Potash Corporation of Saskatchewan (POT)

Supplying the World’s Need for More Potash

Potash is food for the plants that feed animals and people. It is known as the quality nutrient because it enhances crops’ size, color and flavor, increases protein, oil and vitamin C content, and improves storage and shipping qualities. It works with other nutrients to enhance the benefits they provide to crops.

The long-term drivers of the fertilizer business – potash in particular – are undeniable, even in the current difficult economic conditions. World population grows by approximately 75 million every year, and economic opportunities in developing regions are driving up demand for high-quality food. Farmers are awakening to the impact of proper fertility practices on their bottom line, giving them the incentive to invest in crop nutrients to improve yields.

At PotashCorp, we are preparing for the world’s demand for more fertilizer. With our resources, strategies and capability to deliver these vital products, we are an important part of bringing more food, more opportunity and more quality of life to the world.

      

Introduction
Letter from the CFO			2
Comparison to Peers			3
Management’s Discussion & Analysis
The Global Story			4
Company Overview			6
Factors That Shaped Our Business in 2008			10
Potash
Overview			13
Strategy			16
Capability to Deliver			17
Risks			18
Performance			18
Phosphate
Overview			21
Strategy			22
Capability to Deliver			24
Risks			24
Performance			24
Nitrogen
Overview			27
Strategy			30
Capability to Deliver			30
Risks			30
Performance			30

2009 Outlook			33
Key Performance Drivers			35
Rewarding Results			38
Risk Management			39
2008 Financial Overview			41
Expenses & Other Income			42
Quarterly Results			45
Key Earnings Sensitivities			47
Financial Structure
Financial Condition Review			47
Liquidity & Capital Resources			49
Capital Structure & Management			52
Market Risks			54
Related Party Transactions			54
Critical Accounting Estimates			54
Recent Accounting Changes			58
11 Year Report			61
Financials
Financial Performance Indicators			62
Management’s Responsibility for Financial Reporting			65
Independent Registered Chartered Accountants’ Reports			66
Consolidated Financial Statements			68
Appendix			119

WAYNE BROWNLEE
EXECUTIVE VICE PRESIDENT AND CFO

No company, and no sector of the economy, was untouched by the financial crisis that gripped the world in the second half of 2008. While we don’t know when this crisis of economics and confidence will end, our business is tied to the world’s need for food – and when producing food, time is of the essence. Crops must be planted, fertilized and harvested.

In this economic downturn, the market has generally not differentiated between essential and non-essential businesses, between commodities and their underlying fundamentals, or among companies within a sector. But we think this will change and the strengths of PotashCorp will again be obvious. We believe premiums for quality will reappear.

Our resources, strategy and history of doing what we say we will do set our company apart. While we have world-class assets in phosphate and nitrogen, our emphasis on Potash First is the heart of our success. With an eye to long-term demand for this vital nutrient, PotashCorp, the largest producer, is in the best position to bring on the most new capacity in the least time. Expansions are underway at all of our operations, and we are primarily funding them from our cash flow. We are in this business for the long term and are confident our expanded potash capacity will be critical to meet future demand growth.

As we put our strengths to work for our stakeholders, we look for opportunities. Again we reinvested in what we believe are the world’s best potash assets – our own – through our share repurchase program. Like our previous share repurchases, this is a long-term investment that we expect will be recognized as an excellent creator of shareholder value. We also increased some of our offshore potash investments, and we continue to explore further opportunities that may become available. We believe decades of prudent balance sheet management will enable us to take advantage of those that fit our Potash First strategy. While this is not a forecast, we believe it is possible that we could far exceed our record potash gross margin of 2008 when we complete our expansion projects.

Our goal is always to maximize long-term value for our shareholders. While the current environment is a difficult one, we have achieved five consecutive years of record earnings growth and we continue to believe that PotashCorp is well positioned for future growth.

February 20, 2009

In our efforts to achieve the highest sustainable results for our shareholders, management evaluated our 2008 performance against basic materials indices and our peers in the fertilizer sector. For 2009, our peer group has been expanded. Some of the key metrics tracked are set out on this page.

This information is included for comparison only. All peer group financial information included in the performance summary was obtained from publicly available reports published by the respective companies. We have not independently verified and cannot guarantee the accuracy or completeness of such information.

Readers are cautioned that, other than PotashCorp and Agrium, none of the companies identified in this group prepares its financial statements (and accompanying notes) in accordance with accounting principles generally accepted in Canada (Canadian GAAP). Accounting principles generally accepted in the foreign jurisdictions in which these peers operate may vary in certain material respects from Canadian GAAP, and such differences (if and as applicable) have not been identified or quantified for this performance summary. For those companies with fiscal year-ends other than December 31, all financial information was based on the 12-month period comprising the most recent four fiscal quarters reported upon by such companies. In addition to the issues described above, the different reporting periods among the peer group may affect comparability of the information presented.

Note: Full-year comparable information for Intrepid not available due to IPO April 21, 2008.

 

Helping Produce More per Acre

The rapid decline in investor confidence in the latter half of 2008 may have temporarily shifted political and public attention away from global food issues, but it did not change long-term agricultural realities. The world needs every available arable acre to produce more food, and more fertilizer to keep those acres healthy. These needs drive the growth of our business and our industry.

The world depends on modern agriculture, which makes it possible to feed a rising population and help people in developing nations enjoy better, protein-rich diets as their incomes increase. Agriculture can help improve energy self-reliance, maintain a healthy environment and sustain the parks, gardens, rainforests and open spaces that enrich our lives and protect the planet.

More than ever, farmers are challenged to respond to rising global needs for food, animal feed, fuel and fiber. Together with modern agricultural techniques, quality seeds and good weather, fertilizers make it possible for farmers to meet that challenge by maintaining soil fertility. Increased use of potash is especially important, since it works synergistically with nitrogen and phosphate and has historically been under-applied relative to the other two nutrients.

Research suggests that approximately 40 percent of the world’s food production is a direct result of fertilizer application. The value of PotashCorp products continues to increase as the need for food rises. We believe potash will become even more important to the agricultural picture, and we are ready to supply it.

World population grows by approximately 75 million every year, mostly in developing nations. Despite the financial turmoil in 2008, China, India and other major emerging nations are expected to continue to drive global GDP growth, which the International Monetary Fund predicts will average 3.6 percent annually over the next five years. This will give increased purchasing power to millions of people.

2. More and Better Food Is Wanted

Diets are changing around the world as people with rising incomes choose better-quality foods rich in protein. Grain-fed chicken, pork and beef are becoming more affordable in developing countries, and more meat is being produced and consumed there. Demand for fruits and vegetables is also rising, particularly in Asia, where they are displacing cereal crops. Substantially more fertilizer, especially potash, is needed to produce quality fruits and vegetables.

3. Arable Land per Capita Is Shrinking

As population rises, cities expand and industry and transportation infrastructure grow, farmland is being converted to other uses. By 2020, there are expected to be barely 0.2 hectares per person for animal and crop production – less than half what was available in 1950. Farmers must use proper fertility practices to produce enough food from this diminishing agricultural land base per capita.

4. Grain Stocks-to-Use Ratio Remains Below Average

Despite reduced grain buying in the second half of 2008 that left more in inventories, and a record grain harvest which met world demand for only the third time in a decade, stocks-to-use ratios remain near historical lows. Because of long-term population growth and rising consumer incomes, this is unlikely to change soon.

5. Strong Crop Prices Will Encourage Farmers

Although crop prices, like nearly all commodity prices, fell during the latter half of 2008 after setting records in the first half, they remain well above historical levels and approximately twice the levels of three years ago. The factors that drove up those prices – rising world demand, low stocks and competition for planted acreage – are expected to continue, giving farmers a strong incentive to increase production and motivating them to use proper fertilization.

6. Fertilizer Is Needed More than Ever, and It Pays

Record harvests like the one in 2008 pull vast amounts of crop nutrients from the soil, nutrients that must be replaced to feed the next crop. After years of under-applying fertilizer, especially potash, China, India, Brazil and other countries are beginning to improve their nutrient balance. Fertilizer typically generates a return of $3 for every $1 invested.

The Company With More

The world needs more fertilizer to produce more crops in response to rising demand for food. Farmers want to increase their production to take advantage of higher prices, while those in developing regions, in particular, need to apply more fertilizer – especially potash – to correct soil nutrient imbalances brought about by historical under-application.

PotashCorp has built a thriving international fertilizer enterprise on world-class potash (K) resources, high-quality phosphate (P) and nitrogen (N) assets and strategic offshore potash investments.

We sell our products in three markets – fertilizer, focused on plant nutrition (N, P, K); feed supplements, focused on animal nutrition (mainly P, some N); and industrial, focused on products for high-grade food, technical and other applications (N, P as phosphoric acid, K). In 2008, fertilizer provided 70 percent of our sales and 82 percent of gross margin.

Offshore customers, primarily government agencies and private importers, accounted for half of our fertilizer sales in 2008 – including almost two-thirds of our potash sales. Approximately one-third of our sales volumes in each of the three nutrients was sold in North America to retailers, cooperatives and distributors that provide storage and application services to farmers. Feed and industrial customers consumed most of the remainder of our phosphate, and industrial customers the remainder of our nitrogen.

In both Northern and Southern hemispheres, fertilizers are mainly applied in spring and fall. Prices and profitability, choice of crop, soil quality and conditions, climate, weather, and government policies and subsidies influence customer purchases.

Among major world crops, rice, corn and wheat require all three nutrients, while soybeans need mainly potash and phosphate and oil palm uses mainly potash.

Potash has structural and market advantages that we believe make it the best fertilizer business. Good deposits that are economical to mine are rare and barriers to entering the industry are high: significant upfront and continuing capital investment and at least seven years are required to bring a new conventional mine to production. Government involvement in and ownership of the industry are low, so economics, not politics, is more likely to drive business decisions.

And the world needs more potash. At PotashCorp, we are drawing on our unique strengths as we continue to prepare to respond to that need.

PotashCorp began as a potash producer and, even after adding excellent phosphate and nitrogen businesses, the quality nutrient remains the heart of our company.

Anticipating today’s market conditions, we have used acquisitions and internal investments to build a company with almost one-quarter of global potash capacity: six large low-cost mines in Saskatchewan and New Brunswick and mineral rights at another Saskatchewan mine.

Potash is the biggest contributor to our earnings, generating 62 percent of our gross margin in 2008. Its position is strengthened by our interests in four offshore potash-related industry players: Arab Potash Company Ltd. (APC) in Jordan, Israel Chemicals Ltd. (ICL) in Israel, Sociedad Quimica y Minera de Chile S.A. (SQM) in Chile and Sinofert Holdings Limited (Sinofert) in China.

For two decades, we have worked to maximize long-term value for our shareholders by following strategies that emphasize earnings growth and reduce the volatility inherent in our business.

Its significant increases in volumes and expanded margins make potash the best place for us to invest. We seek to minimize downside risk by following our long-held strategy of matching production to market demand, which helps reduce volatility in difficult market conditions such as those experienced in late 2008.

In our other nutrients, too, we focus on strengths that lead to higher margins and less cyclicality. In phosphate, we leverage our high-quality rock to produce a flexible range of products that lets us take advantage of shifting market conditions. Our focus in nitrogen is our lower-cost Trinidad production.

At 23 percent and 15 percent, respectively, phosphate and nitrogen were important contributors to PotashCorp’s gross margin in 2008.

We are the most diversified global phosphate company, economically making phosphoric acid, liquid and solid fertilizers, animal feed supplements and products used by industry, such as purified acid. We stress the product combination that offers the best returns with the least volatility.

Our nitrogen production in Trinidad benefits from long-term, lower-cost natural gas contracts, which together with our proximity to the United States provides significant cost advantages in the markets we serve. Our US nitrogen production emphasizes industrial products.

To ensure we can meet the needs of growing offshore markets, we are expanding our potash capacity significantly. By the end of 2012, we expect to have completed construction on projects that will bring our total capacity to 18 million tonnes. We are funding these Potash First expansions primarily through operating cash flow.

Beyond internal expansions, we are vigilant and disciplined in seeking to allocate our cash in ways that best benefit the company, always with the goal that cash flow return exceed the cost of capital. We continue to look for opportunities that expand our potash reach. We consider repurchases of our own stock an effective way to add long-term shareholder value. In 2008, for example, we spent $3.4 billion to repurchase 22.8 million of our shares at an average price of $147 per share. We also pay dividends quarterly, with $123 million paid in 2008.

Our unique assets enable us to deliver on our value proposition and support our vision and strategy. These include:

•

An experienced management team able to conceive, develop and implement long-term strategies and commit the company to them

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Balance sheet strength over two decades that enables us to take advantage of opportunities and withstand short-term business fluctuations

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Substantial cash flow, which is both the result and the cause of our success

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A productive workforce, motivated sales teams and a coordinated transportation network to serve our target markets.

			More potash to respond to world demand.

Living by our core values means we strive always to build support and understanding among stakeholders, focus on creating long-term value for our shareholders, deepen our relationships with customers and improve quality of life in the communities in which our employees live and work. Our goal is no harm to people and no damage to the environment, and we are determined to achieve it.

A Year of Crisis in Food and Finance

1. Economic Crisis Slowed Strongest Global Growth in 30 Years

In the first half of 2008, tight supplies of agricultural products led to restrictions on food exports and fears of increased world hunger. The overriding concern was how to produce more food. Then the focus shifted abruptly as the global financial crisis boiled over. In the deepening downturn, world economic growth dropped from an average of 4.9 percent in 2004-2007, the strongest four-year period in three decades, to 3.4 percent in 2008. By year-end, several mature economies were in recession; US growth fell from 2 percent in 2007 to 1.1 percent. The strong growth in emerging economies was moderated; China and India slowed from 13 percent and 9 percent, respectively, in 2007 to 9 percent and 7 percent in 2008.

2. Commodity Prices Were Highly Volatile

Spurred in the first half by robust demand from developing economies, prices for most commodities – from base metals to oil to soft commodities such as grains and oilseeds – were strong. However, as the economic crisis unfolded in the second half, many investors broadly liquidated their commodity holdings. We believe they acted first out of fear of slowing global growth, particularly in Asia, and then out of need to attain and preserve cash as prices fell across the board. Consistent with other commodities, prices for crop futures weakened considerably, although the ongoing balancing of supply and demand provided floor prices substantially above historical averages.

3. Highest Global Grain Demand – and Production – in History

Record grain demand for food and biofuels, plus a historically low stocks-to-use ratio, continued in the first half of 2008, challenging producers and helping to push crop prices to levels that encouraged maximum production. Farmers responded and, with excellent weather in key growing areas, produced the largest harvest in history. However, the increase to ending global grain inventories for crop year 2008/09 was slight. The stocks-to-use ratio is expected to be 19 percent, substantially below historical levels, and inventories still represent only 69 days at normal demand.

4. Farmers Postponed Fall Fertilizer Applications

Cool, wet weather and floods in several states delayed seeding throughout the US Midwest, causing late maturing of crops and late harvests. Little time was left for normal fall fertilizer application. By then, uncertainty caused by the growing world economic crisis and falling nitrogen and phosphate prices had made farmers around the world defer purchases of major inputs, including fertilizer.

5. Record Net Income Contributed to US Farmers’ Strong Balance Sheets

With strong crop prices and high production, US farmers achieved record net cash farm income of $93 billion in 2008, USDA reported. At year-end, they had strong balance sheets, with a debt-to-equity ratio of 10 percent, the lowest level ever reported.

 

 

6. Tight Global Potash Market Continued

In the first half of 2008, growth in global potash demand exceeded increases in supply, consuming all available production and leaving major markets short and on allocation. Increased shipments to markets in India, Southeast Asia and Latin America more than offset the reduction in shipments to China that resulted from lengthy contract negotiations with suppliers early in the year. India, with its nutrient-hungry soils and need to boost food production, increased imports by about 2 million tonnes, and record palm oil production supported healthy Southeast Asian demand. Brazil raised its purchases early in the year, but later, during its primary planting season, farmers’ concerns over credit availability and declining crop prices kept annual potash imports in line with the strong 2007 total. In the North American market, fourth-quarter shipments were reduced by a late harvest and economic uncertainty.

7. Potash Prices Rose Significantly

With tight producer supplies worldwide, offshore and North American potash prices increased significantly in 2008. Delivered prices in the major spot markets of Brazil and Southeast Asia rose by more than $600 per tonne. India paid an additional $355 per tonne and China’s annual contract price was up $400 per tonne. North American prices increased by approximately $600 per tonne. We believe improving prices also reflected market recognition of the need for reinvestment in capacity to meet future demand.

8. Food Security Concerns Led to Chinese Agriculture Programs

Increasing concern over food security led China to tax urea and phosphate fertilizer exports to ensure sufficient domestic supply. This reduced its exports of DAP/MAP from 4 million tonnes in 2007 to 2 million tonnes in 2008, and its urea exports from 6 million to 5 million tonnes. To encourage farmers to boost food production, farm subsidies were doubled from 2007 levels, crop prices were raised for 2009 and a program to allow farmers to use their land leases as equity was begun. These actions could lead to the use of enhanced farming technology and to increased fertilizer consumption over the long term.

9. India Was Major Buyer in Phosphate Markets

The government of India took steps to boost food production and improve food security. Subsidies to fertilizer producers and importers more than doubled DAP imports from 2.6 million tonnes in 2007 to 5.7 million tonnes, tightening the global DAP market and pushing up prices. Due to China’s reduced DAP/MAP sales, India’s high demand was satisfied largely from the US.

 

 

 

 

10. Sulfur Market Was Volatile

High demand for phosphates early in 2007 through first-half 2008 drove up demand for sulfur, a byproduct of oil and gas production and a key input in phosphate production. With supplies constrained by unexpected refinery outages and delays in new refining and processing projects, sulfur prices soared. As approximately one tonne of sulfur is required to make a tonne of phosphoric acid, phosphate production costs were pushed up sharply. At their peak, international spot sulfur prices were more than eight times higher than they had been just one year before. Later in 2008, with a sharp decline in global phosphate production and more sulfur available from refineries, sulfur prices fell precipitously. This encouraged phosphate buyers to defer purchases as they waited to see if the lower sulfur costs would be passed along in the form of lower phosphate prices.

11. High Gas Costs Reduced Western Europe, Ukraine Competitiveness in Nitrogen

With natural gas costs averaging $13/MMBtu for 2008 – and reaching $16 late in the year – Western Europe, the high-cost global ammonia producer, was forced to shut down nitrogen capacity. Its demand for ammonia sourced from other regional suppliers increased. Natural gas costs also rose substantially in Ukraine, to $7.50/MMBtu, reducing nitrogen production and raising the global floor price for nitrogen exports.

12. In Troubled Environment, Potash Prices Held Firm

Tight supplies of phosphate and nitrogen fertilizers and China’s high export tariffs on these products increased prices during the first part of 2008, but they fell sharply when the global economy slowed. The decline in prices was exacerbated by the collapse in raw material costs and rising inventories.

Phosphate and nitrogen producers reacted by substantially lowering prices to move product or acquire cash, but it was evident through the second half of 2008 that the lowered prices did not result in increased demand. By year-end, approximately 50 percent of world phosphate production and significant global nitrogen capacity were curtailed.

The same global economic environment affected the market for potash quite differently. Inventories did not reach excessive levels due to inherently tight supply, a labor strike at three PotashCorp facilities and widespread production curtailments in response to the slowdown in global demand. As a result, potash prices did not fall.

 

				Highlights
	#	1		IN GLOBAL PRODUCTION AND CAPACITY
	10.1			MMT CAPACITY CONSTRUCTED THROUGH DEBOTTLENECK/EXPANSION PROJECTS FROM 2005 TO END OF 2012
	$	7		BILLION (CDN) CAPITAL EXPENDITURES ON THESE PROJECTS

PotashCorp has potash assets unmatched by any other world producer, and we are expanding to build our competitive strength. We completed construction of an additional 1.5 million tonnes at our Lanigan operation in 2008. Between 2005 and the end of 2012, we will have added 10.1 million tonnes through debottlenecking and expansion, half of the industry projects being built worldwide in that time, with a total investment of CDN $7 billion.

We are also expanding our compaction capacity to produce more granular potash, which has a larger particle that can be easily blended with solid nitrogen and phosphate fertilizers for consistent application. This premium product is used in sophisticated agricultural markets and, increasingly, in developing nations, and we see it as the future of global farming practices. While more costly to produce, granular products provide higher margins and add flexibility to our potash operations.

Potash has many advantages over the other primary nutrient businesses.

Significant potash production occurs in only 12 countries. Half of global reserves are located in the Canadian province of Saskatchewan, while Canada, Russia and Belarus together account for two-thirds of world production and more than 80 percent of reserves.

Most potash companies are publicly owned and traded, so business decisions in the industry are likely to be made for economic rather than political reasons. Only in Belarus, where the economy and GDP growth depend heavily on potash sales in US dollars, is there significant government ownership.

Entry into the potash business is difficult because quality deposits are rare and costs to build a new mine are substantial. A new conventional Saskatchewan mine would require an upfront capital investment of CDN $2.8 billion or more, excluding roads, rail, utilities, port facilities and other infrastructure outside the plant gate that could increase the cost significantly. It would take a minimum seven years to generate positive cash flow from when construction begins.

Greenfield Production At Least Seven Years Away

No significant greenfield projects are on the immediate potash horizon, and the long lead time for a new mine makes the completion of new competitive construction unlikely for at least seven years. While rising prices and profitability increase the likelihood of a future greenfield commitment, the cost and time required to establish a large-scale facility continue to be major impediments. However, if and when we determine that a greenfield project is appropriate, we have property at Bredenbury, Saskatchewan where, we believe, geological exploration is the most advanced of any prospective new mine, complete with previously drilled potential shaft pilot holes.

Expanding offshore markets, particularly in developing nations, provide most of our growth. In 2008, those markets purchased 65 percent of our potash for use on rice, wheat, soybeans, corn, oil palm, sugar, rubber, bananas, oranges, coffee and other agricultural commodities. Most of our remaining potash was sold in North America, a mature and stable agricultural market. A small amount – about 6 percent – was purchased by industrial customers in North America and offshore.

Our company is the largest contributor (54 percent) to Canpotex Limited (Canpotex), which represents Saskatchewan’s three potash producers (PotashCorp, Mosaic, Agrium) in offshore markets. In the key markets of China, India, Brazil and Southeast Asia, Canpotex competes with global marketing agencies such as Belarusian Potash Company (for Belaruskali and Uralkali) and International Potash Company (for Silvinit), and producers such as ICL and K+S. Our New Brunswick facility has logistical advantages in supplying Brazil and other Latin American countries.

Purchasing methods vary among large offshore customers:

•

China buys from Canpotex under three-year memoranda of understanding, with pricing and volumes negotiated annually. The current memorandum expires at the end of 2009;

•

Japan and Korea buy from Canpotex under six-month price and volume contracts;

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India has traditionally bought from Canpotex as needed under six- to 12-month price and volume contracts;

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Brazil buys from Canpotex and PCS Sales, and Southeast Asian countries from Canpotex, on the spot market.

PotashCorp benefits from lower transportation and distribution costs by marketing through Canpotex. These costs can be considerable when shipping from Canada’s interior.

Approximately 25-35 percent of Canpotex customers buy at the port where the product is loaded and pay their own freight (FOB). Canpotex pays the freight for customers who buy on a delivered basis. As a result, ocean freight rates can affect margins significantly.

Sales to the United States are typically made from Saskatchewan, particularly from our Rocanville plant, which is just 95 miles from the border. North American customers – primarily wholesalers, retailers and cooperatives that purchase on the spot market from PCS Sales – buy mainly on a delivered basis. We do not sell directly to farmers. We own or lease more than 100 distribution points in the US (mostly with variable cost leases, paid for only when used) and approximately 3,500 potash railcars.

The principal markets for both Canpotex and former Soviet Union (FSU) producers are China, India, Brazil and Southeast Asia. FSU producers also ship into the European Union. K+S customers are primarily in Europe and Brazil, while ICL ships to India, China, Southeast Asia, Brazil and Europe.

In North America, PotashCorp competes with Mosaic, Agrium and Intrepid. Our share of North American producers’ sales to this market was 37 percent in 2008.

•

Can substantially raise capacity in less time than and at a significant discount to comparable greenfield capacity

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Low-cost, flexible production with small percentage of fixed costs

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Per-tonne fixed costs and mining taxes decrease as production increases

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Existing operations have significant reserves and mine lives

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Offshore investments add considerable global reach and profitability

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Depth and tested experience of management team

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Substantial barriers to entry, with high capital costs and long lead times

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Few world producers, little government ownership

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No known substitutes for potash

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High rail and ocean freight delivery costs for Saskatchewan potash, potential for transportation bottlenecks

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Water inflow at New Brunswick increases costs, and risks loss of production

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Production costs exposed to Canadian dollar volatility

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High Saskatchewan resource taxes and federal and provincial income taxes relative to global competitors

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Substantial and rising global demand for food and biofuels is accelerating long-term growth expectations for potash consumption

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Planned capacity additions could give us a larger share of a growing market, since competitors have limited expansion potential and regions with long-term capacity growth potential may be affected by heightened geopolitical risk and reduced access to credit

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Demand can be temporarily affected by changes in consumption patterns in offshore markets

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Our strategy of matching production to market demand means PotashCorp can be disproportionately affected by market weakness, particularly in the short term

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Potash demand growth could exceed the company’s logistical capability to deliver in the short term

•

Substantial upward pricing trend may attract greenfield projects

 

 

Our investments in four potash-related companies give us strategic opportunities and enhance our bottom line. With 32 percent ownership, we have an influential position in SQM in Chile, the world’s leading producer of specialty potassium, iodine and lithium products. Our 28 percent ownership of APC in Jordan – which has a logistical advantage in delivering to Mediterranean and East Asian markets – enables us to appoint its top four management positions. In 2008, we increased our ownership of ICL in Israel to 11 percent and our investment in fertilizer distributor Sinofert in China to 22 percent. Sinofert – the biggest potash distributor in the world’s largest market - distributes 50-60 percent of the fertilizer imported into China. It has an 18 percent interest in, and handles all product of, Qinghai Salt Lake Potash Company (QSLP), the country’s largest potash producer.

The market value of our offshore investments was $4.6 billion at December 31, 2008.

POTASHCORP’S STRATEGY

Increase Capacity as Demand Grows

PotashCorp amassed world-class potash assets with strategic purchases that first consolidated our Saskatchewan base and then added an operation in New Brunswick, the only potash facility on Canada’s East Coast. We are continuing to add capacity through expansions and debottlenecking for substantially less than the cost of equivalent greenfield construction.

At the same time, we constantly seek opportunities to add to our offshore potash investments, which have contributed strongly to our bottom line. Such opportunities must blend into our Potash First strategy.

We are timing our capacity additions to meet the expected growth in offshore demand for potash. Demand rarely moves in a straight line upward; it rises and falls with circumstances, as we saw in the second half of 2008. However, we believe it is better to be slightly ahead of the demand curve rather than risk capacity shortage as demand grows.

We attempt to minimize downside risk by matching production to market demand. Short-term fluctuations in sales volumes may result, as temporary events can negatively affect short-term buying patterns. This is particularly true when most growth is in offshore markets.

CAPABILITY TO DELIVER

We Can Deliver, Today and Tomorrow

More than five years ago, we began preparing for the anticipated rise in global potash demand. Between 2005 and 2008, the first round of expansion/debottlenecking projects at our Rocanville, Allan and Lanigan operations in Saskatchewan were completed, adding 2.65 million tonnes of standard product capacity at a cost of CDN $750 million. We also added 2.75 million tonnes of compaction capacity.

Five more projects – a debottlenecking at Patience Lake, a debottleneck/expansion at Cory, an expansion at Allan, a replacement mine and expanded mill at New Brunswick and a mine and mill expansion at Rocanville – are underway.

These projects will add 7.46 million tonnes of standard product capacity, along with significant compaction capability, at a cost of CDN $6.2 billion. Construction is expected to be completed in 2009 (Patience Lake), 2010 (Cory I), 2011 (New Brunswick) and 2012 (Allan, Cory II, Rocanville).

At completion of construction, each facility will begin ramp-up, a process that includes commissioning a large, complex mill. Equipment, including mining machines, bins and conveyor systems, must be lowered to the mining level, assembled and positioned. Maintenance shops must be set up to serve the underground workings. Reaching full productive capability can take more than two years after construction completion.

All expansions will raise our constructed capacity to 18 million tonnes by the end of 2012 at a total cost of CDN $7 billion.

Our potash mine employees had an average of 13.5 years of experience as of 2008. Labor typically represents about 21 percent of the company’s costs of potash production. Our Saskatchewan operations at Allan, Cory, Lanigan, Patience Lake and Rocanville are unionized. Our Sussex mine in New Brunswick is not unionized.

In 2008, a three-month strike at Allan, Cory and Patience Lake lowered our annual production. In November, the workers settled on a new three-year agreement retroactive to May 1, 2008. Contract negotiations at Lanigan began in early 2009. The Rocanville collective agreement expires on May 31, 2009.

Increasing world demand for potash and our rising capacity require us to invest in transportation and distribution infrastructure and ensure close cooperation with our rail transportation partners. To serve offshore markets, Canpotex plans to build a new port facility at Prince Rupert on Canada’s West Coast and is expanding its existing terminal in Vancouver. When both facilities are completed, the marketing agency will be able to move approximately 23 million tonnes of potash annually, nearly double its current capability.

To facilitate potash movement, Canpotex continues to invest in new railcars. It added 1,350 cars in 2008.

Our contract with Canadian National Railway continues until 2010, while the Canpotex CP Rail contract extends to 2012.

In Brazil, we are a shareholder in Perola S.A., and we use the bulk fertilizer terminal it leases at the Port of Santos.

RISKS TO OUR POTASH STRATEGY

We pay particular attention to risks associated with our potash strategy, and act quickly to mitigate them. We considered the following risks of greatest potential impact in 2008:

Rising prices have encouraged potash producers to increase production through expansion and development projects. If supply increases faster than world consumption, prices could be depressed for a prolonged period, negatively affecting our financial performance. While we anticipate that long-term growth in consumption will match or exceed the new supply, fluctuations in demand are characteristic of this market. We attempt to mitigate this risk and protect our margins by producing to meet market demand.

We are preparing for an anticipated increase in world potash demand by investing a total of CDN $7 billion in expansion and debottlenecking of existing facilities. As this new capacity is added, we believe we can capture a significant share of the expected demand growth, further strengthening our potash position and adding long-term shareholder value.

If our estimates of future potash demand prove to be overstated, our return on this investment would be lower than expected due to lower revenues and the related opportunity cost of outlaying significant capital before it was needed. We mitigate this risk somewhat because we are able to operate profitably at reduced rates, matching our production to market demand.

We rely on a complex transportation and distribution infrastructure of railcars, barges, ocean freightliners, warehouse and port storage facilities to get potash to our customers quickly and efficiently. Short-term problems – such as railcar shortages, slow turn times and disruptions such as strikes, derailments or adverse weather – could lead to customer dissatisfaction, loss of sales and higher distribution costs, making it difficult to achieve our growth plans.

We attempt to mitigate this risk by working directly and through Canpotex to ensure sufficient investment is made in transportation infrastructure to help potash move as smoothly as possible. Internally, we continue to optimize our industry-leading distribution network in North America with predictable, consistent mine loading and delivery schedules.

Water-bearing strata that carry the risk of water inflow often exist in the vicinity of underground mines. We are successfully managing water inflows at our New Brunswick operation. Our other conventional mines currently have no significant water inflows. At Esterhazy, where our mineral rights are being mined by another producer under a mining and processing agreement, water inflows are being managed.

All mining companies face the risk of unexpected rock falls that can result in life-threatening injuries. We have developed a mining machine canopy to protect workers, and our earth sciences group has developed ground-penetrating radar to help detect the anomalies that cause rock falls. Advanced geoseismic monitors record micro-events and provide information to help predict falls.

•		Record gross margin of $3,055.5 million, 235 percent higher than 2007
•		Record 169 percent increase in realized sales prices caused by tight market supply and higher crop commodity prices for most of 2008
•		Due mainly to Canpotex price increases to China, Brazil, India and Southeast Asia, average realized offshore prices were up 195 percent over 2007. Average realized North American prices rose 133 percent
•		Average annual offshore prices surpassed North American prices for the first time since 2002. Driven by low global

		grain stocks and record-setting crop prices in key emerging markets, offshore price increases outpaced those in North America, particularly in the first half of the year
•		Sales volumes declined due to limited supply caused by labor disputes at three of our mines and reduced demand amidst uncertainty caused by the growing world economic crisis
•		Canpotex shipped 9.3 million tonnes in both 2008 and 2007. Sales to China were 13 percent of 2008 total (2007 – 26 percent), Brazil 20 percent (2007 – 21 percent) and India 16 percent (2007 – 10 percent). Our New Brunswick operations shipped 0.5 million tonnes offshore in 2008

		(31 percent to Brazil) vs 0.7 million tonnes in 2007 (44 percent to Brazil)
•		The pattern of offshore potash shipments was altered in 2008 by a late contract settlement between Canpotex and China. India benefited from China’s late entry to the market, receiving nearly 60 percent more potash from Canpotex than it had in the prior year
•		North American sales volumes fell 15 percent as farmers mostly passed on a normal fall application due to the late harvest and unfolding global financial concerns

•		Due to reduced fourth-quarter demand, inventories rose to 844,000 tonnes, 24 percent higher than last year but 3 percent lower than the five-year average
•		Cost of goods sold rose due to: increased royalties caused by higher sales prices ($5.50 per tonne or $47.0 million), increased brine inflow costs at New Brunswick ($3.50 per tonne or $29.3 million), strike-related costs ($2.00 per tonne or $19.6 million), a stronger Canadian dollar ($5.00 per tonne or $43.4 million) and increased fixed costs being distributed over fewer tonnes sold

HIGHLIGHTS OF 2007 VS 2006

•		Record gross margin of $912.3 million, 63 percent higher than 2006 and 29 percent above the 2005 record
•		Record sales volumes of 9.4 million tonnes, 31 percent above 2006, due to exceptionally tight market conditions
•		Products sold on allocation for most of the last half of 2007 (sold as ordered in 2006)
•		Offshore sales up 34 percent from 2006, reflecting higher demand as farmers worked to correct decades of under-application and took advantage of higher commodity prices (grains, soybeans, corn and palm oil)
•		Canpotex shipped 9.3 million tonnes in 2007 and 6.7 million tonnes in 2006 (PotashCorp’s share 55 percent); sales to Brazil were 21 percent (2006 – 15 percent) while China and India were 26 percent (2006 – 19 percent) and 10 percent (2006 – 10 percent), respectively. Our New Brunswick operation shipped 0.7 million tonnes offshore in both years with 44 percent to Brazil in 2007 and 53 percent in 2006
•		North American sales up due to stronger dealer fill and field application caused by higher commodity prices and more acreage planted
•		Year-end inventories of approximately 680,000 tonnes, 27 percent below 2006 and second lowest since 1991
•		Offshore prices up 18 percent as Canpotex agreed to total per-tonne price increases with China ($5), Brazil ($175), India ($50) and Southeast Asia ($195) by the end of 2007

•		North American prices up 12 percent due to price increases that totaled $82 per tonne by the end of 2007
•		Gap between North American spot prices and contracted offshore prices due, in part, to lag between spot market and termed pricing in contracts, and different product mix
•		Cost of goods sold up compared to 2006 because of higher production levels, higher brine inflow costs ($5.50 per tonne or $51.5 million), a stronger Canadian dollar ($3.00 per tonne) and 47 fewer shutdown weeks (2006 shutdown weeks higher due to matching production with demand)

 

Potash Production (million tonnes KCl)

								Production													Mine Site
			Capacity					2008				2007				2006					Employees
Lanigan SK				3.828					2.141				1.907				1.471					519
Rocanville SK				3.044					2.834				2.647				1.897					406
Allan SK				1.885					1.093				1.744				0.992					347
Cory SK				1.361					0.420				0.768				0.772					271
Patience Lake SK				1.033					0.282				0.257				0.190					75
Esterhazy SK *				1.313					1.125				1.043				0.953					0
New Brunswick NB				0.785					0.802				0.793				0.743					339
Total				13.249					8.697				9.159				7.018					1,957

 

 

				Highlights
#		3		IN GLOBAL CAPACITY
#		1		WORLD PRODUCER OF SPECIALTY PHOSPHATE PRODUCTS
				LARGEST, LOWEST-COST US ROCK DEPOSITS

PotashCorp has built a diversified and flexible global phosphate business on integrated world-class operations in North Carolina and Florida. Our high-quality phosphate rock enables us to optimize our phosphoric acid to provide the most profitable combination of downstream products – liquid and solid fertilizers, feed supplements for livestock and poultry, and products used in industrial applications.

Approximately 30 countries produce phosphate rock. China, the US and Morocco, the largest producers, together account for 67 percent of world production. Morocco alone accounts for almost half of phosphate rock exports. Producers without their own supply (non-integrated) must buy and process more expensive rock to produce downstream phosphate products.

Following significant increases driven by Morocco’s Office Cherifien de Phosphates (OCP) in 2007, phosphate rock prices continued to climb during early 2008, pushing up prices for all downstream products. Growing product inventories, declining raw material costs and demand deferral due to the economic crisis resulted in falling production costs and prices for these products in the second half of the year. Rock prices, however, remained relatively stable.

Sulfur, a byproduct of oil and gas production, is needed to convert phosphate rock into phosphoric acid, an intermediate product that can be sold or further processed. Strong demand and constrained supply drove sulfur prices dramatically higher in 2007 but they softened in the second half of 2008. In the fourth quarter, they fell faster than they had risen, due mainly to sharply reduced demand.

Significant volatility in the cost of ammonia, an important input in DAP and MAP production, also affected prices and profitability of those phosphate products.

While it is much less of a pure commodity business than nitrogen, the phosphate industry still has many producers and considerable government ownership, as well as intermediaries to facilitate product movement. These situations make the marketplace potentially more volatile.

No major additions to world capacity in solid phosphate fertilizers are expected until Saudi Arabia’s Ma’aden project is completed and its 3 million tonnes of DAP are ramped up, potentially by 2012. China is building some capacity for domestic consumption and Morocco plans to bring on phosphoric acid plant expansions in 2009 that will enable it to increase solid phosphate production. However, without any significant new capacity slated to come online in the immediate future, growth in demand for phosphate products is expected to keep global markets balanced to relatively tight.

We have built our phosphate enterprise on a foundation of abundant and accessible phosphate rock reserves, with low levels of impurities and, therefore, low production costs. This high-quality rock enables us to produce phosphoric acid of equally high quality, and we use about 40 percent of it to make high-margin industrial and feed products outside the more cyclical solid fertilizer markets. We are also strong in liquid fertilizers, where there is increasing demand and we enjoy healthy gross margins on a P₂O₅ tonne basis. Our diversification strategy ensures that we are well-balanced in our exposure to both liquid and solid fertilizers.

Feed and industrial sales have historically been less seasonal and cyclical, and therefore less volatile, than fertilizer sales, which increased the quality of earnings in these segments. We believe long-term global trends make these excellent businesses. However, they were not immune to the global economic crisis, and our performance – particularly in feed phosphates – suffered in the second half as our customers’ businesses were negatively impacted.

World meat producers and processors in general endured a difficult 2008, when increased grain prices led to substantially higher feed costs. Our primary feed customers are US bulk feed producers, while Latin America and Asia are our largest offshore markets. Dical and monocal are used primarily in beef, poultry and pork production. We have a competitive edge in producing DFP for poultry due to Aurora’s quality rock.

Industry uses phosphate in soft drinks, food, metal treatment and other products. We are a significant participant in the purified phosphoric acid business because of our wet process technology and our high-quality rock at Aurora. The US is our major market for industrial phosphate products, but rising incomes in developing countries are driving growth in offshore demand.

Roughly two-thirds of our phosphate sales volumes are sold in North America, where we typically benefit from higher realized prices. Depending on the product, sales are made on a spot or contract basis. Our North American business is handled by PCS Sales, while PhosChem, a US marketing association that includes Mosaic, sells our phosphate fertilizers offshore. PCS Sales handles our industrial sales in all markets.

Our major offshore fertilizer competitor is OCP, while in North America we compete with Mosaic, CF Industries, Mississippi Phosphate, Agrifos and Agrium. Innophos, ICL and Chinese imports vie with us for North American industrial sales, while Mosaic and Chinese producers compete with us for feed sales in both markets.

POTASHCORP STRATEGY

Maximize Returns and Stability Through Product Flexibility

The flexibility provided by our high-quality rock gives us an unmatched ability to optimize product mix, maximize gross margin on a long-term basis and thereby enhance earnings stability.

Our strategy in the stable US industrial phosphate business is to opportunistically capture new high-margin demand. We have expanded our purified acid capacity to gain market share as competitors closed high-cost, energy-intensive plants, thereby contributing to our phosphate gross margin. Profitability, not sales volumes, is our focus in phosphate feed supplements.

Our flexibility is particularly valuable in phosphate fertilizers because it enables us to respond to market demand. We allot phosphoric acid not suitable for feed and industrial products to the most profitable combination of liquid and solid fertilizers, which may change from year to year. Maintaining high operating rates results in lower per-tonne fixed costs.

•		Significant high-quality, low-cost phosphate rock reserves provide cost advantage over non-integrated producers
•		Ability to direct rock with low levels of impurities to diversified product line to optimize margins
•		Mining near processing facilities provides cost advantage over North American competitors
•		Access to lower-cost North American liquid sulfur
•		Strong position in North American purified acid, feed phosphate and liquid fertilizer markets

•		Transporting ammonia to solid fertilizer plants is becoming more difficult and costly
•		Higher sulfur and ammonia costs can negatively impact margins
•		Plants with high fixed costs may not perform profitably at lower operating rates
•		Long-term sales contracts for industrial and some liquid fertilizer products can cause a lag in pricing in times of rising input costs, temporarily impacting margins

•		Balanced to tight phosphate rock, phosphoric acid and solid fertilizer fundamentals expected in the medium term
•		Few companies globally with rock of sufficient quality to profitably produce purified acid
•		Few greenfield projects give at least a three-year window on solid fertilizer supply, until Saudi Arabia’s Ma’aden project comes on stream

•		Significant government control in global phosphate supply and consumption decisions
•		High barriers to exit because of significant environmental restoration and remediation costs
•		Extensive environmental and permitting requirements

CAPABILITY TO DELIVER

Delivering Product Diversity

By the end of April 2009, we expect to have the federal and state permits that will allow us to continue mining at Aurora, our largest phosphate operation, for 37 years. This will be the culmination of nine years of effort.

Following our strategy of leveraging our rock quality to optimize our product diversity, we have a $260 million project underway at Aurora which primarily involves construction of a new sulfuric acid plant. It is expected to be commissioned in 2009, and will enable productive capability to meet stated annual phosphoric acid capacities without purchasing sulfuric acid. Thus we can make downstream products in any combination that maximizes phosphate gross margin.

RISK TO OUR PHOSPHATE STRATEGY

Risk of Cyclicality

Phosphate risk has historically been increased by short-term cyclicality due to fluctuations in demand, competitive costs, availability of supply and government involvement in the industry. Over the next few years, increased competitive supply of solid fertilizer may outpace growth in world consumption, potentially depressing prices and affecting our phosphate margins. To mitigate this risk, we are leveraging our strengths in less cyclical specialty industrial and feed products and streamlining fertilizer operations to minimize production costs.

	More diversity means more options in difficult phosphate markets.

•		Record gross margin of $1,114.5 million exceeded 2007 record of $432.8 million
•		Solid fertilizers generated $438.9 million of 2008 gross margin, liquid fertilizers $366.7 million, feed $203.0 million, industrial products $95.4 million
•		Realized prices were up in all major product categories due to strong agricultural demand, a higher Chinese export tax and the global impact of higher costs for inputs such as sulfur, phosphate rock and ammonia
•		Price increases in the industrial market trailed those of other markets because certain contracts have pricing that resets annually
•		Sales volumes of all phosphate fertilizers declined. Poor weather delayed North American plantings and harvest; and both domestic and offshore demand fell significantly in the fourth quarter as the global economic crisis unfolded and buyers deferred purchases in anticipation of producers around the world dropping prices to move product or acquire cash

•

Gross margin reduced by: $501.9 million in higher sulfur costs (caused by greater demand for most of 2008); $59.3 million in higher ammonia costs impacting solid fertilizers (caused by increased agricultural demand); and a 22 percent increase in rock costs caused by rock quality issues at White Springs and higher maintenance costs at Aurora