 2007,

which was 32% of its total merchandise imports. While India’s dependence on foreign oil isincreasing the demand and economic feasibility of biofuels, India is constrained by a lack

of available arable land. However, the Jathorpa or Physic nut plant, on which biodiesel

production is based in India, can be grown in wastelands and has a low water and

fertilizer requirement. This should mitigate the impact of biodiesel production on existing

land currently in use for essential food crops; however, the actual impact remains to be

seen.

Owing to the rapid pace of development, significant investments are being made in the

infrastructure and energy sectors. Several initiatives have been taken by the Indian

government to attract private and foreign direct investment in core sectors such as power

generation and distribution, oil and gas exploration and refining, roads and highways,

mass transit systems, airports, sea ports and harbors. It is estimated that investments inthe infrastructure sector should grow by 15% annually over the next five years and should

total US$190 billion in this period. Similarly, the construction industry is expected to

attract US$125 billion over the next five years.

In 2005, India consumed 572 million tons oil equivalent of energy (Mtoe) with a per capita

consumption of 531 kilo tons oil equivalent (Ktoe). This is significantly lower than the

global per capita consumption of 1,767 Ktoe and accordingly, it is estimated that the

Indian energy sector needs investments in the range of US$120-150 billion over the next

five years. The International Energy Agency estimates that of the total power generated,

38.7% was coal-based; 23.9% oil-based; 5.4% gas-based; nuclear 0.8%; and hydro-

electricity 1.6%, with the remainder primarily taken up by combustible renewables and

waste. Currently, the price of electricity, automobile fuels, cooking gas, thermal coal, and

natural gas are all regulated and controlled by the government.

RUSSIA

Russia is a presidential form of democracy. Dmitry Medvedev won the federal elections in

2008 with a landslide 70% of the total votes cast. He was first deputy prime minister and

chairman of Gazprom (a state-run gas monopoly) under the Putin presidency and is known

as an economic liberal. He is expected to continue with the economic policies of Putin.

Economic policies are expected to increase government control on strategic resources (oil,

US$190 billion isexpected to be invested in Indian infrastructure

over the next five years.



12


gas, aluminum) and offer limited liberalization in other sectors (private agriculture land

holding). The budget surplus has declined and is expected to become non-existent by 2009

due to increased spending.

Figure 9: Russia’s GDP growth

2,548

1,290

988765

592432

345 8.1%

7.4%6.4%7.2%7.3%

4.7%0

1,000

2,000

3,000

2002 2003 2004 2005 2006 2007 2012E


0.0%

10.0%

20.0%

30.0%

40.0%

50.0%


CAGR

5.6%

Source: EIU

Russia’s current foreign currency reserves and external debts stood at US$490 billion and

US$430 billion, respectively in 2007, while GDP exhibited growth of 8.1%. The EIU

forecasts GDP growth to decline to 7% in 2008 and to 6% in 2009 primarily due to

declining global growth rates and the resultant reduction in demand for energy. The

services sector has the biggest share of GDP, 56.3% in 2007, followed by the industrial

sector and the agriculture sector at 39.1% and 4.6%, respectively (though some economists

estimate that the services sector’s GDP share is inflated due to certain tax avoiding transfer

pricing norms followed by the oil exploration companies). The energy sector is estimated to

have a 20% share of GDP with the metal industry at 8%.

Figure 10: Export trends

0

50

100

150

200

250

300

350

1

9 9 5

1

9 9 6

1

9 9 7

1

9 9 8

1

9 9 9

2

0 0 0

2

0 0 1

2

0 0 2

2

0 0 3

2

0 0 4

2

0 0 5

2

0 0 6

E x p o r t s ( U S D b i l l i o n )

Total Exports Fuels

Manufactured goods Ores and metal

Source: UNCTAD

Although the Russian Ruble has appreciated significantly, around 11% against the US

dollar in 2007, buoyant commodity prices have ensured robust exports, estimated at

US$350 billion. Raw material exports account for 80% of the total exports while the energy

The energy sector contributed 20% toRussia’s GDP in 2007,

followed by metals at 8%



13


sector accounts for 55%. Russian imports, which stood at US$221 billion in 2007,

primarily include machines, medicines, consumer goods and meat.

The legacy of the Communist Era, characterized by mechanized collective farming and

small marginal household farmers, has greatly impacted Russia’s agricultural industry.

The government provides farm input credits in the form of seeds and fertilizer, and then

barters with the farmers for the final produce. The interest on the farm credit disbursed byprivate banks is subsidized up to 67% and the principal is guaranteed by the regional

administrations. Ensuring food security and managing local unemployment is of prime

consideration for the regional administrations. It is expected that by 2010, private land

owners will be able to use their land as collateral for loans. In 2006, the Russian

parliament, or Duma, enacted a law for state investments in the agriculture sector. These

two steps are expected to spur new investment in agriculture. Russia imposes tariff-rate

quotas on meat imports to protect its domestic industry.

Russia is also making significant investments in infrastructure development and is

expected to invest US$185 billion in the infrastructure sector over the next three years. In

2005, Russia enacted a new law to enable private participation in infrastructure

construction projects. Two pilot projects (the Moscow-St Petersburg Highway and the

Western High Speed Diameter) have already been initiated, while new pipeline and port

infrastructure projects are being given high priority to facilitate the increase in energy

exports. Considering its large energy reserves, 60% of fixed investments are in the mining

and exploration industry, though it provides employment to only 2-3% of the population. It

is estimated that the Russian oil sector requires investments of approximately US$77-100

billion while the gas sector requires US$80-84 billion in the 2006-2015 period.

In 2005, Russia consumed 646 Mtoe (million tons oil equivalent) of energy with a per

capita consumption of 4.5 toe. This is much higher than the global per capita consumption

of 1.7 toe. Energy is heavily subsidized for domestic consumption which is leading to

inefficiencies in energy utilization and wastages. The International Energy Association

(IEA) estimates that gas supplied 53.9%, oil 20.6%, coal 16.0%, nuclear 6.1%, hydro 2.3%

of the energy demand.

BRAZIL

In the federal elections of 2006, Luiz Inacio Lula da Silva, or Lula as the sixty-two year old

politician is simply known, was reelected to his second consecutive four-year term. A

member of the left-leaning Partido dos Trabalhadores (PT) party, he is expected to

continue his current policy of attracting domestic and international investments in the

agriculture, agro-processing, and mining and minerals sectors. His government has

focused on improving the export of soybean, sugar cane, ethanol and iron ore.



14


Figure 11: Brazil’s GDP growth

1,618

1,287

1,072

882

664552

5065.2%

3.7%3.1%

5.7%

1.2%2.7%

0

500

1,000

1,500

2,000

2002 2003 2004 2005 2006 2007 2012E

N o m i n a l G D P ( U S D

b i l l i o n )

0.0%

5.0%

10.0%

15.0%

20.0%


CAGR

4.0%

Source: EIU

The Brazilian economy exhibited growth of 4.7% in 2007 and The EIU forecasts its GDP to

grow at 4.4% from 2008 to 2012. Current foreign currency reserves of US$173 billion and

external debt of US$207 billion make Brazil a moderately-indebted country, with a debt

serving ratio of 19.8%. The services sector accounted for the majority of GDP and

contributed 64% to the economy in 2007. This was followed by the industrial sector, which

accounted for 30.8%, while agriculture had the smallest share, contributing 5.1% to the

GDP.

Figure 12: Export trends

0

20

40

60

80

100

120

140

160

1 9 9 5

1 9 9 6

1 9 9 7

1 9 9 8

1 9 9 9

2 0 0 0

2 0 0 1

2 0 0 2

2 0 0 3

2 0 0 4

2 0 0 5

2 0 0 6

E x p o r t s ( U S D b i l l i o n )

Total Exports Agriculture Minerals Fuels

Source: UNCTAD

Although the Brazilian agriculture export surplus at US$27.5 billion is estimated to be the

largest in the world, a significant appreciation in the Brazilian Real in 2007 (16% against

the US dollar) has reduced the competitiveness of the Brazilian agro-products in the

international market place.

From 2002-2004, Brazil provided US$2.7 billion per year in agricultural aid, representing

approximately 0.5% of the country’s GDP; this aid went to agricultural research,

infrastructure development, education, and preferential financing. In order to attract

The lower price of agricultural inputs,improved productivity and government support have led to rapid growthin agricultural exports in

Brazil.



15


further investment, the government has proposed a new public private partnership (PPP)

policy. Under this policy, from 2007 to 2010 approximately US$235 billion is expected to

be invested in the oil and gas, transportation and sanitation sectors. While the government

is expected to provide 14-15% of the investment, the remainder is expected to come from

the private sector. The government has also created a guarantee money pool of

approximately US$2.2 billion to further stimulate additional private investments.

According to the World Energy Outlook, Brazil would require investments in the energy

sector of around US$470 billion during 2005-2030 to meet its energy requirements. In

order to achieve this, the country has liberalized the sector and allowed foreign direct

investment in petroleum exploration and power transmission. Of the total energy supply,

oil supplied 42%; coal 7%; gas 8%; nuclear 2%; hydro 14%; and biomass 27%.

In addition, the government has started promoting alternative energy by providing

financing for the construction of renewable energy power plants, biodiesel plants, and has

begun to offer tax incentives to improve energy efficiencies. Brazil promotes ethanol (a

biofuel made from sugarcane) usage by allowing consumers to have flex fuel engines for

vehicles that can run on 25% blended gasoline or ethanol. Castor seed-based biodiesel has

also been promoted and a 5% blending target has been set for 2013.

NATO

The North Atlantic Treaty Organization (NATO) is an alliance of 26 countries, including the

U.S. and Canada, Norway, Iceland, Turkey, and 21 countries from the European Union,

sharing the common goal of safeguarding mutual interests, such as the promotion of

democracy, individual liberty, the rule of law and the peaceful resolution of disputes. It was

originally formed as a military alliance in 1949 to counter the perceived threat of the Soviet

Union. The UK and nine other countries from Western Europe, as well as the U.S. and

Canada are its founding members.

With a GDP of over US$13 trillion in 2007, the United States is the largest economy in the

world, accounting for about 21% of the gross world product. The GDP growth rate of theUS declined in 2007 to 2.2% from 2.6% in 2006 and is expected to decline further in 2008.

The economy is experiencing near recession like conditions due to the sub-prime crisis,

decrease in residential fixed investments and a downturn in private inventory investments.

However, the economy is expected to recover gradually and achieve a growth rate of 2.5%

by 2012.

In 2007, the service sector constituted the bulk of the US economy, contributing 78.5% of

GDP followed by the industrial sector with 20.6%. Agriculture contributed less than 1% of

GDP. Although agriculture has a small share of GDP, the US is the world’s leading

producer of soybeans and corn. Corn has the largest share both in terms of value as well

as volume of domestic agricultural production in the U.S. and accounted for approximately

42% of the global production in 2006. The U.S. is not only the top producer of corn, but

also the top exporter, accounting for almost 68% of the global corn exports in 2006. As

part of its continued support of agriculture, the 2007 Farm Bill, introduced by the Federal

government and ratified by Congress, allocated US$288 billion for agricultural subsidies

over a five-year period. The 2007 Farm Bill continues, in effect, the government’s

commitment to preserve natural resources and support the development of renewable

energy. The Bill includes US$1.6 billion for the development of new renewable energy

sources and cellulosic ethanol projects, of which US$500 million has been earmarked for

bio-energy and bio-based product research initiatives.



16


With imports worth US$1.9 trillion and exports of US$1.1 trillion in 2007, the US is the

largest importer of goods and the third largest exporter after Germany and China. The

leading export commodity was capital goods while industrial supplies led the list of

imports. The estimated current account balance for the same period reflected a deficit of

US$747 billion and external debts of US$12.3 trillion. Although the U.S. has a trade deficit,

it has a surplus in agriculture with forecasted farm exports of US$78 billion in 2007, with a

majority of the exports to Asian countries.

The U.S. is one of the world’s largest producers of energy, the largest consumer and a net

importer of energy. It is the third largest producer of oil with a production of 8,331

thousand barrels per day and a consumption of 20,687 thousand barrels per day in 2006.

It is also the world’s largest consumer and second-largest producer of natural gas,

consuming 21% and producing 18% of the global usage in 2005. It has the world’s largest

coal reserves with 55% of coal production occurring in the western U.S. On an industrial

scale, ethanol and biodiesel are the only biofuels produced. In 2005, 1.43 billion bushels of

corn grain, representing 13% of the total corn crop, were used to produce most of the 4

billion gallons of ethanol compared to 3.4 billion gallons produced in 2004. Ethanol is

extensively used in the United States with E10 (10% ethanol and 90% gasoline blend)

available in a majority of the gas stations.

The European Union’s GDP, estimated at US$16.6 trillion in 2007, grew at a rate of 3%

and accounted for approximately 31% of the global economic output. The services sector

contributed to a majority of the EU’s GDP in 2007. The EU was the largest exporter and

second largest importer of goods in 2005. In 2006, the U.S. was the major trading partner

of the EU, with 23% share in exports and 13.8% in imports; China came in next with

13.4% in imports. In 2007, the current account deficit was US$146.8 billion with an

inflation rate of 2.2% of GDP.

The European Union is pushing its infrastructure on cross border linkages within the EU to

improve trade and mobility. A major component of this effort is the Trans-European

Transport Networks (TEN-T) which includes projects like Channel Tunnel, LGV Est, the

Frejus Rail Tunnel, and the Oresund Bridge. It is estimated that by 2010 this network willcover 75,200 kilometres of roads, 78,000 kilometres of railways, 330 airports, 270

maritime harbors, and 210 internal harbors.

Currently, the EU is the leading importer of oil and gas. It buys 82% of its oil and 57% of its

gas from other countries. Russia is a large supplier of energy to the EU and a series of

clashes between Russia and the Ukraine have raised concerns in the EU regarding a

sustained supply of gas. As a result, the EU is attempting to diversify its energy supply

sources. Officials have set a target of 20% energy from renewable resources and 10% of

vehicle fuel from biofuels to reduce its dependency on oil and gas by 2020. The new energy

strategy also seeks to address climate change and emphasizes the use of renewable

sources, such as wind and biofuels.

Representing one of the oldest policies of the EU, The Common Agriculture Policy (CAP) isa system of subsidy payments and programs. The main objectives of the policy are to

increase productivity, stabilize markets and ensure the availability of food at fair prices,

while maintaining a reasonable standard of living for farmers. It also guarantees a

minimum price to producers, imposes import tariffs and quotas on certain goods from

outside the EU and provides a direct subsidy payment for cultivated land. In 2005, CAP

represented 44% of the EU’s budget, with cereals, beef/veal and dairy products accounting

for a majority of the funding.

The Common Agricultural Policy (CAP) of the EU

subsidizes farming and significantly impacts

global agricultural trade.



17


THE REST OF THE WORLD

The global agriculture trade is dominated by the European Union (48%), the Cairns Group

(26%), and the United States of America (10%). Agriculture trade remains one of the most

protected types of trade agreements under the WTO charter. EU nations give export

subsidies to encourage exports, the U.S. provides budgetary support to its farmers while

other countries prefer tariffs, tariff-restricted quotas and non-tariff measures like sanitaryinitiatives.

In terms of the overall exports of the top ten agriculture-exporting nations, agriculture

exports make up less than 15% of their total, and eight out of these ten nations are

represented by developed economies. Although an important aspect of these economies,

developed nations are typically more economically diversified and less dependent on

agriculture exports than their developing counterparts. Additionally, much of their

agriculture exports are processed, value-added commodities and not in raw form.

Figure 13: Agricultural exports by regions

86 84 93 98 103 116

222 266321

367395

433140144

163197

212235

988574686056

252421191614

0

300

600

900

2001 2002 2003 2004 2005 2006

A g r i c u l t u r e E x p o r t s ( U S D b i l l i o n

)

Asia America Africa Europe Cairns Group

Source: UNCTAD

Figure 14: Top 10 agriculture export-dependent countries 2006 (exports> US$1 billion)

1.6 1.63.5

21.3

1.91.8

13.2

2.61.61.2

52%45% 43%

46%

54%55%59%

65%

83%84%

0

M a l i

P a r a g u a y

U r u g u a y

N e w Z e a l a n d

G u a t e m a l a

I c e l a n d

K e n y a

A r g e n t i n a

G h a n a

C ô t e d ' I v o i r e

A g r i c u l t u r e E x p o r t s ( U S D b i l l i o n )

0%

20%

40%

60%

80%

A g r i c u l t u r e E x p o r t s % T o t a l E x p o r t s

Source: United Nations Conference on Trade and Development (UNCTAD)



18


The importance of agriculture exports is high for so-called developing and underdeveloped

economies, as they form the bulk of their exports. Moreover, these economies are typically

dependent on a small basket or a single agricultural commodity, and often these exports

are raw or semi-processed in form. As a consequence, these economies are extremely

vulnerable to commodity-price fluctuations. For example, Ghana is one of the largest

exporters of raw cocoa beans. Cocoa beans form a majority of that country’s agriculture

exports and, in fact, constitute approximately 45% of its total exports. Another example

includes Mali, which is heavily dependent on its cotton exports.

Figure 15: Top 10 agriculture-exporting countries 2006 (excluding NATO and BRICcountries)

13.2

9.2

6.5

11.5

14.515.6

18.2

21.321.622.2

23%

1%

59%

21%

6%10%

18%

46%

17%18%

0

5

10

15

20

A u s t r a l i a

T h a i l a n d

A r g e n t i n a

I n d o n e s i a

M a l a y s i a

M e x i c o

N e w

Z e a l a n d

C h i l e

V i e t n a m

J a p a n

A g r i c u l t u r e E x p o r t s ( U S D b i l l i o n )

0%

20%

40%

60%

A g r i c u l t u r e E x p

o r t s % T o t a l E x p o r t s

Source: United Nations Conference on Trade and Development (UNCTAD)

The Cairns Group

The Cairns Group is a coalition of 19 agriculture exporting countries and represents over25% of the world’s agricultural exports. Key members of The Group include Australia, New

Zealand, Brazil, Argentina, Canada, Malaysia and South Africa. Along with other

developing countries, The Cairns Group promotes agriculture and agriculture trade

reforms at multilateral trade negotiations within the WTO. The Group seeks a reduction in

bound rate tariffs, a reduction in trade-distorting domestic support and export subsidies,

and the elimination of certain “amber box” subsidies. At the same time, the Group seeks to

promote improved market access, the continued support of developing members, and

further harmonization in sanitary and phytosanitary measures. A vocal advocate for

market reform, The Cairns Group recently expressed its disappointment at the decision by

the United States Congress to approve a Farm Bill that they believe “clearly contradicts the

objectives and mandate of the WTO Doha Round of trade negotiations.”

Australia

The Australian government’s agriculture policy focuses on food safety, bio-security, farm

productivity, and environmental and climate-change management. In addition, as a

member of The Cairns Group, it seeks to promote international market access and fairness.

At WTO trade negotiations, Australia, along with The Cairns Group, has been advocating

the reduction and elimination of certain trade measures that it believes have a distorting

affect upon the agricultural marketplace. It has signed a bilateral free trade agreement

Excluding the NATO and BRIC countries, major agriculture exportersinclude Australia,

Thailand, and Argentina.



19


(FTA) with the U.S., Singapore and Thailand to get preferential market access for its agro-

exports. Scientific research institutions like CSIRO (Commonwealth Science and Industrial

Research Organization) are funded by levies on producers and matching grants by the

government. In 2006, an estimated US$1 billion was invested in agriculture and livestock

research. To supplement its declining farm-labour resources, Australia boasts a fairly

liberal foreign workers program in an effort to support its farming activities.

Argentina

Argentina is another major exporter of agricultural products, and its agro-exports

contribute up to 46% of the country’s total exports. Major agro-exports include wheat,

soybean, corn and beef. To promote its domestic agricultural efforts, the Argentinean

government has eliminated all quantitative restrictions on imported agricultural inputs like

fertilizers, farm machinery and pesticides, and has a cap of 15% on import duty. It has

reduced all export taxes to make its agro-industry internationally competitive, privatized

the grain trade and export by removing overly-bureaucratic government agencies, and has

privatized grain silo, port and transport facilities. It also actively promotes the use of

fertilizers and transgenic GM (genetically-modified) crops to boost farm-sector yields. More

than 95% of the soybean crop is estimated to be of the biotech “roundup” variety. Theinternal waterways in the Pampas (agriculture zone) have also been improved to make way

for larger ships, which has lead to lower transportation costs from the hinterland to the

exporting ports.



20


INDUSTRIALIZATION OF THE BRIC COUNTRIES

High economic growth and the industrialization of the BRIC countries are already having a

significant impact on the global economy. China is now around 8% of worldwide GDP and

the EIU estimates that China’s GDP will surpass that of the United States by 2050.

Figure 16: GDP growth forecast

Country

AnnualGDP

GrowthGDP (US$

billion)% of US

GDP

% ofWorld

GDPGDP (US$

billion)% of US

GDP

% ofWorld

GDP

2010E 2010E 2010E 2050E 2050E 2050E

US 2.3% 17,545 100.0% 34.5% 43,518 100.0% 22.6%

China 6.8% 3,949 22.5% 7.8% 54,871 126.1% 28.4%

India 8.5% 1,465 8.4% 2.9% 38,296 88.0% 19.9%

Brazil 5.2% 1,498 8.5% 2.9% 11,386 26.2% 5.9%

Russia 4.3% 1,463 8.3% 2.9% 7,882 18.1% 4.1%

Source: EIU

Developed countries are typically characterized by moderate and stable economic growth,

and their per-capita disposable income is much higher than the world average. Per-capita

food consumption forms a relatively smaller share of their per-capita disposable income;

however, in absolute terms, developed countries spend a lot more on food than other

countries.

The BRIC countries feature rapidly-growing economies fueled by continued

industrialization. Their per-capita incomes are also growing at a brisk pace. In addition,

industrialization has given rise to a growing middle class and further urban development

within these countries and, as a result of the increase in disposable incomes, the BRIC

countries have begun to witness a shift in their consumption patterns, from basic amenities

to an increasing demand for luxury goods and services.

CONSUMPTION

Consumption in the BRIC countries is approaching levels that have been enjoyed by the

developed world for some time. No less immune to socio-economic influences, the

agricultural sector in these countries has also witnessed a number of developments. China,

for instance, has begun to experience an organic farming boom. Although largely serving

the export market, an estimated two million hectares of farmland are under organic

cultivation and approximately 1,400 companies and farms have been certified organic.

Chinese organic products are exported mostly to Europe where they dominate the supply

of pumpkin, sunflower seeds, and kidney and black beans. The U.S. and Japan are also

major buyers. However, with the growing affluence of the Chinese consumer, the average

urban shopper is seeking out healthier food options as well. Companies such as ChinaOrganic Agriculture (CNOA : OTC : US$0.66 | Not rated) have begun to tap into this demand

at home, and the company’s products command a premium over non-organic offerings.

CNOA approximates that it receives a 15% price differential for its organic rice brands, and

a 10% premium for its green rice.

Whereas the economic activity in undeveloped nations is primarily aimed at sustenance,

growth in industrial activity has historically excited periods of large urban migrations,

where its inhabitants inevitably adopt an industrialized way of life. As the country moves

China will surpass US GDP and will account for over 28% of world GDP by

2050.



21


up the development cycle, its inhabitants look to consume more in terms of quality and

quantity. Consequently, expenditures on food as a share of total expenditure initially

increase after periods of rapid urbanization. As the economy grows, however, expenditure

on food as a proportion of total consumption expenditure declines due to improvements in

per-capita income and an increased demand for luxury items.

Figure 17: Consumption – 2010Country Consumption (US$ billion)

US $10,877

China 2,096

Russia 1,092

India 1,013

Brazil 909

Nigeria 78

Source: EIU

Figure 18: Per capita consumption of food, beverages and tobacco

0%

20%

40%

60%

1990 1995 2000 2005 2010E P e r c e n t a g e s p e n d o n f o o d

Nigeria Brazil China India Russia USA

Source: EIU

As mentioned above, the developing nations’ consumption expenditure is dominated by

food. As the economy grows, the proportion of food expenditure declines while demand for

luxury items increases with improvements in income. Emerging economies, such as the

BRIC nations, are witnessing a reduction in food expenditure and an increased demand for

transport, communication and luxury goods as compared to less developed nations such as

Nigeria, which will continue to spend a higher proportion of their income on food. Nigeria

has steady economic growth and significant urbanization activity since 1990. As a

consequence, the per capita food consumption as percentage of total per capita

consumption has jumped from 40% to 60%. However, per capita consumption and

disposable income in Nigeria have also begun to see marginal increases since 1990.

Meanwhile, as implied in the figure above, the emerging economies of Brazil, Russia, India

and China have exhibited steady growth rates as well as significant increases in per capita

disposable income over the last two decades. This has greatly improved the ratio of foodexpenditures as a share of total expenditures in the BRIC nations.



22


Figure 19: Urban population as a % of total population

26%27%

73%75%75%

35%

30%

45%

73%

87%82%

52%

0%

25%

50%

75%

100%

USA Brazil Russia China India Nigeria

U r b a n p o p u l a t i o n

1990 2010E

Source: EIU

Concurrent with this growth, per-capita consumption has increased steadily, while per-

capita food consumption as a share of per capita consumption has shown a marginal

decline. This trend is reflective of a stage of growth cycle wherein people are spending

more to avail non-basic amenities. The consumption led growth in BRIC countries is also

marked by greater expenditure on food products in absolute terms.

At the other end of the spectrum, developed nations like the US practice a high-end

mechanized form of agriculture, which involves little manual involvement and allows

people to engage in other economic activities. High disposable income in such countries

implies greater demand for high-end value-added products. Consequently, per capita food

consumption as a share of total consumption is low; though in absolute terms the former is

fairly high, when compared to the developing countries.

China

China has been witnessing high growth in its economy, largely do to strong growth in its

industrial and service sectors. A key feature of China’s growth is that it is increasingly

capital intensive. Its industrial sector has been growing at an annual rate of about 12%

since 1990 and has accounted for almost 50% of the country’s GDP. Industrialization in thecountry has primarily been led by an increase in the labour productivity as compared to

increasing employment. Interestingly, disposable income and consumption in China are

growing rapidly at about 16% annually, second only to Russia among the BRIC countries

and significantly higher than developed nations such as the U.S.

Figure 20: China’s economic overview2

(in US dollars except ratios) CAGR 2002 2007 2012E

Per capita income 17.0% 579 1,177 2,789

Per capita taxes 28.5% 33 117 409

Per capita disposable income 15.9% 546 1060 2,380

Per capita consumption 15.9% 494 909 2,166

Consumption as a % of disposable income 90.6% 85.7% 91.0%Per capita net savings and investment 15.3% 52 151 214

Source: EIU

2 (1) Per capita disposable income and per capita consumption have been sourced directly from EIU (2)Per capita net savings and investment = (Per capita consumption – Per capita disposable income). Itrepresents per capita savings and investment net of borrowings (3) Per capita income = Grosspersonal income/ population (both these figures are sourced from EIU as well)



23


However, agriculture is the most important economic sector in China, employing nearly

half of the country's work force. The country continues to industrialize its farming efforts,

with increasing levels of investment to enhance its international competitiveness. The

country has the largest agricultural output of any country in the world, but only 15% of its

total land area can be cultivated. Agricultural production has seen rapid growth in China

following the major economic reforms launched 1978, which also included the dismantling

of state-run farming communes that had hampered agricultural efforts throughout the

preceding decades. Since then, the output of major agricultural crops has increased

steadily, and the country has become almost self-sufficient in meeting domestic demand

with the ratio of self-sufficiency to imports at 99.6%. However, as compared to industrial

labour, the labour productivity in agriculture is low.

Food will continue to account for a major portion of China’s total consumption.

Consumption trends are determined by various factors such as the population,

urbanization, behavioral changes and per capita disposable income. A positive outlook for

China’s economy and an increase in China’s disposable income are expected to lead to

changing consumption patterns and a lower proportion of spending on basic necessities.

Increased disposable income will likely act as a catalyst for the travel, entertainment,

media, fashion, luxury goods, and consumer appliances sectors.

Figure 21: Consumption pattern – 2007

13%6%5%

11%

7%

5%

28%19%

6%

Food, beverages & tobacco

Health

Housing & fuels

Household goods & services

Hospitality

Leisure & education

Clothing

Transport & communications

Other goods and services

USD

Source: EIU

According to The Economist Intelligence Unit, China’s household consumption expenditure

on food, beverages and tobacco will continue to increase, but at a diminishing rate due to

an increase in spending power. Demand for non-basic products and services are expected

to grow at a higher pace. Spending on transport and communications is expected to grow

at 23% annually to account for 23% of the total consumption expenditure in 2012 as

compared to 19% currently. With the urbanization of the economy, consumers are

expected to spend more on leisure, education, housing and healthcare.

Economic growth and urbanization has led to an increase in the consumption of meat overstaple foods with per capita meat consumption expected to grow at 4.2% annually during

2007 to 20113. Additionally, the demand for convenience foods such as ready-to-eat meals

is increasing owing to the changing lifestyles of urban China.

3 Chinese Food, Beverages and Tobacco Market Forecast Report

Chinese consumers areexpected to spend more ontransport, communication,and healthcare with

growing disposable income.



24


Figure 22: Food, beverage and tobacco consumption

657

280201329226

2,945

1,005

635

1,202

771

0

1,000

2,000

3,000

2002 2004 2006 2007 2012 C o n s u m p t i o n ( U S D b i l l i o n )

Food, Beverage and Tobacco Total

Food, beverages and tobacco will

continue to account for the maximum

share of consumer expenditure

Source: EIU

Urbanization has been increasing rapidly in China since 1990 and currently accounts for

43% of China’s total population; the urban population is expected to further increase to

47% by 2012 and 57% by 2015. Urbanization will affect the food industry in the country

leading to an increased focus on commercial agriculture, modern food industry,infrastructure development and a changing food-consumption pattern. As the urban

population increases, spending on non-basic items is expected to increase and demand for

nutritious food and meat will also rise.

Figure 23: Growth in urban population

637573

484

47%

43%38%

0

200

400

600

800

2002 2008E 2012E

U r b a n P u p u l a t i o n ( M i l l i o n )

30%

40%

50%

60%

70%

P e r c e n t

a g e o f P o p u l a t i o n

Source: EIU

Figure 24: Per capita disposable income

2,380

1,760

1,280

900682

546

0

1,000

2,000

3,000

2002 2004 2006 2008E 2010E 2012E

D i s p o s a b l e I n c o m e ( U S D )

CAGR – 15.9%

Source: EIU



25


Real disposable income for those living in urban environs grew at a higher rate than for

their rural counterparts. Urban disposable income grew at 12.2% as compared to 9.5% for

the rural population in 2006-2007 and at 10.4% as compared to 8.3% in 2005-2006,

respectively. The government has laid emphasis on increasing the rural incomes in the

11th five-year plan, as currently urban disposable income is more than three times the

disposable income of the rural population in China.

The high growth of the Chinese economy has led to an increase in the savings and

investment rate in the country. The household savings rate in China was 16% in 2006 as

compared to India’s 22% for the same period. The high savings rate can be attributed to

factors such as underdeveloped financial markets and the fear of large future expenditures

due to economic insecurity and high inflation.

India

The Indian economy is experiencing high growth. With positive indicators such as a stable

annual growth of over 8%, increasing foreign exchange reserves, a growing capital market

and expanding FDI inflows, India has emerged as the second fastest growing economy in

the world. The industrial and service sectors have been the major contributors of this

growth.

Figure 25: India’s economic overview4


Per capita income 16.4% 483 1,008 2,212

Per capita taxes 24.5% 74 221 662

Per capita disposable income 14.3% 409 787 1550

Per capita consumption 13.4% 310 573 1,089

Consumption as a % of disposable income 75.8% 72.8% 70.3%

Per capita net savings and investment 16.6% 99 214 461

Source: EIU

Agriculture is an important sector of the Indian economy contributing about 18.5%

towards national income and employing two-thirds of the work force. India has favourableclimatic conditions and a rich natural resource base which combine to make it the world's

largest producer across a range of commodities such as coconuts, mango, banana, cashew

nuts, pulses, ginger, turmeric, and black pepper. It is also the world’s second-largest

producer of wheat and rice after China.

Exports of agricultural products have been increasing steadily. For example, India

accounted for 12% of the cotton trade in 2006-2007 as compared to 8% in 2005-2006.

Additionally, the government plans to increase India's share in the processed food trade

from 1.6% in 2006-2007 to 3% by 2015.5

4(1) Per capita disposable income and per capita consumption have been sourced directly from EIU

(2) Per capita net savings and investment = (Per capita consumption – Per capita disposable income). Itrepresents per capita savings and investment net of borrowings (3) Per capita income = Grosspersonal income/ population (both these figures are sourced from EIU, as well)5 IBEF (http://ibef.org/artdispview.aspx?in=1&art_id=18030&cat_id=128&page=2)



26


Rural India is matching the urban spending pattern

Figure 26: Consumption pattern comparison – 2007

44%

14

10%7%7%

6%

8%

1%

3%Rural

Rural

56%

Urban

44%3%

4%

7%

5%7% 9%

13%

20%

32%

Urban

Source: McKinsey report, The Bird of Gold: The Rise of India's Consumer Market

As the Indian economy continues to grow, consumption expenditures are also increasing

along side an increase in the country’s per-capita income. Spending on food and beverages

as a percent of total consumption has decreased from 48% in 2000-2001 to 42% in 2006-

2007. This is primarily because of increasing urban population and the subsequent

changing consumption patterns.


33% 36% 49%

67% 64%51%

0%

25%

50%

75%

100%

1995 2007 2025E

C o n s u m p t i o n E x p e n d i t u

r e

Urban Consumption Rural Consumption

Source: EIU

Consumption is expected to grow dramatically at an annual rate of over 7% until 2025; the

highest growth segments are expected to be healthcare, transportation andcommunications. Food is the largest consumption segment accounting for over 40% of

expenditures.

The Indian food industry is at an early stage of development. Millions of households in the

rural areas still depend on subsistence farming or local village produce for meeting their

food requirements. In the long run, the rural population’s consumption trend is expected to

change with increasing urbanization.

Spend as apercent of total

consumption58% 39% 24%



27



500

288

213

38%

28%

25%

0

200

400

600

1992 2002 2017

U r b a n P u p u l a t i o n

( M i l l i o n )

20%

30%

40%

50%

P e r c e n t a g e o f P o p u l a t i o n

Source: McKinsey report, The Bird of Gold: The Rise of India's Consumer Market

India’s urban population is a major contributor towards the country’s overall economic

growth. Less than one-third of India’s population lives in cities and towns, but generates

over two-thirds of the country’s GDP and accounts for almost 90% of government revenues.

Increasing urbanization in India will lead to changing consumption trends and an increase

in per capita and disposable income, which should further drive demand of luxury

products and services. In India, the urban population is expected to grow at a CAGR of

2.5% until 2017 and will account for almost 38% of the Indian population.

Per Capita Income

India's per capita income has increased at a rapid pace, and is expected to reach US$1,021

in 2007-2008. Though consumption is expected to grow alongside the increase in per

capita income, savings are expected to increase at a higher pace as compared to

consumption.

Per capita consumption will be driven by factors such as the growing economy, increasing

literacy levels and urbanization. The consumption pattern of the rural population is morefocused towards the basic necessities of food, clothing and shelter; however, their urban

counterparts are driving demand for high-end products and services.

Figure 29: Per capita income growth

6.8%7.6% 7.2%

8.1%

6.6%

2.2% 5.3%5.6%

7.0%

3.6%4.2%

1.1%

0%

2%

4%

6%

8%

10%

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

G r o w t h R a t e

Per Capita Income GrowthPer Capita Consumption Growth

Source: Indian Economic Review

India’s per capita income isexpected to reach US$1,021

in 2007-2008.



28


Figure 30: Per capita disposable income growth

1,550

787654

582508

469410

250

500

750

1,000

1,250

1,500

1,750

2002 2003 2004 2005 2006 2007 2012

P e r C a p i t a G D

P ( U S D )

CAGR 13.9%

CAGR 14.5%

Source: EIU

There are a number of factors that are beginning to influence spending patterns in India,

and these include growing income levels resulting in more personal disposable income,

changing attitudes towards consumption, changes in prices, the introduction of new

products, the improving availability of credit such as loans, mortgages and credit cards,increasing aspiration levels, increased literacy, growing brand consciousness and rapid

urbanization. India’s per capita disposable income in 2002 was US$410 (at current prices)

and was expected to almost double to US$787 by 2007. Needless to say, this high growth

in disposable income has led to changes in the consumption, savings, and investment

patterns of the population.

In terms of annual growth, disposable income has grown at almost 14% annually and is

expected to follow a similar trend until 2012. Consumption should follow a similar trend

and is expected to grow at a CAGR of over 13% until 2012. Savings, on the other hand, will

grow at over 19% annually. This disparity is due to the increasing consumer awareness

toward savings and investments.

Growth in the Indian economy has lead to an increase in the level of savings andinvestment. While the gross savings rate as a proportion of GDP has increased from 25.5%

in 2001-02 to 31.6% in 2006-2007, the investment rate, reflected as the gross capital

formation as a proportion of GDP, has increased from 16.7% in 2001-02 to 27% in 2006-

2007. 6

Brazil

Interestingly, per capita consumption in Brazil is higher than per capita disposable income.

Both income and consumption levels in Brazil are expected to grow more rapidly than

developed economies, such as the U.S., where the corresponding CAGR for income and

consumption is about 4%.

6 India Budget 2007-2008.



29


Figure 31: Brazil’s economic overview7


Per capita income 9.7% 1,688 3,881 4,244

Per capita taxes 19.2% 234 1,011 1,354

Per capita disposable income 7.1% 1,454 2,870 2,890

Per capita consumption 10.8% 1,770 4,170 4,940


Per capita net savings and investment -316 -1,300 -2,050

Source: EIU

The Brazilian economy is growing at approximately 5% annually. Brazil has emerged as

the sixth largest economy in the world (based on purchasing power parity) due to positive

factors such as a growing economy, moderate inflation and the lowering of fiscal and

foreign exchange deficits. Brazil has a growing industrial and service sector with a

contribution of over 90% to the GDP while the agricultural sector contributed around 8%.

Agriculture is an important sector of the Brazilian economy with a contribution of about

8% towards national income and employing about 37% of the work force in 2005. Brazil’s

agro-food trade surplus is the largest in the world and it is a leading exporter of soybeans,

soymeal, sugar, poultry, beef, coffee, tobacco, frozen concentrated orange juice, soy oil,and ethanol.8 Exports of agriculture and allied products have been increasing steadily. For

example, between 2000 and 2005 corn exports grew by 48% and ethanol by 79%.

Food will continue to account for a major portion of consumption spending.

Figure 32: Consumption patter -- 2007

22%

5%3%10%

13%

4%

22%

18%

3%


Health

Housing & fuels


Hospitality

Leisure & education

Clothing



Source: EIU

Consumption patterns in Brazil have witnessed a shift from food, beverages, and tobacco

to non-basic and luxury items such as housing, leisure, and transportation and

communications.

7(1) Per capita disposable income and per capita consumption have been sourced directly from EIU

(2) Per capita net savings and investment = (Per capita consumption – Per capita disposable income). Itrepresents per capita savings and investment net of borrowings (3) Per capita income = Grosspersonal income/ population (both these figures are sourced from EIU, as well)8 USDA, http://www.ers.usda.gov/AmberWaves/November06/Features/Brazil.htm

Brazil is now the sixth-largest economy in the world based on

purchasing power parity.



30



197142

70170

88

999

647

312

789

397

0

400

800

1,200

2002 2004 2006 2007 2012E

C o n s u m p t i o n ( U

S D b n )


Source: EIU

Consumption is expected to grow rapidly due to increasing per capita income. Increasing

income, coupled with decreasing interest rates, are leading to an increased level of per

capita disposable income. This has lead to increased spending and improvement in the

standard of living.

Going forward, consumer expenditures will be dominated by food and basic amenities.

However, as income levels increase, there will be a shift from cereals to livestock.

Additionally, increasing urbanization and changing consumer lifestyles will lead to

increased spending on automobiles, electrical appliances, and property.


177164

145 87%86%

82%

0

50

100

150

200

2002 2008E 2012E


40%

60%

80%

100%

P e r c e n t a g e o f

P o p u l a t i o n

Source: EIU

Brazil has a significantly high urban population with about 86% of the people living in

urban areas (2008 forecast). Increases in the urban population will lead to increasing

industrialization and changing consumption patter ns as consumer spending power

increases.



31



2,8902,870

2,470

2,191

1,803

1,5881,454

1,000

1,500

2,000

2,500

3,000

3,500

4,000

2002 2003 2 004 2005 2006 2007 2012

CAGR 14.6%

CAGR 0.7%

Source: EIU

Increasing employment rates, falling inflation, readily available credit and falling interest

rates have all contributed to an increase in disposable income. High growth in disposable

income has also led to changes in the consumption and savings and investment patterns.

Savings and investments have increased from 20% in 2000 to 22% (of Brazil’s GDP) in

2005 while investment rate has declined from 22% in 2000 to 18% (of GDP) in 2005.

Russia

The Russian economy has traditionally been driven by the oil and gas sector and, in view

of very high crude oil prices, the sector is expected to continue to contribute to a significant

portion of the economy. However, the government’s policies are directed at simultaneously

developing the manufacturing industry and the consumer sector. The consequent growth

in consumption is expected to propel growth of 27% in the food sector during 2006-2010.

Over the same period, the textile industry is expected to grow by 43% and mechanical

engineering by 20-30%9

.

Figure 36: Russia’s economic overview


Per capita disposable income 24.2% 1,384 5,050 12,050

Per capita consumption 24.2% 1,215 4,390 10,580


Per capita net savings and investment 24.1% 169 660 1,470

Source: EIU

Consequently, both per capita disposable income and per capita consumption for Russia

are projected to grow at about 24% annually through 2012, which is significantly higher

than all other BRIC countries. The corresponding figure for China, which ranks second in

terms of annual growth of disposable income, is 16%. In absolute terms, Russia is expected

to see over eight-fold growth in its per capita disposable income and consumption during

2002-12. The proportionate increases in disposable income and consumption imply a

similar growth rate for net savings and investments in Russia.

9Source: The Organization of Asia Pacific News Agencies

http://web5.bernama.com/oana/news.open.php?nid=359388&open=1

Russia’s per capita disposableincome and per capitaconsumption are expected to

grow more rapidly than all other BRIC countries.



32



12%7%2%

11%

4%

5%

34%

15%

10%


Health

Housing & fuels


Hospitality

Leisure & education

Clothing



Source: EIU

The consumption pattern in Russia reflects the dominance of food and beverages with over

one-third of the total expenditures being spent on food. However, going forward, growth in

food and beverage consumption is expected to be slower than overall consumption growth.

Meanwhile, in absolute terms, the former is still expected to exhibit strong growth of 14.8%

annually during 2007-2012. The growth in food consumption is expected to be mainly

driven by increased demand for higher-value food products. The steady growth indisposable income is also expected to facilitate increased spending on communication,

housing and transportation.


420

16875211

111

1,482

479

177

625

297

0

400

800

1,200

1,600

2002 2004 2006 2007 2012

C o n s u

m p t i o n ( U S D b n )


Source: EIU

Meanwhile, Russia is expected to see a marginal decline in its urban population through

2012. This can primarily be attributed to a declining overall population, a growing interest

in agriculture and absorption of more land into cultivation-related activities. Large tracts of

arable land are expected to be brought under cultivation in order to increase agricultural

output. The agriculture sector continues to adjust to a market-oriented system following

the breakup of the Soviet Union in 1991, though significant progress has been made with

land privatization and improved efficiencies.



33


Figure 39: Decline in urban population

101103106

72%73%

73%

60

80

100

120

2002 2008F 2012F


40%

60%

80%

100%

P e r c e n t a g e o f P

o p u l a t i o n

Source: EIU

The growth in Russian economy and industry is expected to be fueled by the growing per

capita income and domestic consumption. It is believed that government polices aimed at

encouraging the market for domestically produced goods as opposed to imported goods

will drive manufacturing growth.


12,050

5,0503,890

3,0942,418

1,8171,384

1,000

5,000

9,000

13,000

2002 2003 2004 2005 2006 2007 2012

P e r C a p i t a G D P ( U S D )

CAGR 9.5%

CAGR 19%

Source: EIU

However, wages are growing faster than labour productivity, which is expected to lead to

accelerated inflation and a distortion in the employment market. The Russian markets are

further marred by a high degree of monopolization and a tendency towards cartelization.

Also contributing to an inflationary outlook is the excessive inflow of revenues from energy

exports. The consequent dampening of consumption growth and shortage of skilled labour

could become an obstacle in rapid industrial development. However, improvements in the

country’s infrastructure, particularly transportation, should stimulate industrial growth.



34


WEALTH

This section overviews global capital markets and sovereign funds in an attempt to better

understand how these sources can be employed to generate capital required for

investments in infrastructure and agriculture technology.

CAPITAL MARKET

The rapid growth of stock market capitalization (at 23% annually) has resulted in an

increase in its share of the global capital market from 15% in 2002 to 27% in 2006. The

debt markets remain stable with a contribution of 36% in 2006 as compared to 29% in

2002. However, the contribution of bank assets declined from 57% in 2002 to 37% in 2006

primarily due to the deceleration in North American bank assets which declined at the rate

of 16% annually. The rise in the global capital market from 2002 to 2006 was mainly

driven by the emerging market countries which grew at 18% annually compared to EU and

North America which increased at an annual growth rate of 8% and 2%, respectively.

Additionally, the share of emerging market countries in the global capital market alsoincreased from 10% in 2002 to 15% in 2006, primarily due to the significant growth of

equity market capitalization, which grew at 60% annually.

Figure 41: Global capital market, 2002-2006 (in trillions of US dollars)CAGR 2002 2003 2004 2005 2006

Stock Market Capitalization 23% 22.0 31.2 37.2 37.2 50.8

Total Debt Securities 12% 43.4 51.9 57.9 58.9 68.7

Bank Assets -4% 85.0 40.6 49.6 55.7 70.9

Total 6% 150.4 123.7 144.7 151.8 190.4

Source: Global financial stability report ,IMF

SOVEREIGN FUNDSSovereign funds, investment funds owned by national governments, are generally created

when governments have budgetary surpluses with little or no international debts. They are

used to reduce the volatility of government revenues, counter the boom-bust cycles’

adverse affect on government spending and the national economy, or to build up savings

for future generations.

Sovereign funds have been in existence since the 1950s, but their sizes have grown

significantly over the last 10-15 years. From a total estimated value of US$500 billion in

1990, sovereign funds reached a value of around US$2-3 trillion in 2007 and, based on the

current account surplus of different countries, is estimated to achieve US$10 trillion by

2012. This growth can be attributed to the rapid growth of Russia and China as well as the

sharp rise in oil prices, which has given oil-rich countries an extra financial premium. Infact, more than half of the assets are held by countries which export significant amounts of

oil and gas.

In 2007, more than 20 countries held sovereign funds. However, around 80% of the total

assets were concentrated in the world’s eight biggest funds, dominated by oil-producing

nations and emerging economies including the UAE, Saudi Arabia, Kuwait, China, and

Russia.

UAE has the highest sovereignfund assets globally, at 28% of

the global assets.



35


Figure 42: Current account surplus, 2007 (est.)Rank Country Name Billions(USD )

1 China 363.3

2 Japan 195.9

3 Germany 185.1

4 Saudi Arabia 88.9

5 Russia 74.0

6 Switzerland 67.9

7 Netherlands 59.3

8 Norway 55.8

9 Kuwait 51.5

10 Singapore 41.4

Source: CIA World Factbook

Figure 43: Sovereign wealth funds by size, 2007

Saudi Arabia

9%

Singapore GIC

10%

Norway

12%

UAE - Abu Dhabi28%

Kuwait

8%

China

6%

China - Hong

Kong

5%

SingaporeTemasek

5%

Others

17%

Total Assets

US$ 3,204

billions

Source: Sovereign wealth fund institute

The majority of sovereign funds do not publish information about their assets, liabilities or

investment strategies. Only Norway, out of all the big funds, provides some kind of

transparency by disclosing its investment portfolio and returns at the end of each year. As

such, it is difficult to understand the interests of these funds.

Of late, sovereign funds have focused on the recapitalization of the banking and financial

services sectors, where cash is needed to re-establish stability after the massive losses

following the subprime meltdown. U.S. and European banks have been aggressive in

seeking help from these funds. In June 2007, China invested US$3 billion from its

sovereign fund in Wall Street investment bank Blackstone Group LP. Some of the biggest

beneficiaries of the sovereign funds included UBS AG, Merrill Lynch & Co, Morgan Stanley,and Citigroup Inc.



36


ARABLE LAND

When understanding and analyzing agriculture and related businesses, one needs to

understand the trends in arable land. We believe total arable land has stayed relatively flat

over the last 10 years, however, industrialization, mineral exploration and urbanizationare putting pressure on this inventory just as the world’s population requires growth in

arable land.

Total cultivated land represents 10.4% of total global land area and 2.95% of the entire

planet. The cultivated area includes arable land and plantations. Of the world’s 13.4 billion

hectares (ha) of land reserves, around 5 billion hectares is agricultural land, of which

cultivated area accounts for 1.5 billion hectares. Agricultural land may be defined as land

that is suitable for use in farming and includes cultivated land (that is under permanent

crops currently), arable land (land that is suitable for cultivation but includes non-

cultivated land), as well as pastures used for cattle grazing and forest areas.

Since the beginning of human civilization, arable land has been in steady decline. We have

lost two billion hectares of arable land since agriculture was developed over 10,000 yearsago. However over a much more recent timeframe, advancements in agricultural related

technology facilitated an increase of 80 million hectares in arable land between 1961 and

1983, but urban growth and industrialization have impeded further additions to arable

land. Since 1981, we have lost 6 to 7 million hectares of soil annually, due to degradation,

as a result of industrialization and changes in climatic trends. Per capita arable land has

been on the decline from 1961 to 1981, it has declined from 0.45 hectares per capita to

0.31 hectares per capita. It expected to decline to 0.2 hectares per capita by 2010.

The other concern for arable land inventory is desertification. A total of 4.7 billion hectares

of our land area is subjected to arid land desertification, while 900 million hectares is

subjected to anthropogenic desertification. The former desertification is caused by a range

of factors including wind, water, or pasture erosion. Anthropogenic desertification ascaused by industrial excavation and the processing of raw materials, renders large tracts of

fertile land useless. Consequently, the total arable land has stagnated at 1.5 billion

hectares.

While cultivated land is being lost due to degradation and other reasons, newer

technologies are helping to convert non-agricultural land to agricultural land. The share of

agricultural land to the total land area was estimated to be increasing at 0.9% in 2000. The

corresponding figure for developing countries was 1.6%, while Asia recorded a growth rate

of 2.5%. The total irrigated land accounts for 17.8% of the total arable land. The highest

share of irrigated land in the total arable land is found in South Asia, where 35% of the

arable land is irrigated.

The potential for new agricultural land additions appears to be the greatest in Russia andSouth America. This is likely to offset the large tracts that are being lost to industrial and

residential development in Asia and Europe. Russia is developing substantial potentially-

arable land. The land, priced at US$500 per hectare in Russia, is much cheaper than in the

rest of Europe. With economic reforms, and better opportunities in the agricultural sector,

Russia is expected to see a lot of developmental activity in this sector. Additionally,

sufficient water availability will ensure that Russia remains largely unaffected by potential

food shortages. At present, only 4.6 million hectares (or 4%) of arable land in Russia is

irrigated.

Of the world’s 13.4 billionhectares land reserves, around 5 billion hectares isagricultural land, of whichcultivated area accounts for

1.5 billion hectares.



37


Russia has large tracts of unused arable land, primarily due to the inability of local farmers

to raise sufficient funds for agricultural activity and related development activities. Over

400,000 hectares of highly fertile arable land is lying idle in the Penza region. However,

this land is now being brought into use in view of the land reforms initiated by the

government, including provisions for the acquisition of agricultural land on 49-year leases

and the establishment of private farms. Several companies have started buying leases for

land in these regions and sub letting lands at prices as low as one tenth the average rent in

the country. Improving technology, seed quality and access to better machinery will ensure

that a lot of marginal land is also brought under cultivation.

Similarly, Brazil offers significant opportunities for arable land expansion, with only 24%

of its arable land presently under cultivation. The country has 250 million hectares of

arable land, whereas 60 million hectares of this is presently cultivated. However, tight

monetary credit conditions and environmental concerns constrain expansion of arable

land. Additionally, large scale diversion of arable land towards biofuel production also

limits the land brought under livestock and crop production. Still, Brazil is expected to

record one of the highest growth rates in terms of arable land under food production,

which is expected to increase at 4.5% annually.

Conversely, China, with 20% of world’s population, has only 7% of the world’s arable land.

China has lost eight million hectares over the last decade, with over 2 million hectares of

land lost to new construction over the past five years alone. It has 121.8 million hectares of

arable land at present with per capita land as low as 0.1 ha. The extent of irrigated land in

China is 55 million hectares (or 45% of total arable land). Chinese authorities have

mandated that total arable land should not fall below a threshold of 120 million hectares. A

significant portion of land lost to construction in Eastern China was high quality

agricultural land. Of the remaining arable land, 28% is high yielding arable land; while

32% is low yielding land. The remaining 40% of land suffers from soil erosion and

degradation; about 15% of this land is polluted by metals.

Weather patterns are further affecting agricultural production. 22.9 million hectares of

China’s land was severely affected by drought and snow during the winter of 2007-08. Thedrought affected 11.1 million hectares of land in North China. Freezing temperatures and

heavy snow and sleet have impacted 11.8 million hectares of land in South and East China.

About 1.89 million heads of livestock were affected and 2.43 million people were left

without potable water. Water shortages in North China were caused by a decline of over

70% in the region’s rain and snow.

China also suffers from a highly uneven distribution of resources and arable land. 81% of

its water resources are concentrated in southern China, while 64% of arable land is found

in northern China. Per capita arable land in 20% of the China’s counties is less than 0.053

hectares, the minimum limit recommended by the Food and Agricultural Organization

(FAO).

Meanwhile, India has bountiful arable land, but it is marred by inadequate utilization of resources and a poor state of infrastructure. The entire south Asian region is known for

having a very high share of arable and permanent crop land in total agricultural land.

India has 162 million hectares of arable land (93.3% of total agricultural land), which is

54% of the country’s total land area (the largest in the world). This compares very

favorably against China, where only 13% of the total area is arable; in absolute terms,

India has 34% more arable land than China. Around 55 million hectares of the arable land

in India is irrigated (or 34% of the arable land), a figure comparable to China. However,



38


only 1.6% of the total arable land uses efficient irrigation systems, as compared to 100% in

Germany and Israel. Additionally, Indian land resources are getting strained because of

low efficiencies, use of outdated technology and the lack of land reforms.

MAJOR CROP GROWTH REGIONS AND DEMAND-SUPPLY

TRENDSThe global food demand and supply trends are largely influenced by various geophysical,

geopolitical and economic factors. The geophysical factors, including availability of

resources like arable land and water, influence the food supply. The geopolitical factors

like international trade relations, government policies and regional nutrition habits affect

the demand supply scenario. The economic factors like food prices, purchasing power and

inflation directly influence the demand, which in turn determines the supply through

market forces.

The demand for cereals has grown sharply since the 1960s, essentially, because of growing

populations and rising income levels. The huge demand was met by efforts at technological

development by several countries like India to attain self sufficiency. Simultaneously,

regions with surplus production including North America, Europe, Australia and Argentinaresponded by flooding the international markets with exports. Consequently, the volumes

of cereals traded in the international markets more than doubled in a period of 30 years to

250 million tons. This rise in production and exports was partly facilitated by a slew of

government subsidies to farmers in North America and Western Europe. These subsidies

were partly withdrawn in the 1990s, leading to a slowdown in production of cereals.

However, a sharp rise in salary levels in the developing world since early 2000 have again

led to unprecedented increases in demand and the commodity prices, making it highly

lucrative to produce cereals. A consequent increase in livestock consumption has further

enhanced the demand for cereals required as feed for livestock or as an alternative food

product for coarse grains which are being diverted to livestock industry.

Wheat Wheat is, primarily, grown in Asia, Africa, Europe and America. The total worldwide

wheat acreage fluctuates between 205 and 230 million hectares, depending upon the

global climate scenario from year to year. The most significant wheat growing countries

include China, India, France and Russia. In terms of land under cultivation, India accounts

for the maximum land (13% of total global wheat acreage) under wheat cultivation; it is

followed by the EU, Russia, China, the USA, Australia, Canada, and Kazakhstan.

Figure 44: World wheat supply-demand balance (million metric tons)Country 2001 2002 2003 2004 2005 2006

Harvested Area (Million Hectares) 215.5 216.3 210.4 218.3 219.6 213.5

Production 587.7 572.1 560.1 628.3 624.6 596.0

Consumption 601.1 608.0 598.9 615.5 620.4 621.4

Ending Stock 238.1 204.7 165.8 181.8 184.9 161.2

Source: OECD

Central Asia is emerging as a significant wheat exporting region of the world. Of the 400.7

million hectares of land in this region, 307.4 million hectares are arable. Of this, 262.9

million are used for mowing or as pasture land and 43.3 million are used for agricultural

purposes. However, only 7.7 million of this is irrigated land.



39


Figure 45: Wheat production and consumption 2007-2008

Russia

8%

Others

32%

US

9%

India

13%

China

18%

EU-27

20%

Production (2007-2008)

Russia

5%

Others

42%

US

6%

India

12%

China

16%

EU-27

19%

Consumption (2007-2008)

Source: USDA

The global wheat production in 2007-08 is projected to be 605 million tons while the

global wheat supplies in 2007 are estimated to be 619.6 million tons. This marks a

marginal increase over the previous year on account of increased harvest in Argentina andFormer Soviet Union (FSU-12) countries. The maximum wheat production comes from the

European Union, followed by China, India and the United States. Around 18% of wheat

produced globally is traded in international markets. According to estimates, 108.1 million

tons of wheat will be traded in the international market in 2007-08.The major exporters of

wheat include the USA, Australia, Canada, the European Union, and Argentina. Wheat

exports are expected to rise sharply in Canada, the European Union, Australia, Russia,

Ukraine and Kazakhstan in 2008-09, while the USA and Argentina are projected to see a

decline in exports.

China and India, owing to their huge internal needs, consume almost their entire

production. Major wheat importing countries include China, Egypt, Japan, Brazil, the

European Union, India, Mexico, Indonesia, Algeria, the Philippines, and Iraq. The globalwheat demand is estimated to rise to 775 million ton by 2020. Two thirds of this demand

will come from developing countries, which are expected to double there wheat imports by

then. The major regions expected to import wheat in 2008-09 are Latin America, the

Caribbean, Asia Pacific, the Middle East, and the USA.

As a result of this booming demand, world wheat ending stocks have plummeted to a 30-

year low of 109.7 million tons. US wheat-ending stocks have been pegged at a 60-year low

of 242 million bushels. The decline in ending stocks has been accentuated by the lowered

ending stocks in the USA, Saudi Arabia, Canada and FSU-12, though partially offset by

higher ending stocks in Australia, Argentina, Brazil, EU-27, and India.

Short-term estimates suggest that global wheat production will increase as more seeded

area is brought under wheat cultivation. Consequently, the global wheat production isprojected to rise to 638.6 million tons in 2008-2009. The new seeded area will include 0.5

million hectares of land in the USA, 1.7 million hectares in the European Union and 1.95

million hectares in Russia, Ukraine, and Kazakhstan.

Rice

Rice is essentially grown in developing countries (particularly in humid tropical regions),

which account for 96% of global rice production. Asia, alone, accounts for 90% of global

rice production and consumption. The most significant rice growing countries include

The US, Australia, and Canada are major wheat

exporters.



40


China, India, Thailand, Indonesia, Bangladesh, Vietnam, Myanmar, the Philippines, Japan,

South Korea, the United States and Australia. Rice is also grown in Southern Europe and

parts of South America. Farmers in most of the Asian countries grow rice for personal

sustenance and consumption; and sell only the surplus produce. Consequently, most of the

produce is consumed locally.

Figure 46: World rice supply/demand balance (million metric tons)Country 2001 2002 2003 2004 2005 2006

Harvested Area (Million Hectares) 152.1 148.3 149.9 151.9 156.2 155.0

Production 402.9 383.3 396.4 408.9 426.2 424.8

Consumption 416.0 414.9 417.8 419.1 423.4 426.8

Ending Stock 142.6 113.2 94.4 86.2 89.7 87.1

Source: OECD

The international trade for rice, valued at USD 8.6 billion, is as low as 6.1% of the total

production. 29.6 million tons of rice is projected to be traded in the global markets in

2007-08. 74% of this trade is on account of developing countries, with Africa and West

Asia alone accounting for 35%. Major rice importing countries in South Asia are Indonesia,

Bangladesh, the Philippines, Malaysia, Japan, and Singapore. Besides, the Middle East,

Southern Africa, Oceania, and Latin America are other major regions which importsignificant quantities of rice.

Figure 47: Rice Production and Consumption 2007-2008

Bangla-

desh

5%

Others

27%

Vietnam7% Indo-

nesia

8%

India

22%

China

31%

PrProduction (2007-08)

Bangla-

desh

4%

Others

29%

Vietnam7% Indo-

nesia

9%

India

21%

China

30%


Source: USDA

In the near future, Iraq, Bangladesh, Australia, Afghanistan, Cuba, China, and the

Philippines are expected to significantly increase their imports. However, weaker imports

by Iran, Indonesia, Malaysia, Turkey, and Haiti will partially offset the increased demand.

The major exporters of rice are Thailand, Vietnam, India, the United States, China,

Pakistan, Australia, Italy, Uruguay, Argentina, Egypt, and Spain, Uruguay, and Guyana.

Thailand alone accounts for 30% of rice exports. India, China, Vietnam and the USA,together export 45% of total internationally traded rice. These countries are believed to

have even more unutilized capacity for rice production, and are expected to expand upon

these in the future.

Global rice exports are expected to increase by 3% in 2007-08 over the previous year. This

is primarily on account of increased rice exports by Thailand, Vietnam, China, Uruguay,

Egypt, and the United States. However, India, Australia, and Guyana are projected to

Thailand, Vietnam and India are major rice

exporters.



41


reduce their exports; particularly Australia. Australian exports in 2007-08 will be at their

the lowest since 1962.

Both the production and demand for rice are largely dependent on the economic status of a

society, particularly on that society’s per-capita income. In countries marked by a low

standard of living, where basic sustenance is a challenge, rice is considered to be a luxury.

Consequently, demand in these countries is low. However, rapid economic growth istypically followed by a transition in dietary habits from root crop-based diets to diets based

on rice. West Asia and Sub Saharan Africa, for instance, are expected to experience this

trend in the near future, and, in fact, are now beginning to witness a strong growth in the

demand for rice.

Global rice production in 2007-2008 is projected to be 422.9 million tons, with China,

Indonesia, Vietnam, Brazil, Thailand, Japan, Argentina, the U.S., and Uruguay expected to

harvest larger crops on account of enhanced plantation areas. However, India, Australia,

North Korea, South Korea, and Turkey are likely to witness a decline in rice production.

The global rice supplies are estimated to be 498.4 million tons, which is 9% below the

record levels of 546.6 million tons achieved in 2001-2002.

Of these supplies, 422.5 million tons of rice is projected to be consumed in 2007-2008,with China, India, Indonesia, the Philippines, and Bangladesh accounting for most of the

increase in consumption. As a result of increased consumption, and inadequate increases

in production, the global ending-stocks have touched the lowest levels in recent history.

The global inventory has declined by 4% over the previous year to touch 75.2 million tons,

the lowest since 1983-1984. This also marks a 50% decline over the peak value of 147.3

million tons achieved in 2000-2001.

Corn/Maize

Corn is one of the most versatile and enduring crops, grown in more countries (75

countries) across the world than any other crop. Of the top 25 maize-growing countries,

eight are industrialized and 17 are developing countries, including nine from Africa, five

from Asia and three from Latin America. Each of the corn-growing countries cultivates atleast 100,000 hectares of maize crop. Globally, 157 million hectares of land are under

maize cultivation, producing 770 million metric tons of maize annually. Two thirds of the

maize-growing area is located in the developing countries. There are around 200 million

maize farmers worldwide, 98% of them in developing countries. Around 150 million

farmers grow maize in Asia; 105 million in China alone.

Figure 48: World corn supply-demand balance (million metric tons)

Country 2003-04 2004-05 2005-06 2006-07 2007-08(March)

Production 627.3 714.8 696.3 704.3 770.2

Consumption 648.9 688.0 704.0 721.8 772.3

Trade 79.1 76.0 82.6 90.9 95.1Ending Stock 104.6 131.4 123.7 106.2 104.0

Harvested Area (Million Hectares) 142.0 145.0 145.6 148.1 157.1

Source: USDA

Since 1980, the use of better technology and agricultural practices has resulted in a 54%

increase in maize yield. Consequently, maize production has risen by 78% despite only a

15% increase in land under maize cultivation.



42


Figure 49: Corn production and consumption 2007-2008

Mexico3%

Others

22%

EU-27

6%

Brazil

7%

China

19%

US

43%

Production (2007-2008)

Mexico

4%

Others

29%

EU-27

8% Brazil

6%

China

19%

US

34%


Source: USDA

The major corn producers include the U.S., China, Brazil, the European Union, Mexico,

France, Argentina and India. The United States accounts for 43% of global corn production

– 13.1 billion bushels, 20% of which is exported. The U.S. presently uses 20-30% of its corn

production for biofuels. The world maize stocks for 2007-08 are estimated to be 104

million tons, an increase of 14% over the previous year. The world stocks-to-use ratio is

pegged at 13.5%, two percentage points10 above the figure in the previous year. The huge

demand for maize is reflected by the fact that the stocks-to-disappearance ratio for major

exporters stands at 14%, up from 13% in 2006-2007 and from the low of 8% recorded in

the mid 1990s.

12.4% of the corn produced is traded in the international market. The global maize trade is

likely to be 95.1 million tons in 2007-2008 with the major exporters of corn being the U.S.,

Argentina, China, Brazil, Ukraine, South Africa, and Paraguay. The U.S. alone accounts for

68% of total export volumes.

The major corn importers are Japan, Mexico, Taiwan, Canada, Egypt, and Colombia.

Besides, the European Union, South Asia and East Asia are expected to see enhanced

demand for maize in view of the growing use of maize in the livestock industry as the

supply of other feed grains, such as wheat and barley, tightens. Maize supplies are likely to

come under further strain as use of maize-based ethanol is becoming more prevalent. The

USA alone is projected to consume 81.3 million tons of maize for ethanol production in

2007-2008 as compared to 54 million tons used in 2006-2007.

Global demand for maize is expected to grow to 850 million metric tons by 2020, primarily

on account of greater demand for meat by a more affluent global society. Maize is,

therefore, expected to outstrip rice and wheat in terms of global demand as a result of the

multitude of its uses in food, feed stocks and biofuel production. 80% of the new demand

for maize is expected to come from the developing countries.

10The Stocks to Use Ratio is a convenient measure of supply and demand interrelationships of

commodities. The stocks to use ratio indicates the level of carryover stock for any given commodity asa percentage of the total demand or use. It is calculated as:((Beginning Stock + Total Production -Consumption) / (Consumption))

The US produces 43% of all corn worldwide. Japan

is the largest importer.



43


Soybean

Soybeans represent the most versatile and commonly-used oilseed crop, accounting for

almost 60% of global oilseed production. Due to the ratio of their oil and high-quality

protein content, typically 18-22% oil and 40-42% protein, soybeans remain a highly-valued

legume. They find a multitude of uses in the food processing, livestock and biofuel

industries. The soybeans’ use in the food industry include the manufacturing of oil, flour,milk, vegetable cheese, cookies and many other processed food products.

Global soybean production is expected to see a decline from 238 million tons in 2006-2007

to 224 million tons in 2007-2008, though this trend can be attributed to the periodical

switch in the U.S. from soybeans to corn. The global soybean output has quadrupled over

the past 30 years, spurred by the unprecedented demand for high-value processed foods

and livestock products, particularly from China. China is expected to further double its

demand to 80 million (source China National Grain and Oil Information Center) metric tons

by 2015.

The major producers as well as consumers of soybeans include the U.S., Brazil, Argentina

and China, producing 200 million tons and accounting for 90% of global soybean

production. Brazil and Argentina are exhibiting robust growth rates of 14% and 27%,respectively, with Brazil becoming the second largest producer of soybeans, accounting for

23% of the global soybean crop. Meanwhile, Argentina has seen its production rise by

216% between 1995 and 2005. Subsequently, its share of global production has risen from

10.4% in 1995 to 17.8% in 2005. The U.S. has seen its share of global soybean output

decline over the same period, primarily because of increased production capacities in other

countries. With the exception of China, these nations export a significant portion of their

produce. In addition, Indonesia, Korea and Japan also produce substantial amounts of

soybeans, but their quantities only feed local consumption. Brazil is the largest exporter of

soybeans and is projected to increase it exports by another 27 million tons over the next 10

years. Meanwhile, the U.S., and Argentina are expected to be restrained by limited

capacity for expansion in future.

Figure 50: Global soybean production

Others

13%

China

9%

Argentin

a

10%

Brazil

18%

US

50%

1991-1992

Others

13%China

8%

Argenti

na

18%

Brazil23%

US

38%

2003-2004

Source: Asia Food Journal

The major importers include China, the European Union, Japan, and Mexico. Despite

producing significant amounts of soybean internally, China has seen its soybean imports

rise by an incredible 27 times between 1995 and 2005. This is mainly attributed to the use

of soybeans as a highly-productive livestock feed, coupled with stagnating production in

China is expected todouble its soybeanconsumption by 2015 to

80 million tons.



44


Northern China likely caused by a falling water table. In 2005, China imported 74% of its

total soybean consumption. Although the country has produced soybeans for the past

5,000 years, recently China has seen a decline in its share of world soybean production,

from 9% in 1995 to 8% in 2005.

The high-commodity-price scenario in the world markets has led to rapid integration of

soybean crops into higher-value ingredients and products, involving heavy investments insoy foods, bio-products, and soy protein products. These pricing pressures have also

encouraged large-scale construction of soybean processing and crushing facilities outside

the U.S., particularly in South America and China.

Figure 51: Global soybean crushing capacity

China

4%

Others

20%

Arg'tina

8%

Brazil

16%EU

14%

US

38%

1991-1992

China

16%

Others

18%

Arg'tina

15%

Brazil

17%

EU

10%

US

24%

2003-2004

Source: Asia Food Journal

Soybeans are a highly-preferred crop among farmers because they provide flexibility and

versatility. They can be grown both as a spring as well as winter crop and have a short-

duration growing season. They are fairly successful in rain-fed as wells irrigated areas.

Soybeans consume a lot of water, but being a leguminous plant, they have the ability toreplenish the quality of soil. They are, therefore, generally alternated with crops such as

rice, wheat, corn, sorghum, cotton, or sugarcane.

Livestock

The livestock industry provides livelihoods to about 1.3 billion people worldwide and

contributes about 40% to global agriculture output. It is also a major source of organic

fertilizer for the crops of developing countries where poor farmers cannot afford to buy

chemical fertilizers. The growing trends in population, income levels and urbanization

have also led to a sharp rise in the demand for animal-sourced food. Consequently, global

meat production has more than tripled since 1960, while milk production has nearly

doubled and egg production has increased nearly four fold. Global meat production is

projected to reach 465 million tons by 2050.



45


Figure 52: Major meat exporting countries, 2006

Beef,Pork and Broiler MeatOthers

16%China

5%

Australia

8%

Canada

9%EU

12%

US

23%

Brazil

27%

Total Export

18.8 million

Source: USDA

In 2006, global meat production (beef, pork and poultry) stood at 213 million metric tons.

Pork is the major meat produced and has a 45% share of the global meat output, followed

by beef and poultry contributing 25% and 30%, respectively. The major meat producing

countries in 2006 were China, the U.S. and Brazil, supplying about 60% of global

production, with the Global export market reaching close to 20 million tons.

Global consumption was 209 million metric tons with China consuming the largest share at

33% followed by the EU (18%) and the U.S. (17%). The major importing nations were

Russia, Japan, the U.S., the EU, and Mexico, importing 72% of the global imports.

As stated above, the world produces and consumes more pork than any other meat. Total

production of pork in 2006 was 98.5 million tons, with China producing about half of that.

Other major producers were the EU, the U.S., and Brazil. China also consumes more pork

than any other nation. The domestic demand is so high that, even after producing nearly

53% of the global pork, China only exported a tiny portion (about 1%) in 2006. The global

production in 2008 is expected to decline to 93 million tons primarily because of the major

contraction in the output of China, which has been affected by the outbreak of the PRRS

virus (PRRSV). However, export growth is expected to remain flat due to the growth in the

U.S. and Brazil. Total pork export in 2006 was 5.3 million tons with the U.S., the EU and

Canada accounting for 70% of the exports.

In 2006, total beef production was 53.7 million tons with the largest producers, the U.S.,

Brazil, the EU, and China, producing about 53% of the total global beef output. Global beef

output in 2008 is forecast to be 54.6 million tons with Brazil and China expected to witness

an increase in their production. Beef production in Brazil is also expected to go up as

producers benefit from elevated domestic prices and expanding export market

opportunities. China’s production is expected to expand by approximately 3%, surpassingthe EU to become the third largest producer of beef. This expansion is primarily due to the

disease outbreak in the Chinese pork sector which led to a demand for substitute protein,

such as beef.

Beef exports are expected to reach a record 8 million tons by 2008 due to the continued

economic growth in major beef importing countries. Brazil is the leading exporter selling

23% of its production abroad. Australia is the second largest exporter contributing 20% to

the global exports in 2006. Although the US is the largest producer of beef, it is unable to



46


meet its domestic demand and is therefore a major importer, accounting for 26% of global

beef imports. Other major importing countries include Russia, the EU and Japan.

Total production of poultry was 60.5 million tons in 2006. Major poultry producing regions

were the U.S., China, Brazil, and the EU, constituting about 70% of the global poultry

output. The U.S. and China alone consumed around 40% of total production. Brazil and the

U.S. are the leading poultry exporters with a share of 76% in the global export market,which is 6.4 million tons. Despite the recurrence of avian influenza, the demand for poultry

is expected to grow. The global production in 2008 is expected to rise by 3% from 62.3

million tons in 2007. Growth is expected in all regions of production except in North

America. This is likely due to the economic impact of ethanol in livestock, which has

increased the production cost of poultry by two or more times over the last decade. The

export forecast is also favorable for poultry as there is strong import demand from

countries in the Far East, the EU, Venezuela, and Middle East countries, such as Saudi

Arabia and Kuwait.

Environmental Risks to Livestock

The rapid growth of the livestock industry has also taken a toll on the environment. The

livestock sector accounts for 9% of CO2 derived from human-related activities, while themanure generates 65% of human-related nitrous oxide, which has 296 times the global

warming potential of CO2. The digestive systems of ruminants produce 37% of human-

induced methane and 64% of ammonia, which are the major contributors to acid rain.

Livestock production uses 30% of earth’s surface of which the majority is permanent

pastures, but it also includes 33% of the earth’s entire arable land for feedstock. Moreover,

the clearing of forests for new pastures is driving deforestation, especially in Latin

America, where about 70% of the former forest area in the Amazon has been converted to

grazing pastures. The livestock business is also affecting the planet’s water resources.

Animal wastes, antibiotics and hormones, chemicals from tanneries, fertilizers and the

pesticides used to spray feed crops are major water pollutants. The water cycle also gets

disturbed by overgrazing as it reduces the replenishment of over ground as well as

underground water resources.



47


GLOBAL WEATHER PATTERNSThe perceptible change in global weather patterns that we are experiencing as a result of

intense agricultural and industrial activity over the past century is expected to leave an

impact on our practice of agriculture. Global warming, due to the emission of

anthropogenic green house gases, such as carbon dioxide, methane and nitrous oxide, isprimarily responsible for changing weather conditions. Over 24 billion tons of carbon is

emitted every year due to human activities. As a result, average world temperatures have

increased by 0.74 degrees centigrade in the last century and are expected to further

increase by 1 to 3 degrees centigrade over the next century. Erratic weather patterns

leading to delayed or advanced monsoons have already started affecting agricultural

production. Going forward, it is estimated that crop cultivation, particularly in Asia, will be

severely affected by erratic rainfall. Gradual temperature increases and irregular rainfall

will be compounded by sudden weather events such as flooding and hurricanes.

On an annual basis, 11 million hectares of land face crop deterioration due to floods. Of

this, 7 million hectares of land see complete destruction of cultivated crops. Extreme

weather events such as droughts and floods are predicted to occur with greater frequency

and severity in the coming years. The melting ice caps and rising sea levels could mean

that in the future, category 2 and 3 storms could cause much more severe flooding and

crop damage in low-lying coastal areas than otherwise anticipated. Additionally,

fundamental changes in weather patterns along with rising temperatures are expected to

shorten growing seasons and reduce crop productivity in certain areas.

Besides global warming, crops are also likely to be affected by the depleting ozone layer as

a consequence of CFC emissions. One CFC spawned chlorine atom can potentially catalyze

the destruction of as many as 100,000 ozone molecules. The increasing ultraviolet

radiation tends to break down the natural immunity of plants against crop diseases. Higher

temperature and other changing conditions could provide favorable conditions for pests

and other diseases to flourish. The occurrence of crop diseases, such as cassava mosaic

disease, potato blight, rice blast, wheat stem rust, and whiteflies will become morecommon.

The El Niño influence is another factor behind the changing weather patterns, particularly

the occasional extreme condition. The earth has been witnessing unusually intense and

frequent El Niño weather patterns since the mid-1970s. The El Niño phenomenon

primarily involves the eastward drift of warmer waters in the western Pacific, when the

easterly winds die down. This shift in warm Pacific water upsets the atmosphere's energy

balance. The warm water provides energy and moisture for the build up of huge

thunderstorms. The resultant storms take unusual paths and disrupt normal weather

patterns. It is believed that even if these weather patterns become less frequent, they could

increase in severity. Simultaneously, drier weather conditions could be experienced in

much of western America. Vineyards in California are already facing huge losses due to the

consequent warmer temperatures without irrigation.

The best wheat-growing land in the wide arc of fertile area in south Asia – extending from

Pakistan through northern India and Nepal to Bangladesh – is could be decimated by 2050

due to changing weather patterns. The region, better known as Indo-Gangetic Plains,

produces 90 million tons of wheat annually, accounting for 15% of global production. The

region could to become too hot and dry for the crop, risking the livelihood of 200 million

people if current weather model from the United Nations prove accurate. The area could

also see more severe and frequent flooding and a shorter growing season.

Gradual temperature increasesand irregular rainfall, primarily due to global warming areexpected to affect agriculture

production significantly in the

future.



48


Climate change is increasingly depleting water resources in Northern China due to the

rapid retreat of glaciers, which are retreating at a rate far above the world average. China

has seen a severe drought as recently as the winter of 2007. The consequent

desertification, soil alkalization, weathering, and soil erosion have rendered large tracts of

land unsuitable for cultivation. China is also experiencing an increase in sea levels at a rate

higher than the world average. Consequently, Southern China is seeing more frequent

floods and hurricanes.

Similarly cereals and corn production in Africa could be endangered. 500 million hectares

of agricultural land in sub-Saharan Africa has already been degraded. The most vulnerable

areas in this region are West African Sahel, the Rangelands, Great Lakes, coastal areas of

Eastern Africa and drier zones of Southern Africa. Africa and Latin America, together,

could see a 10% decline in maize productivity through 2055. Global warming could also

cause erratic rainfall patterns. In this regard, sub Saharan Africa faces further threat since

95% of the cropland in this region is rain fed. The precipitation pattern in this region is

largely influenced by intra-seasonal and inter-annual climate variability, including

occasional El Niño events in the tropical Pacific.

Rice crops in India and South East Asia face similar threats. As a rule of thumb, every one

degree increase in temperature above the mid-30s, in the key growing season, causes adecline in yield of 10%.

The wheat-growing Great Plains of the U.S. and Canada could also face severe production

losses. The wheat belts will experience a northward shift. Climate change could cause the

expansion of arable area in Canada, Russia and Europe. For instance, a band across the

top of North America from Cape Harrison, about midway up the coast of Labrador, to

Ketchikan, on the Alaskan panhandle, in the west could become suitable for wheat

plantation.

Similarly, warmer conditions will benefit maize cultivation in highland areas. Other

extensive areas will see minor yield reductions, while, equatorial and tropical regions could

see major declines in yields.

The positive influence of carbon dioxide in stimulating crop growth is not materializing as

expected. It hasn’t as of yet facilitated definable increases in corn yields, while the

improvement in wheat and rice yields is less than half of previous estimates. Overall

climatic change can and likely will have a profound impact on agriculture, however our

investment horizon precludes us from defining the impacts more closely, aside from

highlighting and understanding the potential risk.



49


WATER

Although oceans and water bodies cover more than 75% of the earth’s surface, fresh water

(by volume) accounts for only 2.5% of total water, the majority of which is unavailable for

direct consumption as it is locked in glaciers and ice caps. Only ground water and surface

water are readily available for consumption.

Sources of water

Figure 53: Global water sources

Other

3%

Glacier

2%

Surface Water

0.0075%

Ground Water

1%

Salt Water

97%

Source: Britannica Encyclopedia

On a global basis, total renewable fresh water is estimated to be 55,097 cubic kilometres

per year, but distribution is highly skewed between regions and countries. Brazil leads the

world with 15% share of global precipitation whereas the Persian Gulf and sub-Saharan

nations receive a paltry 1% annually; and although India and China represent a third of

global population, they enjoy only 8% of global precipitation annually.

Figure 54: Global renewable fresh water supply 2006

Oceanic

3%

North &

Central

America

14%

Former

Soviet Union

10%Europe

5%

South

America

31%

Africa

10%

Asia

27%

Global 55, 097

cubic km/ year

Source: Pacific Institute

Tropical regions such as South America, Africa,and Asia have 68% of the

global fresh water

availability.

Tropical regions such as South America, Africa,and Asia have 68% of the

global fresh water

availability.



50


Figure 55: Global renewable fresh water supply , Top 10 countries 2006

Colombia

4%

India

3%

Zaire

2%

Peru

3%

Indonesia

5%China

5%

USA

6%

Canada

6%Russia

8%

Brazil

15%

ROW

43%

Source: Pacific Institute

Demand and consumption

Figure 56: Global water consumption by region

China

16%

EU 15

5%India

20%

US

10%

Australia

1%

Brazil

2%

Argentina

1%

Africa

11%

ROW

34%

1,799 cubic

kilometer

1995

ROW

35%

Africa

12%

US

9%

India

19%

EU 15

5%China

16%

Argentina

1%

Brazil

2%

ustralia

1%

2,081 cubic

kilometer

2025

Source: Global Water Outlook to 2025: Averting an Impending Crisis

Global water consumption is expected to increase from 1,799 cubic kilometres in 1995 to

2,081 cubic kilometres in 2025 a CAGR of 0.5%. The current global share of all the major

regions in water consumption is expected to remain more or less stable over this time

frame.



51


Figure 57: Global water consumption by activity 2025

1436 1492

234290

211235

1436

634937

169

157

0

600

1200

1800

1995 2010E 2025E

W a t e r c o n s u m e d c u b i c k m

Irrigation Livestock Domestic Industry

Source: Global Water Outlook to 2025: Averting an Impending Crisis

According to the International Water Management Institute (IWMI), a region deemed tohave physical water scarcity when water demand exceeds 75% of its availability;

approaching physical water scarcity occurs when water demand exceeds 60% of its

availability; economic water scarcity is defined as water withdrawal below 25% of the

available amount due to human and economic capacity limitations; and little or no scarcity

is defined as water demand below 25% of its availability.

Figure 58: Global Water Scarcity Index

Source: International Water Management Institute

The water scarcity map explicitly indicates that the world’s key agriculture regions of the

Southwestern U.S., Pakistan, Southern India, South Africa, Western Australia, and North

Africa; which are all water stressed. It also indicates a large untapped hydrological

potential for Central and Southern Africa, Central America and the Ganges basin in India.



52


Desalination/Desalting

Figure 59: Desalination installed capacity by process in 2005

RO

46%

ED

5%

VC

5%

MED

3%

Others

5%

MSF

36%

Source: GWI 2025

Due to water scarcity and the changing economic, demographic and climatic trends

discussed above an understanding of methods for improving water supply is an important

factor.

Desalination is considered one of the most expensive and energy-intensive options for

providing water to communities; however, it is employed in the Persian Gulf and island

nations in the Caribbean where fresh water is not readily available. Its use is primarily

reserved for urban consumption, remote holiday resorts and industrial purposes. The use

of desalinated water for agricultural needs is generally limited to high-value crops.

Traditionally, thermal techniques were relied upon for desalination, though a number of

membrane-based techniques are becoming increasingly more cost effective. In 2005,

approximately 44% of desalinated water was produced using thermal techniques, such as

Multi Stage Flash (MSF), Multiple Effect Distillation (MED) and Vapor Compression

Distillation (VC). Membrane-based techniques, such as Reverse Osmosis (RO) and Electro

Dialysis & Electro Dialysis Reversal (ED), had 51% share, while the remaining share was

divided between freezing, membrane distillation and Ion Exchange techniques.

Reverse osmosis, amembrane-based technique, accounts for 46% of the global

desalination capacity.



53


Figure 60: Trends in desalination plants 1945-2004

0

10

20

30

40

1945 1955 1965 1975 1985 1995

0

3000

6000

9000

12000

Cummulative Plants numbers (RHS)

Average Capacity per plant (RHS)

Cummulative Capacity in million m3/day (LHS)

Source: GWI 2025

Figure 61: Installed capacity 2004

6.56

4.8

2.42

0

2

4

6

8

Saudi

Arabia

USA UAE Spain Kuwait I n s t a l l e d C a p

a c i t y i n m i l l i o n m 3 / d a y

Source: Global Water Intelligence

It is estimated that half of the world’s desalination capacity is based in the energy-rich but

water-deficient Persian Gulf countries, with Saudi Arabia and the UAE accounting for 18%

and 13% of the global installed capacity, respectively. Most of this capacity is based on

thermal techniques and uses sea water to extract fresh water. Membrane-based techniques

are more prevalent in the U.S. and Spain where brackish water, river water and waste

water is used as input.

Desalination Technologies

Electro dialysis and electro dialysis reversal uses electric current to separate salt from

water. It is used for brackish water treatment and has found applications in industries,

power plant cooling, fresh water fish farms and municipal waste treatment. The operating

cost of the plants is directly related to the amount of salt removed from the water. It can



54


treat water with higher suspended particles compared to the reverse osmosis technique

and has higher fresh water produce ratios compared to thermal systems.

The reverse osmosis technique is based on the transfer of fresh water across a semi-

permeable membrane when mechanical pressure is applied to the impure water. The cost

of operation is directly related to the salt concentration in the water as higher pressure is

required to remove a higher concentration of salts. It is most suitable for purifyingbrackish water and has found applications in municipal water treatment requirements.

This technique suffers from membrane fouling if a pre-treatment of the water is not carried

out. This technology has matured and large new plants like the Tuas in Singapore is based

on this technique.

Multi stage flash distillation is the most widely used thermal desalination technique. This

technique can desalinate the most saline water (up to 60,000 to 70,000 ppm total dissolved

salt). Here the salt water is boiled and the steam generated is condensed as pure water.

This technique is used for municipal water usage. These desalination plants can also be co-

located with thermal energy plants to use the steam generated for electricity generation.

The MSF plant is more cost effective than the MED thermal plants and suffers less from

scaling.

Multiple effect distillation plants are based on a scientific principle, which states that liquid

boils at lower temperature when the atmospheric pressure is reduced. The sea water is

boiled multiple times in a series of chambers each at successive lower temperatures and

pressures. The heat is applied only once in the first stage. It is most suitable for industrial

applications and small cities. Vapor compression distillation is suitable for remote

locations, hotels and resorts and small industries.

Some of the other desalination techniques are yet to achieve large scale commercial

success but have specific niche application areas. The freezing technique is based on the

scientific principle that salts are insoluble in ice crystals. The waste water is frozen and the

resulting ice is separated from the water solution left behind. This technique enjoys a lower

energy requirement, suffers lower corrosion and less scaling compared to thermal methods

but is not yet commercially viable on a large scale. The ion exchange method uses ionized

resins to remove the salt from the water. It is cost effective for low salinity water and

sometimes used as the final step in the water purification process.

Environmental impact

While people absolutely need fresh water to survive, marine desalination does come with

an ecological price. As they draw in large amounts of sea water, desalination plants disturb

marine ecology as the feeds also draw in marine plankton and small fish. In addition, the

plants discharge salt water and water treatment chemicals, which affect the salinity of the

local area and surrounding ecosystem. In fact, disposal of the concentrated salt water has

been identified as one of the biggest challenges within the industry.

It is estimated that the cost of energy for a desalination plant in the U.S. ranges from 33%

to 60% of the total operating cost of the plant, and currently averages US$0.63-0.80 per

cubic metre of water produced (for new plants). Due to the high energy requirement, the

carbon footprint of a desalination plant is considered relatively high.



55


CROP YIELDS AND PRODUCTION TRENDS

As discussed above, the agriculture industry faces numerous threats. As a whole, the

industry will be required to respond to these threats by improving crop production

efficiency, while at the same time reducing emissions, minimizing environmental pollution

and reverting or helping to stall the unfavorable changes in weather patterns. The impact

of these detrimental factors, particularly climate change, will vary over time and across

boundaries depending upon varying agro ecologies, production conditions and farming

systems.

We identify the following eight trends affecting the production and practice of agriculture:

· The development of stress-tolerant crop varieties;

· The prudent management of crops;

· Water management;

· Soil management;

·

The development of strong market incentives;· The establishment of efficient institutions;

· The formulation of favourable policies; and,

· Measures to capture carbon and other greenhouse gases.

The development of stress-tolerant crop varieties involves extensive research activity and is

increasingly drawing investment from the corporate sector as people realize the potential

for returns on investment in the agricultural sector. The genetic properties of stress

resistant crops and wild crop varieties are being studied and subsequently adopted into

commercial crop varieties. Efforts are also being made to conserve the habitat of wild

crops and preserve the samples of different varieties of endangered crops in gene banks.

Considering the fact that scientists expect the growing season to shorten in the comingyears, efforts are being directed at the development of early and extra-early maturing

crops.

As part of these efforts, 50 drought-tolerant varieties of maize have been developed. These

have been sown on an experimental basis over one million hectares of land in eastern and

southern Africa. The resultant crops have seen 20% improvement in yields. This compares

very favorably against the 15% yield decline that previously existing-crop varietals face in

the event of droughts.

Similarly, drought resistant varieties of rice have been developed through hybrid-

engineering of highly productive Asian varieties with stress tolerant African varietals. The

resultant crops have early maturing characteristics, which allow them to escape the

intermittent droughts. These rice crops have been planted over 200,000 hectares of land in Africa. A gene in some of these varieties seems to provide water proofing traits which

allow the plants to survive complete submergence over a period of two weeks. These

characteristics have made the new varieties of rice hugely popular and prevalent in

Bangladesh.

The growing prevalence of naturally hardy crops such as, barley, cassava millet and

sorghum is another significant trend. These crops are being widely grown in drier regions.

Barley is finding greater acceptance as a staple crop in Syria, the Middle East, and North

Technology needs to counter

the various threats toagriculture production such as global warming and arable

land degradation.



56


Africa. Cassava is a tuber crop which is being grown on a large scale in East and West

Africa. Millet and sorghum have genetic traits that allow them to delay the death of their

leaves and enhance grain development. These genes are being studied and introduced into

other crops.

Sorghum is one crop that is expected to address the dilemma of the food-feed-fuel

problem. Besides being a suitable material for biofuel production, it also produces grainand fodder. Sorghum is well adapted to drought prone conditions as it requires only one

seventh the amount of water required by sugarcane. Pongamia and Jatropha trees are

being similarly used for biofuel production. These are inexpensive to cultivate and have

low water requirements. Jatropha has already been planted over 175,000 hectares of land

in India and South Africa.

Drought tolerant varieties of beans have been experimentally sown in Central America,

Latin America and East Africa. These have yielded 600-750 kg of beans per hectare, which

is double the maximum yield that was earlier obtained in Latin America under similar

conditions using other commercial varieties. Similarly, drought-tolerant varieties of

cowpea have been developed which have out yielded the existing varieties by 16 to 142%

under experimental drought conditions. In order to promote better livestock yields, several

stress resistant grasses and legume crops have been developed. For instance, cratylia, a

leguminous forage shrub, is showing strong drought tolerance and improved livestock

nutrition characteristics.

Modern irrigation techniques, such as drip irrigation and water harvesting, are being

adopted to promote better water management. India and other Asian countries are

promoting an integrated approach to watershed management. These initiatives have

doubled the incomes of small farmers, raised groundwater levels by five to six metres and

facilitated expansion of green cover in each watershed by over 50%.

Farmers are adopting better soil management practices, such as reduced tillage, enhanced

fertilizer-use efficiency, and leaving crop residues in the soil. Zero tillage technology has

been applied to more than 3.2 million hectares of land in India, Pakistan and South Asia

with economic benefits of an estimated US$147 million. This practice involves a reduction

in the mechanized tillage of soil, and retention of crop residues. It has facilitated

conservation of soil and water, increased crop productivity, and reduced carbon emissions.

The poorer farmers of Africa are adopting a technique called micro dosing for fertilizer

application. This involves the application of inorganic fertilizers in the holes where the

seed is sown. These fertilizers can also be mulched with crop residues and organic

fertilizers and applied to soil mounds used for planting crops. These techniques allow for

efficient and cost-effective use of fertilizers.

At an administrative level, the developing community must realize the importance of

providing their farmers with a viable marketplace. Strong rural institutions need to be

developed in order to provide risk management, micro credit finance and weather/cropinsurance facilities. Farmers should be encouraged to conduct energy audits at their farms

in order to help cut energy use and adopt more environmentally-sustainable practices.

At a policy level, the promotion of a carbon credit trade in agriculture could provide a

necessary incentive for adopting environmentally-friendly agricultural practices or

implementing pro-environment policies and projects. As part of the Clean Development

Mechanism established by the Kyoto protocol, countries unable to meet agreed targets in

emission reductions can buy carbon credits from other countries. Bio carbon funds cater



57


exclusively to the agriculture and forestry sectors. However, limits on payments to such

projects and the perceived complexity of procedures pose significant barriers to these

trends.

Another example of an environmentally-friendly practice, agro-forestry involves the

integration of agricultural lands with “working trees.” These trees facilitate the capture of

carbon, the maintenance of soil health through nitrogen fixation, and the use of cuttings asfertilizers and mulch. Agro-forestry has begun to catch on, particularly in Africa, and it is

estimated that approximately 90,000 families have adopted agro-forestry in Zambia alone.

The trend is also beginning to catch on in Malawi, Mozambique, Tanzania, and Zimbabwe.

The use of agricultural waste in biofuels is seen as another environmentally-friendly

measure. Biofuels made from agricultural wastes and residues should prove instrumental

in decreasing greenhouse gas emissions. As a pioneer of biofuel use, Brazil has replaced

40% of its gasoline by ethanol. China and India are also looking to increasingly develop

liquid biofuels.

Several leguminous forage species with the capability to suppress methane emissions are

being used in combination with trees and crop plants to provide silvopastoral systems.

These forage grasses have high tannin content, which enables them to capture significantamounts of carbon from the atmosphere and retain in their deep root systems.

We believe these factors are critical in developing and sustaining a growing agricultural

sector. Crop yields and trends will need to continually improve if we are to effectively feed

and grow our planet.

AGRICULTURAL COMMODITY FORECASTS

The global agricultural industry is entering a phase of long-term supply side constraints in

our opinion. It is transitioning from a supply-driven market to a market driven by growing

demand and a scarcity of supplies. This is reflected in the significant increase in the prices

of the majority of the agricultural commodities since the beginning of 2006. Overall, the

Food and Agricultural Organization’s (FAO) Food Price Index (FPI) increased byapproximately 9% in 2006 and 37% in 2007. This increase in prices has been led by food

grains, primarily as a result of the global imbalance between demand and supply. The

supply side crunch can be attributed to factors such as scarcity of water and arable land,

changing weather patterns, significant increase in global population and a sluggish rate of

adoption of economically prudent practices and policies. Additionally, supply is also

constrained by factors such poor handling and transportation infrastructure in the

developing nations with trade barriers and protection norms exacerbating the issues.

Supply imbalance

Between 1960 and 1990, global food production grew at an annual rate of 2.8% while

population increased by 2.1%. However, since the 1990s, population has been growing at

1.8% while production has been growing at 1.5% annually. Production expansion activities

have been limited by structural changes such as climatic upheaval in major production

centers and the enhanced use of major grains as feedstock for biofuel production. On a

long term basis, global warming is expected to lead to a higher frequency of extreme

weather conditions, loss of bio-diversity in fragile environments (e.g., tropical forests) and

loss of fertile coastal lands due to rising sea levels, all affecting agricultural output and

aggravating global commodity prices.

The FAO Food Price Index

increased by 9% in 2006 and

37% in 2007.



58


Although global agricultural production is expected to expand steadily over the next

decade, the growth is expected to be slower than the last decade. Given the growth rate of

consumption the imbalance between supply and demand is likely to keep prices above the

historical equilibrium over the next ten years in our opinion.

While global inventories have been progressively declining over the last decade, very little

additional area has been brought under cultivation.

Figure 62: Major crops – global acreages and inventories

1998-1999

1999-2000

2000-2001

2001-2002

2002-2003

2003-2004

2004-2005

2005-2006

20062007

Wheat

Area (Hectares) 225.1 215.4 217.6 214.7 214.6 209.6 217.7 218.4 211.9

Coarse Grains

Area (Hectares) 308.6 299.7 296.8 301.5 293.2 306.4 29.7 300.8 303.6

Rice

Area (Hectares) 152.6 155.3 151.7 150.6 145.9 148.2 150.5 152.6 152.9

TOTAL

Area (Hectares) 686.3 670.4 666.1 666.8 653.7 664.2 397.9 671.8 668.4

Ending Stocks

(Metric Tons)

579.8 584.2 563.6 532.9 440.2 355.1 403.1 388.3 334.7

Source: USDA

Inventories for each of the three crops (Wheat, Coarse Grain and Rice) have declined by

over 40%. At a global level, the current total grain inventory of 315.2 cubic metric tons is

estimated to be sufficient only for 50 days of human food requirements, which is a historic

low. In 2000, the corresponding figure was 115 days. Growing demand coupled with a

relatively lower growth in production has led to a steady decline in world food stocks over

the last few years. The world stocks-to-use ratio has hit a historic low of 17%.

Figure 63: Global stocks-to-use ratio, 1960-2007

0

10

20

30

40

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

S t o c k - t o U s e R a t i o ( % )

Source: USDA

Declining production growth and lower absolute inventory levels are driving commodity

prices upwards. For example, global production of wheat grew by just 1% in 2007 over the

previous year. Consequently, wheat futures prices have exhibited annualized growth of

about 22% between 2003 and 2008. Along with the increase in prices, volatility has also

increased, especially in cereals and oil seeds, as a result of the uncertainty and the

tightening of supply of agricultural commodities. Policy changes by various nations to



59


safeguard their domestic agricultural sector have also fuelled an increase in global

commodity prices. For example, China, India and Russia have raised export duties and

simultaneously lowered import duties on certain agricultural commodities to satisfy the

demand of their expanding domestic economy.

Figure 64: U.S. monthly average near-month historical futures prices

0

2

4

6

8

10

12

14

Jan-

03

Jun-

03

Nov-

03

Apr-

04

Sep-

04

Feb-

05

Jul-

05

Dec-

05

May-

06

Oct-

06

Mar-

07

Aug-

07

Jan-

08

P r i c e i n U S D / B u s h e l

Wheat Corn Soybean

Source: Economic Research Service, USDA

Increased biofuel production

In light of rapidly increasing oil prices and growing global warming concerns, biofuels are

perceived to be the most viable short- and medium-term solutions to reduce green-house

gas emissions and our dependency on oil. This is leading to a competition among various

agricultural products such as maize, rapeseed and wheat, which can be used as feedstock

for the production of biofuels. In 2007-2008, 6.5% of global grain output was used to

produce biofuels and this figure is expected to increase significantly in the future. The US

Department of Agriculture (USDA) predicts that the rapid expansion in biofuels will change

the price relationships among various agricultural commodities and increase demand forgrain (especially corn). Consequently, the prices of protein feeds are expected to increase at

a slower rate as compared to the price of feedstock products.

Consumption shift also driving the cost (and value) of commodities

Over the last few years, there has been a shift towards the consumption of higher-value

commodities such as bovine, pig and poultry meat, especially in the developing economies.

This heightened demand is reflected in the increase in the meat price index published by

the FAO, which has increased from 112 in March 2006 to 123 in August 2007 (1998-2000

= 100). This price increase can be expected to continue into the foreseeable future.



60


Figure 65: U.S. monthly average cattle farm price

75

80

85

90

95

100

105

Jan-

03

Jun-

03

Nov-

03

Apr-

04

Sep-

04

Feb-

05

Jul-

05

Dec-

05

May-

06

Oct-

06

Mar-

07

Aug-

07

Jan-

08

P r i c e i n U S D / B u s h e l

Source: Farmdoc Project, UIUC

The chart below shows the USDA’s projected market price of beef/veal over the next nine

years. In the initial few years, prices are expected to increase as a result of higher

production costs. This rise in production costs can be mainly attributed to a significant

increase in feed costs as higher amounts of animal feed (mainly corn) are directed towards

the production of biofuels.

Figure 66: Expected future farm price of beef/veal in the U.S.

86

88

90

92

94

96

98

100

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

P r i c e i n U S D / c t w

Source: USDA Agricultural Projections

Though the price of meat is expected to stay above long-term averages, factors such as

disease outbreaks could also affect the demand for meat products as well. As seen in just

this past decade, disease outbreaks in animals, such as Avian Influenza (bird flu) and

Bovine Spongiform Encephalopathy (Mad Cow Disease), have affected the meat trade

significantly and might continue to do so for the next ten years.

The increasing demand for meat products also indirectly affects agricultural production.

Industrialized livestock production generates significant quantities of waste, which not only

affects public health but also degrades the water and air quality in the surrounding areas.

The lack of regulations in developing countries makes this a more serious problem in these

regions. Moreover the consumption of meat demands an even greater quantity of

agricultural products that feed livestock. It is estimated that seven kilograms of wheat is

required to produce one kilogram of beef and three kilograms of grain to produce one

kilogram of pork. Since the rate of growth of meat production is expected to be higher in

developing nations, it might have a long-term negative impact on agricultural produce and

supply in these regions.



61


AGRICULTURE SUB-SECTORS

This section seeks to highlight certain sub-sectors within the agriculture industry: Grains

and Feed, Fuel, Fertilizers, Equipment and Agriculture Technology, and their impact on

agriculture and commodity markets globally.

The global food markets are currently seeing unprecedented commodity price pressure,

fuelled by temporary factors such as drought-related short supply, crop damage due to

erratic weather patterns, reduction of surpluses due to policy reforms, inflationary

pressures and significant increases in demand from livestock and the biofuel industry. In

the long term, commodity prices are expected to plateau at high levels, albeit below their

present peak rates. The expected change in weather patterns and the strain on resources

due to increased demand from livestock and energy sectors provide a basis for these

high price forecasts over the long-term. Meanwhile, agricultural capacity additions and

procedural optimization, development of alternative fuel technologies, policy reforms,

trade liberalization, tariff rationalization and the interplay of market forces will help to

create a marginal decline in commodity prices from current rates we believe. Policyreforms are primarily expected to be caused by the high level of international prices

which have obviated the need for providing local price supports and the imposition of

stiff tariff structures.

We believe we are presently experiencing a “feed-versus-fuel” scenario for much of the

agricultural sector, wherein the three industries – raw food stuffs, livestock and energy,

are competing for the same set of resources. More importantly, governments across the

world are striving to ensure that their citizens have access to good quality food at

reasonable prices. In view of high crude oil prices, biofuel products offer an attractive

alternative, and are causing an unprecedented demand for cereals and coarse grains.

Biofuel feedstock commands high prices, making it more profitable for farmers to sell

their produce to the biofuel industry. The consequent scarcity for livestock feed inflates

its prices, making livestock costlier.

FEED

This section discusses livestock and dairy products and also summarizes the production

and consumption of important grains for human, livestock, and biofuel needs.

Livestock

We expect a significant increase in the level of production and consumption of livestock

in developing countries and stable production and marginal consumption growth in the

developed countries. Globally, the demand for meat is projected to rise at CAGR of 1.7%

for many years, with 80% of the additional global demand expected to originate from

developing countries, mainly in the Asia-Pacific region. The emerging economies, Brazil,

China and India are expected to shore up their production capabilities in line with

growing consumption trends. This trend, accentuated by the high responsiveness of food

demand to income growth in developing countries, is likely to reduce the trade share of

developed countries within the meat industry. Other fast growing economies like South

Korea, Mexico, Saudi Arabia, and the Philippines will also contribute to the rise in

demand in the market, because of the inadequacy of their domestic capabilities in

Consumption of livestock

products in developing countries is growing rapidly.



62


meeting the growth in demand. Additionally, the U.S., Japan, and Russia are expected to

continue as major importers of livestock over the next 10 years.

Figure 67: Trade- livestock (million tons)

Average

2001-2005

2006 2007 2008 2009 2010 2011 2012 2016

Product

Beef 5.96 6.42 6.97 7.17 7.58 7.85 8.06 8.32 9.34

Pork 4.00 4.30 4.70 4.93 5.06 5.13 5.28 5.44 5.90

Poultry 7.56 7.48 8.06 8.35 8.54 8.78 9.08 9.48 10.59

Source: OECD

Each of the beef, pork and poultry meat markets is expected to record a 50% growth in

global trade over the next decade. Geographically, the strongest export growth is

projected to occur in South America; Brazil, in particular, is expected to emerge as the

largest meat exporter, with a 28% share of global meat trade by 2016. Brazil’s meat

exports will be more than the combined exports of the other four largest exporters (U.S.,

Canada, Argentina, and Australia).

The growing livestock markets are increasingly being served by fresh production

capabilities established in developing countries as supplies in developed countries have

been strained by poor weather, high feed costs and cyclical herd rebuilding. The

emerging trend is one of a flourishing south-south trade, wherein the major consumers,

situated in the southern parts procure livestock foods from the major producers in

similar parts of the world.


Mutton

4% Beef

24%

Pork

42%

Poultry

30%

Source: USDA

Globally, pork is the most-consumed type of livestock accounting for over 40% of

consumption. Despite inflationary pressures, pork is expected to maintain its leading

market position.



63


Figure 69: Beef production pattern – 2007

China

15%

European Union

14%

India

5%

Argentina

6%

Russia

3%

Brazil

18%

USA

21%Australia

4%Mexico

4%

Others

10%

Source: USDA – FAS

The top five beef-producing countries include the U.S., Brazil, China, the European

Union and Argentina. The major growth in beef consumption and production is expected

to emanate from China. This growth will largely be offset by a decline in production from

the European Union, due to the adoption of dairy quotas and surplus reduction policies

in this region. France and Spain are the only countries in the EU, which are expected to

increase beef production. Consequently, global production levels will see limited growth.

Since most of China’s production adds are expected to be consumed by China itself,

global trade will also experience limited growth, though Argentina and Brazil are

expected to increase their production, particularly eyeing the opportunity to replace the

EU as the primary exporter in key Russian markets. This should begin a recovery in the

international markets, which had experienced a supply crunch as Argentina hadtemporarily banned beef exports in order to lower domestic beef prices and control

inflation.

Figure 70: Production-consumption beef (million tons)

Average2001-2005 2006 2007 2008 2009 2010 2011 2012 2016

Production 61.6 65.6 66.7 67.7 68.5 69.7 70.8 71.8 76.4

Consumption 61.2 64.9 66.1 67.1 68.0 69.1 70.2 71.2 75.2

Ending Stocks 0.4 0.7 0.6 0.6 0.5 0.6 0.6 0.6 1.2

Source: OECD

Although Argentina in fact accounts for the largest per capita beef consumption in the

world, the grain fed beef products from the U.S. are increasingly finding an attractive

market in high income East Asian markets. Meanwhile, the U.S. is expected to import

grass-fed lean beef from Australia and New Zealand in order to support its ground beef

and processed products industry. The U.S. is also expected to recover from the current

decline in its beef market, with its beef trade, particularly with Canada, Japan, and South

Korea, set to rise. This recovery, however, is likely to be limited by herd rebuilding

activity, reduced grain feeding, and poor pasture conditions. The higher production costs

Beef consumption and production is expected to grow

significantly in China.



64


and higher costs of feedlot gains have led to a trend, wherein cattle are allowed to stay

on pasture for a longer period of time to ensure heavy slaughter weights before entering

the feedlot. This will lead to lower inventories for short-term use; however, post 2010,

the availability of higher slaughter weight stock should facilitate a moderate expansion in

beef production.

Figure 71: Production-consumption pork (million tons)

Average2001-2005 2006 2007 2008 2009 2010 2011 2012 2016

Production 97.0 107.4 110.8 111.9 113.9 116.4 117.3 119.9 129.3

Consumption 96.6 106.6 110.6 111.6 113.6 116.0 116.9 119.4 128.7Ending Stocks 0.4 0.8 0.2 0.3 0.3 0.4 0.4 0.5 0.6

Source: OECD

Pork is the most-consumed livestock food worldwide. Globally, over US$18.5 billion was

spent on the purchase of pork in 2005. The major pork producers include the EU, the

U.S., Canada, Brazil, China and Chile. The top pork consumers are China, Germany,

Italy, the United Kingdom and the U.S. The demand for pork is increasing rapidly in

Eastern Europe, Central Asia, and the Asia Pacific region. The increase in pork imports

by East Asia is largely due to the restrictions on the domestic pork sector based on

environmental concerns. Additionally, these countries presently prefer pork over beef

due to BSE-related11 fears. Mexico is expected to emerge as the fastest growing pork

market, buoyed by rapidly increasing income and population; it is projected to see a 38%

increase in pork imports during 2008-2017. In absolute terms, Russia is expected to see

the largest rise in pork imports as it is expected to import 200,000 tons of additional

pork in 2017 compared to 2008.

China is projected to increase its pork imports in the face of significant damage to

domestic production following an outbreak of Porcine Reproduction and Respiratory

Syndrome (PRRS). The European Union will see a decline in its global pork exports as

policies stipulating intra-EU trade come into force. The EU pork exports are expected to

decline 5% in 2008 (over the previous year) and by about 1% annually over the

subsequent decade. Brazil is recovering from the decline in its pork exports as a result of

a Foot and Mouth Disease (FMD) outbreak; however, its exports will be improved by

renewed opportunities in Russia and Argentina, and new market opportunities in

Eastern Europe over the next few years.

As people become wealthier and more hygiene conscious, the U.S. is expected to benefit

in terms of growing demand for its pork output, primarily because of the high quality

standards that are associated with its pork industry. The attractiveness of the pork

industry is increased further by the variety of high quality by-products that can be

derived from its activity. However, compared to other livestock products, pork requireshigher quality and volume of inputs in terms of feed grains, water, high protein food

ingredients, vitamins and minerals. This makes the pork industry highly sensitive to

commodity prices, which explains the expected slowdown in pork production over the

short term. The high feed costs combined with high demand are expected to slow down

per capita pork consumption through 2012. Thereafter, a rebound in consumption levels,

11Bovine spongiform encephalopathy (BSE), commonly known as mad-cow disease, is a fatal, neurodegenerative

disease in cattle, that causes a spongy degeneration in the brain and spinal cord

Pork is the most-consumed livestock food worldwide, with

Japan being the biggest

consumer.



65


supported by increased production, improved operational efficiencies and stable feed

costs, is expected. In the meantime, countries with lower cost of production and less

stringent environmental regulations, such as Brazil, are expected to increase production.

Figure 72: Production-consumption poultry meat (million tons)

Average2001-2005 2006 2007 2008 2009 2010 2011 2012 2016

Production 77.4 81.9 83.3 85.3 87.3 89.5 91.1 92.5 98.5

Consumption 77.2 81.6 83.0 85.2 87.2 89.4 90.9 92.4 98.6

Ending Stocks 0.2 0.3 0.3 0.1 0.1 0.1 0.2 0.1 -0.1

Source: OECD

The poultry industry has shown relative resilience in its demand supply aspects

compared to the pork and beef industries. This fact is primarily attributable to

competitive poultry prices, good feed-to-conversion characteristics, consumer preference

for white meat and increased use in general food preparations. The major poultry

producers include the U.S., Canada, Argentina, Brazil, Thailand, China, Australia,

Malaysia, Colombia, and India. The U.S. is expected to exhibit stagnation in its poultryindustry because of higher operational expenses and feed costs. Argentina and Brazil are

leveraging their favorable feed situation and competitive production capacities to expand

their global production as well as export share; the latter is projected to emerge as the

largest exporter of poultry products by 2017. The recovery of the global markets from

Avian Influenza (“AI”) and the consequent growth in demand are expected to support a

marginal increase in demand and supply of poultry products. However, the East Asian

countries, earlier inflicted by AI, are primarily producing processed and cooked poultry

products, which are in high demand in the high-income Middle East, Asian and

European countries. The EU, in particular, has imposed an import quota on salted

poultry and cooked chicken.

Asia is expected to account for most of the import growth in the poultry sector.

Consumers in East Asian countries, particularly, China, Vietnam, and Singapore have

substituted a significant amount of their pork consumption with poultry since the

outbreak of PRRS. However, stricter import requirements in Russia and East Asian

countries will limit the market opportunities to countries capable of meeting these

requirements. Besides, strong demand for poultry is also expected to originate from the

European Union, Venezuela, and Middle East countries. Countries like Saudi Arabia and

Egypt are likely to import more as they cut down on domestic production in response to

concerns over the quality of produce following disease outbreaks.

As the livestock sector adjusts to higher feed costs, consumer prices in the poultry

industry, which have traditionally been lower than other livestock, are also expected to

exceed the general inflation rate. The consequent adjustments are expected to provide

strong economic incentives for investment and expansion in the sector, by providinghigher returns in response to high global demand.



66


Figure 73: Production-consumption mutton (million tons)

Average2001-2005 2006 2007 2008 2009 2010 2011 2012 2016

Production 11.3 12.6 12.3 12.6 12.8 13.1 13.4 13.6 14.4

Consumption 11.3 12.5 12.4 12.7 12.9 13.2 13.4 13.6 14.5Ending Stocks 0.0 0.1 -0.1 -0.1 -0.1 -0.1 0.0 0.0 -0.1

Source: OECD

The mutton industry is small compared to other livestock industries; it constitutes only

4% of the net global livestock production. The major producers of mutton are China,

Pakistan and Iran; all are expected to ramp up their production capacities in order to

meet increasing local demand. Additionally, African countries like Sudan and South

Africa are projected to increase their production in line with the increase in herd sizes.

Over the short term, an increase in production in Latin America, particularly Argentina

is forecast, essentially due to the increased slaughter rate of herds as a result of limited

feedstock availability and poor pasture conditions. However, Australia and New Zealand

are scheduled to carry out flock building activities over the next few years. Consequently,

mutton production in these countries is expected to decline. The major importers of

mutton include the U.S. and the European Union. These countries are expected to

witness higher imports as a result of declining local production and increasing demand.

The livestock industry has seen some reverses in the recent past as a result of the

outbreak of animal diseases. The beef trade in North America saw a decline as a result of

the outbreak of Bovine Spongiform Encephalopathy (BSE); the outbreak of the Foot and

Mouth disease in Argentina and Brazil was followed by export restrictions; and the

outbreak of Avian influenza in Asia and Europe led to widespread panic in the

worldwide poultry markets. The consequent perturbations in the global supply demand

patterns and the increase in market share of disease free countries have changed the

dynamics of the global markets. The production trends and purchase decisions are being

increasingly influenced by quality assurance and maintenance measures aimed atlimiting the impact of potential epizootics.

Supply-side trends include:

a. Regionalization of export embargoes;

b. Imposition of stringent animal health and inspection regulations; and

c. Implementation of vaccination policies.

Demand-side measures include:

a. Enforcement of strict packaging requirements;

b. Improvement in processing and production standards; and

c. Ensuring easy meat traceability.



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Figure 74: Prices of selected livestock – U.S. (USD/100 kg dw)

Average2001-2005 2006 2007 2008 2009 2010 2011 2012 2016

Beef 282.0 303.6 303.4 299.0 297.1 288.5 285.0 279.5 297.7

Pork 136.4 145.0 126.2 154.4 165.4 165.4 157.8 160.8 160.6

Poultry 141.8 140.9 159.5 164.8 171.5 179.3 183.0 182.1 177.5Mutton (NZD/100 kg dw) 390.1 330.0 325.4 333.8 343.6 351.9 361.0 370.0 404.7

Source: OECD

These measures are expected to bring about a rationalization in global market prices,

which have been inflated as a consequence of the premium attached with meat quality in

the aftermath of the disease attacks. Beef prices are expected to decline in the future,

though a moderate strengthening is projected over the long term, essentially fueled by

rising feed prices. Pork prices are expected to increase in the short term, particularly

because of increased demand in South East Asia. Additionally, the loss of over one

million pig heads in China due to outbreak of PRRS is adding to inflationary pressures in

the pork market. Poultry prices are projected to increase significantly as the markets

recover and greater demand originates from North America, Latin America and Europe.The high feed cost trends have had a serious impact on operational costs, specifically for

the factory-style feedlot-based production setups. Such feedlots account for 43% of global

beef and over 50% of global pork and poultry production. Price and procedural control

measures are expected to boost the operational capacities of these feedlots, with meat

production projected to increase to 300 million tons by 2020.

The rapid increase in livestock and related processed food consumption is causing a

tremendous strain on agricultural production. This is primarily because the energy cost

of livestock consumption is very high. Two to seven kilograms of feed is required to

produce one kilogram of chicken, pork, or beef, respectively. At present requirements,

we need to raise 5 billion hoofed and 16 billion winged animals for meat. It is estimated

that, presently, livestock consumes 35% of all the grain and 90% of soybean produced atthe global level. In the U.S., 50% of the grain production is directed feed to the livestock

industry. The U.S. pork industry alone consumed 1.08 billion bushels of corn and 265

million bushels of soybean in 2004. Each hog produced in the U.S. consumes 12 bushels

of corn and 130 pounds of soybean. Consequently, feed costs alone add up to US$62.00

per pig.

Dairy

Global dairy market trends are characterized by broad changes in consumption as well

as a change in the rigid structure of the global dairy trade itself. The prices of highly-

processed dairy products have seen a spike in recent years, though increases in

production capacity are expected to moderate the price of dairy going forward, due to

infrastructural investments, such as improvements in storage and processing facilities.

Changing dietary trends (as a result of urbanization and higher income levels) have led

to an increase in the consumption of butter, cheese and a variety of milk powders. This

consumption growth has been fuelled by the development of dairy marketing and related

retailing channels along with government programs encouraging the consumption of

dairy products. Additionally, the dairy industry has been boosted by technological

advances and widespread global investment. The major dairy producers include India,

China, Pakistan, New Zealand, Australia, Argentina, Ukraine and the European Union.

Present estimates suggest that livestock consumes 35%of all grain and 90% of all

soybeans produced globally.



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The latter four are expected to see a decline in their production levels primarily in

response to poor weather and pasture conditions, higher feed prices and the transfer of

pasture land for crop growth activities. India, Pakistan, and New Zealand will show

continued development in the industry in response to growing domestic and

international demands, while China is likely to witness double digit growth in the sector

in coming years.

Figure 75: Trade-dairy products (million tons)

Average2001-2005 2006 2007 2008 2009 2010 2011 2012 2016

Butter 0.7 0.71 0.76 0.8 0.82 0.83 0.84 0.85 0.87

Cheese 1.4 1.46 1.5 1.55 1.59 1.62 1.67 1.71 1.83Whole MilkPowder 1.4 1.58 1.64 1.66 1.73 1.82 1.87 1.95 2.2Skim MilkPowder 1.17 1.20 1.19 1.18 1.16 1.17 1.18 1.18 1.24

Source: OECD

India and China consume a substantial portion of their production domestically.

Australia, New Zealand and the EU are the major exporters. However, following theformulation of intra-EU restrictive export policies, the EU’s global exports are likely to

decline, while the intra-EU trade is projected to outpace the combined global trade.

Australia and New Zealand are expected to continue to dominate the world dairy

markets, though developing countries, such as Argentina, China and India are projected

to experience an increased market share in butter and skimmed milk powder markets.

Central and South American countries are formulating policies aimed at stimulating

growth of dairy industry and ensuring domestic food security with respect to dairy

products. While Argentina has imposed export taxes, Mexico has put in place import

tariff quotas.

Major importers of dairy products include Russia, Japan, and the U.S. Besides,

significant demand for milk and reconstituted milk products is projected to originatefrom the Middle East, North Africa, Mexico, and Southeast Asia. The growing demand,

high feed prices, and development of high value processed foods explain the inflationary

trends in dairy markets. Additionally, dairy market reforms implemented by several

countries specifically in the EU have checked subsidized exports and interventionist stock

building activities. The checks on these distortion policies will allow prices to be

influenced by market forces. Meanwhile, the weakening of the US dollar is expected to

make the situation highly favourable for the U.S., with its supplies effectively priced at

very competitive rates in the international markets.

Figure 76: Prices – dairy product – U.S. (USD/100 kg )

Average

2001-2005 2006 2007 2008 2009 2010 2011 2012 2016Butter 155.9 186.5 196.2 193.0 188.3 188.3 195.1 200.9 222.6

Cheese 231.3 272.8 300.4 310.9 303.2 300.0 301.0 300.5 307.3Whole MilkPowder 141.8 140.9 159.5 164.8 171.5 179.3 183.0 182.1 177.5Skim MilkPowder 190.8 229.4 254.6 262.7 256.7 248.2 250.3 249.0 253.1

Source: OECD

Australia and New Zealand arethe major exporters of dairy

products.



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The dairy industry is also affected by short-term concerns, similar to the ones affecting

the livestock industry. Adverse weather-related events like droughts in Australia, poor

pasture conditions in Argentina and Uruguay as a result of flooding and hot weather in

the EU, and the sudden spike in feed prices have brought the industry under price

pressures. Raw milk prices have risen by 40% in the US and the EU, while South

America has seen the near doubling of dairy product prices. These trends havepotentially made the dairy industry a lucrative investment option.

Figure 77: Production – consumption – butter (million tons)

Average2001-2005 2006 2007 2008 2009 2010 2011 2012 2016

Production 8.1 8.7 9.0 9.1 9.3 9.5 9.8 10.0 10.9

Consumption 8.0 8.6 9.0 9.1 9.4 9.7 9.9 10.1 11.0Price (USD/100 kg) 156 186 196 193 188 188 195 201 223

Source: OECD

The butter and cheese markets are primarily driven by increasing purchasing power and

are expected to witness fast-paced growth. Although stringent tariff quotas in the U.S.,Canada, the EU, and Japan might limit trade growth in these key markets, developing

economies, most significantly Russia, could fuel growth in demand for butter and cheese.

Figure 78: Production – consumption – cheese (million tons)

Average2001-2005 2006 2007 2008 2009 2010 2011 2012 2016

Production 17.6 18.7 18.9 19.1 19.4 19.7 19.9 20.2 21.3


Source: OECD

Figure 79: Production– consumption – skim milk powder (million tons)

Average2001-2005 2006 2007 2008 2009 2010 2011 2012 2016

Production 3.5 3.1 3.3 3.2 3.2 3.2 3.3 3.3 3.5


Source: OECD

The major producers of skimmed milk powder include the EU, the U.S., New Zealand,

Australia, Argentina, and Ukraine. Major importers include China, the Philippines,

Thailand and Saudi Arabia.



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Figure 80: Production – consumption – whole milk powder(million tons)

Average2001-2005 2006 2007 2008 2009 2010 2011 2012 2016

Production 3.6 4.2 4.3 4.4 4.5 4.7 4.8 4.9 5.4

Consumption 3.4 4.0 4.1 4.2 4.4 4.5 4.6 4.7 5.2

Price (USD/100 kg) 191 229 255 263 257 248 250 249 253

Source: OECD

The whole milk powder (WMP) market is the fastest growing dairy product market, due

to roll in value-added products and for reconstituting or blending to make fluid milk

drinks. New Zealand, the EU, Argentina and Australia are the major producers and

exporters of WMP. Major import demand for WMP comes from the Middle East and

South Asia, particularly China.

Grains

Feed stock and feed grains account for a very substantial portion of production expenses

in livestock and dairy industries. The most critical case is that of pork production where65% of total expenses go into feedstock procurement. The various grains used as feed

stock include corn, barley, milo (grain sorghum), oats and wheat. Global grain shortages

are a result of the increased demand for grain, due to livestock consumption and biofuel

requirements. The U.S. witnessed a doubling of corn prices partially as a result of these

developments in 2006; however, the consequent attractiveness of the corn saw a

substantial increase in corn production, which partially offset these inflationary trends

until recently. The U.S. alone witnessed a 19% increase in its corn acreage.

Global agricultural production is set to rise in the short to medium term in response to

the increased attractiveness of the sector as commodity prices and technological

advancements offer more efficient and productive business opportunities in our opinion.

However, over the long term, limited natural resources and high input costs will restrain

further production growth. Consequently, the U.S., the EU, Argentina, Canada, and

Australia are expected to maintain their dominant position in world grain trade; while

countries such as Brazil, Russia, Ukraine and Kazakhstan are all set to ramp up their

participation in global grain markets.

Livestock and related feed industry dynamics have led to rapid expansion in the global

soybean market which has resulted in soybean and soybean products surpassing wheat

and coarse grains in terms of global trade volumes. The increased demand for vegetable

oil and protein meal, accentuated by the growth in the biofuel and livestock sectors, is

expected to keep soybean demand high over the next decade. In this scenario, it is

believed that wheat, coarse grains and soybeans will continue to compete with each

other for the planet’s limited resources, and market trends will be directed by the

fluctuating demand and price scenario for these crops. More than two thirds of thegrowth in crop yields is expected to derive from increased crop yields. Simultaneously,

aggressive expansion in agricultural land is expected to occur in regions with available

land reserves, such as, Brazil, Argentina, and eastern European countries like the

Ukraine and Russia.

Wheat

Wheat is expected to be used more commonly in the feedstock industry, essentially due

to the lower price of wheat as compared to corn. Europe is expected to generate the

The US witnessed a 19%increase in corn acreage in2006 consequent to the highdemand from the biofuel and

livestock industries.



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highest demand for wheat feedstock. In addition, limitations in production growth

coupled with population pressures are expected to spur greater wheat imports from

developing countries. Consequently, sub-Saharan Africa, North Africa and the Middle

East regions are expected to contribute 45% of the 26 million tones of growth in the

global wheat trade over the next decade. Egypt is expected to hold its position as the top

wheat importer; while Brazil is expected to emerge as a major wheat importer, as itsclimate does not favour domestic wheat cultivation.

Figure 81: Production – consumption – wheat (million tons)

Average2001-2005 2006 2007 2008 2009 2010 2011 2012 2016

Production 594.5 596 628.3 640.3 639.9 646.1 649.5 655.5 672.6

Consumption 608.8 621.4 623.7 633.8 639.7 647.1 652 656.6 674Ending Stocks 195.1 161.2 167.6 175.8 177.7 178.3 177.6 178.1 179.9Price (USD/

ton) 152 204 204.5 197.5 191.8 186.1 184.6 184.5 183.2

Source: OECD

The top-five wheat exporting countries (the U.S., Australia, the EU, Argentina, and Canada)

have seen their share of global trade decline from 89% in 1997-1998 to 70% in 2007-2008,

primarily due to increased exports from the Black Sea region. The U.S. is projected to see

its exports decline from 25% of global trade to 19% over the next decade. Canada is likely

to experience a reduction in its wheat growing area and wheat production, due to the

increased demand for vegetable oils, such as rapeseed oil for biofuel production and barley

for livestock production. Meanwhile, Argentina, Australia, the EU, Russia, and Ukraine are

projected to show continued growth in their respective wheat trades. The latter two along

with Kazakhstan have come to capture almost 20% of global trade over the last two years.

However, unpredictable weather and yield scenarios in these countries will also account

for increased volatility in the wheat markets. Meanwhile, other major producers, like India

and Turkey, are likely to see a decline in exporta as domestic demand outpaces production

and stocks in inventory touch historic lows.

Coarse grains

The global coarse grains trade is essentially driven by growth in the livestock industry,

especially in regions unable to meet their feed demands locally, such as China, Mexico,

North Africa, the Middle East and Southeast Asia. However, two of the largest markets --

Japan and South Korea -- are expected to stagnate due to the inherent maturity of these

markets and demographic trends.

The most dominant coarse grain in the international markets is corn, with 79% of

market share, followed by barley at 15% and sorghum at 4%. The coarse grain

marketplace has also been influenced by the growing commercialization of livestock

feeds, particularly in the pork and poultry industries, where feedstock options are limited

to corn and soybean meals unlike ruminant-related livestock production.

The world coarse grain trade is projected to increase by 21 million tons from 2008 to

2017, with two thirds of this growth coming from tanimal feed demand. Additionally, use

in higher value products, such as starch, ethanol and malt are expected to bring

production as well as prices under greater strain. We believe the direct use of coarse

grains as food in Latin America, Africa and Asia are likely to decline as growing incomes

enable people to buy higher-value agricultural commodities. The steady growth in the

Corn is the most dominant coarse grain, with 79% of theinternational market share,followed by barley at 15) and

sorghum at 4%.



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livestock industry in these regions along with the Middle East is projected to account for

most of the growth in global coarse grain imports.

Figure 82: Production – consumption – coarse grains (million tons)

Average

2001-2005 2006 2007 2008 2009 2010 2011 2012 2016Production 950.2 980.5 1046 1082 1104 1112 1126 1141 1184

Consumption 948.7 1016 1049 1071 1091 1105 1119 1132 1175Ending Stocks 241.5 204.1 194.5 200.1 207.3 209.2 210.5 214 225.8Price (USD/

ton) 103.6 140.4 158.9 157.6 147.1 143.3 144 140.8 138.2

Source: OECD

The world coarse grain trade is dominated by the U.S., with its share of world corn trade

accounting for 60% of total trade. However, the increasing diversion of corn for ethanol

production in the U.S. is expected to mitigate growth in the US corn trade over the short

term, though the exports will likely gain momentum in the long term as the ramp up in

US ethanol production slows down in our opinion due to its inferior energy storage

attributes. Several countries, including Argentina, the Ukraine and Brazil, are increasingcorn production and exports due to sustained higher prices. China is one of the largest

producers as well as consumers of corn; it exports very limited amounts of corn due to

huge domestic demand spurred by its vibrant livestock and industrial sectors. China’s

exports are competitively priced in international markets, particularly in South East Asia,

where transportation freight rates are much lower for China, compared to the U.S. These

exports are projected to progressively decline as a result of policy formulations which

have eliminated export subsidies and imposed export taxes.

Barley

Global barley trade is projected to grow 22% over the next decade, being driven by increased

demand for malting and feed barley. The North African and Middle Eastern countries are the

largest barley importers globally. However, increasing poultry production has led to corn

overtaking barley as the principal coarse grain imported by these countries, though barley

imports will also continue to grow steadily. Saudi Arabia is the world’s largest barley

importer, accounting for over 35% of the global barley trade. The major importer of malting

barley is China, which is experiencing rapid growth in its demand for barley due to a huge

demand for beer and subsequent expansion in China’s brewing capacity.

The major exporters of barley include the EU, Australia, Canada, the Ukraine, and

Russia. The EU and former Soviet Union together account for 65% of global barley

exports. Russia and its neighbors barley exports are expected to surpass eight million

tons by 2017. The Common Agricultural Policy (CAP) reforms along with the abolition of

intervention for rye in the EU are expected to drive barley growth in this region.

Sustained high barley prices will enable the EU to export barley to non-EU countriesdespite the withdrawal of export subsidies. Consequently EU trade to non EU countries is

projected to grow by 50% over the next decade, reaching 4.7 million tons. The growing

demand for biofuel feedstock is expected to lead to the transfer of large tracts of barley

cultivation to canola cultivation, and the significant premium that malting barley

commands is likely to influence planting decisions in Canada and Australia, resulting in a

decrease in the production of feed barley in our opinion.



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Sorghum

Sorghum is used as an alternative to corn or soybean depending on global market

demand. In the present scenario, high corn and soybean prices are expected to lead to a

decline in sorghum production over the short term. However, over the long-term the

stabilization of commodity prices will lead to a recovery in sorghum production. The

major exporters of sorghum include the U.S. and Argentina, with the former accountingfor over 80% of global trade. Brazil is also emerging as a significant exporter of sorghum;

specifically, the central-west regions of Brazil are increasingly planting sorghum during

the dry season (between their soybean and cotton crops). Meanwhile, Argentina is

expected to see no growth in sorghum production as increased price and profitability of

soybean and corn increase substitution.

The major importers of sorghum include Mexico, the EU, Japan, and Chile. Mexico is

expected to experience a decline in its sorghum imports, following the elimination of over

rate quotas. However, Mexico will still account for 45% of global sorghum imports. The EU

has started importing large amounts of sorghum, following the tightening in the supplies of

non-genetically modified corn and the rise in corn prices. The EU is projected to increase

its domestic production and reduce dependence on imports. Japan’s sorghum imports are

primarily driven by the need to maintain diversity and stability in its feed grain supplies.

Oilseeds

The global oilseed industry has seen very rapid growth in recent years, being primarily

driven by increased demand for protein meal for livestock production and vegetable oils

for food consumption, not to mention biodiesel production. International trade in

oilseeds is increasing while the trade of oilseed products has begun to decline as

countries with limited oilseed production capacity establish large scale oil seed crushing

facilities in an attempt to capitalize on the domestic demand for oilseed products.

Consequently import demand for soybean and rapeseed is growing rapidly. Countries

raising their oilseed crushing capacity include China and countries in North Africa, the

Middle East and South Asia. China alone is projected to account for as much as 50% of global oilseed imports by 2016. The most commonly produced oilseeds are soybean and

rapeseed. The EU plans to set aside large tracts of land for rapeseed cultivation in order

to provide raw material for biodiesel production.

Figure 83: Production – consumption – oilseeds (million tons)

Average2001-2005 2006 2007 2008 2009 2010 2011 2012 2016

Production 263.5 302 302.5 313.5 322.9 330.5 337.9 344 367.6

Consumption 263 301.8 312 320.4 326.1 333.2 340.4 346.7 369.8

Crush 226.6 262.9 274.5 283.4 289.1 295.9 302.9 309 331.6Ending Stocks 28 38.1 30.9 26.5 25.7 25.3 25.2 24.9 25.6Price (USD/

ton) 266 289.8 310.4 311.7 306.5 300.8 297.4 297.7 299.6

Source: OECD

Soybean

The world soybean trade is projected to grow by 35% over the next decade. A significant

portion of this demand shall emanate from countries which increase their soybean

crushing capacities in order to produce soybean oil and other products. Argentina, in its

bid to operate its crushing facilities at full capacity, is projected to import 4 million tons



74


of soybeans from Brazil, Paraguay, Uruguay, and Bolivia during 2008-2017. It is believed

that as a policy decision China will choose to increase its corn production in lieu of its

declining soybean production. Consequently, China’s soybean imports will represent over

80% of the global soybean trade, which will serve to feed its huge crushing facilities and

satisfy its protein meals and vegetable oil requirements. The EU was a leading importer

of soybean until recently; its increased reliance on wheat and rapeseed meal to providefeed has replaced its soybean imports. Simultaneously, the EU prefers importing soybean

meal rather than soybean.

The major soybean exporters include the U.S., Brazil, and Argentina, and together they

account for 90% of the global soybean trade. South American countries like Uruguay,

Paraguay, and Bolivia are other emerging players in the global soybean markets, with their

exports set to rise by 40% over the next ten years. Brazil is expected to maintain its

position as the largest soybean exporter, despite the transfer of some land in southern

Brazil from soybean to corn cultivation in response to attractive corn prices in global

markets. The Argentine government has levied higher export taxes on soybeans than other

soybean products, leading to a decline in its soybean export and large scale development of

soybean crushing facilities in order to produce soybean products for export. Meanwhile,

Russia and the Ukraine are also expected to significantly raise their soybean and rapeseed

output in response to high international demand for oilseeds and their byproducts. The

U.S.’s soybean trade has been affected by high domestic crush demand and reduced

soybean acreage as a result of increased substitution of soybeans for corn.

Soybean Meal

Figure 84: Production – consumption – oilseeds meals (million tons)

Average2001-2005 2006 2007 2008 2009 2010 2011 2012 2016

Production 163.7 189.2 197.6 203.9 207.8 212.7 217.7 222.2 238.6

Consumption 161.2 188.2 196.8 202.6 206.4 211.3 216.4 220.9 237.2Ending

Stocks 7.4 7.4 7.1 7.2 7.4 7.7 7.8 8 8.8Price (USD/

ton) 201 204.9 215.2 217 212.8 207.5 204.6 203.1 200.8

Source: OECD

The rapid growth in the livestock sector and limited avenues for expanding domestic

oilseed production are driving the trade in soybean meal, particularly in middle-income

developing countries. The global soybean meal trade is projected to grow by 30% during

2008-17. The growth trend is expected to be accentuated by the competitive pricing of

soybean meals compared to soybeans and other grains. The EU is the largest soybean

importer and is expected to maintain its lead despite the ramping up of its domestic

feedstock producing capacity. This is primarily because the biofuel expansion in Europe

will encourage production of rapeseed oil and meal, which is expected to provide scopefor continued soybean meal import. In addition, the rising demand for livestock feed is

expected to fuel the consumption of soybean meal in Southeast Asia, Latin America,

North Africa, and the Middle East. Mexico is projected to see rapid growth in its soybean

as well as soybean meal consumption, particularly in view of the lifting of its over quota

tariff on soybean imports from the U.S.

Argentina, Brazil and the U.S. are the major exporters of soybean meals as well.

Argentina is expected to raise it share from 45% currently to 55% over the next decade.



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This is primarily because of tax incentivized soybean meal production in Argentina,

which makes it profitable to import soybean beyond its domestic production, in order to

feed its huge soybean crushing capacities. Brazil is projected to maintain its market

share in the 20-25% range. Unlike Argentina, the differential export structure in Brazil

favours exporting soybeans rather than its derivatives, thereby, dissuading expansion of

soybean crushing facilities. Additionally, the growing demand in domestic consumptionof soybean meals by the livestock sector will also limit growth in soybean meal exports.

Soybean Oil

Figure 85: Production – consumption – vegetable oils (million tons)

Average2001-2005 2006 2007 2008 2009 2010 2011 2012 2016

Production 85.3 102.9 106.9 110.8 113.5 116.6 119.5 122.6 134.6Palm oilproduction 31 39.2 40.4 42.1 43.2 44.7 45.8 47.5 54.1

Consumption 82.6 100.8 105.1 108.6 111.3 114.3 117.3 120.3 132.3

Ending Stocks 7.9 9.2 8.8 8.8 8.9 9 9 9.1 9.3Price (USD/

ton) 520.6 590.7 618 619.7 622.9 611.9 610.8 608.5 613.9Source: OECD

The increased food demand and increasing growth of the biofuel industry are driving the

global soybean oil market. The two largest soybean oil importers include China and India;

both the countries use soybean for food consumption uses. India’s limited domestic

production capacity is marred by low yields, erratic weather conditions and low input use

in production. Additionally, India imports soybean oil at import tariffs lower than that for

other vegetable oils due to WTO commitments. This makes India a key player in global

soybean oil markets. China is constrained by limited arable land availability, despite of the

attractiveness that is associated with the soybean markets. Though China has established

huge soybean crushing capacities, oil obtained from these crushing facilities still falls short

of its huge demand. Consequently, China is compelled to import increasing quantities of soybean oil as well. The increasing purchasing power and population in North Africa, the

Middle East and Latin America are also driving soybean oil consumption and imports,

though high international prices are expected to temper the demand growth in a few

relatively poorer nations. The EU is also projected to import large quantities of soybean oil

in order to replace the rapeseed oil that is diverted from food use towards biodiesel

consumption.

Argentina and Brazil are the largest exporters of soybean oil with an 80% market share

which is expected to rise to 85% by 2017. Argentine market share is driven by an export

tax structure that favors the export of soybean derivatives over soybean; this policy has

led to the development of large crushing capacities and a small domestic market for

soybean oil. It is further expected to increase its soybean production by introducing

double cropping, cultivating marginal lands in the north western parts of the country and

bringing further adjustments to crop pasture rotations. Additionally, it is also projected

to import huge amounts of soybean from South American countries. A significant portion

of the additional soybeans is expected to be used for raising soybean oil production

capacities. It is believed that expansion of soybean cultivation areas in Brazil will enable

it to increase its soybean oil production and export capacities as well. The U.S. is

projected to see a decline in its share in global trade, primarily because of the large scale

use of soybean oil for domestic biofuel production. However, over the long term, the U.S.

China and India are the largest importers of soybean oil, for

food consumption.



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is expected to increase its exports by substantially increasing its soybean production to

exceed its domestic demand. The EU is projected to witness a significant fall in its

vegetable oil exports, essentially because of the diversion towards biodiesel production.



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FUEL

The pressure on global food supplies and prices can largely be attributed to the growing

energy demands and the limited availability of cheap natural resources. The near-term

threat is that processing capabilities will continue to fall short of demand. However, over

the long term, the exhaustion of non-renewable resources poses a more severe threat tothe world economic order. Presently, global crude oil prices are at historic highs due to a

shortfall of supplies in the international market. It is expected that over the next few

years, fresh crude oil supplies will help offset the increase in demand from Asia, though

crude oil prices will likely continue to show an upward trend throughout the coming

decades. Meanwhile strong economic growth – particularly in Asia – will underpin fuel

demand. In this scenario, fresh oil discoveries, technological improvements, adoption of

non-oil energy technologies and further development of renewable energy resources are

the factors which are expected to mitigate inflationary pressures.

As is the case with global food demand, almost 80% of fresh global energy demand is

also expected to come from developing countries. It is believed that fossil fuels will

continue to account for 80% of global energy supply in 2030, with oil and natural gas

alone projected to provide for 55-60% of our energy needs. Petroleum prices are thereby

expected to maintain an upward trend over the long term, since the crude oil, which

accounts for two thirds of the cost, is projected to trade at high costs. Meanwhile, among

fossil fuels, oil is expected to lose a part of its share to coal and natural gas; the former

would be in demand due to its competitive price and the latter will gain prominence due

to high efficiency and environmentally friendly features associated with its use.

Figure 86: Projections for primary energy consumption by type of fuel

Others

9%Nuclear

6%

Coal

25%

Natural

Gas

24%

Oil

36%

509.7

Quadrillian

B tu

2010

Others

9%Nuclear

5%

Coal

27%

Natural

Gas

26%

Oil

33%

721.6

Quadrillian

Btu

2030

Source: IEA

Global energy demand is projected to grow by 47%, from 283 quadrillion Btu in 2004 to

702 quadrillion Btu in 2030. According to OECD estimates, annual growth in the

developed and mature OECD economies is expected to be limited to 0.8%, while the non-

OECD countries are expected to see an increase in their energy demands at a CAGR of

2.6%. The energy requirements of non-OECD countries, which primarily include

undeveloped and underdeveloped countries, are expected to surpass the requirements of

the OECD countries by 2010; by 2030, the difference is estimated to be as high as 35%.

Almost two thirds of the demand amongst the non-OECD nations is expected to originate

from India and China, which are expected to see a combined demand growth of 3.2%.

As in the case of food, 80% of the fresh energy demand is

expected to come fromdeveloping countries.



78


The non-OECD Asia region consumed 48% of the total global consumption, and is

expected to raise its share of global consumption to 56% by 2030. Fossil fuels,

particularly liquids, are expected to continue to provide for the largest share of world

consumption; increasing crude prices and environmental concerns will help to spur a fall

in the share of fossil fuel liquids from 38% in 2004 to 33% in 2030. It is expected that

post-2015, alternative fuels will gain prominence over conventional fossil fuels.

Figure 87: Primary energy demand-supply balance for top five consumers of energy, 2005

US China Russia Japan India

Production(Quadrillion Btu) 69.6 63.2 52.7 4.1 11.7Consumption(Quadrillion Btu) 100.7 67.1 30.3 22.6 16.2

Source: Energy Information Administration (USA)

Presently, the top five energy consumers include the U.S., China, Russia, Japan, and

India; among these, only Russia produces more than its consumption requirements. The

demand for fuel is expected to increase at marginal rates. This is primarily because

advanced technologies and materials will facilitate the achievement of greater efficiency,which in turn will offset the expected rise in demand due to high purchasing power and

development. The U.S. is also expected to significantly raise its biofuel utilization by

mandating an increased amount of ethanol in its liquid mix and investing heavily in

cellulosic biofuels. With over 130.8 million automobiles, the U.S. is the largest consumer

of transport fuel; its fuel requirements can be gauged by the fact that China has only 4.5

million automobiles. It consumes 54% of OECD’s total energy spend on transportation.

Furthermore, the U.S. is expected to maintain its position as the largest consumer of

industrial, residential, and commercial energy in OECD through 2030.

Figure 88: Global primary energy consumption projections

0

160

320

480

640

800

2010 2015 2020 2025 2030

Q u a d r i l l i o n B t u India

Japan

Russia

China

US

Rest of the World


Meanwhile, China and India are expected to show a large increase in energy demand

among non-OECD nations. China’s energy use in the transportation sector is estimated to

grow at 4.9% through 2030; unlike the U.S., most of the growth in China’s consumption

is expected to be in the form of liquid fuel. China has, in fact, accounted for over 30% of

global incremental consumption of liquid fuels. It is further expected to account for 28%

of the increase in demand during the period 2004-2030, with is global demand share in



79


2030 being 14%, nearly double of its share in 2004. Besides China, India is also expected

to see rapid growth in its transportation fuel requirement, with an estimated CAGR of

3.3% during the period 2004-2030. The burgeoning demand for fuel in developing

countries, particularly India and China, is attributed to rapid economic development,

increasing income levels and large-scale development of infrastructure, particularly the

transportation system.

Figure 89: Oil consumption for top five consumers of energy – 2006


Proved Reserves(Billion Barrels) 21.8 18.3 60 0.1 5.4Total Oil Production(Thousand barrels/day) 8,330.5 3,780.8 9,513 128.5 834.6Crude Oil Production(Thousand barrels/day) 5,102.1 3,608.6 9,043.1 6.6 664.7Consumption(Thousand barrels/day) 20,687.4 6,720 2,757 5,305.1 2,438


Global oil demand in 2007 stood at 86 million barrels per day and is estimated to haverisen to 87.5 million barrels per day in the first quarter of 2008. Long-term projections

suggest an increase in daily consumption to 97 million barrels in 2015 and subsequently,

118 million barrels in 2030. China accounts for more than 25% of the growth in

consumption. The U.S.’s total petroleum consumption averaged at 20.7 million tons per

day and is projected to rise to 21 million tons in 2008.

Figure 90: Global oil consumption projections

0

24

48

72

96

120

2010 2015 2020 2025 2030

M i l l i o n B a r r e l s p e

r d a y India

Japan

Russia

China

US

Rest of the World


Meanwhile, China and India are expected to show the maximum increase in energy

demand among non-OECD nations. China’s energy use in the transportation sector is

estimated to grow at 4.9% through 2030; unlike the U.S., most of the growth in China’sconsumption is expected to be in the form of liquid fuel. China has, in fact, accounted for

over 30% of global incremental consumption of liquid fuels. It is further expected to

account for 28% of the increase in demand during the period 2004-2030, with is global

demand share in 2030 being 14%, nearly double of its share in 2004. Besides China,

India is also expected to see rapid growth in its transportation fuel requirement, with an

estimated CAGR of 3.3% during the period 2004-2030. The burgeoning demand for fuel

in developing countries, particularly India and China, is attributed to rapid economic

Oil production in China and India is less than half their

consumption.



80


development, increasing income levels and large-scale development of infrastructure,

particularly the transportation system.

Figure 91: Oil consumption for top five consumers of energy – 2006


Proved Reserves(Billion Barrels) 21.8 18.3 60 0.1 5.4Total Oil Production(Thousand barrels/day) 8,330.5 3,780.8 9,513 128.5 834.6Crude Oil Production(Thousand barrels/day) 5,102.1 3,608.6 9,043.1 6.6 664.7Consumption(Thousand barrels/day) 20,687.4 6,720 2,757 5,305.1 2,438


Global oil demand in 2007 stood at 86 million barrels per day and is estimated to have

risen to 87.5 million barrels per day in the first quarter of 2008. Long-term projections

suggest an increase in daily consumption to 97 million barrels in 2015 and subsequently,

118 million barrels in 2030. China accounts for more than 25% of the growth in

consumption. The U.S.’s total petroleum consumption averaged at 20.7 million tons perday and is projected to rise to 21 million tons in 2008.

Figure 92: Global oil consumption projections

0

24

48

72

96

120

2010 2015 2020 2025 2030

M i l l i o n B a r r e l s p e r d a y India

Japan

Russia

China

US

Rest of the World


The strain put on resources due to high demand has been further aggravated by global

geopolitical tensions and a decline in OPEC’s spare capacity to produce oil. Over the long

term, global energy demands are projected to grow at a CAGR of 1.3% during 2005-

2030, resulting in a 40% increase in demand by 2030 in absolute terms. Sector wise, the

strongest growth in energy demand is projected to originate from the transportation

sector which is set to grow at a CAGR of 1.7% and would account for two thirds of the

additional crude demand. Meanwhile, the power generation sector is expected to accountfor 27% of the growth, increasing at 1.5% annually. Energy demands from the industrial

and residential/commercial sector are projected to grow at 1.2% and 0.7%, respectively.



81


Figure 93: Top five oil producers – 2006

SaudiArabia Russia US Iran China

Proved Reserves(Billion Barrels) 266.8 60 21.8 132.4 18.3Total Oil Production(Thousand barrels/day) 10,664.7 9,513 8,330.5 4,148.1 3780.8Crude Oil Production(Thousand barrels/day) 9,152.3 9,043.1 5,102.1 4,027.8 3,608.6Consumption(Thousand barrels/day) 2,139.4 2,757 20,687.4 1,685.8 6,720


Over the last two decades, the oil sector has seen a declining share of the OPEC countries

in the global markets. OPEC’s share has declined from 52% in 1973 to 41% in 2004.

However, the forecast for the period 2004-2030 suggests that OPEC will account for 65%

of growth in production during this period and consequently, its share in global supplies

will rebound to reach 48% by 2030.

Figure 94: Natural gas demand-supply balance for top five consumers of energy, 2006


Proved Reserves(Billion Cubic Feet) 204,385 53,325 1,680,000 1,400 38,880Production(Billion Cubic Feet) 18,531 1,960 23,166.6 120.4 1,066.5Consumption(Billion Cubic Feet) 21,821 1,995.3 16,598.1 3,137.3 1,348.7


Rising crude oil prices have led to increased market viability for natural gas. Energy

companies are shoring up their natural gas supplies in response to enhanced demand.

Increasingly, natural gas is expected to replace the fossil fuel liquids in industrial and

electric power sectors. Industries are expected to consume as much as 43% of naturalgas produced by 2030.

The fact that natural gas is a more efficient fuel and is also less carbon intensive, is

expected to make it a more attractive fuel in global markets, considering the increase in

environmental concerns. Consequently, its share in global electricity generation is

Figure 95: Global natural gas consumption projections

0

40

80

120

160

200

2010 2015 2020 2025 2030

T

r i l l i o n C u b i c F e e t

India

Japan

Russia

China

US

Rest of the World

Source: EIA

The share of natural gas in global electricity generation isexpected to increase from

31% in 2004, to 36% in 2030.



82


projected to grow from 31% in 2004 to 36% in 2030. The global natural gas consumption

is projected to increase at a CAGR of 1.9%, from 100 trillion cubic feet in 2004 to 163

trillion cubic feet in 2030.

Figure 96: Coal demand-supply balance for top five consumers of energy, 2006


Production(Million Short Tons) 1,161.4 2,620.5 340.6 0 497.2Consumption( Million Short Tons ) 1,114.2 2,578 264.2 197.6 542.8


Amid the inflationary pressures in the energy market, coal is increasingly being seen as

an attractive and cost-effective alternative to oil and natural gas. China and India have

shown a sharp increase in coal consumption in the recent past and are expected to

continue adopting coal in place of more expensive fuels. Both countries along with the

U.S., are projected to account for 86% of the increase in coal consumption during 2004-

2030. It is believed that coal’s share of world energy consumption will rise to 28% from

the present 26% by 2030.

Meanwhile, countries with slowing growth in electricity demand, such as OECD-

European countries and Japan are expected to experience a decline in coal consumption

as they find additional nuclear power and natural gas facilities sufficient to fulfill their

fresh electricity demands.

Figure 98: Electricity demand-supply balance for top five consumers of energy, 2005


Net Generation(Billion Kilowatt-hours) 4062 2,371.8 904.4 1,024.6 661.6Net Consumption(Billion Kilowatt-hours) 3,815.7 2,197.1 779.4 974.2 488.5Installed Capacity(GWh) 956.7 442.4 217.2 247.9 137.6


Figure 97: Global coal consumption projections

0

2,200

4,400

6,600

8,800

11,000

2010 2015 2020 2025 2030

M

i l l i o n S h o r t T o n s India

Japan

Russia

China

US

Rest of the World




83


The global electricity generation capacity is projected to nearly double from 16,424

billion kilowatt hours in 2004 to 30.364 billion kilowatt hours in 2030. Developing

nations are expected to account for the most significant growth in power capacity; the

estimated rate growth for relatively underdeveloped or undeveloped OECD countries

being 3.5% annually. Meanwhile, relatively developed OECD countries with well

developed infrastructure are expected to see 1.3% annual increase in electricitygeneration through 2030. Natural gas and coal are estimated to account for even greater

share of global power capacity in 2030.The higher efficiency and environmental benefits

associated with natural gas would lead to an increase in its share from 20% in 2004, to

24% in 2030.

Meanwhile, considering high crude and gas prices, coal is expected to gain in

prominence with its share in the global power sector expected to increase from 41% in

2004 to 45% in 2030. However, high fossil fuel price, global energy security concerns,

and environmental consideration will press a case for increased nuclear power

generation, with globally installed capacity projected to increase from 368 gigawatts in2004 to 481 gigawatts in 2030. Nuclear power generation in 2030 is estimated to be

3,619 billion kilo watt-hours compared to 2619 billion kilo watt-hours in 2004. The

European countries are expected to see a decline in their existing nuclear power capacity

due to planned phase-out of existing reactors. However, developing nations are expected

to witness a large build up in nuclear power capacity. China, Russia, and India are

expected to increase their nuclear power capacity by 36 gigawatts, 20 gigawatts, and 17

gigawatts, respectively.

Figure 99: Global electricity consumption projections

0

6,400

12,800

19,200

25,600

32,000

2010 2015 2020 2025 2030

B i l l i o b K i l o w a t t h o u r s India

Japan

Russia

China

US

Rest of the World


China, Russia, and India areexpected to increase their nuclear capacity by 73

gigawatts by 2030.



84


Renewable sources-based power generation capacities are expected to see a marginal

increase in share from 7% in 2004 to 8% in 2030. The government policy support for

renewable resources-based programs and high fossil fuel prices are expected to facilitate

1.9% annual increase in renewable power generation through 2030. Much of the growth

in hydropower generation is expected to come from non-OECD Asia and Central and

South America.

Biofuels

Biofuels have emerged as an economically-viable alternative to fossil-based fuels. The

high prices of crude oil products have made it highly profitable to grow crops for biofuel

production. Additionally, the present scenario allows producers of biofuels to charge

premiums and still be competitively priced compared to crude. The main feed-stocks

used in biofuel are corn and sugar for ethanol, and rapeseed and soybean oils for

biodiesel. In addition, barley, wheat, rye, wine, and cassava are being used for ethanol

production and a variety of other vegetable oils, recycled oils, and fats from the food

industry for biodiesel.

Significant effects of the increase in biofuel demand on the livestock sector are:

a. Prices for corn, soybean, and soybean oil are expected to increase further as a result

of high demand from the biofuel sector;

b. high commodity prices will incentivise an increase in acreage for corn and soybean,

which could spur a decline in cotton and wheat acreage; and,

c. the use of crops for feed and food purposes would decline due to the diversion of

produce to the biofuel industry. However, increasing soybean crush capacity for

biodiesel would result in greater production of soybean meal as a co-product.

Consequently, soybean meal is expected to gain prominence as the prevalent

livestock product in the market.

The major factors that are expected to drive the growth of the biofuel industry over the

long term are:

a. Increasing concerns over future energy supplies in view of the limited availability of

natural resources and increasing reliance on less reliable countries for oil imports;

Figure 100: Global renewable energy consumption projections

0

14

28

42

56

70

2010 2015 2020 2025 2030

Q u a d r i l l i o n B t u

India

Japan

Russia

China

US

Rest of the World

Source: EIA



85


b. the ability of biofuels to address pollution-related environmental concerns; and,

c. the development of new and more attractive avenues of income for farmers.

Consequently, ethanol production in the U.S. has witnessed rapid growth, with volumes

rising from less than 3 billion gallons in 2003, to over 6 billion gallons in 2007. Ethanol

production is further projected to grow to 12 billion gallons by 2010 and 14 billiongallons by 2017. Nevertheless, even at these volumes, ethanol would account for only

8.5% of the U.S.’s annual gasoline use. These trends are expected to be accentuated by

government policies, such as tax credits available to blenders of ethanol and reduced

import tariffs on ethanol used as fuel. The expansion in ethanol production is expected to

consume more than one third of the U.S.’s annual corn production. In absolute terms,

corn use for ethanol production is projected to double from 55 million tons in 2006 to

110 million tons in 2016. The consequent rise in corn demand is expected to put

inflationary pressures not only on corn products, but also trigger supply-demand

adjustments for other crops, as well. Biodiesel production is expected to witness limited

growth in the U.S. due to high feedstock costs attached with soybean oil-based biofuels.

Soybean oil use in biofuel production is expected to increase marginally from 2 million

tons in 2007 to 2.3 million tons in 2011.

The growing significance of biofuel as an alternative source of energy has mandated

biofuel policy formulation on the part of governments around the world. The major

biofuel producers and consumers besides the U.S. include the EU, Brazil, Canada,

Argentina, China, India, Malaysia, Indonesia, and the former Soviet Union. The EU has

set a mandate of sourcing 5.75% of its transportation fuel needs from biofuels by 2010,

and to further increase the share for biofuel to 10% by 2020. The EU has provided a per

acre subsidy on energy crops in order to facilitate this; additionally, individual memberstates are offering tax credits in biofuel production. It is projected that by 2010, biodiesel

will account for two-thirds of the biofuel and ethanol will account for the rest in the EU.

However, despite the 170% increase in biofuel production between 2006 and 2010, the

5.75% fuel share target is not expected to be met. Most of the biofuel-related acreage in

the EU is expected to be dedicated to rapeseed cultivation; the region is expected to

witness a sharp rise in rapeseed production and development of oilseed crushing

facilities as well. Meanwhile, more than 18 million tons of wheat, 21 million tons of

oilseed and 5.2 million tons of corn are projected to be consumed by the biofuel industry

Figure 101: Global ethanol production, 1980-2006

0

2

4

6

8

10

12

14

16

1980 1984 1988 1992 1996 2000 2004

E t h a n o l P r o d u c t i o n ( B i l l i o n G a l l o n s )

Source: OECD

Major biofuel consumersinclude the U.S., the EU,

Brazil, Canada, and Argentina.



86


in the EU by 2016. As well, the EU is expected to import significant quantities of

rapeseed oil from Russia and the Ukraine, palm oil from Southeast Asia, and biodiesel

from the U.S. and Southeast Asia.

Figure 102: Production – consumption – oilseed meals (million tons)

Average2001-2005 2006 2007 2008 2009 2010 2011 2012 2016

The EU 0.89 0.97 0.92 1.05 1.13 1.29 1.46 1.62 2.24

Brazil 13.9 19.4 21.5 23.6 25.7 28.2 30.8 33.4 43.8

Source: OECD

Brazil is known for substituting a large share its petroleum-based fuels for biofuels,

particularly ethanol. Large tracts of land have been shifted in southern Brazil from grain

and oilseed production to sugarcane production in order to provide substantial raw

material for ethanol production. Brazil presently uses nearly 50% of its sugarcane output

for ethanol production; it is further projected to consume more than 60% for biofuel

production by 2016. Consequently, ethanol production is projected to grow by 145%

during 2006-2016 and reach 43.8 billion litres in 2016. Simultaneously, recent

government policies – aimed at stimulating biodiesel production in the soybean-

production areas of Central Western Brazil – are expected to provide a boost to the

biodiesel industry, particularly in regions where transportation costs of petroleum-based

diesel is prohibitively high.

Canada has a relatively small biofuel production capacity. However, it has doubled its

ethanol production in 2006, the same year it commenced biodiesel production. The

Canadian government has mandated a 5% ethanol blend in gasoline by 2010 and a 2%

biodiesel blend in on-road diesel and heating oil by 2012. The nation is projected to

more than double its biodiesel production over the next decade, essentially by increasing

the acreage and yield of rapeseed grown in its prairie provinces and by expanding its

processing and crushing capacities. Canada is also projected to expand its ethanol-

production capacity by bringing a significant area under wheat and corn cultivation, inorder to provide the requisite feedstock. Consequently Canada’s ethanol production is

slated to rise from 550 million litres in 2006 to 1.9 billion litres in 2009. Similarly,

biodiesel production is expected to grow strongly from 70 million litres in 2006, to 600

million litres in 2012. More than half the growth in bio diesel production is expected to

emanate from oilseeds and vegetable oil; yellow grease and tallow are expected to

account for the remaining growth in production.

Argentina has developed huge oilseed crushing facilities, which are fed not only by its

substantial domestic feed stock output, but also by its large-scale soybean imports. The

differential export taxes in Argentina have incentivized biofuel exports compared to

vegetable oil or feedstock exports. Consequently, it is estimated that Argentina will

double its biodiesel production capacity during 2008-2017.China is expected to focus on the development of non-grain feedstock-based biofuel

production in line with its food security policy, which seeks to cut down on corn-based

ethanol production to ensure ample corn supplies to satiate its food needs. Still, in view

of its burgeoning fuel requirements, China presently uses 3.5 million tons of corn for fuel

ethanol production and more than 17.5 million tons for ethanol is required for industrial

and beverage uses.



87


Most of the biofuel industry-induced growth in FSU, Malaysia, and Indonesia is expected

to be driven by the growing demand in the international markets and the high premium

attached with the biofuel products. Russia and the Ukraine are projected to more than

triple their rapeseed production over the next decade, specifically eyeing the rapeseed

and rapeseed oil markets in the EU. Meanwhile, Malaysia and Indonesia are expected to

moderately raise their palm oil production in order to serve the biofuel requirements.In addition, India, despite its recent food security, land scarcity, and inflation-related

problems, is coming up with a national biofuel policy which mandates meeting 10% of

total transport fuel needs with biofuels by 2017. India is expected to bring 12 million

hectares of forest wasteland under biofuel crop plantation. Unlike the U.S. and Southeast

Asia (where corn and palm crops are diverted towards biofuel production) India plans to

grow non-edible crops on agricultural wastelands. Already 600,000 hectares of land is

under Jatropha cultivation which is expected to provide 300-500 million litres of biofuel

annually.



88


EQUIPMENT

With the development and use of agricultural equipment, manpower used on farming

operations has reduced significantly. In the 1930s, the primary occupation of 24% of the

American population was agriculturally-based compared to less than 2% today.

However, with the help of a great variety of farming devices, the current manpower

provides significantly more food than the nation’s consumption. Modern farm machinery

allows farmers to produce and harvest more bushels in less time. Farming devices cover

a wide range of complexities, from simple hand-held implements used since prehistoric

times, to the complex harvesters of modern mechanized agriculture. This agricultural

machinery is primarily used to improve the efficiency and effectiveness of various farm

activities especially in crop growing, harvesting, and livestock raising.

A majority of the demand for agriculture equipment comes from the operators of food-,

livestock-, and grain-producing farms, and from independent contractors that provide

services to such farms. The most significant factor that influences the demand for farm

equipment is net farm income. Other influencing factors include general economic

conditions, interest rates and the availability of financing. In actuality, there is a strong

correlation between the net farm income and spending on equipment.

Figure 103: Farming income versus agriculture equipment spending, U.S., 2006

20

40

60

80

100

2001 2002 2003 2004 2005 2006

F a r m i n c o m e ( i n U S D b i l l i o n )

60

75

90

105

U n i t s a l e s i n ' 0 0 0

Net Farm Income Tractors/combines (40hp+)

Source: USDA

Net farm income is primarily impacted by the volume of acreage planted; commodity

and/or livestock prices and stock levels; demand for biofuel; crop yields; farm operating

expenses, including fuel and fertilizer costs; fluctuations in currency exchange rates; and,

government subsidies. Farmers tend to increase the purchase of equipment when thefarm economy is prospering and postpone their purchases when economic conditions

are depressed. Weather conditions significantly affect crop yields and consequently, also

impact equipment buying decisions. In addition, the geographical variations in weather

from season to season may result in one region witnessing a decline in income and

another region is experiencing growth. Government policies also affect the demand for

agricultural equipment. Policies regulate the acreage planted and provide direct and

indirect subsidies affecting specific commodity prices. World organization initiatives,

such as those of the WTO, also affect the market with demands for changes in

Agricultural equipment spending has a highcorrelation with the level of farming income and theavailability of sufficient

equipment financing options.



89


governmental policies and practices regarding agricultural subsidies, tariffs, and the

acceptance of genetically modified organisms (GMOs) such as seeds, feed, and animals.

Different climatic regions and farming calendars cause a seasonal demand for farm

equipment. For example, the demand for tractors and tillage is at its peak in March

through June in the Northern Hemisphere and in September through December in the

Southern Hemisphere.Higher farm incomes and sufficiently available equipment financing makes the

acquisition of agriculture machinery affordable in developed regions especially in North

America, Western Europe, and portions of the Pacific Rim. Conversely, in Africa, Asia,

and Latin America, farm incomes are still low, capital is scarce, and equipment often

consists of hand-held plows. According to the USDA, equipment represents 30% of total

farming expenses in developed regions, whereas in developing regions, it is only 10% of

total farming expenses. This is primarily because developing regions lack the

infrastructure, know-how, farm size, sophistication, and money to employ substantive

equipment and technology to complement their farming techniques. Additionally, in

developing regions, labour is abundant and infrastructure, soil conditions and/or climate

are not conducive to intensive agriculture12, and as a result, the demand is for durable

machines with lower purchase and operating costs. Tractors are the primary agricultural

equipment used in these regions and the work that cannot be performed by a tractor is

carried out by hand.

All the BRIC countries are below average in terms of equipment usage and of these

countries, India has the least usage of equipment, with about 60% of its labour force still

engaged in agriculture while only about 16% of its GDP is derived from this sector. The

farm income in these countries is limited due to the practice of subsistence farming13,

which curtails the purchase of even lower-end mechanized products.

In the U.S. and Western Europe, subsidies given by government are a significant source

of income for farmers raising certain commodity crops such as soybean, corn, and

wheat. In years of natural disasters, the support level can reach 50% of the annualincome. The cyclicality in the agriculture equipment industry is reduced with the

existence of such a high level of subsidies. Consequently, the demand for farm equipment

is significantly affected by the US Farm Bill, the Common Agricultural Policy (CAP) of the

European Union, and WTO negotiations. Additionally, the Brazilian government also

provides subsidies on financing of agricultural machinery, which also influences its sale

in this region.

The US Farm Bill 2007 was passed by the United States House of Representatives on July

27, 2007. In the U.S., the USDA administers agriculture programs for the government. In

the 2009 budget proposal for the USDA, tabled by President Bush along with the US

Farm Bill 2007 in July last year, certain reforms were suggested. These reforms, if

enacted, may reduce subsidies to farmers, which in turn, can lead to a reduction in the

demand for agricultural equipment. However, the sale of farm equipment in the U.S. and

Canada is forecast to increase by 10% to 15% for the year 2008 primarily due to a

substantial increase in farm cash receipts.

12 Intensive farming or intensive agriculture is an agricultural production system characterized bythe high inputs of capital, fertilizers, labour, or labour-saving technologies such as pesticidesrelative to land area.13 Subsistence agriculture is defined as self-sufficient farming in which farmers grow only enoughfood to feed the family, pay taxes, or feudal dues.



90


Agricultural programs in the EU are governed by the Common Agricultural Policy (CAP).

It aims to provide farmers with a reasonable standard of living, provide consumers with

quality food at fair prices, and to preserve the EU’s rural heritage. In June 2003, the

“Single Payment Scheme” was introduced by the farm ministers from EU member

nations. Under this new program, single-farm payments will go to farmers based on the

size of their farms rather than their output. However, the old system would be allowed tocontinue in limited circumstances where there is a risk of farmers discarding the land,

especially for cereal grains and beef. Reduction was carried in direct payments for bigger

farms to fund the rural development policy on the expectation of the May 2004

enlargement of the EU and a 55% increase in farmers covered by the CAP. In January

2007, the number of farmers in the EU increased by 53% as a result of the EU increasing

its membership to 27 countries. This increase caused further impetus for a regulatory

review of the policy and a review of future financing of the CAP. In the Doha Round talks

of the WTO, the EU has offered to enact a number of changes, including the elimination

of export subsidies and a 50% reduction of the average tariff on agricultural imports.

Other proposals include a scheme to limit subsidies to individual landowners and factory

farms, and a reduction in capital distributed to the original EU members to fund

payments to new member countries. Along with theses proposals, the EU needs to meettargets set for a reduction in greenhouse gases and to obtain 20% of energy needs from

renewable sources. In December 2007, the EU also agreed to suspend import duties on

many cereal grains. This step was taken to reduce pressure on the European grain

market, as the EU, a traditional exporter of cereal crops, expects to be a net importer in

the 2007-2008 marketing year. About 80% of the land area in the EU is farmland and

changes and proposals like these can have a significant impact on farmers. If the impact

on farmer income is negative, the demand for agricultural equipment may decline. In

2005, France accounted for 25% of the regional demand for machinery; Germany for

20%; Italy for 18%; and the UK for 7%. Industry sales for 2008 in Western Europe are

forecast to be either stable or to increase marginally for the year with a higher increase

expected in Eastern Europe and the CIS (Commonwealth of Independent States)

countries, including Russia.

The government of Brazil supports agriculture by providing subsidized long-term loan

programs controlled by the development agency, Banco Nacional de Desenvolvimento

Econômico e Social (BNDES). The most important agricultural program is the

MODERFROTA Program (Programa de Modernização da Frota de Tratores Agrícolas,

Implementos Associados e Colheitadeiras) which provides capital for the purchase of

tractors, combines, and farm machinery. The program provides subsidized funding to

financial institutions to be loaned to farmers in accordance with the provisions of the

program. In South America, Brazil accounted for 49% of the regional agricultural

equipment purchases in 2005 while Argentina accounted for 27%. Interestingly, Brazil is

the only country in this region which had a surplus in the foreign trade of farm

machinery with a net export US$0.5 billion in 2005. The demand for farm equipment in2008 in this region is forecast to increase by 10-15%. Although strong commodity prices

in Brazil are expected to influence the demand for farm machinery positively,

uncertainty in the future of government-backed financing programs may affect sales.

Tractors and combineharvesters are the two largest

segments in the farmequipment industry,accounting for 46% of the

market.



91


Figure 104: Market segments in farm equipment industry, 2005

29%

17%

6%

17%

20%

6%5%

Farm tractors

Farm Combine Harvesters

Planting, seeding and fertilizingmachinery

Haying machinery

Plowing and cultivating machinery

Parts and attachments

Other agricultural equipment

Source: World Agricultural Equipment Study #2089, The Freedonia Group

Global farm conditions are positive on account of increasing economic prosperity, strong

commodity prices, and an increase in demand for renewable fuels. Grain stocks

worldwide are continuing to run at or near 30-year lows, especially wheat and corn.These conditions are favourable for the agricultural machinery industry. The agricultural

machinery and equipment sector exhibited 6% growth annually between the year 2000

and 2005, which was much higher than agricultural output (2.6% annualized growth)

and population growth (1.2% annualized growth). The corresponding figure for 2005 to

2010 is lower at 4.8%, primarily due to the weakening of the US economy, which

exhibited strong growth from 2002 to 2005.

Figure 105: Five largest farm equipment companies by revenue, 2007

Company Name Revenues (in US$ billion) % growth

Caterpillar Inc14 $41.7 8.0

Deere & Co $21.5 8.0

CNH Global $9.9 26.9

AGCO $6.8 25.9

Kubota Corp $6.3 8.6

Source: World Agricultural Equipment Study, The Freedonia Group

However, in absolute terms, global demand for farm machinery has increased from

US$ 52.7 billion in 2000 to US$70.2 billion in 2005 and is expected to reach levels of

US$ 88.8 billion in 2010. In 2005, the largest producers of farm equipment were the

U.S., China, Germany, and Italy, each with annual shipments in excess of US$4.5 billion

followed by India, France, Brazil, Canada, South Korea, and the UK, each with

shipments in excess of US$1.5 billion. Although manufacturers in developed regions

have advantages such as a large, diversified domestic market; possessing technical,managerial and marketing expertise; and relatively better access to capital and labour;

they are finding developing regions as more attractive investment options due to rapid

growth in these regions and additionally, cheaper labour.

14Revenue represents sales of construction, mining, and forestry machinery.



92


Agricultural tractors

Farm tractors have multiple uses and can be utilized for pulling plows, rakes, mowers,

planters, etc. Different specifications are available including the horsepower (hp) which

varies from less than 40 hp to over 400 hp.

Figure 106: Global farm tractor sales growth, 2000-2007

541

677

812795

758

500

600

700

800

900

2000 2004 2005 2006 2007

U n i t s a l e s i n ' 0 0 0

CAGR 6.0%

Source: CNH Global’s 10-K filing

In North America, the under 40-horsepower tractor market segment exhibited the most

rapid growth from 1992 to 2004, increasing from approximately 36,000 units sold in

1992 to approximately 141,000 units in 2004. However, since 2005, this industry

segment has been declining and in 2007, the number of units sold was approximately

127,500, a decline of 4% over 2006 sales. On the contrary, sales of over 40-horsepower

tractors have been increasing since 2001 and reached a peak of 115,000 units in 2007,

an increase of 7% over 2006. The sales of over 100-horsepower tractors are more

cyclical, and have ranged from 22,000 and 37,000 units in the recent past, depending

largely upon the agricultural commodity price levels. On the strength of the high corn,

soybean and wheat prices, sales of over 100-horsepower tractors were approximately29,300 units in 2007, which was an increase of 22% over 2006. The demand for such

tractors generally comes from production farmers, who have large-sized farms and grow

large quantities of cash grain crops.

Figure 107: Global farm tractor unit sales by region, 2007

Latin

America

4%

Western

Europe

21%

Rest of

the World

42%

North

America

33%Total Units

812,200 (approx)




93


In Western Europe, the annual sales of tractors have fluctuated within the narrow range

of 160,000 to 170,000 units in the recent past. These fluctuations largely depend on the

government subsidies and the CAP of the EU, animal diseases, and unusual weather

patterns. In 2007, industry sales were 168,000 units, 3% higher than in 2006 sales.

Additionally, the EU has set a target of obtaining 20% of its energy needs from renewable

sources, including 10% of its transportation fuel supply from biofuels. However, thedemand for farm tractors is not the same as compared to North America or Brazil.

Moreover, in many Western European countries, there are restrictions on weight or

dimensions of equipment such as road regulations and bridge or overpass height and

width constraints, which may affect the demand for large machinery.

Figure 108: Farm tractor industry unit sales for North America, Western Europe, and LatinAmerica, 1990-2007

0

50

100

150

200

250

1990 1994 1998 2002 2006

U n i t s a l e s i n ' 0 0 0

North America under 40 HP Western Europe

North America over 40 HP Latin America


In South America, the demand for tractors has been increasing since 1996. However, a

severe drought in Brazilian states in 2005 resulted in the decline of tractor sales by about

40% in that year. Another reason for the decline was low soybean prices. The

revaluation of the Brazilian Real also acted as catalyst during this decline, as agriculture

exports were denominated in US dollars. But in 2006, the Brazilian tractor market

exhibited a 15% increase year-over-year primarily due to the strong demand in the sugar

cane and citrus-market segments. During 2007, sale figures were approximately 31,000

units, an increase of 50% over 2006 levels. This was primarily fueled by the strong

demand from sugar cane producers who are looking to modernize their operations and

develop further efficiencies in the production of fuel ethanol from sugar cane and fromthe citrus market segments.

In other world markets (excluding North America, Latin America, and Western Europe),

tractor industry volumes have increased from 2001 to 2006. In 2006, the sales volume

reached approximately 352,000 units. However, in 2007, the market declined by 3%

below 2006, primarily due to depressed market conditions in China. Overall, the global

demand for farm tractors have been growing since 2001 ending 2007 at levels that are

2% higher than in 2006 and 50% higher than in 2000.



94


Agricultural combine harvesters

Agricultural combine harvesters are used to cut crops and threshers are used for

removing the grain or seed. They are used in large-scale corporate farming operations.

The worldwide sale of agricultural combine harvesters in the early 1990s ranged

between 23,000 and 25,000 units. It increased to approximately 32,500 units in 1998.

Since then, sales have been cyclical with a range between 23,500 to 29,400 units. In2007, the industry sales increased by 21% compared to 2006 to approximately 28,100

units primarily due to a strong demand from all major markets, which were supported

by higher agricultural commodity prices for corn, soybeans, and wheat. All these

commodities require the usage of combines for harvesting. In 2007, sales in North

America were 8,800 units as compared to 7,800 units in 2006. The corresponding figure

for Western Europe in 2007 was 6,700 units, an increase of 3% compared to 2006. In

Latin America, industry unit retail sales increased by 85% compared to 2006 to

approximately 4,900 units, led by the strong market conditions in Brazil and Argentina.

Figure 109: Farm combine industry unit sales for North America, Western Europe and LatinAmerica, 1990-2007

0

2

4

6

8

10

12

14

1990 1993 1996 1999 2002 2005

U n i t s a l e s i n ' 0 0 0

North America Western Europe Latin America


Other agricultural equipment such as planting, seeding and fertilizing machinery, haying

machinery, plowing, and cultivating machinery also showed strong growth in 2007,

particularly, in North America and Brazil.

Product technology

Although modern-day harvesters and planters perform their jobs efficiently, no major

technological changes have taken place in this sector in the recent past and thesemachines still do the basic job of cutting, threshing, and separating grains. Innovation is

now expected in the human interface with this machinery. New computer monitoring

systems, GPS locators, and self-steer programs are expected to increase tractor efficiency

and implements by making them more precise and less wasteful in the use of fuel, seeds

or fertilizers. It is also expected that some agricultural machinery may be capable of

driving themselves using GPS maps and electronic sensors.



95


INFRASTRUCTURE

The product loss or wastage between the point of production and consumption depends

on the efficiency and capacity of transportation and distribution networks. This is most

significant with perishable goods, including unprocessed agri-products. An immature

and inefficient transportation and handling infrastructure has wide-scale implicationsranging from food spot shortages and regional disparities, to lower domestic income.

When resources remain misallocated, realizing economies of scale also becomes a

difficult task and may even hamper the economic growth of a country.

Figure 110: Logistics cost as percentage of GDP

6

9

12

15

C h i n a

M e x i c o

I n d i a

I t a l y

S i n a g p o r e U

K

F r a n c e

G e r m a n y

C a n a d a

B r a z i l

A u s t r a l i a

J a p a n

U S L

o g i s t i c s c o s t

a s % o f G D P

Source: FICCI15

The logistics spending of a country as a percentage of its GDP is indicative of the existing

infrastructure. For example, a relatively high percentage for India, as compared to the

U.S., highlights the inherent inefficiencies in India that result in overheads and added

expenditure. While developing countries need high spending to develop new and efficientinfrastructure, developed countries such as the U.S. also need high spending to maintain

existing infrastructure and its efficiency.

India

By 2012, India expects to raise its infrastructure investments to 9% of the GDP which is

currently at 5%. In the 11th five-year plan (2007-2012), the Government has planned to

invest US$384 billion in infrastructure developments. Such large investments are

necessary because of the current situation of infrastructure in the country, particularly

the transport sector which has not been able to keep pace with the growing economy.

The post-harvest loss of fruits and vegetables in India is about 35-40% of the produce

each year. This, in value terms, is about US$10 billion per year, which is equivalent to

the annual consumption of the United Kingdom. These losses are primarily due to poor

handling, insufficient storage capacities, and underdeveloped transportation

infrastructure.

15 Federation of Indian Chambers of Commerce and Industry (FICCI) is an association of businessorganizations in India. It is one of the main organizations to fund and support many governmentaland non-governmental educational institutes.

The high logistics cost incountries such as China and India highlights the

inefficiencies in their infrastructure that result inoverheads and added expenses.



96


In 2007, there were around 1,300 cold storage facilities in India. However, they are

under utilized or completely unused throughout the year. The operating costs of these

cold storages are over US$60.00 per cubic metre which is far more as compared to

US$30.00 in the developed countries. This difference is primarily due to the high cost of

energy, which is about 28% of the total cost as compared to 10% in the developed region.

Additionally, the refrigerated trucks, which are used as mobile cold storage facility, aresmall in size as compared to international standards. The Indian cold-chain industry is

estimated to be worth US$2.3 billion and is expected to grow at 20-25% annually to

cross US$9 billion by 2015. The government is planning to invest US$24 billion on cold

or supply chain infrastructure over the next eight years.

Roads and highways are the major modes of transportation in India. They carry about

65% of the cargo traffic on the three-million kilometre network. However, there is only

about 58,000 kilometres of national highway, which carries half of the road traffic and is

used far beyond there capacity. To add to this, the condition of these roads is also very

poor, which further reduces the average speed of trucks to 20 mph, which is low in

comparison to the average speed of 60 mph in developed countries. As an initiative to

improve this situation, the government has launched the National Highway Development

Program (NHDP), to expand the highway network by 50,000 kilometres. The government

is also planning to invest US$48 billion to improve and add a new road network

throughout the country.

India currently has 12 major ports and 185 minor ports along its 9,600-kilometre

coastline. The major ports handle almost 90% of freight traffic. In 2006, these ports

handled 423 million tones of cargo, an increase of 10% over 2005. Vishakapatnam

handled the largest amount of freight, about 56 million tones in 2006, which was 11%

more than it handled in 2005. However, the Mumbai port exhibited the highest growth

rate, growing 26% over 2005.

The freight traffic at ports grew at 7% annually in the period 2000-2007 and is further

expected to grow at a CAGR of 7.7% until 2013-2014. However, the inefficiencies and

incapacities of theses ports have increased the costs of shipment coming in and going out

of the country. As such, the government is planning to increase the capacity, as well as

improve the condition of these ports. It has outlined an investment of US$12 billion over

the next five years for this purpose and expects to double the capacity to 1.5 billion tons

by the end of 11th five-year plan. The government has also allowed 100% foreign equity

investment in port and harbour construction projects. Gujarat has already been

successful in attracting private sector participation to develop four of its minor ports

(Pipavav, Mundra, Hazira, and Jamnagar).



97


Figure 111: Capacity and traffic at major ports, India 2005

0

100

200

300

400

1992 1996 2001 2002 2003 2004 2005

m i l l i o n t o n s

60

80

100

120

p e r c e n t a g e s

Capacity (mn tones-LHS) Traffic (mn tones-LHS) Capacity Utilizationc (%-RHS)

Source: FICCI

India’s railway network is the largest network in the world, with 63,000 kilometres of

railway lines across the country. Rail cargo has witnessed a growth of 6.6% in the period

2000-2007, making India’s railways the fourth-largest carriers of freight, moving over

one million tons of freight daily. To support the growing demand and release some

pressure off the nation’s highways, the government is planning to build two freight rail

corridors at an estimated investment of US$7.5 billion. One corridor is planned to

connect New Delhi, the nation’s capital, to the financial centre, Mumbai, while the other

will be from the prosperous north-western state of Punjab to Kolkata on the east coast.

An estimated capital investment of US$66 billion will be invested by 2012 in the railway

transport system in order to develop private container trains, increase capacity and to

upgrade the stations.

India’s airport infrastructure is also feeling the strain of the rapidly growing passenger

demand, as well as air cargo demands. To cope with the increasing air traffic, the

government is building new airports including an international airport at Hyderabad and

Bangalore which will start operating by the end of 2008. They are also modernizing the

existing airports in Delhi and Mumbai. The government has planned to invest US$9

billion in airport development and construction between 2007 and 2012.

China

The Asian Development Bank estimates that China requires an additional infrastructure

expenditure of US$1.2 trillion between 2007-2011 to keep pace with its fast-growing

economy. Accordingly, China is investing heavily in its infrastructure projects which

include road and transportation infrastructure, building ports, oil utilities, anddevelopment of water infrastructure. Over the next three decades, the government is

planning to invest US$500 billion on rail and road infrastructure alone.

In China, about 30% of the annual agriculture produce is lost due to poor handling and

inadequate infrastructure, which is significantly high, compared to a 2% loss in the U.S.

The cold storage capacities in China are out of date and have a capacity to store only

25% of the total produce. Due to the underdeveloped cold chain logistics, only 15% of the

perishable products are transported by refrigerated vehicles. Additionally, the cold



98


storage facilities are generally located in major port cities, which are not always near to

supply bases and therefore, are unable to receive timely treatment and processing.

In 2007, China had 30,000 refrigerated trucks and 250 million cubic feet of cold storage,

whereas the projected requirement for 2017 is 365,000 refrigerated trucks and 5 billion

cubic feet of cold storage. The government is taking initiatives to improve the situation

and is joining hands with foreign companies for this purpose. In October 2007, Iceland-based Eimskip Group, the world’s largest refrigerated logistics operator, along with

Qingdao Port Group opened the biggest cold storage facility of the country in Qingdao.

The company is also planning to open one more cold storage facility with the same

capacity (60,000 tones) by the end of 2008. In 2006, the Sinotrans Shanghai Cold Chain

Logistics Centre with a floor area of 66,667 square metres and three storage facilities

operating at different temperatures was opened for business. It also includes a loading

dock and refrigerated vehicles. The centre was built at a cost of US$29 million by the

logistic arm of Sinotrans Group, a government-owned company. The group is also

planning to add more cold chain logistics centers in major economic zones across the

country.

Figure 112: Freight traffic by mode of transportation, 2005

Railways

26%

Watrwys

62%

Roads

and

Highways

11%

Aviation

& Gas

pipelines

1% Total

80,258.1

(100 million tons

per km)

Freight Turnover

Railways

14%

Watrwys

12%

Aviation

& Gas

pipelines

2%

Roads

and

Highways

72%

Total

1,862,066

(10 000 tons)

Freight Traffic

Source: National Bureau of Statistics, China

In 2005, rail freight in China increased by 8% over the previous year to reach 2.7 billion

tons and is further expected to grow to 3.3 billion tons by the end of 2008. To support

this growth, the government has planned to invest US$213.7 billion during the 11th five-

year plan (2006-2010), by increasing the railroad network by 19,800 kilometres.

Additionally, it is also upgrading its trains from 60 to 70-ton trains, which will help

increase the railway freight transportation capacity by 16%. To improve efficiency, the

upgraded trains will also be equipped to carry higher loads and travel at a faster speed

of 75 mph compared to current trains which run at a speed of 50 mph. The governmentis also planning to modernize the railway networks, and as a part of this program, it is

building high-speed rail corridors connecting major urban cities, such as the high-speed

magnetic levitation railway between Shanghai and Hangzhou, which is being constructed

at an estimated cost of US$4.4 billion and is expected to commence operations in 2010.

With the sixth large-scale speed-up, trains in many parts of China now run at more than

200 kilometres per hour. Such technological changes and increases in speed have made

China loses 30% of its annual

agricultural produce due to

poor handling and inadequate

infrastructure.



99


the rail freight industry more efficient. The railroads are now connected with 90 major

cities and eight major ports across the country.

The government has also taken initiatives to increase the number of direct lines for

resource products such as coal, oil, iron, and corn; an example being the Hongshenxi

Coal Railway. To cater to the growing freight transport industry, the Ministry of

Railways, in its first major joint venture project, signed a contract with other investmentpartners like Rail Transport International, Zim Integrated Shipping Service Co., LTD,

Deutsche Bahn AG etc, to set up a 50-year joint venture to build and operate railway

container hubs in 18 cities. The Chinese government, along with four other countries,

has also started a new freight railway service between Beijing and Hamburg, Germany.

The freight train completed its first trial run in January 2008 and took 15 days to cover

about 10,000 kilometres. The same journey via sea takes around 30 days.

Figure 113: Freight traffic by port, 2005

Rank Port Country Metric tons

1 Shanghai China 537.0

2 Singapore Singapore 448.5

3 Rotterdam Netherlands 378.4

4 Ningbo China 309.7

5 Guangzhou China 302.8

6 Tianjin China 257.6

7 Hong Kong China 238.2

8 Qingdao China 224.2

9 Busan South Korea 217.9

10 Nagoya Japan 208.0

Source: National Bureau of Statistics, China

China’s ports are an important point of entry and exit to the country for trade. At the end

of 2006, China had about 15,000 productive berths which included 1,257 deep water

berths for 10,000-ton vessels. In 2006, the movement of cargo and containers exhibited

an increase of 17% and 22%, respectively over 2005. The Shanghai port became the

largest port by cargo volume globally for the first time in 2005 and retained that position

in 2006, as well. Other major ports such as Ningbo, Guangzhou, Tianjin, Qingdao,

Dalian, Shenzhen, Xiamen, and Yantian had freight-handling capacity of more than 150

million tons during 2006. The government is planning to increase the port handling

capacity by 80% or more over the period 2006-2010. The target is to raise the annual

handling capacity to 6.1 billion tons and the container handling capacity to 120-140

million TEUs16.

Since the mid-1990s, there has also been a significant increase in the rate of

construction of roads. Globally, China is now considered the fastest-growing country interms of building out a road network. The planned national highway network of 70,000

kilometres is the same size as that of the U.S. interstate highway system. However, China

plans to finish the project within 15 years, which is substantially lower than 40 years

taken by the U.S. to build its network.

16Twenty-foot Equivalent Unit (TEU) is based on the volume of 20-foot long shipping container (a

standard-size metal box) and is used to describe capacity of container ships and containerterminals.



100


As in the case of rail and road transport, there has also been a rapid increase in air

traffic in China. This has increased the burden on the existing 142 airports across the

country and the government is now planning to add around 97 new airports by 2020.

China is also building some of the largest infrastructure projects in the world such as the

Three Gorges Dam, with an estimated investment of US$30 billion. Such spending is

necessary to support its growing economy, to create employment, and to improve itscompetitiveness globally.

U.S.

According to the American Society of Civil Engineers (ASCE), the U.S. will have to invest

US$1.6 trillion over the next five years to repair and replace its ageing infrastructure.

Since the collapse of the 40-year old Minneapolis Interstate 35W bridge on August 2007,

the spending on infrastructure has become more intense. Poor road conditions are

costing motorists US$54 billion annually on repairs and operating costs alone. Most of

the infrastructure in place is more than 50 years old and needs urgent repairs and

upgrades.

Figure 114: U.S. logistics percentage of GDP, 1985-2006

6

10

14

18

1981 1984 1987 1990 1993 1996 1999 2002 2005

p e r c e n t a g e s

Source: US Department of Transportation

Logistics costs in 2006 were US$1.3 trillion, an increase of US$130 billion over 2005.

Despite the fact that the logistics expenditure of the U.S. is larger than the national GDP

of all but 10 countries around the world including India, Russia, and Brazil, the spending

as a percentage of its national GDP is low. Although the logistic costs have been growing

at 4% annually since 1980, as a percentage of US GDP, it has significantly decreased

primarily due to the increase in the efficiency of the logistics industry. Logistics costs as a

percentage of GDP was lowest in 2003 and since that year, it has been increasing

primarily due to the increase in crude prices, which have increased from US$30.00 per

barrel in 2003 to more than US$125.00 per barrel in 2008.

The U.S. will need to invest US$1.6 trillion over the next five years to repair and

replace ageing infrastructure.



101


In 2006, most of the cost categories experienced growth; the highest growth being

transportation costs (motor carriers and other carriers), which increased by 9.4% over

2005 to US$809 billion, primarily due to higher crude prices. Doubling of interest ratesin 2006 over the 2005 rates also resulted in an increase of 13.5% in carrying costs,

which stood at US$446 billion in 2006. In addition, the warehousing costs also increased

by 12% due to the higher rents.

In 2006, the 20 largest cold storage companies in the U.S. had a capacity of 1.2 billion

cubic feet.

Rail transport is a very important part of the country’s freight transportation system. The

freight rail industry continually reported loses in the 1980s before the Federal

Government deregulated the railroad industry. Since then the railroads have increased

their efficiency by taking several measures including cutting track mileage from 380,000

miles to 172,000 miles, cutting back on rolling stock and employees, and consolidating

ownership into six Class I Railroads, and 551 short-line railroads. However, rail capacityhas already become constrained and it is expected that by 2020 freight rail tonnage will

increase by 50%. The freight rail industry is expected to require an investment of

US$175-195 billion over the next 20 years to retain its current share of the freight

transport market and to accommodate the growing demand. The six Class I Railroads

alone require funding of approximately US$3.5 billion annually.

The US highways have not kept pace with the growing usage, which has resulted in over

capacity usage of many existing roads. The 75,000-kilometre interstate highway network

will have to be expanded to 100,000 kilometres by 2035 to accommodate the growing

demand. Such expansion will increase the existing capacity of 341,000 lane kilometres by

an additional 278,000 lane kilometres. Large amounts of investments are required to

maintain and to improve the present condition of the highways and bridges. An estimatedUS$78.8 billion annually (until 2024) is required just to maintain the present conditions

and an additional annual investment of US$131 billion is needed to improve it.

17The Council of Supply Chain Management Professionals (CSCMP) is a not-for-profit professional

organization involved in supply chain management

Figure 115: U.S. logistics costs by category, 2006

Carrying costs

34%

Motor Carriers

48%

Shipper-related

costs

1%

Logistic

administration

4%

Other Carriers

13%

Source: CSCMP’s17 18th Annual state of Logistics Report



102


The country’s 360 commercial ports and approximately 3,200 cargo handling facilities

stand testimony to the well established logistics industry. The U.S. port industry works

with trucking companies, railroads and airports to provide the most proficient

transportation system in the world, handling over 2.5 billion tons of cargo annually,

which is expected to double within the next 15 years. To address the increasing demand,

the public port industry invested US$2.1 billion in 2005. In addition, they will spendUS$8.6 billion during the five year period of 2006 and 2010. Such a level of investment is

necessary to modernize and expand the existing facilities so that they can become more

efficient for Intermodal transportation.

The aviation industry is also facing the pressure due to the growth in freight industry. In

2007, there were 510 US airports with commercial services and the Federal Aviation

Administration estimates that it requires US$9 billion annually to meet increasing

demand. Additionally, the aviation sector requires US$41.2 billion by 2011 to improve

the condition of its ageing infrastructure. According to ASCE report, the U.S. economy

will lose about US$170 billion between 2000 and 2012 due to airline delays which will

occur primarily because of insufficient investment in airport infrastructure.



103


BIO ENGINEERING

Genetic selection for a better breed of a plant or an animal has been practiced by

mankind for centuries. Humans have cross-bred different animals and plants to get

superior offspring (cows providing more milk, faster-growing rice) while rejecting the

weaker ones. The resulting increase in livestock and farm productivity has helped meetthe growing demand for these products from an increase in global population. For

example, the introduction of the high-yielding seeds of Manila rice and the Mexican

cross-bred wheat in the 1970s led to the green revolution in developing countries,

making them self sufficient in their staple food requirements.

As per UN estimates, the global population is expected to increase to 9.2 billion by 2050

and the current methods of agriculture are unlikely to be able to meet the demand for

agricultural and forestry products. This estimation, coupled with decreasing arable land

reserves, requires a new generation of high-yielding crop seeds to meet rapidly growing

demand. Genetic engineering has emerged as a new technique to improve the yields and

the characteristics of the plants and animals.

Genetic engineering allows the isolation of specific genes in an organism (exhibiting adesired characteristic), extracting it, and inserting it into the genetic structure of the

target organism (plant, animal, microbe, and human). This transfer of genes is done to

transfer the desired characteristic to the target organism. The key difference between the

traditional methods of breeding and genetic engineering are that in traditional methods

of breeding, the hybrid varieties created are from genetically similar or closely related

species (regular corn seed with a fast-growing wild corn) while in genetic engineering,

using gene splicing and gene planting, genetic material is transferred between different

species (from microbes to plant for Bt Cotton). Genetic engineering could result in species

having characteristics that were earlier not associated with them. These revolutionary

methods have the potential to change the face of agriculture, livestock, and

pharmaceutical industries with a new generation of agriculture produce. As with any

new technology, however, it carries significant environmental, social, food safety, health,and bio-diversity risks.

The genetic engineering era began in 1953 with the discovery of the DNA structure. In

1980, the US Supreme Court permitted patents for genetically modified organisms (GMO)

paving way for commercialization of GMOs. The first GMO patent was awarded to

General Electric for a bacterium to assist in clearing oil spills. In 1998, the recombinant

Chymosin for making cheese got FDA approval. The first transgenic crops of corn and

wheat were developed in labs in 1992. 1994 saw the introduction of a slow ripening

“Flavr Savr” tomato for the consumer market. GM crops were introduced for commercial

production in the U.S. in 1996. Also in 1996, the first genetically cloned adult mammal

“Dolly” the sheep was developed by English embryologist Dr. Ian Wilmut at The Roslin

Institute in Scotland. In 2000, rice fortified with vitamin A named “golden rice” wasdeveloped. The new millennia saw the introduction and wide-scale commercialization of

the Bollworm resistant Bt-cotton, herbicide-resistant canola, corn, and soybean crops.

2003 was a landmark year for genetic engineering when the genome (DNA structure of

an organism) of the most complex species, humans, was mapped completely.



104


Figure 116: Trends in biotech crop area by country

0

10

20

30

40

50

60

70

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

i n m i l l i o n h e c t a r e s

US Canada Argentina Brazil ROW

Source: ISAAA

Commercialised GM crop cultivation began in 1996 in the U.S. (soybean, cotton, canola,

and corn), Canada (canola, corn, and soybean) and Argentina (soybean and corn) and

has now spread to Brazil (soybean), Uruguay (soybean and corn), Paraguay (soybean),

Mexico (corn and cotton), Romania (soybean) , Spain (corn), South Africa (corn, soybean,

and cotton), Australia (cotton), India (cotton), China (cotton) and Philippines (corn). GM

cotton has been widely adopted in U.S., Australia, India, and China. GM Canola has been

adopted by Canada and the U.S. The U.S. has been a leader in the adoption of the

biotech crop farming with a majority share of the total crop area. India, China, and

Australia have taken cautious steps by first testing non-food crop of Bt-Cotton before

going for full fledged adoption of the GM crops while Paraguay and Uruguay have totally

shifted to the GM food crops. As of 2007, 63 other countries were at various stages of lab

trials, field trials, and limited-area plantation. European countries were initially totally

opposed to the GM foods, but have changed their stance over a period of time and

accepted GM technology in agriculture.

Figure 117: Trends in biotech crop area by countries

0

1020

30

40

50

60

70

80

90

100

U S A

C a n a d a

A r g e n t i n a

S o u t h

A f r i c a

A u s t r a l i a

C h i n a

P a r a g u a y

B r a z i l

U r u g u a y G

M c r o p

a s p e r c e n t a g e o f c r o p l a n d

Soybeans Corn Cotton Canola

Source: ISAAA

The U.S. is the leader inadoption of biotech cropfarming with nearly 60,000hectares under biotech crop

cultivation.



105


Figure 118: Global biotech crop area by country 2006

Country

GM Crop Area(in million

hectare)

Total ArableLand (in million

hectare)

GMCrop

Area % GM Crops

USA 57.7 174.5 33%Soybean, corn, cotton, canola, squash,papaya, alfalfa

Argentina 19.1 28.5 67% Soybean, corn, cottonBrazil 15 59 25% Soybean, cotton

Canada 7 45.6 15% Canola, corn, soybeanIndia 6.2 159.6 4% Cotton

China 3.8 143.3 3%Cotton, tomato, poplar, petunia, papaya,sweet pepper

Paraguay 2.6 4.2 62% SoybeanSouth Africa 1.8 14.7 12% Corn, soybean, cottonUruguay 0.5 13.7 4% Soybean, cornPhilippines 0.3 5.7 5% CornAustralia 0.1 49.4 0% CottonSpain 0.1 13.7 1% CornMexico 0.1 25 0% Cotton, soybeanColombia <0.1 2 Cotton, carnationChile <0.1 1.9 Corn, soybean, canola

France <0.1 18.5 CornHonduras <0.1 1.1 CornCzechRepublic <0.1 3 CornPortugal <0.1 1.3 CornGermany <0.1 11.9 CornSlovakia <0.1 1.4 CornRomania <0.1 9.3 CornPoland <0.1 12.1 Corn

Source: Clive James, ISAAA, FAO

Monsanto (MON), Dowagro (DOW), Bayer Cropscience and Syngenta (SYN) are significant

global players in the development of GM/enhanced seeds. These companies identify the

beneficial genes and create master seeds possessing the desired characteristics. These

master seeds are then commercialized by cross-breeding them with the local varieties of

the seeds to obtain the seeds sold in different geographic markets. The master seeds are

also licensed to private and government players for them to independently develop seeds

for their markets.

In 2007, Syngenta increased its seeds business by 16% to US$2.0 billion and has secured

approval for the triple-stacked corn (Rootworm trait, corn borer trait, and herbicide

glyphosate tolerance) for the U.S. market and the Bt11 corn (Bollworm trait) for the

Brazilian market. The R&D pipeline of the company includes the MIR162 corn, which

offers protection against Lepidoptera pests and has been submitted for approval in the

U.S., Canada, Mexico, Japan, and Brazil. U.S. FDA has concluded the consultation

process for feed and food safety of corn kernel bred “amylase” enzyme. This is essential

for converting corn into bioethanol. Syngenta has also entered into an alliance with Rohn

& Haas to develop and commercialize crop stress protection in field crops underInvinsaTM brand. Additionally, it has identified genes to regulate the water consumption

of plants and plans to develop seeds that require lesser water to grow. For example, it

has introduced a tropical (warm weather) sugar beet variety (currently undergoing field

trials in India), which offers reduction in water consumption and a shorter harvest time

compared to sugar cane.

Monsanto, Dowagro, and

Bayer Cropscience are significant companies

developing GM seeds.



106


Figure 119: Monsanto revenue trends by crop

1.49 1.792.81

0.890.96

0.90.38

0.320.57

0.61

0.34

0.23

0.33

0.28

0.29

0

1

2

3

4

5

6

2005 2006 2007

R e v e n u e i n U S D b

i l l i o n

Corn Soyabean Cotton Vegetable & Fruit Other

Source: Monsanto Annual Report 2007

Monsanto, the pioneer and current the global leader in GM seeds, saw its seeds and

genomics business grow by 25% in 2007 to US$4.9 billion. It has been led by stronggrowth in corn sown in the U.S. for ethanol production. However, the company

witnessed a drop in the sale of soybean seed, mirroring the diversion of soy crop land to

corn. In September 2007, Monsanto entered into an agreement with Dowagro to develop

an eight-gene stack corn (an industry first) by the end of the decade. This will involve

mutual cross licensing of the intellectual properties of both the companies. Monsanto’s

R&D pipeline is expected to introduce Roundup Ready 2 soybean (an improved version of

the commercially successful Roundup Ready soy) and a high value corn with “lysine”

enzyme. In the medium term (by 2010) the company is expected to introduce SmartStax

(eight-gene corn), drought resistant corn, high oil soya and omega-3 soybeans. The

company also has development plans for nitrogen-fixing corn, high oil corn, drought-

resistant cotton, and high-stearate soya. These plans are expected to get commercialized

by 2015.

Technological trends

GM crops are defined as first, second, and third generation based on the enhancement/

traits achieved in these crops. First-generation crops exhibit input/farm side

characteristics like increased yield, improved pest and plant disease resistance (Bt Cotton

resisting Bollworm attacks), environment stress tolerance (drought-resistant crops,

higher soil salinity tolerance), improvements in soil chemistry (plants supplying nutrients

to the soil). Second-generation crops exhibit the consumer/output side characteristics

like improved oil quality (more beneficial omega fats in soybean), enhanced nutrition,

taste and flavour (golden rice enhanced with vitamin A), improved post-harvest shelf life,

ease of processing (less waste), and functional and fortified foods. Third-generation crops

work as plant-based factories like pharmaceutical crops (a banana delivering a vaccine

for polio immunization), non-food industrial crops (biodegradable plastics from

sugarcane), and phyto-remediation (plants removing toxins and pollutants from the

environment). First-generation GM crops of cotton, soybean, canola, and corn have

gained acceptance from the regulators and farmers across the world. R&D work is being

conducted across the globe to produce newer breeds of genetic crops.



107


USDA and EU food police

US Department of Agriculture (USDA), the Food and Drug Administration (FDA) and

Environmental Protection Agency (EPA) are responsible for the approval of the

introduction of the GM crops in US farms and supermarkets. GM crops are assessed for

the potential migration of the unique traits from the engineered crops to the wild

varieties, weed characteristics of new crops, the effects of GM crops on birds, insects,mammals and worms. The crop is checked for various proteins, amino acids, and

toxicity levels. US companies maintain traceability of the food produced, helping them

track the food contamination and control the damage caused by them. The traceability of

the meat products is considered good, while for grains it is considered to be average by

USDA studies. The U.S. does not have any food labelling policy to indicate GM or non-GM

foods; as such, US consumers do not have a choice to accept or reject GM foods.

However, the nutrient labelling requirements for processed foods is compulsory, helping

consumers make informed choices. The import of food products in the U.S. has been

broadly divided into import of unprocessed foods and processed foods. The unprocessed

food import has the potential to introduce new and exotic biological matters in the

environment. All exporters of unprocessed foods are required to have a Food Safety &

Inspection Service (FSIS) certified inspection and testing facility in their home countriesto export to the U.S. These inspection facilities are audited by FSIS on an annual basis.

The FDA is charged with the inspection and regulation of imports of processed foods.

The European Food Safety Authority (EFSA) is the nodal agency in Europe charged to

assess and communicate risks associated with the food sector. EFSA works in close

conjunction with member states to assess risks in the food chain from the farm to the

fork, from domestic, intra-EU and international suppliers. It helps member nations to

formulate policies to ensure food safety for their citizens. Europe is the biggest exporter

and importer of food (sourcing food from 200 countries) and has the most stringent

sanitary and phyto-sanitary standards. EU food laws make nutrient labelling, additive

labelling, and GM food labelling compulsory for all food items to help its citizens make

informed decisions. Traceability of food from the source to the consumer is mandatory inthe EU. EFSA provides scientific advice on the risks associated with introducing GM food

in the Euro zone. The EU has been very conservative in introducing GM food entry via

imports and GM food production. EFSA has set up a working group for assessing the

safety of nanotechnology enhanced food. EU governments provide financial support to

the developing and underdeveloped countries to upgrade their agriculture support

infrastructure to meet the stringent food safety norms and to facilitate improved agro-

trade.

Implications

As is the case with any new technology, genetic engineering is facing both awe and

apprehension from admirers and sceptics in international multilateral organizations,

governments, regulators, farmers, bio-tech companies, and farm/trade-relatedcompanies. Since this technology has a direct impact on the global food chain, it needs to

be closely monitored and regulated – both at the domestic and international level – until

it is scientifically tested and found to be safe.

Interest groups favouring GM crops cite the benefits of higher yields per unit of

agricultural input resources, drought-resistant crops, chemical fertilizers, and pesticides.

Lower resource requirements and higher yields per acre also translate into higher

returns for farmers. Further benefits arise from bringing the current waste lands and

The primary benefit of GM crops is higher productivity

and yield per unit of agricultural input resources.



108


saline lands into agriculture production by using adverse environment-resistant seeds

which will boost the agricultural area and production. Various nutrient-enhanced and

nutrient-fortified crops like vitamin-enriched golden rice could help to reduce and

eliminate nutrient deficiency in impoverished societies.

On the other hand, critics opposing GM crops have dubbed them “Frankenstein foods.”

They cite that GM foods are cross species which is the equivalent of a new organismentering the environment. The entry of the new organism must be tested for their

compatibility with the environment, toxicity, effects on the soil, and long-term effects of

their consumption before being allowed wide-scale commercial production. They also

claim that introduction of GM crops will reduce the bio-diversity of the available seed

banks with the farmers and will lead to global mono-culture crop cultivation. This

assumes significance as agricultural scientists have observed that bio-diversity is the best

defence against a crop disease, pests and climate change. Some of the GM seeds

introduced have “terminator” and “traitor” genes. The terminator seeds are designed not

to reproduce in their second generation and hence cannot be sown again. The traitor

seeds are designed to geminate and grow only on application of certain pesticides or

fertilizers. Although these seeds are designed to protect the intellectual capital of the

innovator companies they would make the farmers totally dependent on the seeds,

chemical fertilizers and nutrients supplied by the agro-MNC. Environmentalists are

worried about the possible cross breeding of the GM crops with non-GM crops which

could release super-weeds in the environment. Managing these super weeds would be a

difficult task. Since the gene transfers are related to the proteins of the organisms, the

GM foods consumption could result in an increase in food allergies for the population.

Ethical queries have been raised over whether to classify plant-animal trans-genic foods

as vegetarian or non-vegetarian and how far humans should interfere in the natural

selection process.

The development of new GM foods would help increase in yields for the crops, offer

better plant protection, offer better flavour and nutrients to the consumers, offer vaccines

against dreaded diseases. The GM animals could be developed to give high milk yieldingcows, lean meat animals, and nutrient dense eggs. The future possibilities offered from

genetic engineering range from customized genetic medicines, cloning of humans,

designer babies, to creation of new superior species and artificial life. The ability to

tinker at the level of the building blocks of life (genes) gives the scientists enormous

power to manipulate life, inviting criticism for “playing God.” Like any new technology, it

is for us to decide how we want to reap the benefits of it or allow its usage for misery

and destruction. The GM food industry has to address the concerns of the regulators,

government, farmers, and consumers in a scientific manner to usher in the next green

revolution.



109


FERTILIZERS

We have discussed the growth in protein-rich diets and the grains required to fuel this

growth. As the world grapples with expanding grain use and low grain inventories, the

only solution is to grow greater amounts of grain through either increased plantings or

yield growth. A significant determining factor of increased yield growth is the optimaluse of fertilizer, and in many countries, this requires significant amounts of fertilizer in

addition to what is already being consumed.

Grain inventories and related stock-to-use ratios are at their lowest levels in decades due

to the onset of an expanding middle class in the developing world, most notably China

and India. As lower-income earners graduate to middle income, their diets evolve and

become more protein-oriented as they consume better qualities of food. What was

formally a rice diet now becomes a chicken-and-meat diet. Most importantly, as diet and

income graduate to a higher level, individuals rarely revert back to their previous

lifestyle. As the world consumes greater amounts of protein, we require larger quantities

of poultry and beef and the vast amounts of feed grain to serve those animals. Currently,

half of the world’s population uses rice as their primary staple. As the world becomes

wealthier, the possibility for shifting asset classes is staggering, and the potential for

increasing the protein diet among certain nations is immense. Basic food staples are

almost recession proof – after all, people must eat. And fearing massive social unrest,

governments will attempt to secure an adequate food supply for the population.

Figure 120: Kilograms of grain to produce one kilogram of meat

Source: Doane, PotashCorp

As corporations and governments work to provide solutions to augment crop yields, one

obvious end result will be an increased use of fertilizer. As fertilizer application to

increased yield is a proven cause and effect, we are certain the world will continue to use

greater amounts of fertilizer in the future than that of the past.

All crops require nitrogen (N), phosphate (P), and potash (K) to grow, but the staple crops

required for human and animal consumption require the greatest amount of fertilizer.



110


Figure 121: World NPK fertilizer consumption by crop

Source: FAO, IFDC, PotashCorp

Furthermore, the developing world will use an optimal application mixture that allows

much larger yielding crops per acre than less developed countries. We note that there

are other factors at work including irrigation, the use of GMOs, and technology, to name

a few. However, singling out fertilizers, over time, we expect the developing world to

close the yield gap versus developed nations regarding the optimal use of fertilizer per

crop. We do not expect the gap to disappear, nor to close quickly, but a gradual

tightening of the spread is expected as we move forward. The resulting potential growth

in fertilizer consumption in these economies is enormous.

Figure 122: Potential fertilizer consumption growth

Source: IPNI, Fertecon, PotashCorp



111


As we venture into the topic of fertilizers, we will discuss each in turn, including their

characteristics, individual demand/supply function, and forecasts for growth. We will

conclude with an outlook on the individual fertilizers over the short and medium term.

Figure 123: Global fertilizer demand, 2007

Phosphorus

18%

Potassium

16%

Nitrogen

66%

Total Demand

195 million tons

Source: FAO Fertilizer Outlook

Although nitrogen fertilizers hold a majority share, the proportion of potash and

phosphate fertilizers is expected to increase over time as countries seek greater yields.

As we will discuss in greater detail, we expect strong pricing levels for all three nutrients

over our forecast period but prefer the outlook for potash and phosphate fertilizers over

nitrogen fertilizers.



112


Nitrogen fertilizers

Nitrogen is essential for protein formation and plant growth. Nitrogen provides

vegetation with strong root development, stems, leaves, colour, and yield.

Figure 124: Nitrogen process chart

Source: PotashCorp

Nitrogen fertilizers are manufactured by reacting atmospheric nitrogen with natural gas.The resulting initial product of ammonia is then utilized to produce various forms of

nitrogen product, both solid and liquid. As such, the prices of these fertilizers are

affected by the price of natural gas. Since transportation of fertilizers is easier than the

transportation of natural gas, the global nitrogen fertilizer industry is witnessing a shift

of its production base to the inexpensive natural gas-rich regions. As we will see in our

company reports that follow, the benefit of a lower-cost feedstock is sometimes offset by

the political risk and supply risk of the particular country.

Nitrogen fertilizers are the most widely used fertilizer with a market share of 66% by

weight in 2007. Urea, the most common form of solid nitrogen fertilizer, displayed strong

pricing over the past six months due to tight supply and strong demand from Latin

America and continued purchases from India. In April, the Chinese governmentannounced an increase of their then 35% export tax to 135%, effective April 20, 2008

until September 2008. This announcement had an immediate impact on price, driving it

up dramatically to U$700/t from U$400/t in slightly over a month’s time. We could safely

assume approximately U$200/t of this impact was a direct result of the Chinese

announcement (Figure 125).



113


Figure 125: Urea pricing

Source: British Sulphur

To understand the significance of the Chinese announcement, we note that in 2007

China was the largest exporter of urea, estimated at 5.9mt (15.7% of the export market).

Due to government-controlled urea pricing within China (at approximately U$170/t),

urea producers were exporting product in order to secure the highest margins. It became

evident to the government that the 35% tax in place was having little effect on deterring

domestic producers from exporting product. In order to secure supply for domestic use,the government implemented the large increase in taxes. Over the past three to four

years, China has implemented export taxes of 15% in the winter and 30% in the summer,

increasing the amount to 35% this past winter, and then 135% in April. That speaks

volumes to how market pricing has changed compared to their domestic pricing controls.

We believe the direction of world pricing will be a direct result of what the Chinese

government will decide in September regarding export taxes. If the tax is extended, the

current situation will remain with elevated pricing. If the tax is removed, we assume

urea pricing will decrease significantly as Chinese exports return to the market. We

caution that this year is unlike previous years and in the current environment, we would

expect the government to announce an extension of the export tax or an increase if urea

pricing were to rise further. We do not envision a situation where the tax would be

returned to 35%, unless the government significantly increased the allowed domesticprice. We believe this is a very remote possibility.

Production capacity is expected to grow at a 3.8% CAGR in the next four years, while

demand is likely to lag at 2.8%. China, India, Russia, Pakistan, the Ukraine, and Egypt

were the leading manufacturers of urea fertilizers in 2007 while China (35%), South Asia

(including India) (26%), North America (8%), and Latin America (5%) accounted for the

majority of the consumption.



114


Figure 126: Global nitrogen fertilizer demand-supply trends, 2006-2016


We should note two items regarding the estimated capacity increases in the CAGR

mentioned above: (1) in the above chart, the supply is represented by capacity. Due to

plant turnarounds, limitations on carbon dioxide supply, contracts, etc., the amount of

supply will always be less than the amount of available capacity. Therefore, any increase

in capacity will be a lesser increase in supply, which would overstate the above

calculated CAGR of 3.8%. This would explain why the market supply/demand function is

tight but a gap exists between demand and what we would call “perceived supply” in the

above chart; and (2) of the forecasted 26.4mt of additional capacity to come online

between 2008 and 2012, 11.7mt (or 44%) is expected from China. This should help state

the full impact of the urea market pricing outlook on what would occur when the Chinese

government decides the fate of their export taxes at the end of Q3/2008 and the profound

impact on pricing over the next 12 months and possibly beyond.

It follows then that the growth in capacity over demand would affect the utilization rate.

As a rule, we expect pricing to follow the utilization rate. As the above chart illustrates,due to the expected supply additions over the next few years, pricing should soften

somewhat before being absorbed in the market, followed by marginally tighter

supply/demand beginning in 2012. The decline in the price depends on a variety of

factors, not the least of which is the cost of the marginal producer. There are two

important points that we must discuss to this end: (1) we expect Russia to continue to

increase natural gas pricing to the Ukraine from its current US$5.80/mmbtu in 2008 to a

supposed range of US$9.60-US$11.50/mmbtu; and (2) this would have an immediate

effect of raising the base price of ammonia and urea, forcing marginal producers to close

facilities and others to switch product to industrial from agricultural.

We believe the fertilizer market has performed a step change where pricing will not

revert back to previous levels, and the market will experience much higher cyclical highsand lows in the future. This is a result of the tightness in the market, the increased cost

of the marginal producer, and poor government policies now and in the future. Our

forecasts assume a softening in pricing from current levels but still above the pricing

levels of 2007. We believe the risk remains to the upside of our pricing forecast as we

await the outcome of the China decision.



115


Phosphate fertilizers

Phosphate is vital to a plant’s health, structure, growth, early maturity, and for the

conversion of the sun’s energy.

Phosphate rock is mined extensively in the U.S., Morocco, Russia, Tunisia, Brazil, Israel,

South Africa, Senegal, Togo and Syria. Key phosphorus fertilizer manufacturing

countries are China, the U.S., Russia, Brazil, India and Morocco. Phosphate fertilizers are

manufactured by reacting phosphate rock with sulphuric acid to form phosphoric acid. It

is further processed to produce various phosphate-based fertilizers, both liquid and solid

form (Figure 127). The most common form of phosphate fertilizer is diammonium

phosphate (DAP) representing approximately 30% of production. Monoammonium

phosphate (MAP) has experienced a higher growth rate in applications over the past

decade and now accounts for 22% of total production.

Figure 127: Phosphate flow diagram

Source: PotashCorp

To better understand the pricing structure of DAP, it is important that we distinguish

between integrated (70% of world production) and non-integrated producers (30%). The

integrated producers own their rock supply and may purchase all or some of the added

ingredients to produce the phosphate fertilizers through their production plants. Non-

integrated producers manufacture the end product, but purchase all of the inputs.

Examples of North American integrated producers are Mosaic, Potash Corp. and Agrium.



116


Figure 128: Integrated versus non-integrated DAP producer

Source: Fertecon, Mosaic

It is important to explain how we arrived at today’s current pricing and how that impacts

the non-integrated versus the integrated producer. Below, we discuss each major input.

Rock pricing: Of the 30mt of annually traded phosphate rock, OCP (Morocco) accounts for

45% of the trade volume. Furthermore, the top five producers control 75% of the tradedvolume. We have witnessed a step change in phosphate product pricing primarily due to

increased rock costs. The rock supply has become constrained and demand has proved

to be inelastic to date. The OCP-lead quasi-cartel is managing supply in order to provide

continued strength in pricing. To that end, a portion of the tightness in the phosphate

rock supply is created artificially and we expect it to remain over the next four years. The

old adage “high prices are the best cure for high prices” holds true, in this regard. As

rock prices have increased to the U$400 level and purchasers look for an alternate

source of rock, new rock mines are beginning to put forth plans for production. However,

this is not an immediate solution, as new mines take time to enter production. Once the

new supply enters production, we expect, similar to the structure in potash, continued

management of supply by the largest suppliers, keeping pricing elevated over historic

levels and the formation of higher base pricing. The end result will be higher longer-termpricing of phosphate rock, phosphoric acid and solid fertilizers (DAP and MAP).

Sulphur: Sulphur prices have increased dramatically over the past 12 months due to

supply constraints (Figure 129). We expect sulphur to soften as new supply from oil

producers enters production within 12-18 months, reducing the overall cost of phosphate

products (isolating sulphur input only). The end result would be a reduction in the overall

cost for the non-integrated producer and slightly reduced margins for the integrated



118


Figure 130: Phosphoric acid supply/demand balance (million tonnes P2O5)


China went from a major importer of phosphate fertilizer of over 5mt in the late 1990s to

a significant exporter of almost 4mt in 2007. Between 2000 and 2006, Chinese

phosphoric acid production increased from 1.8mt to 8.1mt. In so doing, the country went

from the largest importer to the second-largest exporter. This was due to the

government’s decision to build capacity to secure supply and eliminate its reliance on

imports. The impact from this policy was mostly felt over the past four years and forced

the closure of several higher-cost U.S.-based facilities that relied on the export market –

specifically, China, and Asian customers that are now supplied by China. On a capacity

basis, the impact of that growth on worldwide supply was muted by the U.S. closures.

Globally, the phosphate market lacked the required supply growth in the past few years,

tightening the markets considerably. The previously mentioned increase in the Chinese

export tax to 135% in April only exacerbated the situation.

In the solid fertilizer market, we expect a continued tightness in the market until the

supply-side is relieved in 2012 from the expected start-up of the Ma’aden facility at a

3mtpa combination of DAP and MAP, once in full production. There is discussion

regarding a doubling of output at Ma’aden once the initial construction is complete.

Given the difficulty the project has experienced to date, we would caution against a

doubling, and assume a more gradual increase. With solid fertilizer demand growing at arate of 3.5% per annum the past two years, the market requires a further 1.5mt of supply

each year. We expect this supply to remain constrained until 2012, followed by a

softening of prices for up to two years as Ma’aden would represent a large portion of the

global traded market. Similar to the situation in phosacid, we estimate the absorption

into the market would take a maximum of two years before pricing tightened again. The

overall capacity CAGR through 2016 is expected to be 2.5% per annum.



119


Figure 131: Phosphorus fertilizer demand by region 2007

Latin

America

13%

West Asia

3%East Asia

35%South Asia

20%

North

America

12%

Central

Europe

2%

West

Europe

6%

E Europe

and C Asia

2%

Oceania

4%Africa

3%

Total Demand

36 million tons

Source: FAO Fertilizer Outlook

South Asia is expected to account for 36% of the growth in demand for phosphorus

fertilizer, while East Asia and Latin America account for 34% and 18% of the growth

respectively. South Asia, East Asia, and Western Europe are expected to be net

importers, while Africa is expected to be the major exporter.

Phosphate pricing will continue to remain elevated due to the shortage of inputs to

produce the end products. From an integrated producer perspective, these companies

will continue to benefit from current pricing through 2012. As 30% of the overall market

is supplied by non-integrated production, it is the combination of the tightness in the

supply of phosphate rock, the supply of sulphur and the lack of new supply during this

time frame that will ensure the market is robust. Beyond 2012, we would assume the

significance of the Ma’aden project will be absorbed into the market during 2012-2013and will depress prices somewhat before they strengthen again. More importantly,

integrated producers will be generating significant earnings over our forecast period.



120


Figure 132: DAP Pricing 2002–2008

0

200

400

600

800

1000

1200

1400

2002 2003 2004 2005 2006 2007 2008f

U S $ p e r t o n n e

fob N.

Africa

fobTampa


Potash fertilizers

Potash is an important ingredient that benefits plants through increased strength,

increased yields, higher water retention, and resistance to disease.

Potash is extracted from deep underground mines where deposits were formed by

evaporated seas millions of years ago. Over time, sediment layers were formed atop the

potash mineralization. The minerals are extracted via conventional or solution mining.

Conventional mining involves sinking a shaft to depths of up to 3,000 feet and employing

a continuous miner to remove the ore to load onto conveyor belts to the ore crusher and

then hoist to the surface for refining. In solution mining, heated brine is injected into thepotash deposit via wells to dissolve the ore. The solution is then pumped to the surface

for refining.

The potash industry is primarily driven on the supply side by the production of two

cartels, Canpotex and the Belarusian Potash Company (BPC), both of whom have the

economics of business as their motivating priority (versus government ownership that is

more concerned about supply over returns). 81% of current potash production is owned

by corporations who make production decisions based on economics. This lowers the

risk that supply additions will be the result of political forces. It is this lack of participants

in the sector that further adds to the tightness in the supply/demand function over the

medium term and it allows those who produce the product to manage supply in order to

reduce volatility in pricing. At present, it takes at least five years to build a greenfieldpotash deposit, and the standard 2mt conventional deposit has a hefty $2.6+ billion cost

that is risked to the upside. There is also a great amount of visibility in the build-out of

new supply which allows potash producers who have excess capacity to add new supply

when the market warrants it (and remove supply when the market weakens).



121


Figure 133: Potash export sources of supply – 2007

Source: Ferticon

The potash market is a spot market for all but two of the largest users, China and India.

This is important to note, as these two countries accounted for 30% of potash demand in

2007. In 2008, both countries agreed to pay significant increases over their prior-year

contracts. This is reflected in the fact that India, a major importer of potassium fertilizers

had to negotiate and settle for an import price of U$625/t in March 2008, which is

significantly higher as compared to the U$270/t for the previous year. China then

followed suit with a U$576/t fob price (which is higher than the Indian settlement when

accounting for freight). The two contracts signaled to the market that we were at a new

plateau in world pricing. Now we look to how tight the market will be when both

countries renegotiate for the upcoming 2009 year. As China extended its contract

negotiations well into the current year, the tightness of the potash market removed any

potential overhang in supply from China having been removed for the initial six months

of 2008. During that period, customers were placed on allocations as producers were

routinely sold out of inventory, increasing the price of the commodity dramatically.

However, due to the limited amount of internal production from China and its limited

inventory position, we do not believe that China will be able to extend the negotiation in

2009, nor will it be in their best interest as we forecast a much higher price next year.

Echoing this sentiment, Sinofert, China’s largest distributor of potash, is concerned about

a shortage of the fertilizer. As such, the company is looking to secure potash through an

earlier negotiation for the 2009 season, with a goal to finalize a deal in late 2008.

Current spot pricing has been listed at U$750/t cfr for Canpotex shipments while BPC is

tabling pricing on the spot market of U$1,000/t cfr. This is indicative of how tight the

market is and the direction of pricing as we enter the latter half of 2008.



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Figure 134: Historical price of MOP

Source: Fertecon

As the supply of arable land is constrained, it will simply become a necessity for the

growing regions of China, India, and Brazil to employ a more optimal amount of potash

to generate higher-yielding crops. China, in particular, has a significant structural

problem regarding their potash requirements. Of the 11.5mt KCl they required in potash

fertilizer in 2007, their domestic production only produced 3.4mt. The remaining 8.1mt

must be procured from foreign means. The bottom line is that China is much more

concerned about securing their fertilizer requirements in order to maintain its

agricultural security and keep its population fed. To put it another way, securing potash

supply is more important than price, regardless of the chess game that is played during

each contract negotiation. In Figure 135, we isolate a portion of a chart we presented

earlier in the fertilizer section that displays potash deficiencies to optimal application

rates in China, India and Brazil. The reason we have done so is to graphically display

that potash is the fertilizer that has the greatest discrepancy between actual and optimal

rates. The end result is clear: the world requires more potash. The fact that so much

growth can and will come from China, India and Brazil is immensely bullish for the

commodity.



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Figure 135: Potential potash consumption growth

Source: Potash Corp., IPNI, Ferticon

Figure 136: Potassium fertilizer demand by region 2007

Source: Ferticon

With the expected growth in demand over the next five years to average above 4% per

annum, the world will require the equivalent of a new 2.0mtpa potash mine each year to

keep pace with demand. As we expect supply to struggle to maintain balanced within the

marketplace, the current tightness in the market is expected to remain throughout our

forecast period. As we have seen through announcements of the various debottlenecking

projects of the large global producers, additional supply from new entrants will be

warranted.



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Figure 137: Global potassium fertilizer demand trends 1985–2020

Source: Ferticon

We are very bullish on potash pricing through our forecast period. We see pricing

continuing to rise in the latter half of 2008, and well into 2009, remaining elevated at

these levels through 2012. The world is short the commodity, customers are on

allocations, and the build out in supply, which has great visibility, will take until 2012 (at

the earliest) to reduce this tightness. However, supply should be managed going forward

and elevated pricing will be the norm beyond 2012, never again reaching the pricing

level we witnessed only a few years ago.



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AGRICULTURE TECHNOLOGY

The U.S. is at the forefront of agriculture technology worldwide and, over the last 50

years, gains in productivity have been a driving force for US agriculture. The results have

been exceptional; for instance, the average amount of milk per cow increased from 5,314

pounds per year in 1950 to 18,201 pounds in 2000. Similarly, the average yield of cornper acre increased from 39 bushels in 1950 to 153 bushels in 2000, and each man-hour

of farm labour produced 12 times the farm output in 2000 as compared to 1950. The

primary reason for these improvements is the development of new technology and the

productivity increase in the US needs to be customized and replicated in other

developing nations as well.

In the U.S., agricultural inputs such as capital, labour, land, energy and chemical inputs

began to decline after 1980. However, agricultural output continued to grow and this

output growth was entirely driven by higher productivity. Additionally, the high growth

in productivity limited price increases and between 1948 and 2004, prices of agricultural

commodities increased at less than half the rate of economy wide prices. Here, it is

imperative to analyze trends over the long-term since agricultural productivity can

fluctuate significantly in the short-term primarily as a result of weather conditions.

Figure 138: Changes in output, input and total factor productivity18, U.S., 1948-2004

80

100

120140

160

180

200

220

240

260

1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003

Total output Total farminput Total factor productivity

Source: ERS USDA

Agriculture in the U.S. witnessed a decline in the inputs of crop land, labour and

financial capital invested and an increase in price of the seeds, agrochemicals and

machine farm equipment. The decline in inputs of crop land, labour and capital has been

much higher than the increase in costs of seeds, agrochemicals and machinery from

1948 to 2004 leading to a marginal decline in the inputs while the farm output hasincreased by 170%. This translates into a CAGR of 1.8% for total factor productivity (TFP)

in US agriculture. Similarly, labour inputs have declined by 0.6%, capital by 0.1%, while

the material inputs have increased by 0.6% annually from 1948 to 2004. Agricultural

productivity growth in the US has been achieved in two distinct phases. The first phase

18 Total factor productivity measures total output per total inputs, or the overall efficiency of

agricultural production.

The average yield of corn per acre increased from 39bushels in 1950 to 153bushels in 2000 due toimprovements in productivity

as a result of better technology.



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from 1948 until 1980 witnessed substitution of labour with non-labour inputs of agro-

chemicals and machinery to increase productivity. However, since the 1980s, there has

been a decline in both labour and non-labour inputs, without a decline in farm output

growth.

The growth in the TFP has been consistently positive over the long term. However, the

growth in TFP has not been uniform and in the short term, there have been significant

declines due to oil shocks in 1974 and 1979, and droughts in 1983, 1988 and 1995. The

decline in productivity in 1983 was compounded by the US Government’s payment in

kind (PIK) program. The US Government, confronted with a huge agriculture surplus at

that time, launched the PIK program to discourage farmers from increasing agricultural

production. Long term production growth is affected by Government policies oninvestments in irrigation, transport networks, grain handling facilities and agro-R&D,

market development and trade policies. As observed in the TFP data, weather conditions

play a very important role in productivity. Any change in the global weather patterns can

have a disruptive effect on the global agricultural growth, threatening global food

security. Additionally, global macro economic events such as oil shocks and wars, and

Government-led interventions in the agriculture market can distort the market and

disrupt the growth of agriculture productivity.

Figure 140: Growth factors for US agriculture and industry, 1960-2004

US Agriculture US Industry

Average annual growth in output 1.7% 3.2%

Factors affecting output

Growth in non-labour inputs 11.8% 54.1%

Growth in labour hours -34.2% 23.7%

Growth in labour quality 5.6% 8.8%

Growth in TFP 116.8% 13.4%

100.0% 100.0%

Source: ERS USDA

Figure 139: Trends in Total Factor Productivity, U.S., 1948-2004

0

50

100

150

200

250

1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003

-15%

-10%

-5%

0%

5%

10%

Total factor productivity Trend Deviation RHS

Source: ERS USDA



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To summarize, productivity growth has been the most significant growth driver for US

agriculture over the last 45 years. While the industrial sector exhibited high growth as a

result of high investments and increase in labour, the total factor productivity of the

industrial sector has been much lower than the agriculture sector. Consequent to a

decline in overall labour hours, it had a (-34.2%) impact on the agriculture output. The

corresponding figure for industry’s output growth was +23.7%. Non-labour inputscontributed a significant 54.1% to output growth for the industrial sector while the

corresponding figure for agriculture was 11.8%.

Due to the improvement in agricultural productivity, the US agriculture sector has

managed to keep the increase in prices of food and other agriculture products atreasonable levels as compared to the general price index in the US. This has benefited

farmers as well as agro-product based industries. The agriculture input price index has

generally moved along with the general price index, however, the input price index

changed significantly during the 1973 oil crisis. The gains in agriculture productivity

have benefitted consumers by keeping the increase in prices well below the general price

index and have helped US agriculture to maintain its competitiveness with the rest of the

world.

Development of new biofuels

The high demand for petroleum products and consequently, their high prices have led to

significant interest in alternative sources of energy. Biofuel, being a renewable source of

energy, is an attractive alternative propostion. Biofuels are now used globally and areconsumed extensively for automotive transport and as a result, this industry is growing

rapidly across the world.

Since 2000 and beyond, there has been a renewed interest in biofuel research and

development primarily due to the rising oil prices, apprehension over the possible oil

Figure 141: Price movements in U.S., 1948-2004

0

100

200

300

400

500

600

700

1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003

General Price Index Output Price Index Input Price Index

Source: ERS USDA



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peak19, greenhouse gas emissions, rural deveolopment interest and instability in the

middle east (the major exporters of oil). Biofuels can be produced from any carbon

source. Until now, the types of biofuels can broadly be categorized into three different

generations.

The first generation biofuels refers to biofuels extracted from sugar, starch, vegetable oil

or animal fats. Ethanol fuel is the most commonly used under this category. It is

extracted from the fermentation of sugars derived from wheat, corn, sugar cane etc.

Although biofuels are considered to reduce global warming and improve energy security,

the use of corn-based ethanol poses several problems. The entire US corn crop if

dedicated to ethanol production would only cover about 15% of the gasoline demand.

Additionally, the release of nitrous oxide from rapseed oil and corn contributes more to

global warming than the fossil fuel they replace. In addition, diverting crops from food to

fuel has created a high demand for crops used as biofuel, thereby increasing prices of

food products. Farmers are now more interested in cultivating feedstocks for biofuels as

it is more profitable thus creating problem for global food security. Such significant

limitaions of the first generation of biofuels have lead to the development of second

generation of biofuels.

The second generation biofuels are derived from non-food crops, which include waste

biomass, stalks of wheat, corn, wood etc. All plants contain cellulose which have sugar

molecules. These sugar molecules can be fermentated to produce ethanol. Supporters of

biofuels consider second generation biofuel as a more viable solution for the replacement

of non renewable sources.These biofuels do not compete with food crops nor do they

require any extra land to grow thereby solving the problem of lower food production and

tropical deforestation. Many second-generation biofuels are still under development such

as biohydrogen, biomethanol, DMF (2,5-dimethyl furan), bio-DME (dimethyl ether),

Fischer-Tropsch diesel, biohydrogen diesel, mixed alcohols and wood diesel. Second

generation biofuel techniques have the capacity to produce more biofuel with

environmental gains but a major constraint is the eastablishment of second genration

biofuel manufacturing facilities, which are estimated to require high capital investments.

Altough second generation biofuels have several advantages over its predecesors, third

generation biofuels are expected to be the most promising fuels for the future. Algae fuel,

also known as oilgae, is a third generation biofuel extracted from algae. Algae is a low

cost input feed which can produce almost 30 times more energy per acre as compared to

first generation biofuels. It can produce 5,000 galllons of bio diesel in a year from an

acre of land. Additionally, it helps in reducing greenhouse gases by capturing large

amounts of carbon dioxide and nitrogen oxide present in the atmosphere. According to

the United States Department of Energy, about 39,000 square kilometres of algae

farming will be enough to replace the total demand of petroleum in the country. If

cultivated properly, micro-algae can yield 10 times more oil than Jatropha, a second

generation biofuel that can be grown in deserts, in the same piece of land. More researchis currently in progress to produce different fuels from algae cultures for making

biodiesel, bioethanol, biomethanol, biobutanol and other biofuels.

19 Peak oil is the point of time when extraction of oil from the earth reaches its maximum and thenstarts declining. Some experts believe that 2000 was the year of global peak oil production.

Algae fuel, a third- enerationbiofuel, can produce almost 30

times more energy per acre ascompared to first-generation

biofuels such as corn.



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Precision agriculture

Due to the increasing costs of agro-inputs and concerns of the environmental impact of

the intensive agricultural practices followed in the US, emerging agro-technologies focus

on getting optimal yields from the land rather than the maximum possible. A doctrine of

precision agriculture has been proposed; it has been defined as “a management system

that is information and technology based, is site specific and uses one or more of thefollowing sources of data: soils, crops, nutrients, pests, moisture, or yield, for optimum

profitability, sustainability, and protection of the environment” (adapted from Precision

Ag. 2003). It is a ‘need-based’ input application policy instead of uniform application of

inputs. It is expected to assist farmers to increase the economic returns from agriculture

while minimizing the environmental impact to soil, air and water bodies. It helps

farmers in identifying the specific areas in their fields that require extra application of

fertilizers to boost yields, optimal water application in different farm segments and

application of herbicides and pesticides to the infested farms only. Various tools such as

GPS guided auto-steer equipment is used to precisely align the equipment. A light bar

guided system is the most inexpensive such system; it shows the path to the tractor

operator to uniformly fertilize a farm without overlapping pesticide application. The

farmer obtains the crop patterns of his farms using satellite-based remote sensingsystems. He then looks for any crop growth deviations and checks in the field for any

nutrient deficiency or crop infestation and takes appropriate remedial actions.

The soil samples are tested for each farm to assess the nutrient requirements of every

field. All this information is utilized to plan the nutrient application for every field and is

entirely computerized and synchronized with different farm equipment. Modern farm

equipment is equipped with variable flow systems that work in accordance with data

inputs in the central computers. This delivers plant nutrients in the right quantity and to

the right areas in the farm. The key benefits of precision agriculture are reduced

utilization of fertilizers and agro-chemicals, thus increasing farm productivity and

reducing the impact on the environment. The soil not suitable for crop growing can be

identified and set aside as fallow. Variable rate irrigation systems instead of thetraditionally used center pivot irrigation system is used when multiple crops are being

sown in the same fields or the soil moisture holding characteristics vary widely in the

field. This helps in optimum application of water in the fields.

Drip irrigation technology is used in water stressed regions of the world. It has been

successful for growing horticultural and floricultural crops. It delivers the precise amount

of water right at the roots of the plants. This helps in significantly reducing water

requirements as the entire field is not irrigated and field vaporization losses are

minimized. The plant nutrients required are also applied using the drip irrigation,

consequently eliminating any waste of nutrients and preserving soil salinity. Due to

restricted moisture availability in the field, the growth of weeds is also restricted. A

variant of drip irrigation is sub-terrain irrigation used for deep rooted trees. Perforated

water pipes are inserted into the soil near the deep rooted trees and water is supplied to

them. This helps in keeping sub-terrain soil moist around the plants while achieving high

water saving. Drip irrigation however suffers from high initial cost involved in setting up

the irrigation system and finds utility in regions where water availability is limited.

Agriculture technology in developing countries

Success in the agriculture business relies on multiple externalities like quality and

reliability of water availability, favourable weather patterns, optimal soil condition, seed



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input, fertilizers and agrochemicals applied, insect, pests & weed growth, degree of farm

mechanization, market demand and supply situation, weather and calamity insurance,

availability of bank credit, supporting infrastructure, handling and transportation

networks, etc.

In contrast to the farmers in the developed countries, the farmers in the developing

countries face numerous disadvantages. The developing country farms are dependent onrains and do not have assured irrigation facilities. The farmers do not have access to

local weather patterns resulting in considerable yield reduction, limited availability of

soil testing facilities to recommend optimal fertilizer application and poor

communication flow of market price trends. Due to the abundant availability of labour

and fragmented land holding of the farm, farm mechanization levels are low. The rural

transport and distribution infrastructure networks are weak leading to higher costs of

transportation and distribution for both agricultural inputs and agricultural produce.

Formal institutions (banks, farmer cooperatives) to disburse farm credit are absent or

inadequate, forcing farmers to rely on money lenders charging usurious interest rates.

e-Choupal in India has emerged as a successful example of private sector rural

development mechanism. e-Choupal is a village-based farmer information dissemination,agro-input supplier and grain procurement system, pioneered by a diversified Indian

company, ITC India Ltd. Choupal in the local language in India (Hindi) means a centrally

located place to meet, discuss and trade. e-Choupal has provided farmers in India access

to information on prevalent global (CBOT) and regional wholesale market prices of the

farm crop output and district level weather forecasts. This helps the farmer decide which

would be the most lucrative crops to grow. With the availability of the weather forecasts,

the farmer is able to advance or postpone the sowing of the seeds to protect its crop from

adverse weather conditions. A local village farmer is appointed the coordinator to

manage the e-Choupal centre. This facilitates easy communication and trust building

between the coordinators and the farmers as coordinators are fellow village men. The

coordinators are trained by the ITC centers on usage of computers, crop quality testing

machines and soil quality testing kits.

The coordinators at the village level provide value added services of soil testing facility,

quality seeds and trends in agriculture to help the farmer decide the crops they should be

sowing to get the best returns for their efforts. The soil testing facility helps farmers

assess the deficiencies of the soil and allows them to decide the optimum application of

the soil nutrients and fertilizers to get the best yields. With the availability of higher yield

seeds through e-Choupal, farmers can select the better varieties of seeds to improve the

per acre yield. During the harvest season, the e-Choupal sets the benchmark

procurement prices for the crops on a daily basis. These prices are based on the prices

prevalent in the wholesale market. The crops are directly purchased from the cultivators

at the e-Choupal centers. The crop quality is tested at e-Choupal and the farmer is paid

according to the quality of the produce. The farmer gets the money immediately and isnot at the mercy of the middlemen at the wholesale market; the previously prevalent

system was highly inefficient and involved at least six to eight middle men between the

farmer and the end consumer. By selling to e-Choupal, the farmer benefits by getting a

fair price for a better quality crop, saves the transportation and travelling costs to the

local wholesale market, gets immediate payment for his crop reducing his interest

burden.

e-Choupal, an initiative inIndia, offers farmersinformation on commodity

prices, supplies most inputs,and also procures grains fromthem making the supply chainmore efficient and reducing

the role of middlemen.



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e-Choupal, therefore, acts as a single point shop for the farmer to purchase the key agro-

inputs of seeds, fertilizers and agro-chemicals like pesticides, and herbicides All these

facilities help the farmer concentrate on his core competency of managing the farm

activities. The e-Choupal network is beneficial to ITC as well by helping them manage

their agriculture procurements better. The company is able to grade the agriculture

crops at the farm gate itself leading to better quality management of procurement; ithelps them in having a complete traceability record of the produce starting from the farm

gate. Traceability of the food to the farm gate is an important prerequisite for

agriculture-based exports to European Union. The company has also been able to setup

an inbound distribution setup in the rural India which helps the company to sell

agricultural inputs and its FMCG products in rural India. Financial institutions like bank

and microfinance groups can associate themselves with the e-Choupal network to

provide affordable credit to the farmers.

Consequently, e-Choupal has become an important point of communication, information,

trading for the farmers of rural India. It was launched by ITC in June 2000 and today

reaches out to about 3.5 million Indian farmers in 31,000 Indian villages through 52,000

kiosks. This is expected to assist the farmers in raising the productivity in their farms

and achieve greater economic prosperity and better agriculture sustainability in India,

which continues to rely on small scale agriculture as compared to the intensive

agriculture approach of the developed nations.



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FINAL THOUGHTS

As we have stated throughout the report, the current global food crisis is the product of

years in the making. As a massive amount of people in the developing world attain middle

class status, and demand better nutrition, it creates a ripple effect in the demand forlivestock, grains, arable land, irrigation, genetic seeds and fertilizer, to name a few. As this

wave of change occurs, our agricultural resources are being strained and many individuals

are finding a world with much higher food prices due in part to low levels of inventories of

various commodities and significant increases in the input costs of final downstream

products. Compounding the issue are the numerous governments that failed to develop

strategies to help alleviate some of the issues that we see today. Although we do not believe

corn to be the solution to America’s energy woes, to assume the world’s food crisis should

be blamed on a fraction of the world agriculture story is incredibly misleading, in our

opinion. Moreover, we feel for foreign governments to state the same is a simple case of

shifting blame from either their lack of foresight or their inability to develop food security

for their respective populations.



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Potash Corporation of Saskatchewan Inc.

POT : TSX : C$211.25

POT : NYSE

BUY

Target: C$425.00 Keith Carpenter, MBA, CFA [email protected]

COMPANY STATISTICS:

52-week Range: C$76.96-246.29

Avg. Daily Vol. (000s): 3560.0

Market Cap (M): C$68,884.6

Shares Out (M) basic: 315.7

Shares Out (M) diluted: 326.1

EARNINGS SUMMARY:FYE Dec 2006A 2007A 2008E 2009ERevenue(M): US$3,377 US$4,764 US$11,157 US$19,106

EV/EBITDA(x): 64.2 38.0 11.8 5.9

EPS: US$2.08 US$3.52 US$12.40 US$25.21

P/E (x): 101.8 60.0 17.0 8.4

SHARE PRICE PERFORMANCE:

COMPANY SUMMARY:Potash Corporation of Saskatchewan is the world’slargest producer of potash, second-largest nitrogenproducer by ammonia capacity and the third-largestproducer of phosphate. In 2007, Potash Corp. produced17% of the world’s potash, 2% of the world’s ammonia,and 6% of the world’s phosphoric acid.

All amounts in US$ unless otherwise noted.

Metals and Mining – Agriculture

INITIATING COVERAGE WITH A BUY –ADDING TO OUR BEST IDEAS LISTInvestment thesis

We are initiating coverage of Potash Corporation of Saskatchewan Inc.

(Potash Corp.) with a BUY rating based on the following conclusions:

· Strong fertilizer markets throughout our forecast period

As we highlighted in our thematic piece, “The Modernization of the

BRICs”, we believe the fertilizer market will be robust for years into

the future, specifically the potash and phosphate sectors. Prices are

expected to remain strong as supply will not be able to meet the

growth in demand over the next five years. With current pricing

expected to rise into 2009 and 2010, earnings should continue to

increase.

· Strong margin expansion throughout our earnings forecast

Given the production profile, our view on fertilizer pricing

throughout our forecast period, the firm’s low operating cost and

growth profile over the same period, Potash Corp. should be

accumulating significant earnings, we believe unmatched by its

peers.

· Adding to its position as world leader in potash production

Potash Corp. has implemented a growth strategy that should see it

adding on average 1mt or production capacity every year through

2012.

· Valuation

We value the shares of Potash Corp. on a 17x multiple of 2009E EPS

of $25.21, for a target price of C$425.00, representing a 103%

return to the current share price.



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INTRODUCTION

Potash Corp. is the world’s largest producer of potash, second largest nitrogen producer by

ammonia capacity and the third-largest producer of phosphate. In 2007, Potash Corp.

produced 17% of the world’s potash, 2% of the world’s ammonia and 6% of the world’s

phosphoric acid. The company is well positioned to capture stronger margins across its

business units as we believe the fertilizer story is still in the early days of an upswing as

the world will require significant amounts of fertilizer at prices higher and for longer than

the investment community has assumed to date.

Strong fertilizer pricing throughout our forecast period

As we detailed in our thematic piece, “The Modernization of the BRICs”, we believe that

fertilizer pricing has performed a step-change, as a solution to the world’s food crisis has

become dependent on a variety of factors, one of which is the increased usage of fertilizer.

Among the fertilizers, we believe potash has the strongest outlook over the near, medium

and long term. A close second, phosphate pricing should remain strong until at least 2012.

Although we place nitrogen third due to our concern over high gas prices, we do note that

Potash Corp. should benefit from significant margins at its low-cost Trinidad operations.For these reasons, we believe the company is well positioned for an explosion of margins

over our forecast period.

Strong margin expansion throughout our earnings forecast

Given the production profile, our view on potash pricing throughout our forecast period,

the firm’s low operating cost and growth profile over the same period, Potash Corp. should

accumulate significant earnings, we believe unmatched by its peers. Margins will increase

significantly beyond levels witnessed to date as the company expands output, prices

increase and a large portion of its operating costs remain muted. Potash Corp. should

generate earnings next year that in hindsight could prove today’s stock price is very

inexpensive.

Adding to its position as world leader in potash production

Through its production growth profile, we should see an average of 1mt of potash capacity

added by the company per annum through 2012 for a total growth in output of

approximately 50% over 2007 levels.

Where to next?

Many investors ask how long fertilizer companies can continue to enjoy upward

momentum in their respective share prices. As we have detailed in our thematic report,

due to the growth in demand of better food, the world requires more fertilizer in order to

grow those crops that are the inputs for better food. As this demand has been and is

expected to remain strong, and the supply of that fertilizer is capacity constrained,

specifically in the potash and phosphate sectors, fertilizer producers should continue toincrease margins and earnings and therefore share prices. As we attempt to demonstrate

in our Valuation section at the end of this report, the thesis for owning Potash Corp. is

straightforward: the world requires more fertilizer. Throughout our forecast period, we

believe Potash Corp. will continue to benefit from increasing margins due to commodity

price increases; the company offers low potash operating costs; and the potash segment is

expected to see increasing production through 2012 of greater than 50% over 2007.

Finally, we believe that it is going to take some time to correct the current food crisis,



135


which has been building for years, much longer than the result of next year’s crops and

fertilizer application cycles.

THE COMPANY

Potash Corp. enjoyed significant earnings contributions from all three segments in 2007,

but we must highlight the contributions enjoyed by both the potash and phosphatebusinesses, and the forecast gross margins for 2008 as expected by the company for

illustrative purposes:

Figure 142: Gross margin contribution by segment

Source: Potash Corp.

Although the company produces a significant amount of ammonia, it is its competitive

advantage in the production of potash and phosphate that provides the most upside to

valuation. Within the potash segment, the company does not experience much inflation

within its operating costs. However, as we have detailed in our thematic report, the

structural issues within the potash market should ensure that prices remain elevated

throughout our forecast period. Within phosphate, although Potash Corp. has experienced

cost input pressures similar to its peers, due to the company being an integrated producer

of phosphate products, we expect margins to increase as input costs are increasing.

Furthermore, few companies can match Potash Corp.’s competitive cost advantage

regarding brownfield potash supply additions.

Potash strategy

From a competitive point of view, the potash commodity is the most insulated from a glut

of near- or medium-term supply additions. The barriers to entry are significant financially,

as well as from an infrastructure and time to production viewpoint. This allows the market

great visibility to assess the supply situation over the short, medium and long term. This

market structure enables Potash Corp. to bring significant new supply online in a timely

and cost-competitive manner, which is the cornerstone of the company’s rollout of



136


production expansions. Its first debottlenecking measures were announced at Rocanville in

2003 and completed in 2005, with several more announced after. We expect to witness

capacity growth of 57% between 2006 and 2012 (that has been announced), and an

anticipated further addition of 1.5mt by 2015, or sooner. Additionally, the company is

evaluating a potential greenfield project at Bredenbury, Saskatchewan. The company

expects to add on average, 1mt of new capacity per annum through 2012, providing an

earnings capability that will be quite significant (see Valuation discussion below). As seen

in 2006 when demand was temporarily disrupted by extended price negotiations with

significant offshore customers, the company follows a strategy of matching production to

market demand (that year pulled over 2 million tonnes offline) to prevent an oversupplied

market. The above-noted expansions should also allow Potash Corp. to be viewed as a

growth company. The combined potential earnings contribution from both the estimated

price increases and production expansions is enormous. Because the company began this

process of expansion several years ago, they are the only company that will see the full

benefit of the bullish outlook in potash over the next five years.

Figure 143: Planned potash capacity expansions


Phosphate strategy

Management is confident that that the phosphate business will be strong throughout our

forecast period; however, similar to its peers, expansions within the industry are more

difficult to locate. Organically, Potash Corp. is set to expand its Aurora facility in 2009 withthe addition of 180kt of P2O5 output. Due to the high quality rock at its North Carolina

operation, the company has the flexibility to move between product lines based on the

margin dynamics in any given year. This will serve the company well going forward in

order to benefit from a maximum gross margin. Regarding expansion outside its assets,

management is always looking but nothing is imminent. The company has stated that it

would look at opportunities where it can have more of a marketing focus, similar to potash

where price is more important than volume.



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Nitrogen strategy

Although the nitrogen business is expected to remain the smallest contributor to earnings

over our forecast period, it is a segment that will remain core to the company’s operations.

Management made a strategic move in 1997 to push forward with an offshore platform

through the addition of the Trinidad Nitrogen Complex. Due to the cost of natural gas,

Potash Corp. added this significant lower cost operation to its nitrogen portfolio. The

Trinidad complex accounted for 65% of 2007 ammonia production. Although nothing has

been announced regarding expansion within the nitrogen business, management is

exploring the possibility of expanding the Trinidad complex by adding a fifth train at 700kt

or larger due to the available space and infrastructure, and modular design of the existing

operation. If this addition can be accomplished on similar terms of the original gas

agreement, the low cost nature of the operation will continue to add to the company’s

bottom line and expanded earnings. We remain concerned about the impact of sustained

high natural gas pricing as it affects the margins on southern US operators, but with a

significant portion of the company’s nitrogen output coming from a lower-cost base

offshore, we believe this impact would be muted in that scenario.

OPERATIONSPotash operations

The company’s potash production comes from a total of seven plants (six in Saskatchewan,

and one in New Brunswick). Of the seven facilities, all but one (Esterhazy), are owned and

operated by Potash Corp. In 2007, the company produced 9.2mt of potash and has guided

to production of just over 10.0mt in 2008. Although the company has a stated nameplate

capacity of 13.2mt, as we will discuss in the Canpotex section below, this is not a realistic

attainable capacity.

Figure 144: Location of Potash Corp.’s potash operations




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Saskatchewan

Allan

The Allan facility produced 1.7mt KCI in 2007 and has a capacity of 1.9mtpa. The ore is

mined at a depth of approximately 3,400 feet and then processed into standard, granular

and soluble fertilizer products as well as industrial grade.

Cory

The Cory deposit is undergoing a debottlenecking and expansion project that will increase

capacity by 1.2mtpa to 2.0mtpa by mid-2010. Expected cost of the project is $890 million.

The facility produced 0.8mt in 2007. The mine is at a depth of approximately 3,400 feet

and currently produces only white MOP products (soluble and granular product, chicklets

and k-prills), however all tones in the debottlenecking/expansion will be red product

(fertilizer).

Esterhazy

Esterhazy is owned by Mosaic and has a capacity of 5.3mt. Through an agreement with

Mosaic, Mosaic mines and processes Potash Corp.’s mineral rights at Esterhazy. Under the

agreement and following the expansion at the mine in 2007, the most Potash Corp. can

receive from the mine is 1.313mt in a given year, with 453.6kt as a minimum. As prices

have reached all-time highs and capacity is very tight, Potash Corp. will be receiving

1.0mtpa from Esterhazy throughout our forecast period. The original Esterhazy agreement

was made in the 1960s under predecessor companies and contained a variety of

parameters, including the amount of ore produced. A timeframe of 2013 was originally

assumed as the end of the agreement. However, due to the recent ramp in production, that

end date has been moved forward, but the exact date of that push forward is open to

negotiation. Managements of both companies are in discussions on when the agreement

will and should conclude. It is possible that we may have a solution by year-end. We have

assumed that the allocation to Potash Corp. reverts back to Mosaic in 2012.

Lanigan

The mine produced 1.9mt in 2007 and has a current capacity of 3.8mtpa. The 1.5mtpa

debottlenecking project has a cost of $410 million and will be completed by July 2008.

Lanigan is Potash Corp.’ largest potash mine. It operates at a depth of 3,600 feet and

produces granular, standard and suspension potash products.

Patience Lake

Patience Lake is the only Potash Corp. mine that is solution mined. Originally a

conventional operation, it was converted to solution mining in 1988 following two periods

of closure due to flooding. The facility produced 0.3mt in 2007. The debottlenecking project

at Patience Lake should be completed by year-end 2008, adding 0.4mt in capacity at a cost

of $110 million. Nameplate capacity is 1.0mtpa (established before flooding), however it isnot expected to ever produce at that level. The mining operations are at approximately

3,300 feet below surface with final products consisting of lawn and garden and granular

grade potash for agricultural purposes.

Rocanville

Rocanville produced 2.6mt in 2007 and has a capacity of 3.0mtpa. Management

announced an expansion to the Rocanville operation, which includes the enlargement of

both the mine and the mill, with an expected completion date of 2012 at an announced



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cost of $1.8 billion. The mine depth is 3,150 feet and produces granular and standard

potash for agricultural purposes and standard industrial potash.

Sussex, New Brunswick

2007 production equaled the mine’s current capacity of 0.8mtpa. The company announced

in July 2007 that it was expanding the facility through the addition of a new mine and

expanded milling facility. The mine plan entails a 2.0mtpa greenfield mine (to replace the

existing 0.8mtpa mine plagued by brine inflow) and a 1.2 mtpa mill expansion with initial

production from the new deposit by year-end 2011 at an announced cost of $1.66 billion.

Mining occurs between 400-700m and produces both potash and salt.

Reserves

Figure 145: Potash reserves

Source: Company reports

Years of remaining life are based on current output rates. In addition to the reserves, the

company has mineral resources of significance. Due to the nature of the solution mine, the

company states that it cannot complete a reserve or resource calculation at Patience Lake.

Port expansion

Canpotex recently announced an over $500 million port capacity expansion, adding 11mt

of shipping capacity to its existing 12mt. The additional capacity will include an expansion

of its existing Vancouver facility as well as a new terminal at Ridley Island near Prince

Rupert, British Columbia. The added shipping tonnage is expected to be in service by 2012

in order to accommodate the expansion plans of its three member owners. We have

assumed Potash Corp. will pay approximately 55% of the cost due to its weighting within

Canpotex.

Bredenbury

Bredenbury is a greenfield site in Saskatchewan the company has deemed a target of

potential production growth. Historically, Potash Corp. completed geological work on the

site in the early 1980s with dozens of test holes and the inclusion of pilot holes having

been drilled for eventual shaft construction. The company is currently revamping the site

with 3D seismic testing (which wasn’t available in the early 1980s) in order to better

understand the geological formation with regard to anomalies. It would be a logical step

that this site would be added to the list of operational capacity additions during the 2015-

2020 period. Currently, management assumes that it will be able to add capacity through

brownfield expansions until the overall capacity is roughly 18mt of annual output.



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Phosphate operations

Potash Corp. produces phosphoric acid, solid and liquid phosphate fertilizers, animal feed

supplements and purified phosacid. The company operates two mines, three processing

plants and six feed plants in the US as well as a feed plant in Brazil.

Figure 146: Location of Potash Corp.’s phosphate operations


Aurora, North Carolina

This integrated plant consists of a phosphate mine and a processing plant. The mine

produces 6mtpa of phosphate rock and the plant can produce 1.2mtpa of phosphoric acid

(P2O5). The facility also boasts four sulphuric acid plants, four phosphoric acid plants, four

purified acid plants, a liquid fertilizer plant, a superphosphoric acid plant (SPA), a

deflourinated phosphate plant (animal feed), two granulation plants (for production of DAP

or MAP), and a silicon tetrafluoride plant. The Aurora facility hosts a phosphate rock that

allows the company to produce purified acid for the industrial market. Historically, this

product is a higher margin product that is sold pursuant to long-term contracts. Of course,during the recent increase in DAP pricing, those existing contracts have become lower

margin contracts relative to the current margins enjoyed in the production of DAP. As the

company rolls those contracts forward, we expect to see an increase in margins quarter

over quarter throughout 2008, and then a large increase in margins during 2009 as a large

portion of the existing contract is renewed at significantly higher prices.

White Springs, Florida

The company’s White Springs facility encompasses a mine and two processing plants

(Suwannee River and Swift Creek). The Suwannee plant is home to two sulphuric acid

plants, one phosacid plant, two DAP plants, an SPA plant, a dicalcium phosphate plant and

a DFP plant. At the Swift Creek complex, the company operates two sulphuric acid plants,

a phosacid plant and an SPA plant.Other facilities

Potash Corp. produces animal feed at its Marseilles, Illinois; Weeping Water, Nebraska;

Joplin, Missouri; and Sao Vincente, Brazil facilities. In addition, the company owns a

technical and food grade phosphate plant in Cincinnati, Ohio, and terminal facilities at

Morehead City, North Carolina, and Savannah, Georgia.



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Reserves

Both the Aurora and White Springs complexes process the phosphate rock that is mined at

site. At the Geismar, Louisiana, nitrogen facility, phosphate rock is purchased under a

long-term agreement with a Moroccan government-owned entity, with pricing set at

predetermined dates at negotiated rates.

Figure 147: Phosphate Proven and Probable Reserves


At current output rates, the above reserves would provide a further 88 years of productionat Aurora and 16 years at White Springs. It should be noted that the above grades are

listed post-beneficiation.

Sulphur

Potash Corp. purchases sulphur in order to produce sulphuric acid, which is one of the

primary ingredients in the production of phosphoric acid. The company currently sources

its sulphur needs from oil refiners primarily in North America and Latin America, with

sulphur price contracts typically established on a quarterly basis.

Ammonia

Ammonia is added to phosphoric acid to produce both DAP and MAP. Potash Corp. sources

a portion of these ammonia requirements from third parties at market rates.Nitrogen

Potash Corp. owns four nitrogen facilities (three in the US and one in Trinidad). The

company produces nitrogen fertilizer, nitrogen feed and industrial products. In 2007,

Potash Corp. produced 3.2mt of ammonia and had a nameplate capacity of 3.9mt. A

substantial portion of the ammonia output is upgraded to urea solids, nitrogen solutions,

nitric acid, and ammonium nitrate solids.

Point Lisas, Trinidad

The complex in Trinidad is the company’s newest and largest facility with a gross

ammonia capacity of 2.2mt. In 2007, gross ammonia output totalled 2.1mt with a portion

of that upgraded into urea. The urea is sold into Latin America and the ammonia isshipped to end users primarily in the U.S. The company has secured a long-term low gas

contract for the facility (see below) and long-term charters of specialized vessel for the

movement of ammonia into several available deepwater terminals in the US Gulf.



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Augusta, Georgia

The facility has a gross ammonia capacity of 0.7mt with 2007 output of 0.6mt. The plant

has the capability to upgrade the ammonia to urea, nitric acid, ammonium nitrate and

nitrogen solutions.

Lima, Ohio

The Lima operation produced 0.5mt of ammonia in 2007 and has a gross capacity of

0.6mt. The plant upgrades ammonia to urea, nitric acid and nitrogen solutions.

Geismar, Louisiana

The facility is the company’s smallest with a gross ammonia capacity of 0.5mt. The plant

has the capability to produce nitric acid and nitrogen solutions. In June 2003, Potash Corp.

discontinued ammonia and nitrogen solutions sales due to high natural gas prices and

subsequent low margins. In September, management decided to restart nitrogen solutions

output but ammonia output remained nil for 2007 (necessary ammonia is imported and

carbon dioxide required to make urea is purchased off a pipeline). The Geismar facility has

an associated phosphate operation, including a sulphuric acid plant, a phosacid plant and

a liquid fertilizer plant. The majority of the phosacid production from Geismar is soldunder a long-term contract to an industrial customer.

Natural gas

Potash Corp. employs hedging contracts for its natural gas requirements in the US. In

Trinidad, Potash Corp. has multiple long-term take or pay contracts for natural gas that

utilizes pricing formulas based on the prevalent market price of ammonia. The Trinidad

contracts supply 100% of its needs through 2010, 90% in 2011, 83% in 2012, 67% in 2013,

56% in 2014-15, and 51% in 2016-2018. Currently, 62% of the company’s gas

requirements are for its Trinidad operation, with the remainder used in the U.S. facilities.

CANPOTEX

Canpotex is owned by Potash Corp., Mosaic and Agrium. It is the marketing arm for all

non-North American sales of Saskatchewan potash for its three owners. Historically, the

sales of potash are done on a spot basis, with India and China the major exceptions.

Contracts with China have typically been for 12 month (calendar year) durations, while

contracts with India are with durations of 6-12 months. As part of the Canpotex

agreement, all new capacity enhancements – if the company desires to include these

potential volumes in their Canpotex allocation calculation -, are to be proven through a 90

day operational trial of the additional capacity. A company will attempt to run the plant at

its maximum output over that period in order to have maximum impact on raising its

allocation. However, this is an inaccurate test to where a plant can run during normal

operations due to the regular maintenance schedule and execution of a sustainable mining

plan at any facility. There are a few other factors that make the numbers unattainable. Asan example to Potash Corp., the Patience Lake capacity relates to a trial run of the old

conventional mine that was flooded. Although it currently operates as a solution mine,

about 0.5mt of the nameplate capacity is no longer possible of attaining. In essence, it is

grandfathered under the Canpotex system. We highlight this for two reasons: one, to

understand the difference between operational and nameplate capacity; and two, to

display why alleviating the current supply constraints in the marketplace with this “excess

capacity” isn’t as easy as turning a switch.



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STRATEGIC INVESTMENTS

Potash Corp. owns investments in Israel Chemicals Ltd. (10%), Arab Potash Company

(28%), Sociedad Quimica y Minera de Chile (SQM) (32%) and Sinofert Holdings Ltd. (20%).

These investments cost the company $1.25 billion and have a current market value of

greater than $10 billion, or $35 per Potash Corp share. It is management’s view that these

potash-related investments are long-term holdings and provide significant global strategicvalue. The company has the intention of adding further levels of ownership in the future

wherever possible.

CAPITALIZATION

There are 316 million shares outstanding (326 million diluted). As of March 31, 2008, the

company had debt of $1.4 billion versus cash of $365 million.

Share repurchase program

In January, Potash Corp. announced a normal course issuer bid for up to 5% of the

outstanding shares of the company over a one-year period. This would equate to a

potential repurchase of approximately 15.8 million shares.

Dividend policy

Potash Corp. currently pays out US$0.10 per share in the form of dividends on a quarterly

basis.

INVESTMENT RISKS

Brine inflow

Water inflow is the single most structural risk to a potash mine. It is not an uncommon

event and is often dealt with through the use of pumps. If water inflow becomes

uncontrollable, it can ruin a mine which would have a material impact to the company’s

earnings.

Sulphur

As one of the key ingredients in the production of phosphate fertilizers, the company

requires an uninterrupted supply of sulphur. If the supply were constrained, the

production of the end product would be negatively impacted, affecting the earnings

contribution to the company.

MANAGEMENT

Bill Doyle, President and Chief Executive Officer

Mr. Doyle joined Potash Corp in 1987 as President, Potash Corp. Sales, covering all of thefirm’s potash sales. In 1995, he assumed the role of Executive Vice-President, where he

held responsibility for all potash, phosphate and nitrogen sales. On July 1, 1998, Mr. Doyle

was appointed President and Chief Operating Officer, and a year later, was appointed Chief

Executive Officer. Mr. Doyle also serves as Chairman of Canpotex Ltd.



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Wayne Brownlee, Chief Financial Officer

Mr. Brownlee joined Potash Corp in the 1980s where he coordinated the privatization of

Potash Corp. in 1988. From 1988 until 1999, Mr. Brownlee’s main role was overseeing

expansion and business development. He was appointed Chief Financial Officer in 1999.

James Dietz, Chief Operating Officer

Mr. Dietz joined Potash Corp in 1997 as the EVP, Potash Corp. Nitrogen and lead the

nitrogen unit until his appointment as Chief Operating Officer in 2000. Prior to joining

Potash Corp., Mr. Dietz was employed in the chemical industry within North America and

Europe.

VALUATION

We derive a C$425 per share target price for Potash Corp. by applying a 17x multiple of

2009E EPS of $25.21 using the following assumptions:

· Production of 11mt of potash, 4.2mt of phosphate and 5.7mt of nitrogen fertilizers in

2009.

· An average netback to the mine potash price of US$970/t. An average phosphate

product price of US$1075/t and an average nitrogen product price of US$425/t.

· An effective income tax rate of 29%.

· A potash operating cost per tonne of $78/t. Phosphate and nitrogen segment operating

costs of US$534/t and US$317/t, respectively.

· A CAD/USD exchange rate of 1.0.

Based on these assumptions, Potash Corp. is currently trading at a 51% discount to our

target price of C$425.

CONCLUSION We believe Potash Corp. is well positioned to continue to benefit from our strong fertilizer

outlook due to its leadership in production, low cost assets and strong production growth

going forward. Furthermore, we believe the significant increase in the company’s earnings

over the next few years will prove current valuations on the stock price to be very

conservative. For these reasons, we initiate coverage of Potash Corp. as our Best Idea with

a BUY rating and a 12-month target price of C$425.00.



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The Mosaic Company

MOS : NYSE : US$129.34BUY

Target: US$210.00 Keith Carpenter, MBA, CFA [email protected]

COMPANY STATISTICS:

52-week Range: US$32.50-163.25

Avg. Daily Vol. (000s): 6,595.7

Market Cap (M): US$57,699



EARNINGS SUMMARY:FYE May 2006A 2007A 2008E 2009E

Revenue (M): US$5,179 US$5,774 US$9,159 US$17,306

EV/EBITDA(x): 323.0 61.3 19.1 6.4

EPS: US$(0.94) US$1.01 US$4.16 US$13.22

P/E (x): NM 128.5 31.1 9.8


COMPANY SUMMARY:Mosaic is the world largest producer of phosphatefertilizer, the largest producer of phosphate-based animalfeed ingredients in the United States and the world’s

third-largest producer of potash fertilizer. During fiscal2007 (May year-end), the company produced 7.9mt of phosphate fertilizers and 7.9mt of potash fertilizers.



INITIATING COVERAGEInvestment thesis

We are initiating coverage of The Mosaic Company with a BUY rating

based on the following conclusions:


As we highlighted in our thematic piece, “The Modernization of theBRICs”, we believe the fertilizer market will be robust for years into


expected to remain strong as supply will not be able to meet growth

in demand over the next five years. With current pricing expected to

rise into 2009 and 2010, earnings should continue to increase.

· Strong margin expansion throughout our earnings forecast

Given the company’s position as the world leader in phosphate and

the world’s third-largest producer of potash, our view on product

pricing throughout our forecast period, and the firm’s low operating

cost in potash, Mosaic should accumulate significant earnings.

· Positioning the company for the future with added potash capacity

Mosaic has implemented a growth strategy in potash that should

position the company for significant additional earnings

contributions beginning in 2012.

· Valuation

We value the shares of Mosaic on a 16x multiple of F2009E EPS of

US$13.03, for a target price of US$210.00, representing a 61%

return to the current share price.



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INTRODUCTION

Mosaic is the world largest producer of phosphate fertilizer, the largest producer of

phosphate-based animal feed ingredients in the United States and the world’s third-largest

producer of potash fertilizer. During fiscal 2007 (May year-end), the company produced

7.9mt of phosphate fertilizers and 7.9mt of potash fertilizers.


As we detailed in our thematic report, “The Modernization of the BRICs”, we believe that

fertilizer pricing has performed a step-change, as a solution to the world’s food crisis has

become dependent on a variety of factors, one of which is increased usage of fertilizer.

Among the fertilizers, we believe potash stands to have the strongest outlook over the near,

medium and long term. A close second, phosphate pricing should remain strong until at

least 2012, positioning the company for an explosion of margins from two significant

contributors to earnings.

Strong margin expansion throughout our earnings forecast

Given the company’s position as the world leader in phosphate output and the world’sthird-largest produce of potash, our view on potash pricing throughout our forecast period,

and the firm’s low operating cost in potash, Mosaic should accumulate significant earnings.

Positioning the company for the future with added potash capacity

Mosaic has implemented a growth strategy in potash that will position the company for

significant additional earnings contributions beginning in 2012. The company has the

ability to increase production through brownfield capacity expansions at its existing

operations. Although the company will not see a significant impact to output until 2012, it

should enjoy a massive increase in production capacity at that time due to announced

expansions and the reversion of the third-party tolling agreement at Esterhazy.

Where to next?Many investors ask how long fertilizer companies can continue to enjoy upward





specifically in the potash and phosphate sectors, fertilizer producers will continue to

increase margins and earnings, and therefore share prices. As we attempt to demonstrate

in our Valuation section at the end of this report, our thesis for owning Mosaic is

straightforward: The world requires more fertilizer. Specific to Mosaic, the company

should continue to benefit from increasing margins due to commodity price increases and

low potash operating costs. Finally, we believe that it is going to take some time to correct

the current food crisis, which has been building for years, much longer than the result of next year’s crops and fertilizer application cycles.



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THE COMPANY

Mosaic was formed in 2004 following the merger of IMC Global Inc. and the Cargill Crop

Nutrition fertilizer businesses of Cargill Inc. Under Mosaic, IMC Global comprised the

potash business and approximately 25% of the phosphate business, while the fertilizer unit

of Cargill accounted for approximately 75% of the phosphate business and the Offshore

segment operations. Cargill is the majority shareholder of Mosaic, owners of approximately

65% of the outstanding shares. Mosaic operates under two principal business units with

the phosphate and potash segments combining for 99% of F2007 operating earnings.

Figure 149: F2007 segmented net sales and operating earnings


Phosphate strategy

As the world leader in phosphate output, and more importantly, an integrated producer of

phosphate fertilizers, Mosaic is well positioned to benefit from expanding gross margins

throughout our forecast period due to the continued strength in finished product pricing.

We reproduce a slide below from our thematic piece, “The Modernization of the BRICs” to

demonstrate how an integrated producer like Mosaic is benefiting from margin expansion

over that of a non-integrated producer (the marginal producer). Non-integrated producers

account for approximately 30% of the phosphate fertilizer market.



149


Figure 150: Mosaic versus non-integrated Indian producer


As an example, Mosaic requires 1.7 units of phosphate rock, 0.42 units of sulphuric acid,

and 0.22 units of ammonia to produce a unit of DAP. The most significant cost to a non-

integrated producer is the price of the rock, followed by the cost of the sulphur. Please

refer to the Fertilizer section in our thematic report for a more detailed explanation on the

input cost for the production of phosphate fertilizer. As Mosaic is sourcing its own rock

requirements and sulphur predominantly from within North America at lower prices thanthe non-integrated producer, the company has and should continue to enjoy margin

expansion based on the pricing of finished product that must clear that of a non-integrated

producer. As we forecast pricing to remain strong throughout our forecast period, Mosaic

should continue to enjoy strong margins in its phosphate division.

Although management would like to expand its phosphate business within the western

hemisphere and is currently looking at opportunities within Brazil, Argentina and Chile,

nothing has been announced. Locating the proper asset with access to the applicable

infrastructure remains the primary focus and issue within its expansion plans.

Management continues to monitor what assets it can add to expand its production base,

which ultimately would serve those markets within South America. Organically, the

company does not have the additional rock capacity to significantly increase its output of

finished phosphate products.

Potash strategy

As we detailed in our fertilizer segment piece, we believe the outlook for potash over the

short, medium and long term is positive due to strong demand and a restricted supply. The

only addition of new mine supply over our forecast period is through debottlenecking

projects. Mosaic will benefit from this market structure in two ways: through continued

strength in pricing that will expand margins for its low cost operating mines in



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Saskatchewan and through new production through the company’s debottlenecking

platform, which should provide strong additional growth in earnings in 2012, positioning

the company for a stronger future. Highlighting its confidence in the potash markets,

Mosaic has announced growth plans for its potash build-out through 2020 (Figure 151).

The company details a 5.1mt annual capacity expansion at its existing facilities. What is

important to note is the ramp in production in 2012. In addition to the 1.3mt expansionthat will be added that year, we forecast the third-party tolling capacity of 1.3mtpa at

Esterhazy to revert to Mosaic in 2012, netting the company total growth of 2.6mt, or 33%

of fiscal 2007 output. It is worth noting the cost differential when expanding capacity

versus adding new capacity. All of these expansions will utilize some of the existing

infrastructure at the current operations, making it a cheaper alternative to greenfield

expansions. Most importantly, the reversion of the 1.3mt at Esterhazy will not cost the

company any capital as it is a portion of current mine production. In line with its Canpotex

partners, Mosaic will be adding capacity over an extended period (12 years as outlined by

the company), ensuring there is no supply shock that would be detrimental to the industry

or Mosaic’s expansion plans. Keep in mind that the projects that are the furthest out will

not be put forward immediately and still provide the company with flexibility to amend the

expansion plans, as the market evolves.

Figure 151: Time chart for potash expansions

Source: Mosaic

OPERATIONS

Phosphate operations

Mosaic operates five mines and three concentrates plants in Florida and a concentrates

plant in Louisiana. In fiscal 2007, Mosaic produced 16% and 57% of global and US’s

phosphate fertilizer output, respectively. Mosaic produces phosphoric acid (P2O5),

diammonium phosphate (DAP), and monoammonium phosphate (MAP). The company

produced 4.1mt of P2O5 (capacity of 4.4mt), 7.9mt of phosphoric fertilizers (capacity of 9.4mt), and full capacity of 0.9mt of animal feed phosphate. It must be noted that the

stated capacity for both phosphate and potash facilities is based on trial runs that excluded

maintenance downtime, and thus stated capacities will be higher than realized production

capabilities over a given year.



151


Figure 152: Map of phosphate operations

Source: Mosaic

Concentrates plants

Bartow (Florida)

The phosphate plant has a P2O5 capacity of 1.0mtpa and a processed phosphate annual

capacity of 2.0mt.

New Wales (Florida)

With an annual capacity of 1.7mt of P2O5 and 3.9mt processed phosphate, this plant is the

company’s largest. In addition the plant produces animal feed phosphates with a capacity

of 0.7mtpa.

Riverview (Florida)

The plant has an annual capacity of 0.9mt P2O5, 1.7mt of processed phosphate and

0.2mtpa of animal feed phosphates.

Uncle Sam/Faustina (Louisiana)

The plant at Uncle Sam has a capacity of 0.8mt of P2O5, which provides the feedstock for

the 1.8mt processed phosphate capacity plant at Faustina. The Faustina plant also

produces ammonia.

Phosphate Mines

The company owns the Four Corners (annual capacity of 6.4mt), South Fort Meade

(5.9mt), Hookers Prairie (1.8mt), Wingate (0.9mt), and Hopewell (0.5mt) phosphate mines.

The total combined annual capacity of the mines is 15.5mt. The Wingate mine was

reopened in June 2007 after having been on care and maintenance since November 2005.

The Fort Green mine was placed on care and maintenance in May 2006 due to a corporate

restructuring. In fiscal 2007, Mosaic’s production of 13.7mt provided approximately 8% of

world phosphate rock production. The company uses all of its produced rock for its

internal purposes following the 2005 termination of a 2mtpa supply contract to a third



152


party. Mosaic is the world’s second-largest supplier of phosphate rock, albeit for internal

usage. The company does on occasion, purchase rock from third parties.

Figure 153: Phosphate mine output 2005-2007

Source: Mosaic

Reserves

Figure 154: Phosphate mine reserves

Source: Mosaic

Management intends to put the Ona/Pine Level and Pioneer mines into production (as one

facility) within five years to replace the Four Corners mine, where the remaining life

expectancy is through 2013.

Sulphur

Mosaic purchases sulphur in order to produce sulphuric acid, which is one of the primary

ingredients in the production of phosphoric acid. During fiscal 2007, Mosaic purchased

3.8mt of sulphur. The company predominantly sources its sulphur needs from US oil and

gas producers under contract. Due to recent availability issues within the US, Mosaic

sourced a small percentage of its sulphur requirements from Canada and Russia at a

higher cost. Contracts for sulphur volumes are set annually with pricing set on a calendar

quarterly basis. The trend for the remainder of the year is to tighter conditions and higher

pricing. Oil sands expansions should help alleviate the supply constraint in the sulphur

market over the next 18-24 months. Still, due to the structure of the pricing of DAP, and

the Asian price of sulphur, Mosaic is still expected to increase margins slightly when solely

looking at the sulphur input equation, all else being equal.



153


Ammonia

Ammonia is added to phosphoric acid to produce both DAP and MAP. In fiscal 2007,

Mosaic consumed 1.5mt of ammonia, of which it produced a third and sourced the

remainder from Trinidad under short-term contracts where price is agreed to monthly.

The Faustina plant in Louisiana is self-sufficient in ammonia. Mosaic sources most of its

gas needs through fixed-price contracts (Natural gas accounts for approximately 87% of the

cost to produce ammonia at Faustina).

Potash

Mosaic has annual capacity of 10.4mt potash (excluding third-party production at

Esterhazy – see below), equivalent to 14% of world capacity. The company produced 7.9mt

(approximately 15% of world output) in fiscal 2007. Mosaic operates four mines in

Saskatchewan, one mine in Michigan and one mine in New Mexico. Of the 7.9mt of

production, 6.9mt was in the form of muriate of potash (MOP) with the remaining amount

produced as K-Mag, a double sulphate of potash magnesia.

Figure 155: Map of potash operations

Source: Mosaic

Belle Plaine, Saskatchewan

Belle Plaine is the company’s lone solution mine (the others employ the standard shaft

access). The mine has a capacity of 2.8mt with production of 2.2mt in fiscal 2007.

Colonsay, Saskatchewan

Colonsay has an annual capacity of 1.8mt of MOP. The facility produced 1.3mt in fiscal

2007.

Esterhazy, Saskatchewan

Esterhazy consists of two mines, K1 and K2, which have a combined capacity of 5.3mt.

Through an agreement with Potash Corp., Mosaic mines and processes Potash Corp.’s

mineral rights at Esterhazy. Under the agreement and following the expansion at the mine



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in 2007, the most Potash Corp. can receive from the mine is 1.313mt in a given year, with

453.6kt as a minimum. As prices are at all-time highs and capacity is very tight, Potash

Corp. will be receiving 1.3mtpa from Esterhazy through our forecast period. Excluding the

toll production, Mosaic produced 2.9mt of MOP at Esterhazy in fiscal 2007. The original

Esterhazy agreement was made in the 1960s under predecessor companies based on a

variety of parameters, including the amount of ore produced. A timeframe of 2013 was

originally assumed as the end of the agreement. However, due to the recent ramp in

production, that end date has been moved forward, but the exact date of that push forward

is open to debate. Management of both companies is in discussions on when the

agreement will and should conclude. It is possible that we may have a solution by year-

end. We have assumed that the allocation to Potash Corp. reverts back to Mosaic in 2012.

Carlsbad, New Mexico

At the company’s Saskatchewan potash assets, the minerals are found in the form of

sylvinite, a mixture of potassium chloride and sodium chloride. From this ore, the

company produces MOP. At Carlsbad, Mosaic produces both potash products from

sylvinite, and langbeinite, a double sulphate of potash magnesia which the company

markets as K-Mag™. Annual capacity is 0.5mt of MOP and 1.2mt of K-Mag™.

Conventional versus solution mining

Mosaic employs traditional shaft mining at four of its five potash facilities. This involves

sinking a shaft to depths of 3,000 feet and employing a continuous miner to remove the ore

to load onto conveyor belts to the ore crusher and then hoisted to the surface for refining.

In solution mining, heated brine is injected into the potash deposit to dissolve the ore. The

solution is then pumped to the surface and refined through evaporation and crystallization

techniques.

Reserves

Figure 156: Potash reserves

Source: Mosaic

Similar to its peers in the Saskatchewan potash evaporite, Mosaic has enough reserves and

resources that allow the company to produce for many years into the future without

concern for exhaustion of resources.

Port expansion

Canpotex recently announced a $500 million port capacity expansion, adding 11mt of

annual shipping capacity to its existing 12mt. The additional capacity will include an



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expansion of the existing Vancouver facility as well as a new terminal at Ridley Island near

Prince Rupert, BC. The added shipping tonnage is expected to be in service by 2012 in

order to accommodate the expansion plans of its three member owners. We have assumed

Mosaic will pay approximately 36% of the cost due to its weighting within Canpotex.

Nitrogen and offshore

Mosaic owns a 50% interest in Saskferco Products Inc., a Saskatchewan-based producer of

nitrogen fertilizer. The company announced in June that it will look to divest its ownership

of Saskferco.

The offshore segment includes sales offices, blending and bagging operations, port terminals

and a distribution network that includes 24 storage facilities with a combined capacity of

1mt. The Offshore segment also includes strategic investments in overseas production

facilities, including Fosfertil (19.9% ownership), a Brazilian phosphate producer.

The combined contribution of nitrogen and offshore to fiscal 2007 earnings was 1%.

CANPOTEX

Canpotex is owned by Potash Corp., Mosaic and Agrium. It is the marketing arm for allnon-North American sales of Saskatchewan potash for its three owners. Historically, the

sales of potash are done on a spot basis, with India and China the major exceptions.

Contracts with China have typically been for 12 month (calendar year) durations, while

contracts with India are with durations of 6-12 months. As part of the Canpotex

agreement, all new capacity enhancements – if the company desires to include these

potential volumes in their Canpotex allocation calculation -, are to be proven through a 90

day operational trial of the additional capacity. A company will attempt to run the plant at

its maximum output over that period in order to have maximum impact on raising its

allocation. However, this is an inaccurate test to where a plant can run during normal

operations due to the regular maintenance schedule and execution of a sustainable mining

plan at any facility. There are a few other factors that make the numbers unattainable. As

an example to Potash Corp., the Patience Lake capacity relates to a trial run of the old

conventional mine that was flooded. Although it currently operates as a solution mine,

about 0.5mt of the nameplate capacity is no longer possible of attaining. In essence, it is

grandfathered under the Canpotex system. We highlight this for two reasons: one, to

understand the difference between operational and nameplate capacity; and two, to

display why alleviating the current supply constraints in the marketplace with this “excess

capacity” isn’t as easy as turning a switch.

CAPITALIZATION


company had debt of $1.65 billion versus cash of $1.13 billion.

Debt

Following its 2004 creation through a merger, Mosaic had a significant debt level, and as a

result, a poor balance sheet. In seven months from May 2007, the company pre-paid $1

billion in debt in order to raise its debt rating to investment grade. Management’s focus

was two-fold: attain an investment grade rating and build out additional capacity to

capitalize on a strong market. On June 9, 2008, the company was granted investment

grade status by Fitch and S&P for its unsecured debt. With the amount of cash flow that



156


will be generated over our forecast horizon, Mosaic will be able to accomplish its capital

expenditure program through cash on hand.

Following the investment grade rating, it can be expected that the company will implement

a modest dividend program, in line with its peers. As per acquisitions, management will be

hesitant to spend money using its cash and would most likely use equity as a means of

transacting if an opportunity were to present itself.

Capital expenditures

Management has forecasted the US$3.2 billion in capital expenditures for the potash

expansions to be evenly distributed over the 12-year build-out period.

MANAGEMENT

James Prokopanko, President and Chief Executive Officer

Mr Prokopanko joined Mosaic in 2006 as the Chief Operating Officer and was appointed

President and Chief Executive Officer on January 1, 2007, following the retirement of

Fredric Corrigan. From 1978 to 2006, Mr. Prokopanko was employed with Cargill. During

his tenure, he was involved in the retail agriculture business in North America, Brazil,

Argentina and the United Kingdom, followed by positions as Vice President of North

American crop inputs, Corporate Vice President responsible for procurement and as leader

of the Cargil Ag Producer Services Platform.

Lawrence Stranghoener, Chief Financial Officer

Mr. Stranghoener joined Mosaic in 2004 as Chief Financial Officer. Previously, Mr.

Stranghoener was Chief Financial Officer of Thrivent Financial for Lutherans from 2001 to

2004 following a 17-year career at Honeywell, the last three of which as the company’s

CFO until its merger in 1999.

Norman Beug, Senior Vice President, Potash Operations

Prior to joining Mosaic, Mr. Beug was the vice president and general manager of IMC

Global’s Potash Business Unit. Mr. Beug has been involved in the potash industry since

1977 and has held various supervisory and management positions including general

manager of the Belle Plaine mine.

Steven Pinney, Senior Vice President, Phosphate Operations

Prior to joining Mosaic, Mr. Pinney was a senior vice president of Cargill and leader of the

Phosphate Production Business Unit. Mr. Pinney joined Cargill in 1976 and held various

positions, including plant engineer in the company’s Oilseeds Processing and Fertilizer

businesses, and as business unit leader for phosphate operations in Brazil and China.

Rick McLellan, Senior Vice President, Commercial

Mr. McLellan previously held the position of Vice-President, North America Sales. He has

also held various positions, including country manager for Brazil, leadership

responsibilities for fertilizer distribution, import and production in Brazil, as well as

various positions with Cargill’s Canadian and US operations.



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INVESTMENT RISKS

Brine Inflow

Water inflow is the single most structural risk to a potash mine. It is not an uncommon

event and is often dealt with through the use of pumps. If water inflow becomes

uncontrollable, it can ruin a mine which would have a material impact to the company’searnings. At Esterhazy, brine inflow has been managed since 1985. In early 2007, the

brine inflow at Esterhazy increased significantly, beyond that of pumping capabilities. The

company responded by grouting around the inflow and succeeded in lowering the level of

inflow to that of the previous two decade average.

Sulphur

As one of the key ingredients in the production of phosphate fertilizers, the company

requires an uninterrupted supply of sulphur. If the supply were constrained, the

production of the end product would be negatively impacted, affecting the earnings

contribution to the company

Ammonia Ammonia is a key input for the production of phosphate and its cost can impact margins.

Management has in place long term contractual arrangements for the supply of ammonia

and hedges the cost through a natural gas hedging program. Mosaic will take positions in

natural gas up to a year to lock in the cost for their expected annual production. The

company does not speculate on gas beyond their requirements. As a rule, approximately

80% of the upcoming quarter will be hedged, followed by 50-60% two and three quarters

out and 15-20% 12 months out.

VALUATION

We derive our 12-month target price of US$210.00 per share by applying a 16x multiple of

F2009E EPS of US$13.22 using the following assumptions:

· Production of 9.3mt of phosphate and 8.5mt of potash in F2009.

· A F2009 average phosphate price of US$1050/t and average netback to the mine

potash price of US$800/t.


· A phosphate and potash operating cost per tonne of US$458/t and US$80/t,

respectively.


Based on these assumptions, Mosaic is currently trading at a 39% discount to our target

price of US$210.

CONCLUSION

We believe Mosaic is well positioned to continue to benefit from our strong fertilizer

outlook due to its leadership role in phosphate production, strong position in potash

production, low cost potash assets and production growth over the medium term.

Furthermore, we believe the company’s earnings over the next few years will prove

current valuations on the stock price to be very conservative. For these reasons, we initiate

coverage of Mosaic with a BUY rating and a 12-month target price of US$210.00.



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Figure 157: The Mosaic Company Income Statement, FYE May

Income Statement FY E FY E FY E FY E

US$ M 31-May-06 31-May-07 31-May-08 31-May-09

Sales 5,179 5,774 9,159 17,306

YOY Growth 18% 11% 59% 89%

Operating Costs 4,464 4,518 5,787 7,923

Depreciation 324 329 341 374

Total Gross Profit 391 926 3,031 9,009

YOY Growth -25.6% 137.0% 227.3% 197.2%

Gross Margin % 7.5% 16.0% 33.1% 52.1%

Expenses

Selling, general and administrative 241 310 325 382

Restructuring 288 (2) 10 0

Other operating (income) expense 7 2 9 0

Total Expenses 536 310 344 382

YOY Growth 158.7% -42.1% 10.9% 11.0%

Sequential Growth

% of Total Revenues 10.3% 5.4% 3.8% 2.2%

Operating Income (EBIT) (145) 616 2,687 8,627

YOY Growth -145.4% -525.9% 336.0% 221.0%

Sequential Growth

Operating Margin -2.8% 10.7% 29.3% 49.8%

Interest expense 153 150 119 140

Foreign Currency Transaction (gain) loss 101 9 69 (6)

Loss( gain) on extinguishment of debt 0 (35) 3 2

Other Income 8 (13) (57) (108)

EBT (406.7) 505.7 2,553.4 8,599.0

YOY Growth -289.3% -224.3% 404.9% 236.8%

Sequential Growth

EBT Margin -7.9% 8.8% 27.9% 49.7%

Income taxes 5 123 698 2,752

Effective tax rate -1.3% 24.4% 27.3% 32.0%

Net Earnings from Consolidated Companies (412) 382 1,855 5,847

Net Margin -8.0% 6.6% 20.3% 33.8%

Equity in net earnings of non-consolidatedcompanies 48 41 113 100Minority interests in net earnings of consolidated companies (4) (4) (11) (16)

Net Earnings (368) 420 1,958 5,931

YOY Growth -319.6% -214.0% 366.5% 203.0%

Sequential Growth

Shares Outstanding

Basic 382 434 443 445

Fully Diluted 382 440 446 451

EPS (reported) - GAAP

Basic (0.96) 0.97 4.42 13.33

Fully Diluted (0.96) 0.95 4.39 13.17

Source: Canaccord Adams estimates



159



Agrium

AGU : TSX : C$99.22

AGU : NYSE

BUY


COMPANY STATISTICS:

52-week Range: C$37.21-116.15

Avg. Daily Vol. (000s): 5,093.7

Market Cap (M): C$15,776.0



EARNINGS SUMMARY:FYE Dec 2006A 2007A 2008E 2009ERevenue

(M): US$4,193 US$5,270 US$9,046 US$11,166EV/EBITDA(x): 39.5 16.8 6.5 5.0

EPS: US$1.28 US$3.62 US$9.19 US$12.42

P/E (x): 77.8 27.4 10.8 8.0


COMPANY SUMMARY:Agrium Inc. is a leading global producer and marketer of agricultural nutrients, industrial products, specialtyfertilizers, and a major retail supplier of agriculturalproducts and services in both North and South America.

All amounts in C$ unless otherwise noted.


INITIATING COVERAGE

Investment Thesis

We are initiating coverage of Agrium with a BUY rating based on the

following conclusions:


As we highlighted in our sector piece “The Modernization of the

BRICs,” we believe the fertilizer market will be robust for years into


expected to remain strong as supply will not be able to meet the

growth in demand over the next five years. With current pricing

expected to rise into 2009 and 2010, earnings should also continue

to increase.

· Strong margin expansion and production growth throughout

our earnings forecast

Agrium’s earnings are derived from a blend of wholesale and retail

businesses that will combine to provide the company with increasedmargins over our forecast period. Given the company’s product

offering in wholesale, its leading position in U.S. retail, and our view

on product pricing throughout our forecast period, Agrium is

expected to accumulate significant earnings.

· Stability of earnings over the long-run

Agrium’s strategy of combining wholesale and retail business

provides greater stability in earnings over the long run.

· Valuation

We value the shares of Agrium on a 13x 2009E EPS of $12.42, for a

target price of C$160.00, representing a 63% potential return to thecurrent share price.



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INTRODUCTION

Agrium’s strategy is to grow across the value chain through organic growth, acquisitions,

and development of new products. The company operates three lines of business: a retail

unit that is a major producer and supplier of retail products in both North and South

America; a wholesale unit that produces nitrogen, phosphate and potash for the wholesalemarket; and the Advanced Technologies unit which produces specialty fertilizers and

chemicals. The company is the world’s third largest producer of nitrogen and the largest

U.S. retailer of crop products.


As we detailed in our thematic report “The Modernization of the BRICs,” we believe that

fertilizer pricing has performed a step-change as a solution to the world’s food crisis has

become dependent on a variety of factors, one of which is the increased usage of fertilizer

going forward. Within the fertilizers, we believe potash stands to have the strongest

outlook over the near, medium and long term. A close second, we believe phosphate

pricing will remain strong until at least 2012. Although we are not as bullish on nitrogen,

the potential risk to the upside in pricing exists. These factors will bode well for Agrium aswe expect an increase in margins and earnings throughout our forecast period.

Strong margin expansion and production growth throughout our earnings forecast

Agrium’s earnings are derived from a blend of wholesale and retail businesses that should

combine to provide the company with increased margins over our forecast period. Given

the company’s product offering in wholesale, its leading position in U.S. retail, and our

view on product pricing throughout our forecast period, Agrium should continue to

capitalize on its significant earnings opportunity.

Stability of earnings over the long run

Agrium has a different philosophy towards building its business versus its peers. The

company has added a great emphasis on the retail aspect of the industry, evidenced over

the past two years with the company’s acquisitions of Royster-Clark and, most recently,

UAP Holdings. Management’s philosophy is to grow the company to enjoy the benefits of

both the current upswing in the agricultural sector and to provide more stable margins

during any potential market downturn.

Where to Next?

Many investors ask how long fertilizer companies can continue to enjoy upward





specifically in the potash and phosphate sectors, fertilizer producers should continue to

increase margins and earnings, and therefore share prices. As we attempt to demonstrate

in the Valuation section below, our thesis for owning Agrium is straightforward: The world

requires more fertilizer. Specific to Agrium, the company will continue to benefit from

increasing earnings due to a mixture of commodity price increases; low potash operating

costs; and greater demand for retail products. Finally, we believe that it is going to take

some time to correct the current food crisis, much longer than the result of next year’s



161


crops and fertilizer application cycles. The world has been years in building up to this

crisis, and we believe that it is going to take quite a while to correct.

THE COMPANY

Agrium produces 8mt of product and markets 18mt (including UAP), or 14mt net of inter-

company transfers. Within the wholesale segment, its primary focus is on the nitrogenbusiness, with growth expected in the potash business and a steady state phosphate

business. As noted in Figure 158 below, Agrium’s recent M&A activity in the retail

business has had a profound impact on the company’s expected earnings going forward.

Agrium has a sound business model that provides the company a strong position across

the production and distribution chain. The company has built a stable business platform;

however, due to the company’s relatively lower (albeit stable) margins across the retail

business, Agrium has been awarded lower valuation multiples during the current

agricultural boom versus its wholesale-weighted peers, where wholesale margins are much

higher and stronger, and are expected to remain throughout our forecast period. That

being said, we forecast Agrium to exhibit continued strong earnings growth over our

forecast period and we expect its share price to react accordingly.

Figure 158: 2007 EBITDA (Actual versus Pro forma)

Note: Pro forma includes synergies.*EBITDA.Source: Company reports

Wholesale Strategy

The company produces, distributes and markets crop nutrients to wholesale customers. In

2007, Agrium produced 4.9mt nitrogen, 1.7mt potash and 1.0mt phosphate for a total of

7.7mt of product. Management has built its wholesale division around its nitrogenproduction. Within Canada, the firm has a competitive advantage to US-based nitrogen

plants based on the spread in the AECO-NYMEX gas cost. This allows the company to

service its customers in Western Canada and the Northwestern United States at a lower

cost than its peers in the United States. This will serve the company well if gas prices

continue to rise as some Southeastern U.S.-based facilities may begin to feel squeezed on

margins. Most recently and going forward, management has implemented a growth

platform based on the availability of low-cost natural gas feedstock. As we have seen in



162


Argentina and Egypt, this strategy is not without risk (for further discussion, please see

below).

In the phosphate business, management is not looking to expand organically or through

acquisition.

As part of Agrium’s balanced growth plan, management has put an emphasis on growing

its potash business through further expansions at Vanscoy and the possibility of a

greenfield mine addition. Deemed a high priority, management continues to evaluate its

options with a decision expected during Q4/2008 regarding further expansion.

Management is positioning the company to take full advantage of a strong market with a

continued focus on brownfield expansions which utilize the same infrastructure, thus

minimizing cost and time to completion. Although smaller in scope, we are still expecting a

38% capacity expansion through brownfield by 2013 (to 2.9mt from the current 2.1mt

through two 400kt increments). A potential greenfield expansion could further increase

capacity by 2mt in 2015.

Retail Strategy

Beyond the recent sizable acquisitions of Royster-Clark (RC) and UAP, Agrium will continue

to look for acquisitions within the United States and abroad. With 15% of the retail market

in the US controlled by Agrium, there is significant room to grow its capacity within the

country. Most additions going forward will most likely be in the form of smaller

acquisitions (below US$60 million) where the approval of the FCC is not required. Like the

RC acquisition, management will continue to look for operations where Agrium can

implement greater efficiencies and scale in order to improve margins. RC had significant

inefficiencies when Agrium purchased the company. Although, the company envisions

synergies with the UAP acquisition, it does not foresee the same inefficiencies that were

embedded at RC.

UAP Acquisition

On December 2, 2007, Agrium entered into a definitive agreement to acquire all of theoutstanding shares of United Agri-Products Holding Corp. (UAP) for US$39 per share in

cash (US$2.65 billion), including US$487 million in assumed debt. Management has

assumed synergies of US$80 million in 2009 and US$115 million per annum by 2010.

Agrium closed the deal on May 7, 2008 after agreeing to sell seven centers that the U.S.

regulatory authorities deemed to have conflicted with their antitrust laws. We expect the

acquisition to run smoothly as shown by Agrium’s successful integration of Royster-Clark

in 2006. Management took an inefficient company in RC and ran ahead of synergies and

expectations in its first year of amalgamation. Following the success of that integration, the

benefit of the doubt has been given to management for the UAP acquisition. With UAP, the

retail segment will have greater than US$5 billion in revenues on a go-forward basis.



163


Common Market Fertilizers Acquisition

On April 10, 2008, Agrium announced that it was expanding its retail business after

entering into an exclusive agreement to acquire a 70% interest in Common Market

Fertilizers S.A. (CMF) for $16 million plus $50 million in working capital. CMF is a Western

European fertilizer distribution company with crop nutrient sales of up to 2.5mt, annual

sales of $600 million and an annual EBITDA of close to $10 million. The transaction closedon July 8, 2008. The purchase provides Agrium with a foothold into Western Europe and

as a vehicle for further expansion targeted to Eastern Europe.

Advanced Technologies Strategy

The Advanced Technologies (AT) segment is a small portion of the company’s overall

earnings profile. Although the company is excited about its future, but incremental growth

in the segment will not be a significant contributor to the company’s earnings within the

near future.

Figure 159: Wholesale Operations


OPERATIONS

Nitrogen Operations

Agrium owns and operates six nitrogen facilities (four in Alberta, one in Texas and one in

Argentina) with a combined capacity of 3.3mt of ammonia (or 4.6mt of upgraded nitrogen

products).

Alberta

The majority of nitrogen product produced in Alberta is sold into Western Canada,

Northwestern U.S. and the Northern Plains of the U.S.



164


Carseland

The Carseland facility produces 535kt of ammonia and 695kt of urea. 140kt of the

ammonia is sold to a third party, with the remainder being used for the production of urea

at Carseland. Included within the urea production is 190kt of controlled release urea in the

form of 150kt of ESN and 40kt of Duration, two specialty fertilizers that are sold under the

Advanced Technologies division. The output from Carseland is sold into markets in Western Canada and the Northwestern Unites States. The facility has storage capacity of

36kt of ammonia, 50kt of urea and 22kt of controlled release urea. The product is loaded

onto both rail cars and trucks for transport to market.

Red Water

The Red Water facility is the company’s largest in terms of output with an annual capacity

of 1.4mt of nitrogen-based fertilizers and 680kt of monoammonium phosphate (MAP). The

company’s Kapuskasing mine in Ontario provides the phosphate rock required to produce

the MAP. The facility produces all forms of nitrogen products, including capacities of 960kt

of ammonia, 720kt of urea, 215kt of ammonium nitrate, 300kt of ammonium sulphate and

180kt of UAN solution. Storage capability at the facility totals 172kt of ammonium product,

70kt of urea and 90kt of MAP.

Fort Saskatchewan

The Fort Saskatchewan operation produces 465kt of anhydrous ammonia, 95kt of 29%

aqua ammonia and 430kt of granular urea. Agrium added 80kt of aqua ammonia capacity

to the facility in 2007. Storage capacity at site is 36kt of ammonia and 65kt of urea.

Joffre

The Joffre facility produces 450kt of anhydrous ammonia. The output from Joffre is

transported via a 19km pipeline to the Chigwell facility.

Borger, Texas

The Borger facility produces 490kt of ammonia and 99kt of urea. All nitrogen productsfrom this facility are sold into the Texas panhandle with ammonia being piped to the

western cornbelt via a 900km third-party owned pipeline to nine distribution terminals

and storage sites. The facility produces both granular and prilled urea and sells the

product to both fertilizer dealers (granular) and animal feed suppliers (prilled). The facility

has a storage capacity of 0.9kt of ammonia and 16kt of urea product.

Bahia Blanca (Profertil), Argentina

Agrium owns 50% of the Profertil operation (Repsol YPF – 50%). The facility has seen an

interruption of gas supply over the past year due to colder than normal weather in

Argentina, which led to lower production volumes. The Argentinean government has since

implemented a price cap on urea at US$410/t. This obviously places a cap on the upside

potential of this facility as the company noted it would abide by the cap and not attempt tosell product into Brazil in lieu of Argentina. It goes without saying the Argentinean

government would not look kindly upon a move of that nature and repercussions would

most likely ensue. Due to the nature of their gas contract, Agrium does capture significant

margins at US$410/t pricing, but with current international urea prices well above the

price cap, the company is losing significant upside. With a further interruption of gas

supply in May 2008, the government offered to import LNG to supply the facility, at a cost

expected to be borne by the government. Urea production has been intermittent since then



165


and is expected to remain so through mid-August, followed by full production towards the

latter half of Q3/2008.

Eqypt

The now-cancelled project is 60% owned by Agrium (Egyptian Petrochemicals holding

Company and Egyptian Natural Gas Holding Company – 24%, Egyptian Natural Gas

Company - 9%, and Arab Petroleum Investments Corporation – 7%). The Egyptian

parliament voted down the project due to the opposition of the local government to the site

being used for industrial purposes versus the expansion of a nearby resort town. Agrium is

in current discussions with the government regarding restitution. The company suggested

that it may take a US$280 million write-down of the facility on its second quarter earnings.

Upgrading Facilities

Agrium owns and operates several upgrading facilities including three in the United States

and two in Alberta. These facilities upgrade ammonia to nitrogen solutions (UAN) and

nitric acid.

Natural Gas Pricing

The company’s largest input cost is the ammonia feedstock cost of natural gas. In Alberta

and Texas, Agrium pays spot prices for gas but will purchase contracts throughout the year

in order to lock-in margins on nitrogen sales. In Argentina, the company operates under a

long-term natural gas contract for 80% of its gas requirements where the blended price of

contracted and spot gas in the most recent quarter was approximately US$3 per mmbtu.

Approximately 70% of Agrium’s gas purchases are for its Alberta operations, 17% for the

U.S. operations and 13% for the Argentinean operations.

Phosphate Operations

The company’s phosphate operations consist of two phosphate rock mines and two

production facilities with a total capacity of 1.3mt. Agrium also operates a granular

micronutrient facility as well as several fertilizer granulation and blending plants, all in theU.S.

Kapuskasing, Ontario

The facility includes an open-pit mining operation, where phosphate rock is mined and fed

into the onsite mill where it is processed and then transported to the company’s Redwater

facility in Alberta for further processing. The company did have a problem with high iron

content and hard rock issues that led to a lower output and higher costs in 2006. This

issue has since been corrected and the mine is operating at full capacity. The mine

produces 1.1mt of rock concentrate at a post beneficiation concentrate of 37% P2O5.

Current reserves at the mine provide an economic operating life through 2013.

Management is reevaluating the deposit to gauge if further economically operational years

are possible.

Redwater, Alberta

In addition to the above nitrogen products, the facility produces sulphur and phosphate

fertilizers with rock supplied from the Kapuskasing mine. The capacity of the facility is

680kt of MAP.



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Conda, Idaho

The Conda operation has a capacity to produce 488kt of phosphate fertilizers, including

300kt of MAP, 177kt of SPA and 11kt of MGA. The facility is supplied phosphate rock from

Agrium’s Dry Valley open pit mine, located 24km to the north of Conda. The mine

produces 1.3mt of 32% P2O5 concentrate.

Sulphur

Agrium sources its sulphur and sulphuric acid for its Conda operation locally and from

Western U.S. natural gas producers. The company’s Redwater facility sources sulphur

locally.

Potash Operations

Vanscoy, Saskatchewan

The Vanscoy facility consists of a conventional mining operation at a depth of

approximately 1,000m and plant facility with a capacity of 2.1mtpa of MOP in coarse and

granular form. The facility has a storage capacity of 230kt. Following a 400kt expansion in

2007, management has indicated that it intends to expand the mine in two further

increments of 400kt in 2011 and 2014. A final decision on the next expansion is expected

by Q4/2008. Approximately 40% of the output at Vanscoy is marketed outside of North

America.

Greenfield Sites

The company is evaluating two greenfield sites in Saskatchewan and Manitoba. 2D seismic

has been completed on the Saskatchewan site with 3D seismic planned for this summer,

followed by a possibility of geotechnical work in 2009. If approved, a 2mtpa production

scenario is envisioned for 2015.

Retail Operations

The retail segment provides services through its more than 850 retail centers across theUnited States, Argentina and Chile. Through this retail chain, Agrium provides a variety of

products, including crop nutrients, crop protection, seed, services and other products.

Agrium is the largest agricultural retailer in the United States. A retail centre consists of an

outlet located in a farming region that sells products in both bulk and packaged form to

farmers within its area. A portion of these products are sourced from Agrium’s wholesale

operations, with the remainder purchased through other major fertilizer companies.



167


Figure 160: Retail Operations in the United States


Crop Nutrients

Agrium provides both liquid and dry crop nutrients including nitrogen, phosphate, potash,

sulphur and micronutrients. As practice, the crop nutrients are customized into a mixture

to suit the requirements of an individual customer.

Crop Protection

The crop protection segment includes fungicides, herbicides, and insecticides to combat

disease, weeds and insects, respectively. The amount of product varies per region, due to

product selection and the increased use of Genetically Modified Seeds (GMOs).

Seed, Services and Other Products

Agrium offers its customers application services that include customized applications and

application machinery. The company also provides crop advisory services that include

weather analysis, soil analysis, etc. Through its farm centers, Agrium provides its

customers with seeds, both major producers’ and Agrium’s brand.



168


Advanced Technologies Operations

The newest and smallest segment for Agrium, Advanced Technologies comprises of

fertilizer technologies and professional products. Fertilizer technologies include controlled

release fertilizers (comprising the Nu-Gro and Pursell brands). Urea from the Carseland

facility is used to produce ESN for the Advanced Technologies segment. The controlled

release fertilizers are produced at four locations – Mobile and Sylacauga, Alabama,Courtright, Ontario and Carseland, Alberta. Professional products include fertilizer and

pest control products for the golf course and lawn care corporation market and structural

pest control industry. These products are produced at facilities in Putnam and Brighton,

Ontario and marketed through a Canadian distribution network. Management envisions

the AT segment doubling or tripling in asset value over the next five years.

Agrium owns a 19.6% interest in Hanfeng Evergreen, a Chinese specialty fertilizer

company. As part of the April 2007 agreement, Agrium has until April 2009 to opt into a

joint venture with Hanfeng, whereby AGU participates in 25% of Hanfeng’s expansions

under the agreement. Agrium announced in April that it had opened a small office in

Beijing.

MARKETING

All of Agrium’s North American nitrogen production is marketed within North America.

The production from Profertil (Argentina) is marketed to both the Argentinean market and

Brazil.

Canpotex

Canpotex is owned by Potash Corp., Mosaic and Agrium. It is the marketing arm for all

non-North American sales of Saskatchewan potash for its three owners. Historically, the

sales of potash are contracted on a spot basis, with India and China the exception.

Contracts with China are for 12 month durations, while contracts with India for durations

of 6-12 months. Agrium accounts for approximately 9% of Canpotex sales.

CAPITALIZATION

Share Capital


company had debt of $957 million versus cash of $1.76 billion (prior to the acquisition of

UAP).

Dividend Policy

The current semi-annual dividend per share of $0.055 has been paid to shareholders since

1996.

MANAGEMENT

Mike Wilson – President and Chief Executive Officer

Mr. Wilson joined Agrium as Executive Vice President and Chief Operating Officer in 2000.

Previously, Mr. Wilson was President of Methanex Corporation, a leading producer in

methanol. Prior to that, he held various senior positions in North America and Asia during

his 18 years with Dow Chemical. Mr. Wilson is a chemical engineer.



170



Based on these assumptions, Agrium is currently trading at a 39% discount to our target

price of $160.

CONCLUSION

We believe Agrium is well positioned to continue to benefit from our bullish fertilizer

outlook due to the company’s product offering in wholesale, its leading position in U.S.

retail and our view on product pricing throughout our forecast period. Furthermore, we

believe the company’s earnings over the next few years will prove current valuations on

the stock price to be very conservative. For these reasons, we initiate coverage of AGU with

a BUY rating and a target price of $160.



171


Figure 161: Agrium Income Statement, FYE December

Income Statement FY E FY E FY E FY E

US$ M 31-Dec-06 31-Dec-07 31-Dec-08 31-Dec-09

Sales 4,373 5,491 9,262 11,382

Less Freight 180 221 216 216

Net Sales 4,193 5,270 9,046 11,166

YOY Growth 27% 26% 72% 23%

Operating Costs

Total Gross Profit 958 1,598 3,323 4,558

YOY Growth

Gross Margin % 21.9% 29.1% 35.9% 40.0%

Expenses

Selling 285 471 640 718

General and administrative 201 125 179 215

Depreciation and amortization 169 173 164 172

Other

Royalties and other taxes 20 43 176 418

Other expenses 75 71 49 200

Total Expenses 750 883 1,208 1,722

YOY Growth 36.8% 42.6%

% of Total Revenues 17.9% 16.8% 13.4% 15.4%

Operating Income (EBIT) 208 715 2,115 2,836

YOY Growth

Operating Margin 5.0% 13.6% 23.4% 25.4%

Interest on long term debt 52 52 53 56

YOY Growth

Other interest 11 18 2 0

EBT 145 645 2,060 2,780

YOY GrowthEBT Margin 3.3% 11.7% 22.2% 24.4%

Current income taxes 63 85 74 0

Future income taxes (44) 119 23 0

Income taxes (24) 204 663 889

Effective tax rate -16.6% 31.6% 32.2% 32.0%

Net Earnings (reported) 169 441 1,397 1,890

YOY Growth -40.3% 160.9% 216.8% 35.3%

Net Margin 3.9% 8.0% 15.1% 16.6%

Shares Outstanding

Basic 132 135 158 158

Fully Diluted 133 136 161 161

EPS (reported) - GAAPBasic 1.28 3.27 8.84 11.96

Fully Diluted 1.28 3.25 8.70 11.78




172



MagIndustries Corp.

MAA : TSX-V : C$3.15BUY


COMPANY STATISTICS:

52-week Range: C$1.25-3.72

Avg. Daily Vol. (000s): 1,889.5

Market Cap (M): C$660.2



NAV: 8.57

Cash (M): US$21.0

LT Debt (M): US$20.1

EARNINGS SUMMARY:FYE Dec 2008E 2009E 2010E 2011E 2012ERevenue(M): US$17 US$48 US$49 US$450 US$781

EPS: US$(0.19) US$(0.12) US$(0.12) US$0.77 US$1.57

P/E (x): NM NM NM 4.1 2.0

CFPS: US$(0.18) US$(0.15) US$(0.10) US$0.32 US$1.29


COMPANY SUMMARY:MagIndustries comprises four business units, three of which (MagMinerals, MagForestry and MagMetals) arelocated in the Republic of Congo (ROC) and the fourth(MagEnergy) in the Democratic Republic of Congo (DRC).



INITIATING COVERAGEInvestment thesis

We are initiating coverage on the shares of MagIndustries with a BUY

rating and a 12-month target price of C$8.50 based on the following

conclusions:

· Step-change in potash pricing going forward As we highlighted in our thematic piece, “The Modernization of the

BRICs”, we believe the potash market will be robust for years into

the future. Prices are expected to remain strong as supply will not

be able to meet growth in demand over the next five years.

· First new potash project to enter production

We believe MagIndustries will be the first Canadian-listed junior

potash company to enter production when Phase I of the Kouilou

project is completed in 2011.

· Existing infrastructure and low operating costs

The Kouilou project is expected to benefit from existing

infrastructure and low operating costs that make the project stand

out versus its peers operating in Canada.

· Optionality with other projects

The company has additional value extraction in its other three

segments.

· Valuation

We value the shares of MagIndustries on a 1.0x NAV of $8.57, using

a long-term potash price of US$500/t fob Pointe Noire and a 12%

discount rate.



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INTRODUCTION

MagIndustries comprises four business units, three of which (MagMinerals, MagForestry

and MagMetals) are located in the Republic of Congo (ROC) and the fourth (MagEnergy) in

the Democratic Republic of Congo (DRC). For the purposes of this report, we value

MagIndustries as a junior potash company due to the substantial valuation of the potash

project within the company. MagIndustries has the most advanced project of the

companies we cover in the junior fertilizer space. In this report, we will detail why the

overall risk of the project has been substantially reduced by management, taking into

account political, financing, project execution, infrastructure and time to production. A

modular design, the initial 600ktpa operation is expected to reach commercial production

in 2011, potentially followed by a doubling or tripling of capacity. As we will detail in this

report, we believe MagIndustries has the management team to put the project into

production, the infrastructure in place to bring the product to market, a government that is

pro-mining and wants the project to succeed, financing that is expected to be completed by

Q4/08 and a low operating cost. Additionally, the company has potential upside regarding

the before-mentioned non-potash projects. All of these items and a strong valuation make

MagIndustries our top pick on a risk-adjusted basis among the junior fertilizer names.

Potash pricing


potash pricing has performed a step-change, as a solution to the world’s food crisis has

become dependent on a variety of factors, one of which is increased fertilizer application

rates going forward. Among the fertilizers, in our opinion, potash has the strongest outlook

over the near, medium and long term.

First greenfield potash project to enter production

MagIndustries should be the first Canadian-listed junior potash company to enter

production when Phase I of the Kouilou project is completed in 2011. We believe the

company will have the added benefit of stronger potash pricing over and above our long-term average during the initial years of the project’s life, generating significant margins.

Existing infrastructure and low operating costs

The Kouilou property has the benefit of being located 20 kilometres from a deep-water

port and all the associated infrastructure required to export the product to market. In

contrast to its Canadian peers, the company has no need to identify a partner on port

facilities. The port facilities have been secured by the company through a 70-year lease

with the ROC government. Furthermore, an off-take agreement has been signed, covering

100% of the potash production. Once in production, the Kouilou project will have a low

operating rate due to the low cost of gas to be used in the solution mining process. With

significantly higher potash prices going forward, the company will greatly benefit from

strong margins throughout the expected mine life.

Optionality with other projects

The company has additional value extraction in its other three segments, including

expansions in forestry, a potential magnesium plant and additional energy capacity.



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THE KOUILOU PROJECT

The Kouilou potash project will be the ROC’s second-largest private project ever in terms of

capital investment. MagIndustries has fostered strong governmental relationships over its

11-year history, and it is paying dividends as the company is in the final stages of pre-

construction. Management’s strategy of seeing the potash industry’s structural change

early and going forward with the project has placed the company in the enviable positionof being the next entrant into the industry.

Figure 162: Location of MagIndustries’ projects

Source: MagIndustries

History

In 1997, MagIndustries acquired the rights to a magnesium/potash deposit in the ROC and

proceeded with a feasibility study on a magnesium project. It was deemed an economic

success dependent on a reliable and inexpensive power source for an energy-intensive

magnesium smelter. The company located such a power source, the INGA power facilityalong the Congo River in the DRC. The facility was in desperate and immediate need of

overhaul, and Mag initiated discussions with the government to refurbish the site. Shortly

thereafter, in 1998, the DRC entered a four-year civil war which prompted all discussions

on INGA to cease. Without the possibility for power, there was no further advancement of

the magnesium project. When the war was ending, Mag re-entered discussions with the

government and, in 2005, the company was awarded the rights to refurbish five

generators through two phases. By that time, potash had supplanted magnesium as the



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Figure 164: Diagram of a solution mine


Bankable feasibility study

The BFS was completed in Q1/08 with the following key point: Construction costs for the

initial phase of the project will total approximately US$723 million. The project benefits

from proximity to the ocean and via low mining operating costs, estimated at US$84/t. It

has always been the company’s position to expand into a Phase II, as many of the built-in

costs of Phase I would support an additional phase at reduced cost. A report on Phase II

should be forthcoming by year-end 2008.

INFRASTRUCTURE

Rail

The national rail line passes through Mag’s potash concession. The company will be

required to build two spur lines, a 3.8-kilometre line connecting the plant to the main rail

line and a 2.1 kilometre section connecting the main rail line to the port facility.

MagIndustries will purchase two locomotives and 18 rail cars for the initial phase of its

project. Under a Phase II scenario, a further 18 rail cars would be purchased. The lead

time to receiving the rolling stock is currently 12-15 months. We must highlight that

relative to its peers, no other company can state that it requires only 6 kilometres of rail to

be built to ship its product to the port.

Port

Pointe-Noire is known to have the best deepwater port in western Africa. A permit is in

place to construct a 50kt storage unit at the port, sufficient to handle capacity for the initial

two phases. If the company were to develop a third phase, an expanded facility would be

required at the port (not necessarily adjacent to the planned storage area for Phases I and

II). The ROC government has granted MagIndustries a 70-year lease at the port. Again, it

must be highlighted that MagIndustries is the only company that has ready access to a

deepwater port, as its peers must locate a port through which to ship their product.



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Offtake agreement

Mag signed an offtake agreement with Ameropa AG for 100% of the output of Phases I and

II of the Kouilou project for the initial 12 years of production, with pricing based on

contracts settled by Ameropa in the market for which the product will be sold to. The

contract includes a US$5/t flat fee and a floor price agreement. Ameropa’s costs including

freight charges and other costs totaling $50-80/t will be netted out of the landed price.

Ameropa is a private Swiss-based company which specializes in the marketing of grains

and fertilizer products, selling 11mt annually. It is assumed that most of the Mag potash

fertilizer will be sold to end users in Brazil, and south and west Africa.

Figure 166: Regional potash supply imbalances



Conventional mining involves sinking a shaft to depths of up to 3,000 feet and employing a

continuous miner to remove the ore to load onto conveyor belts to the ore crusher and then

hoist to the surface for refining. In solution mining, heated brine is injected into the potash

deposit to dissolve the ore. The solution is then pumped to the surface and refined through

evaporation and crystallization techniques.

The company will utilize two wells for each of the 25 caverns for a total of 50 wells. In the

two-well system, one well will inject the water into the cavern, and the other will remove

the solution to the surface for processing. The 25 pairs of wells is the design for Phase I.

For a doubling of output, the company would require a further 25 caverns.Once the solution is extracted to the surface, the processing of the product commences with

the separation of the benign MgCl, which is sent to the sea via pipeline for disposal. The

salt is then removed from the KCl and the wet KCl crystals are dried and further processed

through the compactor where it is formed into flakes and sized into particle form. Finally,

a resin coating is added to secure the product from damage during the transportation to

the port and the eventual end user.



180


Figure 167: Solution mining process flow sheet

Carnallite

DecompositionHot Leach KCl Crys tallization

KCl Drying and

Compaction

Carnallite

Evaporation

Brine from

Solution Mining

MgCl2

Brine to

Ocean

NaCl to

Disposal / Mine

KCl/NaCl Brine KCl

BrineNaCl/Carnallite

Steam

KCl Product

Process condensate


Spin-off of MagPotash

In financing the equity portion of the Kouilou potash project, MagIndustries has sold 33%

of its ownership in the potash project ($205 million) to investors in 2008. Subject to a

liquidity event (IPO) in Q4/08 and following a further estimated equity raise of $45 million

in MagPotash, MagIndustries will own approximately 63% of the shares of the newly

formed MagPotash (where the ownership of the Kouilou potash project will be held), which

is expected to trade on the TSX.

TIMELINE

Permitting

In March 2008, the government of the ROC granted Mag a 25-year mining licence for

Kouilou potash project. It is important to note that the exploitation licence in the ROC is

considered to be a strong indicator that the state wants the project to move forward.

Management is currently awaiting finalization of the investment agreement regarding gas

supply, rail use and port use to complete the project financing. These negotiations are near

an end as all three documents have been drafted and presented to the government, and

are in the final stages of approval. An Environmental Social Impact Analysis will be

completed in Q3/08.

Financing

Once the permitting process is concluded, management will look to complete the debt and

equity financing, expected in early Q4/08. We estimate MagPotash will look to raise a

further $545 million in capital ($45 million in equity and $500 million in debt). The debt

financing is being organized by the firm’s advisor, BNP Paribas and is in the final stages of

approval. The consortium of lenders includes European Investment Bank, African

Development Bank, and Export Development Canada. Combined with the previously

mentioned $205 million equity raise in 2008, the total amount raised will be $750 million.



181


Construction

A 30-month construction schedule is expected to begin immediately following the close of

financing (Q3/08), followed by a three-month commissioning period in early 2011 and full

ramp-up by mid-2011. The company has included all long lead-time items into its timeline,

including bearings for the compaction plant which were ordered in March 2008 with an

expected delivery time of 26 months. A drilling contractor will begin drilling the first of 50

wells in September 2008 with completion of the final well by Q1/10. The 50 wells will

create 25 caverns for the solution mining process.

MAGFORESTRY

The forestry concessions consists of 68k hectares (ha) over three properties close to Pointe-

Noire. As shown in Figure 167 above, a significant portion of the forestry concession lies

atop the potash/magnesium deposit. Although MagIndustries has become a diverse

company, there is a strategic as well as financial reason for owning the forestry business.

In 2005, a private South African company had won tender from the state to takeover the

eucalyptus plantation from the state but could not obtain the funds to close the deal. Rather

than see the project pass to a Chinese group waiting in the wings, Mag purchased the

South African based company in two instalments between 2005 and 2006 for a total of $6

million in order to acquire the surface rights, and remove a potential problem of

negotiating access or compensation issues with an unfamiliar party.

Figure: 168 MagForestry eucalyptus plantation


The company has planted eucalyptus trees across 42k hectares of its 68k hectare

plantation, which have a seven-year growth cycle. The original plantation is 30 years old

and thus all levels of tree growth exist on the plantation. Once the trees are harvested, they

are sent by truck 12km to the newly constructed 1.5 million m3 per annum chipping mill at

the company’s port facilities. The US$25 million chipping plant was commissioned in June



182


2008. The trees are processed at the plant and then shipped to Portugal and Spain under

two contracted agreements. Management is continuously evaluating growth within the

forestry segment. A preliminary idea being discussed is the possibility of higher margin

business with the addition of an MDF (fibreboard) plant. The forestry segment provides

approximately 10% to our NAV calculation.

Figure 169: MagForestry chipping facility at Pointe Noire


MAGENERGY

All of the company’s power focus is concentrated in the DRC. Management has a two-

pronged approach regarding power: refurbishing existing power generation infrastructure

and building new power plants to fill the country’s mining energy requirements. Within the

DRC, the government utility, SNEL, owns existing power infrastructure. However, new

power facilities can be built and owned by private companies.

INGA hydro facility

The INGA power facility consists of 14 turbines (INGA I – six turbines of 52MW each andINGA II – eight turbines of 168-178MW each) that were financed by the World Bank during

the 1970s and 1980s at a total cost of US$2 billion. Due to a lack of funding, neglect and

civil war, the facility has never reached its full potential of 1,774 MW and is currently

operating at approximately 20-30% of design capacity. In 2005, MagIndustries signed an

agreement with the government that allowed it to refurbish five units at INGA II under two

phases:



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Phase I

Phase I involves the complete refurbishment of a 168MW turbine at a total capital cost of

US$25 million. MagIndustries has been granted the rights to 50% of the restored capacity

for six years beginning in Q4/08. Mag’s 84MW allocation is split 70% to Mag and 30% to

financial partner Industrial Development Corporation of South Africa.

Phase II

Phase II involves the refurbishment of four INGA II turbines totalling 656MW at an

estimated cost of US$140 million (75% to be funded by MagEnergy). Once complete, 25% of

the restored capacity (164MW) will be marketed for 15 years by MagEnergy (where it will

receive 85% of the revenues). The company is still awaiting final approval from the DRC

government to proceed with the refurbishment. It was originally expected in early 2007.

There are numerous issues at hand, all of them political and all out of MagEnergy’s

control. At this point it is unclear whether the company will be able to benefit from Phase

II of the project. Clouding the issue is the fact that the Chinese have reportedly offered the

DRC government US$10 billion in infrastructure build for which they would expect

significant resources in return. This may be part of the reason the mining industry in the

DRC is undergoing a contract review and is perhaps impacting the review of MagEnergy’sINGA Phase II contract. As such we offer a 25% possibility in our NAV calculation that the

project will be approved.

Figure 170: INGA hydroelectric facility


New hydro

Mag has secured the rights to new hydro build within the DRC. Two sites the company is

evaluating are the Busanga and Zongo 2. We currently offer no value for these projects in

our NAV calculation.

Busanga

Busanga has the potential to be a 250MW facility along the Congo River, in the

southeastern portion of the country. A technical feasibility study was completed in March



185


MANAGEMENT

Bill Burton, President and Chief Executive Officer

Mr. Burton founded MagIndustries in 1997. Mr. Burton has over 30 years of global

experience in mineral property development. Twelve of those years were in the

employment of Rio Tinto.

Stéphane Rigny, Executive Vice President, Finance

Mr. Rigny joined MagIndustries in 2003 as Executive Vice President, Finance. He has

extensive experience in Africa, specifically the ROC, due to his 11 years of project finance

with Rand Merchant Bank of Johannesburg. Mr. Rigny has forged a strong relationship

with the government of the ROC and through past and current dealings, and thoroughly

understands completely the political and social aspects of the country. This point cannot

be understated.

Willy Verbrugghe, CEO, MagMinerals

Mr. Verbrugghe was appointed CEO of MagMinerals in May 2008. Mr. Verbrugghe has

over 30 years of operational experience, including executive management positions. He

has worked with Westinghouse Energy Systems, Kollmorgan Corp. and Sermatech to

name a few. During that time, Mr. Verbrugghe has participated or led the construction of

numerous large industrial projects.

INVESTMENT RISKS

Political

There exists serious political risk in the DRC, as that country’s leaders have

demonstrated in the recent re-evaluation of the country’s mining projects that a contract

is never assumed to be final, as we have seen with the delay in the approval of the

permit for Phase II of the INGA project. It remains anyone’s guess as to when or if theINGA II contract will be finalized.

Within the ROC, the political risk is very much muted, but with any mid-African country,

the risk must always be appreciated.

Financial risk

The project will require significant funds to be raised in the capital market place. It is not

guaranteed that the company will be able to raise the required funds in order to move

their project forward to production.

Project risk

If the capital expenditure assumption exceeds our estimate or if there are delays in the

construction of the project, it will be detrimental to the valuation of the company.

Gas supply

The operation of the project is dependent on the availability of gas to heat the water

being pumped into the deposit and to power the potash plant. If gas is not available

within the specified project timeline, the start-up of the project will be delayed and the

valuation negatively affected as a result.



186


VALUATION

We derive a 12-month target of C$8.50 per share for MagIndustries using a 12%

discount rate and the following assumptions:

· Initial production beginning in H1/11 with 600kt in 2012, 900kt in 2013 and

1.2mtpa by 2014.

· A long-term (beginning 2018) potash price of US$500/t fob Pointe Noire.

· An assumed Phase I financial raise of $750 million, including capital expenditure of

$723 million plus $27 million in additional financing to cover interest and

miscellaneous costs. Furthermore, we have assumed a debt to equity ratio of 70:30.

We assume the debt will be raised in one instalment in Q4/08, and the final equity

instalment during Q4/08.

· An assumed Phase II financial raise of $320 million, with capital expenditure of

$450 million, with the difference funded through revenues generated from Phase I.

In addition, we have assumed a debt to equity ratio of 70:30, with the equity raise in

F2010 and the debt raise in F2011.

· A 10% government free-carried interest on the Kouilou potash project.

· An effective income tax rate of 30% following a tax holiday on the forestry segment

until 2015 and the potash segment until 2020.

· A mine life of 40 years based on current and expected resource escalation due to the

continuous nature of the ore body.

· A mine operating cost of $84/t.


· A $0.25 NAVPS for the optionality the magnesium project presents to MagIndustries

and a $0.15 NAVPS for the optionality of INGA Phase II

Based on these assumptions, MagIndustries is currently trading at a 63% discount to our

12% net asset value per share of $8.57. We derive a 12-month target price of C$8.50 by

applying a 1.0x multiple to the NAVPS.

Sensitivity analysis

We applied the following sensitivity analysis to our model:

Figure 171: NAV sensitivity to debt/equity financing ratio

Debt/Equity Financing

70/30 50/50 30/70

10% 10.48 9.40 8.53iscount

Rate 12% 8.57 7.70 7.00

Source: Canaccord Adams

We have assumed a 70:30 debt to equity ratio for Phase I. Unlike the company’s junior

potash peers in Saskatchewan, the debt that we assume to be available to MagIndustries

will be from quasi-governmental agencies focused on building projects within Africa. As

illustrated by the figure above, the 70:30 debt to equity mix offers the company

significant upside potential in valuation.



187


Figure 172: NAV sensitivity to long-term potash price

Long Term Potash Price (fob Pointe Noire)

$ 8.57 450 500 550 600

800,000,000 8.18 8.51 8.84 9.17

1,000,000,000 8.27 8.60 8.93 9.26

1,200,000,000 7.93 8.26 8.57 8.921,400,000,000 7.81 8.14 8.47 8.79

Capex

1,600,000,000 7.68 8.01 8.34 8.67


With a long-term fob Pointe Noire price of US$500/t, and assuming a financial raise of

$723 million, we have arrived at an NAV of $8.57. Due to the assumption of a 70:30 debt

to equity and the project benefiting from higher potash prices in the initial years of

production, the NAV is not as sensitive to changes in capex or long-term potash price.

We do not offer financial comparisons within potash deposits based on resources or

“pounds in the ground” as the deposits are continuous and relatively easy to find. The

value added is derived from a geologically significant resource, a strong management

team and financial backing to move it forward.

CONCLUSION

MagIndustries is our top selection among our non-producing fertilizer companies. The

company will benefit from high potash prices in its initial years of production, a lower

financing and time risk versus its peers, a low operating cost, strong government

support, continued access to financial partnerships to fund expansions, and a

management team that will be able to see the project through to production. For these

reasons, we initiate coverage of MagIndustries with a BUY rating and a 12-month target

price of C$8.50.



188


Figure 173: Consolidated cash flow statement, MagIndustries, FYE Dec

FY09E FY10E FY11E FY12E FY13E FY14E FY15E FY16E FY17E

US$ 31-Dec-09 31-Dec-10 31-Dec-11 31-Dec-12 31-Dec-13 31-Dec-14 31-Dec-15 31-Dec-16 31-Dec-17

Cash flows from operating activities:

Net earnings (25,573,561) (32,226,224) 154,053,961 327,862,300 437,802,720 503,638,982 382,963,488 384,017,207 382,715,400

Items not affecting cash:

Stock Based compensation 1,692,238 1,861,462 2,047,608 2,252,369 2,477,605 2,725,366 2,997,902 3,297,693 3,627,462

Amortization, depreciation 2,700,000 2,700,000 39,350,000 39,350,000 61,850,000 61,850,000 61,850,000 61,850,000 61,850,000

Non-controlling interest 0 0 0 0 0 0 0 0 0

Foreign exchange loss 0 0 0 0 0 0 0 0 0

(21,181,324) (27,664,762) 195,451,569 369,464,668 502,130,326 568,214,348 447,811,390 449,164,900 448,192,862Change in non-cash working capital (9,204,973) 0 (134,862,888) (99,540,000) (77,430,600) (44,325,000) 57,537,288 (11,040,000) 0

(30,386,296) (27,664,762) 60,588,681 269,924,668 424,699,726 523,889,348 505,348,678 438,124,900 448,192,862

Cash from (used in) discontinued operations

Cash flows from investing activities:

Sustained Capex (2,500,000) (2,500,000) (2,500,000) (2,500,000) (2,500,000) (2,500,000) (2,500,000) (2,500,000) (2,500,000)

Project Capex (350,000,000) (373,000,000) (225,000,000) (225,000,000) 0 0 0 0 0

Additions to Timber holdings (1,000,000) (1,000,000) 0 0 0 0 0 0 0

(353,500,000) (376,500,000) (228,500,000) (228,500,000) (3,500,000) (3,500,000) (3,500,000) (3,500,000) (3,500,000)

Cash flows from financing activities:

Issue of corporate notes 0 0 0 0 0 0 0 0 0

Issue of common shares 0 120,000,000 0 0 0 0 0 0 0

Long term debt issued 0 0 200,000,000 0 0 0 0 0 0

Cash generated by financing activities 0 120,000,000 200,000,000 0 0 0 0 0 0

Effect of exchange rate changes on cash 0 0 0 0 0 0 0 0 0

Net cash flow (383,886,296) (277,604,762) 38,136,181 41,424,668 421,199,726 520,389,348 501,848,678 434,624,900 444,692,862

Cash, beginning of period 699,917,732 316,031,435 38,426,673 76,562,854 117,987,522 539,187,248 1,059,576,595 1,561,425,274 1,996,050,174

Cash, end of period 316,031,435 38,426,673 76,562,854 117,987,522 539,187,248 1,059,576,595 1,561,425,274 1,996,050,174 2,440,743,036

CFPS (0.14) (0.13) 0.29 1.29 2.03 2.50 2.41 2.09 2.14

EPS (0.13) (0.17) 0.74 1.56 2.09 2.40 1.83 1.83 1.83




189



PhosCan Chemical Corp.

FOS : TSX-V : C$1.75BUY

Target: C$3.20

Keith Carpenter, MBA, CFA 1.416.869.7325

[email protected]

Neal Gilmer, MBA [email protected]

COMPANY STATISTICS:

52-week Range: C$0.50-2.48

Avg. Daily Vol. (000s): 1,377.6




NAV: 3.21

Cash (M): 79.0

LT Debt (M): 0

EARNINGS SUMMARY:FYE Jan 2012E 2013E 2014E 2015E 2016ERevenue(M): C$433 C$580 C$603 C$586 C$553

EPS: 0.32 0.50 0.53 0.50 0.38

CFPS: C$0.61 C$0.90 C$1.00 C$0.97 C$0.92


COMPANY SUMMARY:PhosCan is advancing its 100%-owned verticallyintegrated Martison phosphate project near Hearst,Ontario, in order to take full advantage of the structuralconstraints that are expected to remain over the long

term. PhosCan has the ability to potentially servicecustomers in western Canada and the Midwest US bycapitalizing on its cost competitiveness due to its relativeproximity to its target markets versus its peers and itsmixture and flexibility of product offering which includes ahigher value product.



INITIATING COVERAGE WITH A BUY RATING AND C$3.20 TARGET PRICEInvestment thesis

We are initiating coverage of the PhosCan Chemical with a BUY rating

based on the following conclusions:

· Stronger phosphate markets going forward


BRICs”, we believe the phosphate market has undergone a

significant change that will lead to higher prices going forward.

· Lower-cost access to markets

PhosCan’s proposed Martison project is expected to benefit from a

superior product in super phosphoric acid (SPA) and lower-cost

access to its target markets for both monoammonium phosphate

(MAP) and SPA.

· Ability to capitalize on structural issues in the SPA market

Due to the structure of the market and recent events, PhosCan hasan opportunity to serve the supply-constrained SPA market with a

product offering that provides flexibility in output.

· Strong management team

PhosCan has done an excellent job in sourcing the strongest

management team in the junior fertilizer space, in our opinion, to

move the project through to production.

· Valuation

We value the shares of PhosCan Chemical on a 1.0x NAV of C$3.20,

using a long-term MAP and SPA price of US$650/t and US$1,250/t

fob, respectively, and a 10% discount rate.



190


INTRODUCTION

PhosCan is advancing its 100%-owned vertically integrated Martison phosphate project

near Hearst, Ontario, in order to take full advantage of the structural constraints that are

expected to remain over the long term. PhosCan has the ability to potentially service

customers in western Canada and the Midwest US by capitalizing on its cost

competitiveness due to its proximity to its target markets relative to its peers and its

mixture and flexibility of product offering which includes a higher value product.

Phosphate pricing

As we detailed in our thematic piece , “The Modernization of the BRICs”, we believe that

phosphate pricing has witnessed a significant change in pricing structure that has

permanently increased the base pricing for phosphate fertilizers in the long run, due to the

increased usage of fertilizer application rates and the components that provide the inputs

to the finished product.

Lower-cost access to markets

PhosCan will look to enter the MAP and SPA market based on continued demand for theproducts, a freight cost advantage over competitors, and a higher value product with its

output of SPA (discussed in greater detail below).

Additionally, PhosCan will provide optionality within the two product offerings it will be

bringing to market. As we discuss below, the range of operating capacities between the

two products and product offering provides the company over the long term with leverage

to areas that are commanding premiums to areas when markets are soft. As the planned

facilities are based upon a long mine life, optionality is a prudent function.

Structural issues within the SPA market

The market for SPA has become very tight recently, as pricing for the fertilizer has shown.

Only four facilities produce the product within the US: Potash Corp.’s Aurora facility in

North Carolina; Agrium’s Conda, Idaho, plant; Simplot’s facility in Wyoming; and Agrifos’

operation in Texas. Agrifos ceased SPA production in mid-May 2008 due to environmental

concerns in the groundwater per the EPA. The company claims that this is temporary—

time will tell. There are no SPA production facilities in Canada. As a result of strong

demand and constrained supply, pricing has reached all-time highs.

Management

PhosCan continues to do an excellent job of sourcing the appropriate pool of expertise to

move the Martison project into production. As highlighted in the management section,

below, the combination of years of experience and knowledge within the phosphate

business should prove extremely beneficial as the company moves the project towards

production.

Optionality

Beyond our write-up on the phosphate markets in our thematic piece, “The Modernization

of the BRICs”, we believe there is added value within the PhosCan business plan due to the

production of SPA in addition to MAP. As outlined below, the company contemplated two

scenarios in its prefeasibility report (released in May 2008): Scenario A, which assumes the

production of both products; and Scenario B, which outlines only MAP production. We will

offer a valuation for Scenario A, as we believe management will choose this option.



191


Management’s reasons for potential SPA output are many: The market’s need for the

product; the ability of the company to produce the product given its higher-quality rock;

the company’s cost advantage of producing the product versus its peers; and the relative

stability of the SPA market versus the MAP market during economic downturns. The

timeline on the project includes a bankable feasibility study (BFS) due by early 2010,

immediately followed by financing and two years of construction for an initial production

date of early 2012.

THE MARTISON PROJECT

The Martison project consists of a mine and beneficiation plant to be located 70 kilometres

north of Hearst, Ontario, and an associated chemical plant to be situated near Hearst,

adjacent to Ontario Northland Railway (ONR) and 24 kilometres from the CN Railway

terminal in the City of Hearst. The mine site would be connected to the plant via an 86

kilometre slurry pipeline carrying a mixture of phosphate ore and water. The chemical

plant will produce two products: Merchant Grade Acid (MGA), an intermediate product that

would be shipped via rail to the company’s granulation plant in Brandon, Manitoba; and

SPA, shipped directly to the customer in Canada and in the US.

Figure 174: Location of Martison project

Source: PhosCan



192


Geology

Phosphate occurs in two types of mineralization: igneous and sedimentary. Igneous

deposits are formed through the solidification of molten material that originated within the

earth and sedimentary deposits are made up of ancient fossilized sea life formed over

millions of years. The Martison deposit is an igneous deposit with a low level of impurities.

This relative lack of impurities allows for the production of higher-value SPA. It should be

noted that SPA product cannot be produced economically from every phosphate deposit.

For example, the impurity content in central Florida phosphate can be readily used to

produce several end products including DAP, but it is much harder to produce SPA (a

higher-margin product). The ore body begins at 30 metres depth and angles down toward

the west to a yet-to-be-determined depth. In some areas, the ore body extends beyond

drilled depths of 200 metres. Exploration drilling to date shows an area in the northeast

portion of Anomaly A where a low-grade phosphate layer with up to 1% niobium exists.

Within the overall deposit, the niobium grade is 0.34%.

Resource

The deposit contains NI 43-101 measured and indicated resources of 62.3 mt, grading

23.55% P2O5 and 0.34% Nb2O5 (Figure 175). Further inferred resources total 55.7mt at21.87% P2O5 and 0.34% Nb2O5 (Figure 176). It is to be noted that these are as-mined (in

situ) assays.

Figure 175: Measured and indicated resources

Source: PhosCan

Figure 176: Inferred resources

Source: PhosCan



193


The resource pertains only to Anomaly A shown in Figure 177. Anomaly A remains open

at depth and to the northwest and southeast. Approximately 35% of the 28 km² property

has been drilled to date. Aeromagnetic imagery indicates a significant potential upside to

the resource base. Further exploration drilling will be conducted to prove this expectation.

Currently, on a measured and indicated basis, the mine life totals 19 years under either

scenario (see below). In conjunction with the current BFS, an additional 70+ holes will be

drilled on Anomaly A in 2009 to further add to the resource.

Figure 177: Magnetic survey and location of completed drilling

Source: PhosCan

PREFEASIBILITY STUDY

Jacobs Engineering, supported by a mine design prepared by Golder Associates, completed

a prefeasibility study in May 2008 with the following highlights:

Mining

The mining operation will involve an open pit, truck and shovel operation, to be loaded

into the on-site beneficiation plant where the product will be upgraded to 37.5% P2O5

content. Approximately 1.16 mtpa of phosphate rock concentrate will be transported as aslurry (with water) in a pipeline to the chemical plant in Hearst. Operating rates are

estimated to reach 69% in year 1 (2012), 95% in year 2 and full production beginning with

year 3.

Processing

Chemical tests have concluded that PhosCan can expect to recover 75% of the phosphate in

a 37% P2O5 rock concentrate. Tests produced MGA and SPA, which were further upgraded



194


to high-quality MAP and 10-34-0 liquid fertilizer, respectively. The plant will have a

capacity of 400kt P2O5 per annum. We note that management will be studying a 500kt

plant in the feasibility study. This will provide the company with further optionality and a

capital cost efficient increase in capacity. Included in the chemical plant would be an SPA

plant with a design capacity of 150ktpa of P2O5 (under the most probable Scenario A). The

facility would also include all the relevant storage capabilities for SPA, MGA, sulphur and

sulphuric acid. The processing facility at Brandon would include a granulation plant, raw

material (MGA and ammonia) receiving and storage, process utilities, and product storage

and shipping.

Scenario A

Scenario A envisions a plant that would produce 215ktpa of SPA solution (70% P2O5) and

461kt of MGA solution (54% P2O5) utilizing sulphuric acid supplied by base metal smelters.

The SPA would be sold directly to market and the MGA would be sent via rail to a

proposed granulation plant in Brandon, Manitoba, for processing into 474ktpa of MAP.

The MAP would then be sold to market.

Scenario B

Scenario B envisions a plant that would produce 754ktpa of MGA solution, utilizing onsite

production of sulphuric acid, with sulphur sourced from northern Alberta. The MGA would

then be sent via rail to the granulation plant in Brandon to produce 775ktpa of MAP.

Figure 178: Diagram of PhosCan product supply chain

Source: PhosCan

Ammonia

Ammonia will be added to the phosphoric acid (MGA) at the Brandon, Manitoba, facility to

produce MAP. PhosCan intends to source its ammonia requirements from western

Canadian producers as the Brandon facility is within close proximity of several ammonia

plants and storage terminals and along a rail line that transports a majority of the

ammonia that is shipped to the US.



196


Rail equipment

PhosCan will look to lease approximately 100 rail cars for the MGA and SPA products.

END MARKETS

PhosCan will look to sell its end products into the grain-producing regions of Canada and

the midwestern US. Figures 179 and 180 illustrate the North American supply/demand

parameters of MAP and SPA, respectively.

Figure 179: North American supply/demand function of MAP

Source: PhosCan

MAP market

MAP is the most common fertilizer used in Canada and the upper Midwest US with much

of the supply coming from the US Gulf (Florida and Louisiana). The Brandon granulation

plant, however, will be able to produce DAP for the region as well as MAP. Much of the

target market is well within truck-hauling distance giving the project a decided freight

advantage over all other producers, including water bound imports.

SPA market

SPA is used primarily as a starter fertilizer in springtime applications. SPA market demandwithin North America can only be serviced domestically as no vessels or unloading

facilities are capable of handling water-bound SPA imports. This is due to the special

equipment required for shipping and handling the product over long distances and the

relatively small end market compared with the much larger DAP/MAP solids market. The

market for SPA has become very tight recently, as pricing for the fertilizer has shown. Only

four facilities in the US produce the product: Potash Corp.’s White Springs facility in north

Florida; Agrium’s Conda, Idaho, plant; Simplot’s facility in Wyoming; and Agrifos’



197


operation in Pasadena, Texas). Agrifos ceased SPA production in mid-May 2008 due to

environmental concerns in the gypstack water under a directive by both the EPA and

Texas state authorities. The company claims that this is temporary—time will tell. There

are no SPA production facilities in Canada. Enter PhosCan, with a high-quality product due

to the low impurity content of the phosphate rock and a freight advantage to markets in

western Canada and Midwest US. Aside from the product quality and margin advantage,

the market for SPA is bordering on demand destruction if new product is not brought to

market, as dealers will be forced to find alternative sources of phosphate fertilizer (i.e.,

solids). PCS-Aurora, which is planning a 180kt P2O5 expansion by 2009. However, most of

that expansion will be used for purified acid growth and it remains to be seen if any will be

utilized for SPA. SPA is sold on a quarterly and longer-term contract basis to dealers who

convert the product to 10-34-0. Although primarily used as a starter fertilizer in the spring

planting season, the SPA will be shipped year-round and converted to 10-34-0, so that it

can be stored until required. Both customers and PhosCan benefit from the higher-quality

product and lower freight costs.

Figure 180: North American supply/demand function of SPA

Source: PhosCan

COST

Operating costs

We have assumed an operating cost of $335/t SPA and $288/t MAP. At an assumed long-

term price of US$1,250/t SPA and US$650/t MAP, the gross margins should be significant

throughout the project’s mine life.



198



The cost as laid out in the prefeasibility study is $855 million for Scenario A and $977

million for Scenario B. The major difference between the two costs is the addition of a

sulphuric acid plant and the enlarged granulation plant and storage facilities under

Scenario B. Offsetting this would be lower operating costs. We have assumed a Scenario A

capital requirement, with the expectation that a sulphuric acid plant would be built off balance-sheet.

Royalties

Several royalties exist on the property. A net sales return royalty of 1% on phosphate

concentrate exists whereby PhosCan can elect to purchase the royalty prior to the

commencement of commercial production for a one-time payment of $3 million.

TIMELINE

A bankable feasibility study was initiated in February 2008 and is expected to be

completed by March 2010. Although we believe PhosCan will have concluded an

investment agreement with an equity partner prior to March 2010, we have modelled thecompany accessing the capital markets for $920 million in the form of 40% debt and 60%

equity in March 2010. Construction of the facility would begin immediately following

financing of the project with an expected completion date of mid-2012. Commercial

production would follow by year-end 2012 and full ramp during 2013.

CAPITALIZATION

The prefeasibility study detailed two capital expenditure figures. Scenario A has a capital

estimate, including working capital, of $893 million. Scenario B is estimated at $1.017

billion. Management envisions a capital expenditure budget of $70 million over the next 20

months. As at July 2008, the company had $79 million in cash. Management expects

current cash on hand to cover all expenditures through to construction start-up in Q2/10.

We have assumed the eventual capital requirement raise will be 60% equity and 40% debt.

The BFS is expected to cost approximately $30 million, and an estimated $40 million will

be spent on long lead time items.

Management intends to be creative with the financing of the sulphuric acid plant. They

have held initial discussions with several firms regarding moving the plant off balance-

sheet and debt financing it to the tune of 80%.



199


MANAGEMENT

Steve Case, President and Chief Executive Officer

Mr. Case has over 18 years of financing and development experience of mineral assets in

North America. Mr. Case was previously a co-founder of RFC Resource Finance

Corporation, which was sold to Teck Cominco.

James Pringle, Chief Financial Officer

Mr. Pringle joined PhosCan in 2008 as Chief Financial Officer. Previously, Mr. Pringle was

CFO of Frontera Copper Corporation from 2004 to 2005, where he oversaw the successful

financing of the Piedras Verdes project in Mexico, and from 1997-2003, he was an

investment banker with RBC Dominion Securities and CIBC World Markets. Mr. Pringle is

Metallurgical Engineer.

Henry (Hank) Giegerich, Director

Mr. Giegerich has over 40 years’ experience in the mining industry. Under his direction as

President and General Manager of Cominco Alaska Inc., the Red Dog project progressed

from the exploration stage to the construction phase. Prior to that assignment, as Vice

President, Northern Group, for Cominco, he was responsible for bringing the Polaris Mine

into production, as well as the operation of the Con Gold Mine and the Pine Point Mine. For

the past 15 years, he has been a consulting mining engineer providing a variety of services

to various projects worldwide.

Glen Magnuson, Director

Mr. Magnuson has 37 years of agriculture and fertilizer industry experience, 25 of which

were spent at Cargill where he retired as Vice President of the Fertilizer Division. With

Cargill, Mr. Magnuson was involved with the purchase of the Gardiner phosphate facility in

1985 and the development of the Saskferco nitrogen complex. Mr. Magnuson is currently

employed as a consultant to the fertilizer industry.

John Yokley, Director

Mr. Yokley retired in 2006 following a career in the fertilizer industry, most recently with

Agrium where he spent 10 years covering strategic development and planning, marketing

and distribution, and specialty businesses. Prior to 1995, Mr. Yokley was Vice President of

national accounts sales, distribution and raw material purchasing for Nu-West Industries,

a US phosphate producer.

Garry Pigg, Project Manager

Mr. Pigg has over 40 years in the mining and fertilizer industry having senior managerial

experience with both Freeport-McMoRan and IMC Global (two predecessor firms to

Mosaic). He has acted as a consultant to companies with interests in potash and phosphatemining and has managed and directed various aspects of business, plant and product

development. Mr. Pigg is a chemical engineer.



200


INVESTMENT RISKS

Sulphur

We have assumed the company will have unlimited access to sulphur at reasonable prices.

If the supply of sulphur were interrupted or the cost increased significantly, then it would

materially affect the operation and income of the company.

Permitting risk

PhosCan has not obtained all the necessary permits to allow it to graduate from an

exploration company to a development entity. The most significant is the environmental

permit. If permitting is delayed, it will negatively impact the production timeline and the

valuation as a result.

Financial risk


guaranteed that the company will be able to raise the required funds in order to move its

project forward to production.

Project risk



VALUATION

We derive a 12-month target price of C$3.20 for PhosCan Chemical using a 10% discount

rate and the following assumptions:

· Initial production beginning in Q4/12 with full production of 150ktpa of SPA and

474ktpa of MAP by 2013.

· A long-term MAP and SPA price of US$650/t and US$1250/t fob, respectively.

· An assumed financial raise of $920 million in addition to the recent raise of $55

million, including capital expenditure of $900 million plus $20 million in additional

financing to cover interest and miscellaneous costs. Furthermore, we have assumed a

debt to equity ratio of 40:60. We assume the debt and equity will be raised in one

instalment in Q2/10.

· We assume the company will join with a financial partner, but for the purpose of our

model, we assume the partner to take part of the equity raise in 2010.


· A mine life of 19 years.

· A mine operating cost of $335/t SPA and $287/t MAP.


Based on these assumptions, PhosCan is currently trading at a 45% discount to our 10%

net asset value per share of $3.21. We derive a 12-month target price of C$3.20 by




201






60/40 50/50 40/60

8% 4.84 4.43 4.09iscountRate 10% 3.80 3.48 3.21


We have assumed a 40:60 debt to equity ratio, believing that the company will not be able to

raise predominantly debt. We expect management to enter discussions with potential partners

and investors to offer the company financing. As illustrated by the chart above, the risk to the

mix between 40:60 and 60:40 debt to equity is to the upside in valuation. We believe the

company will be able to raise the appropriate funding. The questions remaining are: In what

form and with whom? We believe these questions will be answered within the next two years.

Figure 182: NAV sensitivity to long-term MAP price

MAP

550 600 650 700 750

700,000,000 3.54 3.68 3.83 3.97 4.12

800,000,000 3.23 3.38 3.52 3.66 3.81

900,000,000 2.92 3.07 3.21 3.36 3.50

1,000,000,000 2.62 2.76 2.90 3.05 3.19

Capex

1,100,000,000 2.31 2.45 2.60 2.74 2.88


Figure 183: NAV sensitivity to long-term SPA price

SPA

1150 1200 1250 1300 1350

700,000,000 3.74 3.78 3.83 3.87 3.92

800,000,000 3.43 3.48 3.52 3.57 3.61

900,000,000 3.12 3.17 3.21 3.26 3.30

1,000,000,000 2.81 2.86 2.90 2.95 3.00

Capex

1,100,000,000 2.50 2.55 2.60 2.64 2.69


With long-term pricing of US$650/t for MAP and US$1250/t for SPA, and assuming a

financial raise of $920 million, we have arrived at an NAV of $3.21. Figures 182 and 183

conclude that relative percentage changes in MAP pricing are more sensitive to changes in

SPA pricing. The shares of PhosCan are quite sensitive to changes in capex assumptions.

CONCLUSION

We believe PhosCan will benefit over the long term from a strong MAP and SPA price

environment, low operating costs and strong margins, optionality in its product offering,

access to financial partnerships to help fund the project, and a management team that will

be able to see the project through to production. For these reasons, we initiate coverage of

PhosCan with a BUY rating and a 12-month target price of C$3.20.



202


Figure 184: Cash flow statement, PhosCan, FYE January

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Net Income (Loss) (1,367,989) (18,700,000) (33,900,000) 108,728,866 171,704,184 181,182,842 171,033,425 128,964,851 166,314,232 243,432,908

Non-cash Adjustments

Stock based comp 1,101,165 145,994 160,593 160,593 176,652 194,318 213,749 235,124 258,637 284,501

Amortization 789 - - 144,400,000 163,200,000 160,200,000 154,300,000 175,400,000 109,800,000 6,100,000

Future income taxes (recovery) (1,671) - - - - - - - - -

F/X Loss

Write off mining interests, subsidiary

Net change in W/C (1,876,999) - 110,071 (44,540,782) (24,982,000) 66,300 8,667,930 12,432,223 12,573,945 12,213,340

CFO (2,144,705) (18,554,006) (33,629,336) 208,748,677 310,098,837 341,643,459 334,215,104 317,032,199 288,946,814 262,030,748

Cash flows from investing

Sustaining Capex - (2,500,000) (2,500,000) (2,000,000) (2,000,000) (2,000,000) (2,000,000) (2,000,000) (2,000,000) (2,000,000)

Project Capex (30,000,000) (315,000,000) (585,000,000) (1,000,000) (400,000) (8,600,000) (9,800,000) (8,600,000) (8,700,000) (19,500,000)

Redeption (Purchase) of STI 355,805 - - - - - - - - -

Prepaid transaction costs 847,809 - - - - - - - - -

Mineral property expenditures (2,189,646) - - - - - - - - -

CFI (30,986,032) (317,500,000) (587,500,000) (3,000,000) (2,400,000) (10,600,000) (11,800,000) (10,600,000) (10,700,000) (21,500,000)

Cash flows from financing - - - - - - - - - -

Advances to related party 36,848 - - - - - - - - -

Proceeds from issuance of shares 55,503,200 340,000,000 200,000,000 - - - - - - -

Proceeds from the issuance of debt - 380,000,000 - (400,000,000)

Deferred share issue costs - - - - - - - - - -

Share issuance costs - - - - - - - - - -

CFF 55,540,048 720,000,000 200,000,000 - - - - - (400,000,000) -

Effect of FX on cash held in foreign curr 1,671

Net change in cash flows 22,409,311 383,945,994 (421,129,336) 205,748,677 307,698,837 331,043,459 322,415,104 306,432,199 (121,753,186) 240,530,748

Cash beginning of period 29,870,552 52,281,534 436,227,528 15,098,192 220,846,869 528,545,706 859,589,165 1,182,004,270 1,488,436,468 1,366,683,282

Cash end of period 52,281,534 436,227,528 15,098,192 220,846,869 528,545,706 859,589,165 1,182,004,270 1,488,436,468 1,366,683,282 1,607,214,030

CFPS (0.01) (0.06) (0.10) 0.61 0.90 1.00 0.97 0.92 0.84 0.76EPS (0.02) (0.07) (0.10) 0.32 0.50 0.53 0.50 0.38 0.48 0.71




203

CAnaccord Adams is the global capital markets group of Canaccord Capital Inc. (CCI : TSX|AIM)


Potash One Inc.

KCL : TSX : C$4.29SPECULATIVE BUY


COMPANY STATISTICS:

52-week Range: C$0.93-6.25





Cash (M): 13.8

LT Debt (M): 0

EARNINGS SUMMARY:

FYE Apr 2013E 2014E 2015E 2016ERevenue (M): C$525 C$1,125 C$1,500 C$1,500

EPS: C$0.99 C$2.13 C$2.86 C$2.86

CFPS: C$0.78 C$2.31 C$3.15 C$3.32


COMPANY SUMMARY:Potash One is engaged in the acquisition, exploration anddevelopment of solution mine amenable potash depositsin Saskatchewan. The company holds an option topurchase 100% of a 97,000-acre exploration permit inSaskatchewan and owns 100% of three explorationproperties totaling 239,000 acres. The company’sprimary focus is the advancement of its optioned land,

the Legacy potash project, located 80 kilometresnorthwest of Regina and 32km to the north of Mosaic’sBelle Plaine mine.



INITIATING COVERAGE

Investment thesis

We are initiating coverage of Potash One with a SPECULATIVE BUY

rating and a 12-month target price of C$7.75 based on the following

conclusions:

· Step-change in potash pricing going forward




be able to meet the growth in demand over the next five years.

· Earlier to production and lower capex

We believe Potash One will be the first to production of the

Saskatchewan-based juniors in H1/13 at a lower capital expenditure

that will more than offset a higher operating cost of production

versus conventional mine operators.

·

Financing partnerships forthcomingThere is unprecedented international demand that should ensure

the junior companies have access to financial partnerships. We

believe this will reduce the greatest risk to the junior players in

Saskatchewan.

· Valuation

We value the shares of Potash One on a 1.0x NAV of $7.75, using a

long-term potash price of US$500/t fob Vancouver and a 10%

discount rate.



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INTRODUCTION

Potash One is engaged in the acquisition, exploration and development of solution mine

amenable potash deposits in Saskatchewan. The company holds an option to purchase

100% of a 97,000-acre exploration permit in Saskatchewan and owns 100% of three

exploration properties totalling 239,000 acres. The company’s primary focus is the

advancement of its optioned land, the Legacy potash project, located 80 kilometres

northwest of Regina and 32 kilometres north of Mosaic’s Belle Plaine mine. The project

currently has 36mt in indicated resources and a further 360mt of inferred resources.

Management intends to further delineate the project through an updated resource

estimation in early 2009. We estimate the project will begin production in H1/13 and ramp

up to full production of 2mtpa by 2015, capturing a potash pricing environment that has

increased due to a step change in the fundamentals of the industry. As we will see though

our valuation discussion, the shorter timeline to production and the lesser amount of

required capital expenditures more than offsets the higher operating costs as a result of

solution mining and thus offers investors significant upside to the current share price.

Potash pricing


potash pricing has performed a step-change going forward as a solution to the world’s food

crisis has become dependent on a variety of factors, one of which is the increase usage of

fertilizer application rates going forward. Within the fertilizers, potash stands to have the

strongest outlook over the near, medium and long term. Although the operating costs will

be significantly higher than their conventional mining peers, the expectation for a stronger

potash price going forward should ensure the company has strong margins and cash flow

once in production.

Production earlier and at a lower capex level

Due to the nature of the build-out of a solution mine, the time to production is less than

that of a similar-sized conventional mine due mainly to the lack of shaft construction in asolution mine. The lack of a shaft offers the company significant capital savings and allows

the company to generate earlier cash flows, which on a discounted cash flow basis, offers

significant upside to valuation.

Strategic partnerships

It must be noted that with any significant project undertaking, substantial risks are

inherent to any early-stage company. Regardless of the company’s management or the

project’s method of potential mining, all of these exploration/development junior potash

companies will require significant capital inflow, and specific to the central Canadian

deposits, significant infrastructure requirements with regards to shipping the product to

the end user. Potash One management is in discussions with potential financial partners,

both as an off-take partner and as a port operator.

For the sake of the following discussion, we will de-risk the geology of the project for the

sole purpose of highlighting the risk associated with the financing of the project. Much has

been discussed regarding BHP Billiton’s offer to acquire Anglo Potash in order to

consolidate its ownership in its potash leases. We have little doubt that given BHP’s

balance sheet, it will be a force in Saskatchewan’s potash business at some point in the

future. The reason is simple: BHP has the financial strength to carry out any project that

has economic merit. This is not the case for junior development potash companies in



205


Saskatchewan. We are not stating that it would be impossible for any of these companies

to go from exploration and developer to producer. We have seen this occur in other

sectors, but we believe that, due to the risk and timeline related to developing and

operating a potash operation, further joint ventures or equity alliances will be formed as

this process plays out. We have assumed that all the junior potash companies with

Canadian-based assets will form a financial alliance to serve their fund raising

requirements. And like any sector, some companies with lesser projects will never reach

the point of production. However, we believe Potash One (in addition to Athabasca Potash)

will be such a company that will be able to reach a production level in the future, but

under an alliance of some degree. Since we believe the future is resoundingly positive in

the space, the suitors for financial partnerships are many, some of whom have already

held various levels of discussions with the companies involved.

LEGACY PROJECT

Management envisions the Legacy project producing 2mtpa of potash at full production

through a solution mining process (see below) due to the nature of the ore body. In solution

mining (versus conventional), the company will have the benefit of lower pre-production

capital expenditures and a shorter timeline to production, which will be offset somewhatby a higher operating cost. A prefeasibility study will begin in Q3/08, followed by the

commencement of a feasibility study in Q2/09 with an expected 13-month completion date

(mid-2010).

Figure 185: Location of Potash One’s permits

Source: Potash One

History

The company has focused on the Legacy project due to the historical work completed at the

site in the 1960s. The Legacy project was formerly owned and explored by Imperial Oil and

Lumsden Potash Corporation with 25 surface drill holes completed in the 1960s, 14 of

which penetrated the Prairie Evaporite, for which data is available. The two companies



206


confirmed potash mineralization over two pilot test sites but the sites were abandoned in

the late 1960s. In May 2006, Potash One optioned the land from Invictus Minerals

Corporation (a Saskatchewan-based oil and gas exploration company). Potash One

currently owns 25% of the permit, and as part of the option agreement, the company will

make a $1 million cash payment by September 2008 for a further 26% of the option,

followed by a $1 million in cash and $1 million in shares payment for the remaining 49%

by December 2008. In March 2008, Potash One purchased three potash exploration

permits (KP 355, KP 356 and KP 357) from Giant Potash Corporation (a private Alberta

firm) covering 239,000 acres.

Geology

Within the Prairie Evaporite, there are four members of mineralization (the Patience Lake,

Belle Plaine, Esterhazy and White Bear). Analysis of the historical information shows the

mineralization to have possible economic significance in the Patience Lake and Belle Plaine

members. Further analysis of the five drill holes within close proximity to the two test well

sites are listed in Figure 186. The results point to a consistent orebody with similar grades,

thickness, low magnesium content and percentage of insolubles. The mineralization

generally consists of silvite and halite, with minor amounts of clay, dolomite, anhydrite andcarnallite. Due to the characteristics of the ore body, the company will employ a solution

mining technique. The geology of the Legacy project is similar to that of Mosaic’s Belle

Plaine solution mine to the south.

Figure 186: Grade and thickness parameters of the two pilot test sites

Source: Potash One



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Resources

A NI 43-101 compliant resource was completed on the Legacy project in February 2007,

identifying an indicated resource of 186mt, grading 20.6% K2O (36mt of recoverable

resource) and further inferred resources of 2.1bt at 20.6% K2O (360mt of recoverable

resource) within the Belle Plaine and Patience Lake members. The resources are

calculated based on the 5 historical drill holes. Figure 187 displays the indicated (innerblue circles) and inferred (large red circles) resources with regards to the permit area.

Currently, the indicated resources offer a mine life of less than 20 years. Once the new

resource estimate is released, the estimated mine life by indicated resources should

increase substantially.

Figure 187: Diagram of the indicated and inferred resources at the Legacy project

Source: Potash One



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Resource upgrade

Management will look to publish an updated NI 43-101 resource by year-end 2008 or

early 2009 based on seismic data collection and new drilling. The purpose of the new

resource estimate will be to further define the resource to measured and indicated

status, and to expand the resource. A 3D seismic interpretation of the area has been

concluded to outline anomalous areas to avoid during mining. Details of the findings will

be released in the coming days. The company has recently completed a 2D seismic study,

expected to be released by the end of July, for the purpose of defining a larger scale of

the surrounding area that would display the angle of the ore body, possibly locating more

opportune areas for exploration and to help finalize the location of the plant site. A drill

program will run from August 2008 through to November and include 10-12 holes.

Newly acquired permits

Due to the continuous nature of the prairie evaporate, we have no question the company

will find additional resources on its newly acquired permits. However, given the

commitment required for the Legacy project, we will not offer any value for these other

properties as they will be idled assets with no possibility for advancement by KCL prior to

2015.


Conventional mining involves sinking a shaft to depths of up to 3,000 feet and employing

a continuous miner to remove the ore to load onto conveyor belts to the ore crusher and

then hoist to the surface for refining. In solution mining, heated brine is injected into the

potash deposit to dissolve the ore. The solution is then pumped to the surface and

refined through evaporation and crystallization techniques.

Management intends to employ primary and secondary mining. In primary mining,

heated water is injected into the ore body in order to dissolve the mineralization and

form a cavern. The single well acts as the injection and suction of the brine. In secondary

mining, two caverns are linked together. At this point, the water is pumped into the

cavern via one well and pumped back to surface in a second well. Oil is then injected into

the well to prevent the salt roof from dissolving. The company will utilize two wells for

each of the planned 41 caverns for a total of 82 wells. The caverns will have a diameter

of 70 metres and a height of 25 metres.



209


Figure 188: Diagram of a solution mine

Source: Potash One

Once the solution is extracted to the surface, the processing of the product commences

with the separation of the impurities from the brine. The salt is then removed from the

KCl and the wet KCl crystals are dried and further processed through the compactor

where it is formed into flakes and sized into particle form. Finally, a resin is added to

secure the product from damage during the transportation to the port and the eventual

end user.

Figure 189: Solution mining process flow sheet

Source: Potash One



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Environmental studies

The Environmental Impact Study (EIS) began in March 2008 with an expected

completion and response by the provincial government in Q3/10. Until the government

has approved the EIS, Potash One cannot begin construction on their property.

Feasibility studies

The prefeasibility study is expected to commence in the third quarter of 2008 with a

completion date of Q2/09. Potash One will choose an engineering firm within the coming

weeks. The feasibility study will then follow in Q2/09, with a 13-month completion

timeline of late Q2/10.

Figure 190: Project timeline through 2010

Source: Potash One

Production

We assume the construction timeline would entail a 24-month build for the surface

facilities, during which time approximately 50% of the wells will be completed. First

production could be reached in H1/13 with full ramp-up of 2mtpa by 2015.

INFRASTRUCTURE

The Legacy deposit lies within the potash evaporite, well serviced by roads, rail and

power. The company would have to build spur lines to the rail line, gas pipeline and local

power grid. All-in costs of the infrastructure build are estimated at approximately $150

million.



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Road

Paved roads lie within 10 kilometres of the project.

Rail

The CP and CN rail lines are approximately 2 kilometres and 25 kilometres, respectively,

from the Legacy mine. Spur lines would be required to connect the mine to either rail

line.

Gas

A contract will be required for the supply of gas for the operation of the solution mine.

The company will require a 30-kilometre spur line to connect to the local gas

infrastructure. At full production, the Legacy project will require 232 million m³ of gas

per annum.

Power

Power would be purchased from the provincial power grid through SaskPower. A spur

line would be required to connect to the local grid 9 kilometres away. The project

requires 75MW of power per annum.

Plant

The plant facilities would include an evaporation plant, crystallization plant, compaction

plant, cooling ponds, product drying, product storage, to name a few. All of these

facilities will be included in the pre-feasibility and feasibility studies undertaken by

management.

Port

Discussions are ongoing between Potash One and numerous parties on several solutions.

These include the discussion of a port retrofitting with the cost borne by the terminal

operator, taking on a partner to build a new facility, or another agreement to lessen the

financial risk of Potash One. We would not be surprised if discussions on this level reachan agreement within the next twelve months.

Off-take agreement

The potential suitors for an off-take agreement are numerous. Management is currently

in discussions with a number of parties, including those with significant financial

backing with or without mining experience, those who want the product for their own

use and those who want to control supply of that product.

COST

Operating costs

We estimate the Legacy project will have an operating cost of $140/t. This takes into

assumption the assumed cost inflator to Mosaic’s Belle Plaine solution mine, higher long-

term energy costs, ongoing maintenance, and the recent feasibility level cost of the

Kouilou project in the Republic of Congo.


The expected budget over the next three years is $36 million. The prefeasibility will cost

an estimated $3-4 million, followed by $20 million for the feasibility study. The current



212


drill program will cost an additional $12 million. The current budget incorporates 10-12

drill holes at $1 million each. The high cost per hole is due to the nature of the well.

These holes have a dual purpose: they will aide in the exploration program and they will

be used for the solution mining process once in operation.

The estimated capital expenditure for construction totals $1.8 billion. Although we

believe that the company will form a financial partnership, for the purposes of ourfinancial modeling, a 40/60 debt/equity financing is assumed. We opted to use a lower

debt amount than management is forecasting due to the size of the expected raise and

the thesis that equity partnerships will play a significant role in the project’s future.

CAPITALIZATION

There are currently 42.6 million shares outstanding (50.4 million diluted). As of June

2008, the company had $27 million in cash versus zero debt. Fully diluted cash totals

$52 million. The company has further investments of approximately $32 million.

Ownership

Management owns 1.4% of the shares outstanding. Pinetree Capital is the largest(published) institutional shareholder at 9.0%.

MANAGEMENT

Paul Matysek, President and Chief Executive Officer

In November 2007, Mr. Matysek was appointed President and Chief Executive Officer of

Potash One. Previously, from 2004-2007 he was the Chief Executive Officer of Energy

Metals, a company he founded and subsequently sold to Uranium One in 2007 for $1.8

billion. Mr. Matysek has over 20 years of experience in acquiring and developing

resource companies.

George Lim, Chief Financial OfficerMr. Lim was appointed Chief Financial Officer in 2008. Previously, Mr. Lin was Chief

Financial Officer of Energy Metals for three years. Prior to 2004, Mr. Lin spent five years

as CFO for a group of resource companies with operations in the Americas.

Mike Ferguson, Chief Project Director

Prior to joining Potash One in 2008, Mr. Ferguson served as a general manager for

Wardrup Engineering and operations manager at AMEC. From 1984-2004, Mr.

Ferguson held various management roles in the potash business at Agrium, Mosaic and

Potash Corp. Mr. Ferguson is a mechanical engineer.

INVESTMENT RISKS

Port infrastructure

A significant issue with a new potash project in Saskatchewan will be the means to

which the product is shipped to market. If the company cannot finalize a deal in the

appropriate time in order to export their product to market, the valuation of the

company will be negatively affected.



213


Permitting risk

Potash One has not obtained all the necessary permits to allow it to graduate from an

exploration company to a development entity. The most significant is the environmental



Financial risk


guaranteed that the company will be able to raise the required funds in order to move

their project forward to production.

Project risk

If the capital expenditure assumption exceeds our estimate, or if there are delays in the


Energy costs

The assumed operating cost is very sensitive to the price of natural gas. As such, if gas

costs remain elevated beyond our forecast, it will have a negative impact on the earningsof the company.

VALUATION

We derive a 12-month target price of C$7.75 per for Potash One using a 10% discount

rate and the following assumptions:

· Initial production beginning in H1/13 with full production of 2mtpa by late 2015.

· A long-term potash price (beginning in 2018) of US$500/t fob Vancouver.

· An assumed financial raise of $1.93 billion, including capital expenditure of $1.80

billion plus $125 million in additional financing to cover interest and miscellaneous

costs. Furthermore, we have assumed a debt/equity ratio of 40/60. We assume thedebt will be raised in one installment in H2/10, and the equity in several instalments

between 2011 and 2012.

· We assume no further capex cost borne by the use of a port. We assume the

company will have access to a port through either an off-take agreement or financial

partnership.

· A 4.5% royalty tax payable to the Saskatchewan government.



continuous nature of the orebody.



Based on these assumptions, Potash One is currently trading at a 45% discount to our

10% net asset value per share of $7.75. We derive a 12-month target price of C$7.75 by




214


SENSITIVITY ANALYSIS




60/40 50/50 40/60

8% 15.90 13.33 11.39iscountRate 10% 10.82 9.07 7.75


We have assumed a 40:60 debt to equity ratio, believing that the company will not be

able to raise predominantly debt. Management is in early discussions with potential off-

take partners and investors to offer the company financing. As illustrated by the chart

above, the risk to the mix between 40:60 and 60:40 debt to equity is to the upside in

valuation. We believe the company will be able to raise the appropriate funding. The

remaining questions are: In what form and with whom? We believe these questions will

be answered within the next two years.


Potash Price

$ 7.75 450 500 550 600

(1,400,000,000) 7.90 9.05 10.21 11.36

(1,600,000,000) 7.25 8.40 9.55 10.71

(1,800,000,000) 6.59 7.75 8.90 10.06

(2,000,000,000) 5.94 7.10 8.25 9.40

Capex

(2,200,000,000) 5.29 6.45 7.60 8.75


With a long-term (beginning in 2018) of US$500/t fob Vancouver, and assuming a

financial raise of $1.93 billion, we have arrived at an NAV of $7.75. The chart concludesthat relative percentage changes in potash pricing are twice as sensitive to similar

changes in financial raise.



value added is derived from a geologically significant resource, a strong management

team and financial backing to move the project forward.

CONCLUSION

We believe Potash One will benefit over the long-term from strong potash prices, lower

capital costs and a shorter time to production than its conventional mining counterparts,

access to financial partnerships to help fund the project, and a management team thatwill be able to see the project through to production. For these reasons, we initiate

coverage of Potash One with a SPECULATIVE BUY rating and a 12-month target price of

C$7.75.



215


Figure 193: Cash flow statement, Potash One, FYE Apr

FY09E FY10E FY11E FY12E FY13E FY14E FY15E FY16E FY17E FY18E

30-Apr-09 30-Apr-10 30-Apr-11 30-Apr-12 30-Apr-13 30-Apr-14 30-Apr-15 30-Apr-16 30-Apr-17 30-Apr-18

Net Income (Loss) (6,969,872) (35,800,000) (64,600,000) (64,600,000) 212,642,500 454,427,234 610,614,734 610,614,734 610,614,734 276,364,734


Amortization - - - - - 92,593,237 92,593,237 92,593,237 92,593,237 92,593,237

Future income taxes (recovery) - - - - - - - - - -

Stock based comp 6,487,556 6,487,556 6,487,556 6,487,556 6,487,556 6,487,556 6,487,556 6,487,556 6,487,556 6,487,556

Net change in W/C - - - - (52,590,415) (60,000,000) (37,500,000) - - 50,000,000

CFO (482,316) (29,312,444) (58,112,444) (58,112,444) 166,539,641 493,508,027 672,195,527 709,695,527 709,695,527 425,445,527


Sustaining Capex - (3,000,000) (3,000,000) (3,000,000) (3,000,000)

Project Capex (50,000,000) - - - - - -

Mineral property expenditures - - - - - - - - - -

CFI (50,000,000) - - - - - (3,000,000) (3,000,000) (3,000,000) (3,000,000)

Cash flows from financing -

Advances to related party - - - - - - - - - -

Note payable - - - - - - - - - -

Proceeds from issuance of shares 80,000,000 - 525,000,000 600,000,000 - - - - - -

Proceeds from issuance of debt 720,000,000


Share subscriptions (Share issuance costs) - - - - - - - - - -

CFF 80,000,000 720,000,000 525,000,000 600,000,000 - - - - - -

Net change in cash flows 29,517,684 690,687,556 466,887,556 541,887,556 166,539,641 493,508,027 669,195,527 706,695,527 706,695,527 422,445,527

Cash b eg inn in g of per io d 1 3,59 1,458 4 3,109,142 733 ,79 6,69 8 1,200,684,254 1,742 ,571 ,810 1,90 9,11 1,451 2,402,619,478 3 ,07 1,81 5,00 5 3,77 8,51 0,532 4 ,485 ,206 ,05 9

Cash e nd o f per io d 4 3,10 9,142 7 33,796 ,698 1 ,200 ,68 4,25 4 1,742,571,810 1,909 ,111 ,451 2,40 2,61 9,478 3,071,815,005 3 ,77 8,51 0,53 2 4,48 5,20 6,059 4 ,907 ,651 ,58 6

CFPS (0.01) (0.72) (0.45) (0.27) 0.78 2.31 3.15 3.32 3.32 1.99

EPS (0.15) (0.88) (0.50) (0.30) 0.99 2.13 2.86 2.86 2.86 1.29




216



Athabasca Potash Inc.

API : TSX : C$7.57HOLD


COMPANY STATISTICS:

52-week Range: C$3.60-10.47





NAV: 9.58

EARNINGS SUMMARY:FYE Dec 2014E 2015E 2016E

Revenue (M): C$900 C$1,125 C$1,500EPS: 1.76 2.34 3.43

CFPS: 2.19 3.18 4.32


COMPANY SUMMARY:Athabasca Potash is an exploration and developmentcompany focused on its 100%-owned land package in thepotash-producing region of Saskatchewan, comprising 23exploration permits and totalling approximately 1.5million acres. Athabasca Potash’s primary focus is thedevelopment of the Burr project to become the firstpotash-only producing conventional mining companyoperating in Saskatchewan.



INITIATING COVERAGE

Investment thesis

We are initiating coverage on the shares of Athabasca Potash with a

HOLD rating and 12-month target price of C$9.50 based on the

following conclusions:

· Step change in potash pricing going forward

As we highlighted in our thematic piece “The Modernization of the



be able to meet the growth in demand over the next five years.

· Low operating cost and strong margins

Athabasca Potash should benefit from an operating cost comparable

to those of the lowest-cost conventional potash mines in

Saskatchewan, ensuring strong margins for the company once in

production.

·

Financing partnerships forthcomingThere is unprecedented international demand that will ensure the

junior companies will have access to financial partnerships. We

believe this will reduce the greatest risk to the junior players in

Saskatchewan.

· Improving management team

Athabasca Potash continues to build upon its management and

consultant team to push forward on all the major aspects of the Burr

project.

· Valuation

We value the shares of Athabasca Potash on a 1.0x NAV of C$9.50,

using a long-term potash price of US$500 fob Vancouver, and a 10%

discount rate.



217


INTRODUCTION

Athabasca Potash is an exploration and development company focused on its 100%- owned

land package in the potash-producing region of Saskatchewan, comprising 23 exploration

permits and totalling approximately 1.5 million acres. Athabasca Potash’s primary focus is

the development of the Burr project to become the first potash-only producing conventionalmining company operating in Saskatchewan. The company has been adding to its

management expertise as it moves its project toward a production decision. The asset itself

has had significant exploration work completed on it, and a sizable upside to the resource

is expected in August 2008. As we will discuss in greater detail, we forecast Athabasca

Potash will be producing potash from its Burr project beginning in 2014, ramping to full

production of 2 mtpa by 2016 at significant margins similar to those of its peers in the

Saskatchewan evaporite. To accomplish this and bring the project into production, the

company will require a strong pricing environment, low operating costs, significant

financing, including financial partnerships, and management expertise.

Potash pricing

As we detailed in our thematic piece “The Modernization of the BRICs”, we believe thatpotash pricing has performed a step-change, as a solution to the world’s food crisis has

become dependent on a variety of factors, one of which is increased fertilizer application

rates. Among the fertilizers, potash stands to have the strongest outlook over the near,

medium and long term, in our opinion.

Low operating costs

Once in production, the Burr project is expected to be among the low-cost conventional

producing mines in the region. With significantly higher potash prices going forward, the

company should greatly benefit from strong margins throughout the expected mine life.

Strategic partnerships

It must be noted that, with any significant project undertaking, substantial risks are

inherent in any early-stage company. Regardless of a company’s management or a

project’s method of potential mining, junior potash exploration/development companies

require significant capital inflow and, specific to the central Canadian deposits, extensive

infrastructure requirements to enable shipment of product to the end user. In our opinion,

Athabasca Potash’s management is pushing forward all of these issues in order to alleviate

risks and concerns and to put forth a viable investment project.

For the sake of the following discussion, we will de-risk the geology of the project for the

purpose of highlighting the risk associated with project financing. Much has been said

about BHP Billiton’s offer to acquire Anglo Potash in order to consolidate its ownership in

its potash leases. We have little doubt that, given BHP’s balance sheet, the company will be

a force in the Saskatchewan potash business in at some point in the future. The reason issimple: BHP has the financial strength to carry out any project that has economic merit.

This is not the case for junior development potash companies in Saskatchewan. We are not

stating that it would be impossible for any of these companies to go from exploration and

development to production—we have seen this occur in other sectors—but we do believe

that, due to the risk and timeline related to developing and operating a potash operation,

further joint ventures or equity alliances will be formed as this process plays out. We have

assumed that all the junior potash companies with Canadian-based assets will form a

financial alliance to serve their fundraising requirements and that, as in any sector, some



218


companies with lesser projects will never reach production. That said, we believe

Athabasca Potash (and Potash One, for that matter) will reach a production but under an

alliance of some kind. Since the future of the space appears resoundingly positive, suitors

for financial partnerships are many and some have already held various levels of

discussions with the companies involved. Athabasca Potash management is currently

developing marketing relationships with counterparties in China, India and other Asian

nations.

Management

The company has been adding appropriate expertise during the past year in the areas of

project construction, financial planning, potash mine operation and geology. We expect the

combined management team’s knowledge and experience to help push the Burr project

forward to a construction decision and eventual production.

BURR PROJECT

History

The Burr project is located 107 kilometres east of Saskatoon, adjacent to the northern endof Potash Corp.’s Lanigan mine (Figure 194). It is in close proximity to operating mines and

well served by existing infrastructure. Six holes were drilled on the property during the

1950s, defining potash mineralization across five of the holes. Over the years, Potash Corp.

acquired the rights to the land before allowing its lease to expire in the 1990s. In 2005,

Dawn Zhou, founder and CEO of Athabasca Potash, saw an opportunity to acquire the

rights to the land, and a permit was obtained in 2006. Athabasca Potash commissioned

AMEC to conduct an NI 43-101 resource calculation based on the historical drilling results

only, the results of which were released in September 2007 (for further discussion, please

see Resource section below).

Figure 194: Map of Burr project and surrounding operating potash mines

Source: Athabasca Potash



219


Geology

Historically, the average width of the potash intercepts at the Burr deposit are 4.22 metres,

in line with regional producing mines. The salt back is considered to be of the required width

for conventional mining and the impurities to be within the desired limit, detailing a low ratio

of insolubles and a low ratio of carnallite. Due to the geological understanding and

consistency of the Saskatchewan potash beds, relatively few holes and seismic tests can

outline, with confidence, a continuous resource. Within the evaporite, there are four potash-

bearing members: the Patience Lake, Belle Plaine, Esterhazy and White Bear members. The

Burr property lies on a slight incline from 1,000 metres depth to 950 metres, with the Lower

and Upper Patience Lake sub-members providing the resource tonnage. It should be noted

that the resources are calculated from only one of the sub-members in any given area due to

the narrow layer between the two members, which prevents conventional mining of both

sub-members in the same area. When making comparisons to the Lanigan mine, the grades

are slightly higher. Due to the continuous nature of the prairie evaporite in Saskatchewan, it

can be reasonably assumed that resources are continuous across claims, allowing for a

discount based on assumed anomalies.

Resource

The current NI 43-101 estimated inferred resource totals 73.4 mt at 25.64% K2O and is

based on six historical drill holes totalling 6,021 metres completed during 1956-1959. A

new NI 43-101 compliant resource that will incorporate the drilling results from 2007 will

be released in August 2008. We expect the resource to increase and to include indicated

and inferred resources. Further drilling on the northeast portion of the property (Figure

195) will begin in August, and another updated resource is expected in 2009. The program

will consist of four to six holes to expand the known resource and further define inferred

resources to indicated. We expect the current resource to double or possibly triple by 2009.

Furthermore, if the company can attain some of the freehold rights on the property, the

resources around the previously drilled areas will increase by a wide margin over the

current NI 43-101 resource.

Figure 195: Inferred resources


Property preparation

Management is advancing the project through the use of both drilling and seismic testing.

Six historical drill holes were completed in the 1950s. In 2006, Athabasca Potash

completed a 2D seismic survey of the area and followed it with a five-drill hole (5,617

metre) program in mid-2007 and a 3D seismic survey in late 2007. The company has

decided against confirmatory drilling and has instead focused on expanding the known

resource. The results of the five new drill holes and seismic surveys will be included in the



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updated resource estimate to be released in August 2008. A scoping study on the project is

expected to be completed by September 2008, forming the basis for a feasibility study,

expected to commence in early Q4/08 and to be completed in Q4/09. The company intends

to combine the prefeasibility and feasibility into one document for release in Q4/09. The

shaft pilot hole will be completed by year-end or early 2009.

Figure 196: News flow through early 2009


2008 program

The company has planned an additional six drill holes on the Burr project in 2008. The

drilling will begin in July, followed by a further 3D seismic evaluation of the property

during the fall to expand to the immediate north and east of the 2007 program.

Regional exploration program

Athabasca Potash will begin exploring other leases within its property limits in 2009 with

2D seismic analysis followed by targeted drilling. It is assumed that management is

attempting to add tonnage to the company’s overall portfolio as it intends to look for

financial partners in the coming years. It is possible that the company would look for a JV

partner on other properties as part of a financial agreement on the Burr property. As

mentioned previously, due to the continuous nature of the prairie evaporate, we are

confident that the company will find additional resources. However, given the commitment

required for the Burr project, we will not offer any value for these other properties as they

will be idled assets with no possibility for advancement by Athabasca Potash prior to 2016.



221


Figure 197: Map of 2D and 3D seismic surveys and drilling completed to date


INFRASTRUCTURE

As the deposit is in a potash-producing region, it is within close proximity of all major

infrastructure, including road, rail and power.

Road

A paved road runs through the property. Once the shaft pilot hole is decided upon, a

connecting road would be constructed with a maximum length of 8 kilometres.

Rail

The Saskatoon area is well serviced by both CP Railway and CN Railway. At the Burr

property, CP Railway runs parallel to the south and CN Railway runs parallel to the north.

A CP spur line runs up to the property from the main line. The company would have to

construct an additional 5 to 8 kilometre spur to connect to the CP line. To the north,

Athabasca Potash would need to construct a 25 kilometre line to link to the CN line. The

rail infrastructure will be included within the transportation study (see below).

Power

Power would be purchased from the provincial power grid under a long-term contract with

SaskPower, the provincial power company. A further gas contract may be initiated with

SaskEnergy, the provincial operator. Infrastructure for both electricity and gas are

relatively close to the Burr property.

Port

Options are currently being investigated as part of the company’s transportation study (see below).

Plant and mine

The proposed conventional mine will include a 1,000-metre shaft, related underground

equipment and surface infrastructure. The definitive feasibility study (DFS) will outline a

more precise estimate of the cost when it is complete in Q4/09. Athabasca Potash intends

to build a surface operation similar to that of the Lanigan mine.



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Ownership

Management owns 29.1% of the shares outstanding. Tom MacNeill and his control of 49

North is the largest shareholder at 13.3%. Dawn Zhou and 100%-owned CSIT Consulting

own 12.9% of shares outstanding.

MANAGEMENTDawn Zhou, President and Chief Executive Officer

Ms. Zhou founded Athabasca Potash in 2006 after studying the various potash land claims

in Saskatchewan and locked in a substantial portion of the available leases after realizing

they had been allowed to lapse by the previous holders. Ms. Zhou was studying for a PhD

at the University of Saskatchewan at the time of the purchase of the leases. Prior to 2006,

Ms. Zhou had been involved in the exploration of potash and oil resources within

Saskatchewan. Ms. Zhou is a geologist.

Terry Walbaum, Chief Operating Officer

Mr. Walbaum joined Athabasca Potash in 2008. Mr. Walbaum has 29 years of experience,

the last 27 of which were spent with SNC Lavelin, specializing in prefeasibility andfeasibility level studies in the mining industry, including engineering design, procurement,

construction management and environmental management.

Gary Billingsley, Chief Financial Officer

Mr. Billingsley joined Athabasca Potash as Chief Financial Officer in 2006. Mr. Billingsley

has 32 years of mineral industry experience, 24 of which have been spent in

Saskatchewan. He has held several director and officer positions within the mining

industry. Mr. Billingsley is a Chartered Accountant, Professional Engineer and a geologist.

Brad Fettis, VP, Mining

Mr. Fettis has spent 11 years in the potash industry with Potash Corp. He has worked in

four of Potash Corp.’s conventional mines, including the Lanigan mine, locatedimmediately south of Athabasca Potash’s Burr project. Most recently, Mr. Fettis was mine

manager at PCS Allan. Mr. Fettis is a mechanical engineer.

Kevan Bender, Vice President Communications and Investor Relations

Mr. Bender received his Bachelor of Science in Agriculture Economics from the University

of Saskatchewan in 1995. Previously Mr. Bender held various commercial banking and

client relations positions.

INVESTMENT RISKS

Brine inflow

The largest mining risk to a conventional mine is an uncontrollable brine inflow. This is an

even more substantial risk with a one-deposit company as a brine inflow can ruin an asset

and thus the company.

Port infrastructure

A significant issue with a new potash project in Saskatchewan will be the means by which

product is shipped to market. If the company cannot finalize a deal in the appropriate time



224


in order to export its product to market, the valuation of the company will be negatively

affected.

Permitting risk

Athabasca Potash has not obtained all the necessary permits to allow it to graduate from

an exploration company to a development entity. The most significant is the environmental



Financial risk


guaranteed that the company will be able to raise the required funds in order to move its

project forward to production.

Project risk



VALUATION

We derive a 12-month target price of C$9.50 per share for Athabasca Potash using a 10%

discount rate and the following assumptions:

· Initial production beginning in H1/2014 with full production of 2 mtpa by early 2016.

· A long-term KCl price (beginning in 2018) of US$500/t fob Vancouver.

· An assumed financial raise of $2.9 billion, including capital expenditure of $2.6 billion

plus $300 million in additional financing to cover interest and miscellaneous costs.

Furthermore, we have assumed a debt/equity ratio of 40/60. We assume the debt will

be raised in one instalment in 2H/10, and the equity in several instalments between

2010 and 2013.

· We assume no further capex cost borne by the use of a port. We assume the company

will have access to a port through either an off-take agreement or financial

partnership.

· A 4.5% royalty tax payable to the Saskatchewan government.



continuous nature of the orebody.



Based on these assumptions, Athabasca is currently trading at a 21% discount to our 10%

net asset value per share of $9.58. We derive a 12-month target price of C$9.50 by




225






60/40 50/50 40/608% 17.61 16.39 14.24iscount

Rate 10% 11.85 11.03 9.58

Source: Canaccord Adams:

We have assumed a 40:60 debt:equity ratio, believing that the company will not be able to

raise predominantly debt. Management is in early discussions with potential off-take

partners and investors to offer the company debt financing. As illustrated by the chart

above, the risk to the mix between 40:60 and 60:40 debt:equity is to the upside in

valuation. We believe the company will be able to raise the appropriate funding. The

questions are: In what form and with whom? We believe these questions will be answered

within the next two years.


Potash Price (FOB Vancouver)

$ 9.58 450 500 550 600

2,200,000,000 9.58 11.01 12.45 13.88

2,400,000,000 8.86 10.3 11.73 13.17

2,600,000,000 8.14 9.58 11.01 12.45

2,800,000,000 7.43 8.86 10.30 11.73

Capex

3,000,000,000 6.71 8.14 9.58 11.01


With a long-term KCl price of US$500 fob Vancouver and assuming a financial raise of

$2.9 billion, we have arrived at an NAV of $9.58. The chart concludes that relative

percentage changes in potash pricing are more than twice as sensitive to similar changesin financial raise.



value added is derived from a geologically significant resource, a strong management team

and financial backing to move it forward.

CONCLUSION

We believe Athabasca Potash will benefit over the long term from sustained potash prices,

low operating costs, strong margins and the ability of management to bring the current

project to production. However, based on our valuation, we believe that the risk reward is

balanced. As such, we are initiating with a HOLD and a C$9.50 target. Due to the assumed40:60 debt:equity ratio and estimated $2.6 billion in capex, we believe that our target price

upside of 27% does not warrant a Buy recommendation given the inherent risk in the

project versus the current share price.



226


Figure 200: Cash flow statement, Athabasca Potash, FYE Dec

FY09E FY10E FY11E FY12E FY13E FY14E FY15E FY16E FY17E FY18E

31-Dec-09 31-Dec-10 31-Dec-11 31-Dec-12 31-Dec-13 31-Dec-14 31-Dec-15 31-Dec-16 31-Dec-17 31-Dec-18

Net Income (Loss) (16,000,000) (46,721,858) (92,975,122) (93,227,733) (93,227,733) 336,243,344 445,005,844 653,973,344 652,429,844 327,759,169


Amortization - - - - - 132,152,366 132,152,366 132,152,366 132,152,366 132,152,366

Future income taxes (recovery) - - - - - 36,026,073 47,679,198 70,068,573 69,903,198 35,117,054

Stock based comp 3,428,672 3,531,532 3,637,478 3,746,602 3,859,000 3,974,770 4,094,013 4,216,834 4,343,339 4,473,639

Net change in W/C - - - - 24,960 (90,274,557) (22,500,000) (37,500,000) - 50,000,000

CFO (12,571,328) (43,190,326) (89,337,644) (89,481,131) (89,343,773) 418,121,996 606,431,421 822,911,116 858,828,746 549,502,227


Purchase of capital assets (Project) (25,000,000) (260,000,000) (806,000,000) (806,000,000) (728,000,000) - - - - -

Sustaining Capex (2,500,000) (2,500,000) (2,500,000) (2,500,000) (2,500,000)

Proceeds from disposal of mineral properties - - - - - - - - - -

CFI (25,000,000) (260,000,000) (806,000,000) (806,000,000) (728,000,000) (2,500,000) (2,500,000) (2,500,000) (2,500,000) (2,500,000)

Cash flows from financing -

Advances to related party - - - - - - - - - -

Proceeds from issuance of shares 45,000,000 200,000,000 300,000,000 600,000,000 650,000,000 - - - - -

Proceeds from Debt Issuance 1,150,000,000 (400,000,000)


Share issuance costs - - - - - - - - - -

CFF 45,000,000 1,350,000,000 300,000,000 600,000,000 650,000,000 - - - - (400,000,000)

Net change in ca sh fl ows 7,428,672 1,046,809,674 (595,337,644) (295,481,131) (167,343,773) 415,621,996 603,931,421 820,411,116 856,328,746 147,002,227

Cash beginning of period 23,461,995 30,890,667 1,077,700,340 482,362,696 186,881,565 19,537,792 435,159,787 1,039,091,208 1,859,502,324 2,715,831,070

Cash end of period 30,890,667 1,077,700,340 482,362,696 186,881,565 19,537,792 435,159,787 1,039,091,208 1,859,502,324 2,715,831,070 2,862,833,298

CFPS (0.29) (0.68) (0.99) (0.64) (0.47) 2.19 3.18 4.32 4.51 2.88

EPS (0.37) (0.74) (1.03) (0.66) (0.49) 1.76 2.34 3.43 3.42 1.72




227


Figure 201: Comparables

Company Ticker Currency Shr Price 2008 2009 2008 2009 2008 2009 2008 2009

Producer

Agrium Inc AGU C$ 99.22$ C$160.00 9.19 12.42 8.52 11.80 10.8 8.0 11.6 8.4

CF Industries ** CF US$ 147.16$ NR 14.06 19.01 17.66 22.42 10.5 7.7 8.3 6.6

Hanfeng Evergreen * HF C$ 12.05$ C$16.00 0.51 0.78 0.60 0.90 23.6 15.4 20.1 13.4

Migao Corp * MGO C$ 8.15$ C$11.75 0.50 0.76 0.59 0.92 16.3 10.7 13.8 8.9

Mosaic Co MOS US$ 129.43$ US$210.00 4.16 13.22 5.25 12.56 31.1 9.8 24.7 10.3

Potash Corp of Sask POT C$ 211.25$ C$425.00 12.40 25.21 9.67 21.77 17.0 8.4 21.8 9.7

Terra Industries ** TRA US$ 45.16$ NR 4.33 4.65 5.64 7.14 10.4 9.7 8.0 6.3

Average 17.1 10.0 15.5 9.1

Non-producer

Athabasca Potash API C$ 7.57$ C$9.50

Phoscan Chemical FOS C$ 1.75$ C$4.70

Potash One KCL C$ 4.29$ C$7.75

MagIndustries MAA C$ 3.15$ C$8.50

P/CF

Target Price

EPS CFPS P/E

*Covered by Michael Deng **Estimates for CF and TRA from Bloomberg July 3, 2008




228


NOTES



229


NOTES



230


APPENDIX: IMPORTANT DISCLOSURES

Analyst Certification: Each authoring analyst of Canaccord Adams whose name appears on the front page of this investmentresearch hereby certifies that (i) the recommendations and opinions expressed in this investment researchaccurately reflect the authoring analyst’s personal, independent and objective views about any and all of thedesignated investments or relevant issuers discussed herein that are within such authoring analyst’s

coverage universe and (ii) no part of the authoring analyst’s compensation was, is, or will be, directly orindirectly, related to the specific recommendations or views expressed by the authoring analyst in theinvestment research.

Distribution of Ratings:

Global Stock Ratings(as of 4 July 2008)

Coverage Universe IB Clients

Rating # % %

Buy 353 61.8% 38.0%Speculative Buy 59 10.3% 61.0%Hold 136 23.8% 24.3%Sell 23 4.0% 13.0%

571 100.0%

Canaccord Adams

Ratings System:

BUY: The stock is expected to generate risk-adjusted returns of over 10% during the next 12 months.HOLD: The stock is expected to generate risk-adjusted returns of 0-10% during the next 12 months.SELL: The stock is expected to generate negative risk-adjusted returns during the next 12 months.NOT RATED: Canaccord Adams does not provide research coverage of the relevant issuer.

“Risk-adjusted return” refers to the expected return in relation to the amount of risk associated with thedesignated investment or the relevant issuer.

Risk Qualifier: SPECULATIVE: Stocks bear significantly higher risk that typically cannot be valued by normal fundamentalcriteria. Investments in the stock may result in material loss.

Canaccord Adams is the business name used by certain subsidiaries of Canaccord Capital Inc., includingCanaccord Adams Inc., Canaccord Adams Limited, and Canaccord Adams, a division of Canaccord CapitalCorporation. Clients of Canaccord Adams, in the past 12 months, may have been clients of CanaccordCapital Corporation, Canaccord Capital (Europe) Limited, Canaccord Capital Corporation USA Inc., and/or

Adams Harkness Financial Group Ltd.

The authoring analysts who are responsible for the preparation of this investment research are employedby Canaccord Adams, a securities broker-dealer with principal offices located in Vancouver, Calgary,Toronto, Montreal (all Canada), Boston, New York, San Francisco (all US) and London (UK).

In the event that this is compendium investment research (covering six or more relevant issuers), Canaccord Adams and its affiliated companies may choose to provide specific disclosures of the subject companies byreference, as well as its policies and procedures regarding the dissemination of investment research. Toaccess this material or for more information, please send a request to Canaccord Adams Research, Attn:Disclosures, P.O. Box 10337 Pacific Centre, 2200-609 Granville Street, Vancouver, BC, Canada V7Y 1H2 [email protected].

The authoring analysts who are responsible for the preparation of this investment research have received(or will receive) compensation based upon (among other factors) the Corporate Finance/Investment Bankingrevenues and general profits of Canaccord Adams. However, such authoring analysts have not received, andwill not receive, compensation that is directly based upon or linked to one or more specific CorporateFinance/Investment Banking activities, or to recommendations contained in the investment research.

Canaccord Adams and its affiliated companies may have a Corporate Finance/Investment Banking or otherrelationship with the company that is the subject of this investment research and may trade in any of thedesignated investments mentioned herein either for their own account or the accounts of their customers, ingood faith or in the normal course of market making. Accordingly, Canaccord Adams or their affiliatedcompanies, principals or employees (other than the authoring analyst(s) who prepared this investment

research) may at any time have a long or short position in any such designated investments, Relateddesignated investments or in options, futures or other derivative instruments based thereon.

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The information contained in this investment research has been compiled by Canaccord Adams fromsources believed to be reliable, but (with the exception of the information about Canaccord Adams) norepresentation or warranty, express or implied, is made by Canaccord Adams, its affiliated companies orany other person as to its fairness, accuracy, completeness or correctness. Canaccord Adams has not



231

independently verified the facts, assumptions, and estimates contained herein. All estimates, opinions andother information contained in this investment research constitute Canaccord Adams’ judgement as of thedate of this investment research, are subject to change without notice and are provided in good faith butwithout legal responsibility or liability.

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This investment research is provided for information purposes only and does not constitute an offer orsolicitation to buy or sell any designated investments discussed herein in any jurisdiction where such offeror solicitation would be prohibited. As a result, the designated investments discussed in this investmentresearch may not be eligible for sale in some jurisdictions. This investment research is not, and under nocircumstances should be construed as, a solicitation to act as a securities broker or dealer in anyjurisdiction by any person or company that is not legally permitted to carry on the business of a securities

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