It also offers a way to place an indirect leveraged bet on the outcome of Russia's ambition to re-assemble the Soviet Empire and fulfill the czarist dream of dominating Europe. Together Russia and Belarus supplied 30.5% of 2014 potash production; if the substantial export portion of this output became unavailable due to geopolitical disruption of supply channels, be it through warfare or sanctions, Brazil's potash import cost would skyrocket and the torpidity of Brazil's environmental permitting bureaucrats would vanish. But that is an outlier outcome; the normal outcome is for global demand for food to continue to grow, for Brazil to continue to convert its unused arable land into farm land, and for mundane international supply expansion problems to intensify the pressure on Brazil to develop a meaningful domestic supply of conventional potash or risk punishingly higher potash import prices in 2020 and beyond.

Since 2009 the junior has raised $43.2 million of which it had $7 million working capital left at the end of 2014. NPK has delineated 43-101 compliant resources. It delivered a PEA for ThermoPotash production in 2010. It developed a flow sheet for the production of KCl and delivered a PEA in 2012. It attempted to produce a BFS for a plan that envisioned eventual annual production of 3 million tonnes of KCl, but failed in 2013 because it could not get an equipment maker performance guarantee for the required rotary kiln scale without first conducting an expensive 200 tpd pilot plant study. The escalating resource sector bear market prompted Verde Potash to retrench to its original ThermoPotash production scenario for which it delivered a PFS in 2014. The new ThermoPotash plan envisions mining ore at 700 tpd and processing it with a limestone supplement in a 1,000 tpd plant that will produce 330,000 tonnes of ThermoPotash annually which a marketing study indicates can be sold competitively in Brazil at US $187.74 per tonne. It is a guerilla strategy to establish Verde Potash as a serious player in the Brazilian fertilizer market.

The junior is no longer hoping to be scooped up by a potash major willing to deploy the large $2.4 billion CAPEX required by the KCl PEA to turn the Cerrado Verde resource into a significant potassium chloride supplier to the Brazilian market. Its plan is to establish itself as a supplier of a slow potash release, multi-nutrient fertilizer for the premium potash market where a chlorine content is unacceptable for crop quality and which is well suited for the acidic, rain drenched soils of Brazil. While the successful development of the ThermoPotash business should deliver fivefold plus gains for Spec Value Hunters, the truly big upside, which nobody will recognize unless they have an intimate understanding of the story, lies in the junior's ability to use the ThermoPotash facility temporarily as a pilot plant to demonstrate the feasibility of its KCl process at the large equipment scale needed for this product to be competitive with imported KCl. To understand both how the KCl angle works and why Brazil is so important for the future of global food supplies, check out my SVH Comment - March 27, 2012 which shows how to analyze the conclusions of the 2012 PEA for the KCl process and provides background material on Brazil as an agricultural powerhouse.

Verde Potash Inc has been a KRO recommendation since late 2008 when it was covered as a cash-rich bottom-fish buy in the $0.10-$0.19 range. The company had gone public in late 2007 with a portfolio of Brazilian gold prospects, but during the financial crisis of 2008, CEO Cris Veloso, who has roots in the agriculture sector, staked a 120 km by 20 km belt of green colored "glauconitic meta argillites" whose 6%-12% K2O enrichment was first recognized during the sixties.

Unlike conventional sources of potassium such as the sylvinite mined in Saskatchewan which formed as salt based evaporite beds in which the potassium occurs as water soluble potassium chloride in ore grading 15%-30% K2O, the "Cerrado Verde" rocks appear to have formed in a marine environment with the potassium ending up in a silicate lattice which is not water soluble. It is classified as a metasiltstone that has been weakly deformed and metamorphosed to lower greenschist facies. No serious work has been done to develop a genetic geological model, though that will change if Verde Potash achieves its long term goal of establishing the "verdete slate" as an important domestic source for Brazil's growing potash needs.

Drilling activity since 2009 has outlined a measured+indicated+inferred resource of 3.32 billion tonnes grading 8.9% K2O with a thickness ranging 15-80 metres, of which a proven and probable reserve of 7,020,000 tonnes at 10.85% has been isolated for the ThermoPotash plan which requires surface disturbance of only 35 hectares. It is located in Minas Gerais about 320 km from Belo Horizonte in an area of rolling hills largely used for livestock grazing. The outcropping resource is visible from Google Earth satellite images thanks to the conspicuous blue-green color of the fine grained ore. Ironically, the surrounding area is not lush with green vegetation, for the locked up potassium is not accessible as a nutrient.

Government agencies did during the eighties explore the possibility of turning the Cerrado Verde into a usable form of potash, out of which came the concept of ThermoPotash, a whole rock product which is still not water soluble, but which under Brazil's soil conditions slowly releases the potassium for uptake by crops. ThermoPotash was never commercialized because its production involved calcining the ore in a rotary kiln that resulted in an energy input cost well above the price of imported potassium chloride.

The price of KCl was stable near the $100/tonne level from 1982 until 2005 when the rise of China boosted global GDP and a sharp increase in fertilizer demand that took KCl to a peak of $1,000/tonne in 2008 before stabilizing at the $300/tonne level which is needed to make expansion of global supply feasible to meet long term demand projections. Verde Potash was alerted to the implications of the potash price rise for ThermoPotash by Ysao Munemassa who was granted a 3% royalty that can be bought out for US $3 million.

Verde Potash spent 2009-2010 delineating the Cerrado Verde resource, fine-tuning ThermoPotash production specifications at a small pilot plant, and supplying the resulting sample material for agronomic studies involving various crops. The result of the argonomic studies has been certification of ThermoPotash for argicultural consumption and strong government and academic support for the junior's initiatives. In late 2009 I switched the bottom-fish recommendation to a Spec Value Hunter Buy at $1.63. Verde Potash delivered a PEA on October 28, 2010 that presented two output scenarios of 1.1 million and 2.2 million tonnes of ThermoPotash annually. The PEA projected CAPEX of US $198 million, OPEX of $41.80 per tonne ThermoPotash, an after-tax NPV of $455.4 million at 10%, and an IRR of 32.9% for the 1.1 million tonne scenario with a 40 year mine life. While the economic numbers looked good, the product was positioned as a supplement to conventional KCl fertilizer applications, and even with the endorsement of government agricultural agencies it was not clear how rapidly the product would be adopted, especially at the base case price of US $151.82 per tonne TK. The flow sheet was fairly straightforward, but there were questions about the marketability of the product.

While the junior worked on the ThermoPotash PEA Cris Veloso tackled the bigger question of what it would take to convert the potassium silicate into potassium chloride, a fertilizer product about which farmers ask only one question, "what is the delivered price?" He commissioned Professor Derek Fray of Cambridge University in 2010 to investigate flow sheet possibilities, and ended up with one that the junior began to test during 2011. Verde Potash holds a patent on the KCl process, but, thanks to the uniqueness of the Cerrado Verde deposits, the patent is unlikely to be applicable to other glauconitic deposits elsewhere in the world. It is important to note that while the government ultimately owns the mineral rights, the corporation owns the rights to the patent for the process that turns the Cerrado Verde into a commodity. The news about the KCl process propelled the stock to a peak of $10.95 on April 22, 2011. Verde Potash published a PEA for the KCl process on January 31, 2012, which prompted me to upgrade Verde Potash from a Good Relative Spec Value Buy to a Good Absolute Spec Value Buy at $6.90 (SVH Comment). At the time Vancouver FOB KCl was nearly $600 per tonne, and the PEA projected an OPEX of nearly $300/tonne KCl, which made it look like the project's viability was very vulnerable to a KCl price retreat from a level that was off 40% from the 2008 $1,000 peak but still at a very lofty level by historical standards. One had to review the PEA very carefully to understand that delivery to the farmers in Brazil added $120-$180 per tonne to the FOB Vancouver price due to transportation, port handling, insurance and fine material loss costs. Verde Potash managed to raise $28,750,000 at $6.45 in a bought deal in March 2012. A good part of the funds were used to finance a bankable feasibility study that included pilot plant tests at an FLSmidth facility in Allentown, Pennsylvania.

On May 13, 2013 Verde Potash shocked the market with an announcement that it would be unable to deliver the BFS in Q2 of 2013 because FLSmidth was not prepared to grant a performance guarantee for rotary kilns with a greater than 3,000 tpd capacity. Thanks to cost inflation since the PEA and a decline of KCl FOB Vancouver to about $400/t the KCl Cerrado Verde project was not viable without the economies of scale provided by 12,000 tpd rotary kilns. The news, discussed in SVH Comment - May 14, 2013, was a disaster for the stock which was already under pressure due to the resource sector bear market that began in 2011. It was also a shock to the credibility of management and in fact it led to a split between the Canadian and Brazilian teams. The issue was the failure to anticipate that equipment makers rarely grant performance guarantees where the scaleup from the pilot plant is more than 100 times, especially when it involves a new usage for the equipment. The initial development stage of 600,000 tonnes annual KCl output required 24,000 tpd of rotary kiln capacity, which Verde Potash hoped to provide in the form of two 12,000 tpd kilns. The pilot plant studies for the BFS were done with 4 tpd rotary kilns, which implied a 3,000 times scaleup. FLSmidth was willing to provide a performance guarantee only for its 3,000 tpd kilns, which already represented a surprising 750 times scaleup. But the increased CAPEX and OPEX of 8 rotary kilns rather than 2 killed the economics of the project. FLSmidth indicated that it would provide guarantees for its 12,000 tpd kilns if Verde Potash conducted a 200 tpd pilot plant study, which would have cost an extra $20-$30 million. The market, believing either that management was incompetent or had strung everybody along with a futile plan to deliver a BFS, sold off. When the dust settled the Canadian group, which included highly regarded Peter Gundy, departed, and the Brazilian group took complete charge.

Verde Potash made a strategic decision to retreat to the ThermoPotash plan for several reasons. Commodity prices were weakening amid signs of a global slowdown and the prospect of raising capital for the 200 tpd pilot plant study without severe dilution was poor. The company had recognized that marketing ThermoPotash as a supplement for crops already fertilized with KCl would be a hard sell, but it also realized that ThermoPotash could compete with premium potash fertilizers that were not based on KCl and which were applied to crops that were sensitive to chlorine such as tobacco or designated as organic and thus not eligible for KCl fertilization. ThermoPotash qualifies as an organic fertilizer because its production only involves crushing, grinding and heat treatment in a rotary kiln before the material is quenched in water and reground to produce the final product. An agronomic study on coffee revealed in 2014 that not only was less potassium content needed for comparable coffee growth because the premium potash fertilizers are water soluble and lose some of their potassium to leaching, but the ThermoPotash coffee achieved superior taste rating and qualified as organic (see SVH Comment - March 11, 2014).

Verde Potash scaled back its original ThermoPotash plan to about a third, and on March 31, 2014 published a PFS for a 330,000 tpa ThermoPotash operation it dubbed a "Flex Plant" because it could also be temporarily shut down and retrofitted at a cost of $2.8 million to function as a 200 tpd pilot plant study for the KCl process. The idea was to build the plant, develop a stockpile during the ramp up phase while the offtake market was being developed, and create a production lull during which the KCl process study could be conducted. In the worst case Verde Potash ends up with a profitable niche business supplying ThermoPotash to specialty crops, and in a best case the cash flow funds the pilot plant study needed to support a BFS for the KCl production plan.

The beauty of the Verde Potash story is that one can suspend belief about the bigger picture KCl outcome, and still find substantial upside in the smaller scale ThermoPotash business plan outlined in the March 2014 PFS. CAPEX was US $113.6 million, sustaining capital for a 31 year mine life was $31.5 million, and OPEX was $55.29 per tonne of ThermoPotash or $78.31 per tonne of ore feed. The PFS assumes 90% of CAPEX debt financing at a rate of 10% with a ten year equal installment repayment term which management thinks could end up as a government subsidized rate as low as 4%. Depreciation of initial CAPEX is straightline over ten years with a 30.9% tax rate. Ramp up is 50% in year one and 75% in year two with full production year three. The after-tax NPV at 10% was US $145.7 million with an IRR of 23.52%, which meet the thresholds for going ahead with development. Based on 39.1 million shares fully diluted, a 100% interest, and a 0.8 USD to CAD exchange rate, this after-tax NPV translates into a valuation target of CAD $4.65 per share for the ThermoPotash business.

In an effort to understand how different ThermoPotash prices affect the business, I have constructed my own discounted cash flow model for the ThermoPotash business which generates a somewhat lower after-tax NPV of USD $127.4 million and 22% IRR at the base case ThermoPotash price. The technical report produced by AMEC is disappointing in that it contains some tables that make no sense and lacks a detailed breakdown of annual cash flows for the mine life. This makes it difficult to understand how sustaining costs and depreciation for after-tax cash flows are handled by the PFS model. I have used the basic description and life of mine averages for my model. At the base case price the target value works out to $4.08 per share, about ten times the current level. The main point of my DCF model is to show what happens if Verde Potash ends up having to sell ThermoPotash at prices well below the base case price. At $119/t for TK the project has a zero after-tax NPV, with payback taking 8 years. This means that the 10% loan gets paid back, but the equity owners do not benefit.

The Verde Potash story is tough one for investors to quantify because it is difficult to predict what price Verde Potash would receive for its ThermoPotash. The benchmarks will be whatever turn out to be the prices for the three main non-chlorine premium potash fertilizers presented in the graphic above: potassium nitrate (NOP - KNO3), potassium sulfate (SOP - K2SO4), and potassium magnesium sulfate (K-Mag). The cost of imported premium potash fertilizers will be a function of both the exchange rate of the Brazilian currency, the real (R$ - reis is plural), and the freight cost of delivering the product from a major port such as Vancouver to a Brazilian port, plus the overland trucking cost to the farm distribution centers such as Uberlandia. The recent dramatic decline in the price of oil hurts the competitive price of ThermoPotash because the transportation cost savings accrue mainly to the imported fertilizers. On the other hand, because the potassium grade of ThermoPotash is only 7% compared to 44%-48% for SOP and NOP, which means more volume of ThermoPotash needs to be applied to the fields which costs extra fuel and labor, the relative cost of TK does decline.

One would think that perhaps TK should be one seventh the price of SOP, or $149 per tonne, but as the table above shows, TK contains nutrients not present in the others, and lacks detrimental elements such as sulphur. The competing potash products do nothing about soil acidity, which the calcium content of TK, courtesy of its process which blends Cerrado Verde ore with limestone, takes care of with a single application. Farmers using the premium potash fertilizers must apply lime separately to balance the acidity of the soil, which represents additional costs. The other potash products, although lacking chlorides which create a salt problem for certain crops, have a higher potash solubility, which increases the rate at which potash is leached away by water before being absorbed by the crops. Since fertilizer application is a time and energy cost, the number of times the premium potash products must be reapplied becomes a factor. Figuring out which product represents the best value when all costs are included is a complex task.

Consumer adoption of ThermoPotash make take time, and require Verde Potash to reduce its price as an incentive. The point I want to make is that this uncertainty about the profitability of the ThermoPotash would normally encourage a discount for the value of the business if it were a standalone operation. But in fact ThermoPotash is a steppingstone to proving that the much bigger business plan of profitably producing 3 million tonnes of KCl annually is a realistic proposition. Rather than wandering around with a begging bowl for $30 million to build and operate a 200 tpd pilot plant that becomes scrap metal at the end of the study, with no guarantee that the conclusion of the study will be positive, Verde Potash is offering to supply a niche market that provides a decent yield to the debt providers, which in effect subsidizes the venture capital cost of the KCl pilot plant study.

For an extra cost of $2.8 million the facility can be adapted for the KCl flow sheet and operated on a pilot plant basis to establish the operational terms needed to secure a manufacturer's performance guarantee. Most importantly, Verde Potash secured conditional financing for R$ 250 million through a government agency called Inova Agro that is to be provided by the Brazilian Development Bank once the final engineering and the mining permit are in hand. The junior thinks it could get a government subsidized rate as low as 4%, but the PFS assumes the rate will be 10% which I have used in my model. At the time when the conditional financing was granted the real was at 2.3:1 USD, which translated into US $109 million. The Brazilian currency has plunged to 3.17:1, which means that today the loan secures only US $79 million. Most of the project's operating costs are domestic, and whatever increases they undergo due to Brazilian inflation, will be offset by the declining exchange rate, which will convert the price of imported potash fertilizers into higher Brazilian currency prices to which Verde Potash can adjust the competitive Brazilian price of ThermoPotash. What hurts is that about $52 million of the CAPEX involves imported equipment, though part of that is from China which has started to let its RMB decline against the US dollar. My currency adjusted estimate is that CAPEX today stands at R$308 million rather than R$262 million. With Brazilian inflation at 7.7%, the amount Verde Potash will have to raise as equity will rise if the Brazilian Development Bank does not adjust its loan. It is thus critical that the ThermoPotash begin construction as soon as possible.

Unfortunately, the project has become bogged down in Brazil's permitting process and it is not clear when an environmental license will be obtained. In a March 24, 2015 news release Verde Potash addressed the delay as politely as it could, but the reality is that workers at the state environmental agency are unhappy about the humiliation the Germans handed the Brazil national soccer team in Belo Horizonte where their offices are based, annoyed that other bureaucrats stole a jaw-dropping $10 billion from Petrobras while they seem to be collecting nothing under the table, worried that Brazil's economic troubles due to the commodity downturn will unleash austerity measures, and are convinced that they are woefully underpaid and underappreciated. So they have shifted from their normal "work to rule" policy, which is what union workers in advanced economies do when they are unhappy about something, to pretending to "work to rule", which is the equivalent of going on strike without having to fight back scabs, not get paid, and get pelted with eggs while walking around with signs.

Verde Potash management is doing what it can to find out what the environmental agency might want next, and is exploring the potential to secure used rotary kiln equipment courtesy of idled cement capacity in Minas Gerais as an alternative to building a brand new facility. The resulting capacity may be less than projected by the PFS, but the CAPEX will be lower, enabling Verde Potash to build within the Brazilian real limits of the promised construction loan. In any case, the resulting capacity will still be well above the 200 tpd needed to validate the KCl process for a performance guarantee. It is unlikely that Verde Potash will get an environmental license before 2016, and it would take about 12 months to build the facility once the capital is in hand. The earliest for production startup is thus 2017, which means that 2015-2016 will largely be a waiting game which Verde Potash has sufficient capital to survive. That makes Verde Potash a good bet on Brazil's potential to turn around its current funk and a geopolitical bet on the future of global potash supply, a good part of which comes from Russia and Belarus. Brazil's potash security of supply vulnerability has not disappeared, and the potential of Cerrado Verde to provide substantial relief as a domestic supply of potassium chloride remains the best reason for Verde Potash Inc to eventually be bought out at a valuation more than ten times the CAD $17 million value implied by the current $0.435 stock price and 39.1 million fully diluted shares. A breakthrough with the permit and a subsequent confirmation of the construction loan would push Verde Potash plc into the $2-$3 range.