The potash market is effectively cartelized, with (until recently) two FSU firms, Uralkali and Belaruskali, having one joint marketing agreement, and three Canadian firms having another (with the blessing of the Canadian government). There was also some coordination between the FSU and Canadian groupings.
This cozy system came crashing down a couple of weeks ago when Uralkali announced its departure from its agreement with Belaruskali, and stated that it would now seek to increase output dramatically, and aim to maximize market share rather than protect price. Potash prices are expected to fall, by as much as 33 percent, and the stock prices of the major producers cratered too. Including Uralkali’s: its price fell 19 percent on the announcement. Other firms fell even more (e.g., Mosaic fell by 24 percent).
There are a couple of theories for Uralkali’s move. One is that it is punishing Belaruskali for selling to China outside the marketing agreement, effectively busting the cartel. The other is that Uralkali is trying to drive out marginal high cost producers and deter the entry of new firms.
The problem is that both strategies are of questionable rationality. In a finite horizon game, or when discount rates are high enough, if you are rational and everyone believes you are rational neither strategy can work. In a finite horizon game, it is never optimal to try to deter entry or punish a cartel cheater in the last period, and backwards induction implies that it would never be optimal to wage a price war to deter or punish in earlier periods. In an infinite horizon game, if discount rates are too high, the future gains (i.e., monopoly profits) from deterring entry or ensuring future survival of the cartel agreement are discounted so heavily that they do not exceed the short term costs of selling at low prices today. And given the low valuation of Russian stocks relative to earnings, you know the relevant discount rate is very high.
Consider entry deterrence. While price is low, nobody will enter, but the price cutter (Uralkali, in this instance) loses a lot of money by selling at a low price. It can only recoup this loss by raising price later. But as soon as it raises its price, new mines will enter, and it would be rational for Uralkali to accommodate this entry rather than wage another destructive price war. Better to earn a moderate price for a long period than a very low price forever.
However, if rivals assign a positive probability to the possibility that firm X is nuts, and gets some sort of psychic thrill from crushing enemies through price wars, the price war strategy can be profit maximizing even if X is totally rational. If X wages a price war it can get a reputation for craziness that will make it less likely that others will test it in the future. Once it gets this reputation, its bluff isn’t called, and its reputation for toughness endures and continues to deter.
So the only way to rationalize in economic terms alone Uralkali’s action is that it is employing a Crazy Ivan strategy. In the Cold War, Russian subs worried about being trailed by American SSNs would perform the Crazy Ivan turn-a wild U-turn. If there was indeed an American sub trailing, the Soviet and American boats would collide, sinking both. Crazy, huh? But if you get a reputation for craziness no American will follow closely and you don’t have to worry about a collision.
The market apparently doesn’t believe that Uralkali’s strategy will be successful. As I noted above its stock price was hit hard. If the belief was that this strategy would deter future entry and/or ensure Belaruskali’s cooperation for the foreseeable future, the company’s stock price would have risen.
Being Russia, there was of course a strong odor of inside dealing and corruption surrounding the event. A large investor, Alexander Nesis, sold out about a month before the announcement. Lucky him. Uralkali denies he had any foreknowledge of the price-crashing news. Sure he didn’t. Like I say, he’s just lucky. And I am Queen Marie of Rumania.
But maybe this isn’t about Uralkali per se, and maybe this isn’t an economic game. Maybe it’s a political one. Maybe Uralkali is just a Putin pawn in his ongoing, under the carpet, war against Lukashenko and Belarus. That would actually make some sense. Because on economic terms alone, what Uralkali did is pretty much inexplicable, except on Crazy Ivan terms: namely, that Uralkali truly is crazy, or is trying to convince everybody it is