Economic nationalism and potash

November 4, 2010 · by wciecon · in Media, Stephen Gordon · 24 Comments

Those were the topics of an online discussion in which I participated at the Globe and Mail this morning.

24 comments

Mike Moffatt · November 4, 2010 - 10:32 am · Reply→

Thanks for the quote!
Stephen Gordon · November 4, 2010 - 10:35 am · Reply→

Gotta say I was tempted to steal the credit, though. It’s a good line.
JP Koning · November 4, 2010 - 10:35 am · Reply→

Excellent points Stephen.
I’m wondering what you would think if the Potash acquirer was a foreign sovereign wealth fund. Are the rules of the game different when it is government and not business engaging in foreign acquisitions?
Mike Moffatt · November 4, 2010 - 10:46 am · Reply→

I would have let you have the credit. Maybe that’s why they think you’re outspoken – because you quote me. 🙂
Anyhow, a great discussion. My students were quite interested in the deal, so I sent them them the link.
Stephen Gordon · November 4, 2010 - 10:55 am · Reply→

JP: I don’t know. I keep getting back to the point that the potash in the ground still belongs to the Saskatchewan government. If a foreign government entity wanted to play games, Saskatchewan would still have a winning hand.
Just visiting from Macleans · November 4, 2010 - 10:55 am · Reply→

SG, in the discussion, when asked about the definition of “strategic” you replied: “Presumably something that is ‘important’ and for which there are no close substitutes. I think a case can be made that potash is one, but then again, it’s already owned by the people of Saskatchewan.”
Later on you refer to an argument “If there were important positive spillovers (‘clustering’ effects) or strong returns to scale” to identify an argument that could be made, but that you don’t believe fits.
I’m of the opinion that in this case, it’s the Canpotex cartel aspect of Sask’s potash production that could put it into the “strategic” category (controlling production – and thereby maximizing Sask’s royalty).
How do you as an economist view cartels, and given that potash appears to be a critical component of worldwide food production, particularly in developing countries, does this matter (a moral component)? Is this worthy of a blog with graphs explaining cartels?
Btw – Paul Waldie in the G&M had a great backgrounder on the potassium cartel on Sat here for those that are interested:
http://tinyurl.com/32y948q
Chris · November 4, 2010 - 11:05 am · Reply→

From the conversation:

[Comment From JudicialReviewJudicialReview: ]
It is not a taxloop hole. BHP has been developing another mine in Sask for years which has allowed them to accumulate billions in tax loses since it has not started producing yet. They will be able to apply those loses to the Potash income to reduce the taxes. That is not a loophole. That is our tax system,
Stephen Gordon:
JR: Thanks. I had the impression from the Conference Board report that there was a relatively easy fix, but as Rob just noted, I’m not a tax expert. But it still seems to me that a well-designed tax system wouldn’t be affected by the sale of Potash Corp.

You are assuming a can opener.
Mark_dowling · November 4, 2010 - 11:42 am · Reply→

If the problem is that the aggregate BHP-PotashCorp entity would control too much of SK potash, isn’t the answer to set conditions whereby BHP would have to divest some of the combined assets to reduce their total to a reasonable level?
Just visiting from Macleans · November 4, 2010 - 11:46 am · Reply→

BHP believed it had made ample concessions and promises to meet Investment Canada’s “net benefit” requirement. It promised to make Saskatoon its global potash headquarters and expand the office. It said it would invest in infrastructure in the province. But BHP’s desire to eventually pull out of Canpotex, the international potash sales and marketing cartel controlled by Potash Corp., Mosaic and Agrium rankled the Saskatchewan government. It feared a BHP takeover would cost the province billions in lost revenue.
Saskatchewan premier Brad Wall came out forcefully against BHP’s proposed takeover. Several other provincial government supported him.
http://tinyurl.com/2fgwumx
Stephen Gordon · November 4, 2010 - 12:05 pm · Reply→

I don’t understand the whole cartel thing. Usually in a case like this, you’d expect that the multinational purchaser would be trying to consolidate market power in order to create a cartel. If BHP thinks that their setup would generate higher prices, maybe it’s a sign that BHP thinks that the current cartel is badly-run.
Chris · November 4, 2010 - 12:15 pm · Reply→

Gordon – in response to your cartel question, here is a quote from the G&M right after BHP announced the bid. It appears they don’t want to work with other companies:
“BHP chief executive officer Marius Kloppers said Wednesday his company would honour commitments among the partners in the powerful group, which represents Canada’s major producers in key negotiations with global buyers, but that the mining giant prefers to market its products itself.
“Philosophically, I have to refer back to our baseline demeanor, which is to market our product ourselves, spend in front of our customers ourselves, run our assets at full capacity and take the market prices,” said Mr. Kloppers, who took his $39-billion (U.S.) bid for Potash Corp. public Wednesday, saying the offer would go directly to shareholders.”
http://www.theglobeandmail.com/globe-investor/potash-corp-soars-bhp-bid-rejected/article1675353/
Chris · November 4, 2010 - 12:18 pm · Reply→

Stephen Gordon – whoops, meant to call you by your full name in last post. Sorry.
Stephen Gordon · November 4, 2010 - 12:18 pm · Reply→

Huh. Interesting. It’s not often you see someone walk away from cartel rents.
Just visiting from Macleans · November 4, 2010 - 12:24 pm · Reply→

I don’t know the specifics either, but it could have something to do with running the Sask mines full out – and becoming low cost producer – going for market share and consolidating through acquisition those mines that can’t compete at the lower price. Then re-emerging in a stronger position. Maybe. Could have a lot to do with how Sask’s royalty schedule is set out (higher % share with higher price??).
Chris · November 4, 2010 - 12:41 pm · Reply→

POT isn’t the only company that mines Potash in SK, they are about half the output. Mosaic and Agrium have a few things to say about royalty changes negatively hitting their bottom line to make up for tax losses from a takeover of a competitor. In my opinion, changing the rules mid-game is much more damaging to foreign investment that allowing or blocking a takeover bid.
Chris · November 4, 2010 - 12:49 pm · Reply→

SK gov’t has two legit concerns: loss of tax revenue and lower royalty payments due to increased supply. If BHP addresses both, with say a BP-style escrow account for the $1Bn in tax and a long term commitment to Canpotex, then they have addressed everything in the net benefit test except the politics of “strategic resources”.
Just visiting from Macleans · November 4, 2010 - 1:45 pm · Reply→

Chris, nothing preventing POT Mosaic and Agrium from buying back stock financed by cheap debt. Since interest on the debt is tax deductable, it could have the same tax effect as BHP taking over POT and loading it up with debt. If Sask then sees a decline in overall revenue, why necessarily would it raise potash royalties as a result?
Also, say Canpotex (which they freely joined I presume) disbanded, or legislation was passed making it illegal. Same effect?
Neil · November 4, 2010 - 3:17 pm · Reply→

I wanted to talk more about this exchange:

[Comment From JudicialReviewJudicialReview: ]
It is not a taxloop hole. BHP has been developing another mine in Sask for years which has allowed them to accumulate billions in tax loses since it has not started producing yet. They will be able to apply those loses to the Potash income to reduce the taxes. That is not a loophole. That is our tax system,
Stephen Gordon:
JR: Thanks. I had the impression from the Conference Board report that there was a relatively easy fix, but as Rob just noted, I’m not a tax expert. But it still seems to me that a well-designed tax system wouldn’t be affected by the sale of Potash Corp.

It’s not clear to me that this is a design flaw in the tax system, so much as a failing in government accounting standards. Assuming the BHP continues to develop their production capacity, then the government isn’t actually losing any money, and the system has functioned as it should. The only potential loss is if BHP would otherwise have never turned a profit in Saskatchewan that they could apply the loss to.
The policy goal of loss carry-forward is to encourage business to incubate, and give it a benefit from it’s prior year losses. In cases like BHP, the loss will eventually be claimed when their mine starts making money. Saskatchewan then gets the long term benefit of an additional potash producer, even if it takes several years before they start seeing any taxes from it.
The POT takeover will instantly create a profit for BHP in Saskatchewan that eats all their carry forwards, costing the government all that revenue the first year. If governments did their books according to GAAP, this wouldn’t matter since the tax credit would already be on the books as a government liability (BHP’s books register the tax credit as an asset). But governments use their own accounting rules, so it all hits the books the year the cash doesn’t come in.
It’s not clear to me what change in tax policy would eliminate this effect without either eliminating the ability to carry losses forward, or introducing a lot more subjective judgment calls to where you can apply the credit.
Stephen Gordon · November 4, 2010 - 3:38 pm · Reply→

Thanks for that. Again, I’m not an expert; I was simply going with the basic intuition that it really shouldn’t matter to the government who owns the asset. And in this case, the problem doesn’t seem to be that BHP is foreign, it’s that BHP has already invested in Saskatchewan. If BHP were an entirely new presence, then would the Saskatchewan govt have a problem with the takeover?
Because it’s very odd to have a policy environment where investing in Saskatchewan should be a source of problems.
Just visiting from Macleans · November 4, 2010 - 3:57 pm · Reply→

Using tax rules to argue to deny a takeover is sooo provincial.
Chris J · November 5, 2010 - 8:05 am · Reply→

Stephen, I can’t help but think that the experience of Vale and Xtrata – in which the PM was answering questions day after day in the house – left a bad feeling in the Tory cabinet. This is not to make judgement on the merits of the deals, just the political optics.
Ian Lee · November 9, 2010 - 9:26 am · Reply→

Stephen,
In support of your argument that ownership does not affect the royalty income to govt, Jack Mintz published an Op-Ed on this precise point. I have only copied the first 3 paragraphs:
Jack Mintz: The potash royalty mess
October 14, 2010
Saskatchewan’s royalty system is the problem, not the takeover
A recent Conference Board report indicating that Saskatchewan will lose $2-billion in potash royalties if BHP Billiton buys Potash Corp. has raised the eyebrows of Saskatchewan Premier Brad Wall. And well it should, not because of a foreign takeover, but due to the potash royalty structure being a fiscal mess.
The suggestion that BHP’s takeover of Potash should be blocked because expenses from the $12-billion Jansen Lake development could be used to reduce Potash Corp. royalty payments is putting the cart before the horse. After all, if Potash were undertaking the Jansen development itself, it would have been able to use the same capital cost deductions to reduce its royalty payments on other projects. In other words, any single owner could achieve the same royalty impact. Foreign ownership is not the point.
The real problem is the design of the Saskatchewan potash royalty, which fails to collect rents properly. It is also so horribly complex that much of this column must be spent just trying to explain it (readers beware — the next few paragraphs could cause a headache).
For rest of article, go here: http://opinion.financialpost.com/2010/10/14/jack-mintz-the-potash-royalty-mess/#ixzz14nLwcjmk
Ian Lee · November 9, 2010 - 9:34 am · Reply→

Stephen,
In strong support for your argument that Saskatchewan owned, owns and will always own the natural resources – regardless of the nationality of the firm that acquires the license to exploit the resource –
the Constitution Act of Canada 1982 (formerly the BNA Act of 1867) – Canada’s Magan Carta – states the following in section 92 A dealing with the authority of the provinces:
Non-Renewable Natural Resources, Forestry Resources and Electrical Energy
Laws respecting non-renewable natural resources, forestry resources and electrical energy
92A. (1) In each province, the legislature may exclusively make laws in relation to
(a) exploration for non-renewable natural resources in the province;
(b) development, conservation and management of non-renewable natural resources and forestry resources in the province, including laws in relation to the rate of primary production therefrom; and
(c) development, conservation and management of sites and facilities in the province for the generation and production of electrical energy.
Export from provinces of resources
(2) In each province, the legislature may make laws in relation to the export from the province to another part of Canada of the primary production from non-renewable natural resources and forestry resources in the province and the production from facilities in the province for the generation of electrical energy, but such laws may not authorize or provide for discrimination in prices or in supplies exported to another part of Canada.
Authority of Parliament
(3) Nothing in subsection (2) derogates from the authority of Parliament to enact laws in relation to the matters referred to in that subsection and, where such a law of Parliament and a law of a province conflict, the law of Parliament prevails to the extent of the conflict.
Taxation of resources
(4) In each province, the legislature may make laws in relation to the raising of money by any mode or system of taxation in respect of
(a) non-renewable natural resources and forestry resources in the province and the primary production therefrom, and
(b) sites and facilities in the province for the generation of electrical energy and the production therefrom,
whether or not such production is exported in whole or in part from the province, but such laws may not authorize or provide for taxation that differentiates between production exported to another part of Canada and production not exported from the province.
“Primary production”
(5) The expression “primary production” has the meaning assigned by the Sixth Schedule.
Existing powers or rights
(6) Nothing in subsections (1) to (5) derogates from any powers or rights that a legislature or government of a province had immediately before the coming into force of this section
Just visiting from Macleans · November 11, 2010 - 10:45 am · Reply→

SG, I saw on you twitter feed this comment:
Eric Reguly demolishes any number of BHP-Potash Corp straw men:
http://bit.ly/ai4YCp
I chuckled when I saw this because if you had followed Reguly for some time, you would know that he has long rang the “hollowing out of Canada” bell particularly at the time of Inco Falconbridge etc takeovers.
Earlier on regarding Potash, he warned against Canadian branch plants, pointing to the example of Talisman Energy – previously a BP sub.
The subsidiary death knell
…
BHP promises this time will be different. Potash Corp. will thrive under its ownership and be given a global mandate. Yet BHP is run from Melbourne and London. Saskatoon will not be a true head office unless Marius Kloppers, BHP’s CEO, moves to Saskatoon, buys a shovel and clears his driveway of snow in the dead of winter.
History says subsidiaries rarely thrive. Talisman’s remarkable revival when it shed branch-plant status is a story that Investment Canada should read and reread before it decides whether BHP’s ownership of Potash Corp. will provide a net benefit for Canada and Saskatchewan.
http://tinyurl.com/34bned9
Go back and re-read Reguly’s column in that context. You might take away a different message.