MADRID (MarketWatch) -- At the world's only regulated marketplace for fish and seafood derivatives in Bergen, Norway, the outlook for salmon prices is looking pretty good.

"Currently-traded futures salmon prices should stay at much higher levels than the average of previous years," said Birgitte Sørheim, marketing manager for Fish Pool. The January to December 2010 contract for salmon futures is 30.50 ($4.73) Norwegian krone per kilo, against an average of 26 krone over the last few years, she said. "That's a clear upward trend."

Meanwhile, the volume in salmon contracts is at 32,000 year-to-date, double what it was last year, she said.

No surprise then that Norway's Marine Harvest (MHG), the world's largest producer of farmed salmon, is doing a boom. Shares are up 268% year-to-date, soaring from a November low of 0.77 Norwegian krone to a share price of around 3.87 krone and still climbing. Meanwhile, shares of Cermaq (CEQ), which produces salmon feed and also farmed salmon and trout, are up 81% year-to-date.

Biologists inject the experimental anti-ISA virus vaccine to a salmon in a lab in Puerto Montt, 1000 km south of Santiago on October 2, 2008. AFP

What's been driving prices higher is a disease that has killed millions of salmon in Chile, the world's second-largest producer next to Norway. Since 2007, Chile has been battling infectious salmon anemia (ISA), which causes hemorrhage in internal organs of the fish among other things, is highly contagious and hard to control.

"In contrast to all other commodities, Atlantic salmon has seen rapidly rising prices in 2008/2009. The reason is a dramatic fall in supplies from Chile," said Aslak Berge, analyst at First Securities, who rates Marine Harvest a strong buy.

"As a consequence of severe biological problems, Chile is slashing their salmon production by 75% from 2008 to 2010. This is pulling down the total global salmon supplies. We foresee supply fall year-on-year both in 2009 and 2010," said Berge in an email interview.

Other analysts see a shortage in salmon three and four years out, a loss of some 10% to global output. In earnings released earlier this month, Marine Harvest said supplies from Chile would begin to fall in the second quarter, leading to a drop in global supply of salmon from this quarter and throughout the year.

Fish Pool's Sørheim said futures prices at the exchange, which currently only deals in salmon, are higher than the price levels calculated into the shares by many analysts, implying further upward momentum.

Reeling in the growth

The seriousness of the situation in Chile and its affect on global production became very apparent during the middle of last year, said Sjur S. Malm, equity analyst at

SEB Enskilda.

"ISA gradually grew through 2007, and until mid-2008 -- most estimated Chile's production down some 30% in 2009. During the second half of 2008 it was very evident this was not only big -- but a huge challenge. So gradually through 2008 the problem has been estimated larger and larger. Currently, we estimate Chile's production down 55% in 2009 and another 30% in 2010," he said.

Though Marine Harvest is facing restructuring costs over Chile, its home country of Norway and biggest supplier of salmon appears to be in good shape as far as production goes, with the U.K., Ireland and Canada also delivering good underlying numbers, and Australia a growing producer, the company said earlier in May.

Malm has a buy rating on Marine Harvest and other stocks in the sector, such as Cermaq, Lerøy Seafood Group (LSG) and Austevoll Seafood (AUSS). "We are fundamentally positive to the salmon farming sector for the coming years, given the supply shock from Chile."

On its face, the stock looks expensive, trading on about 28.9 times 2009 earnings, and 8.9 times 2010 forward earnings. Berge said based on "extraordinary profitability in several years ahead, the valuation doesn't worry investors."

Operational gearing -- the extent to which a firm's total costs are fixed -- is high in the salmon industry, explained Malm. "If we say that the production cost for a kilo of salmon is around NOK 20, e.g., when price moves from NOK24 to NOK28, the profitability is doubled. At NOK32, the margin is tripled, so clearly a high salmon price leads to high earnings and supports share prices for the salmon farmers."

But that's not to say there aren't a few possible fish hooks out there. Malm said the big risk for the industry is whether the run-up in salmon prices can be sustained by the consumer. Retailers could turn to other species than salmon, which could cut into demand, he said. Also, the higher price paid to farms has yet to trickle down to the retail chains.

"Thus, the big test of the salmon market will be this price increase. We believe it is very likely that such a price increase will lead to some demand destruction, which is also what we saw in 2006," he said. Others noted that lower business activity for hotel, restaurant and catering could also reduce salmon consumption.

Mikael Clement, analyst with Pareto Securities, has a long-term buy rating on Marine Harvest, with a NOK4.5 price target, given their current salmon price estimates of NOK29.5/kg in 2009 and NOK30/kg in 2010.

"Salmon is a medium-priced protein in retail stores. We believe that salmon thus is pretty well protected in regards to a global recession. Recent reports are for rising demand," he said, but also noted the possibility of price sensitivity, and rising retail prices negatively impacting demand.

Even better in this space, he likes LSG. "We are very bullish on LSG. LSG is more attractively valued, has a significantly stronger balance sheet, has no Chile-exposure, and a strong, global sales and distribution arm," said Clement in an emailed comment. He added that recently, free float -- liquidity of shares -- in LSG "improved significantly."

Higher prices headed downstream

But cautious voices over Marine Harvest are out there. Klaus Halebrekke, analyst with DBN NOR Markets, believes demand for salmon will fall once supermarkets in the European Union -- the biggest consumer market for the fish - increase prices.

He said demand destruction from higher prices will overshadow the effects of much lower global supply.

"Even though we fear demand destruction from higher prices, we expect a very good salmon market that will generate well above normalized margins the next years, but current salmon price closer to NOK40 per kg is probably too high," he said in emailed comments.

"Consumers are trading downwards due to the recession and with a significant price hike for the consumer in the next months, we fear that consumers will choose other alternatives as there are plenty to choose from."

He has a sell rating on Marine Harvest, which he views as expensive, compared to cheaper options such as LSG, Grieg Seafood (GSF), Lighthouse Caledonia (LHC), Cermaq and Austevoll Seafood, the last of which he rates a buy.

In terms of liquidity, Marine Harvest is the best, and also has the highest correlation towards spot salmon prices, therefore when those prices go up, share prices increase, but also vice-versa.

However, the issue with that company, he said, is that valuation implies "super profit" for many years, owing to the Chilean-induced global shortage of salmon. Investors, he said, are leaning too much on price/earnings levels around 10 times on "super profit" margins, which is challenging in a cyclical industry at booming margins.

"Investors did not know this lesson during 2000, and did not learn in 2006-2007 and we fear that investors are heading towards the same situation again, unfortunately."

Tomas Skeivys, analyst at Orion Securities, has a reduce rating on Marine Harvest, and shares the same concerns over higher prices denting consumer demand. "The salmon prices are supported currently by the high shortage of supply from Chile and no significant decrease in the demand. However, I believe that such salmon prices are not sustainable in the longer term."

And even higher prices for salmon, he said, don't support the high premium Marine Harvest commands versus its peers.

"So if one thinks that share prices will be supported by continuously increasing or at least stable high salmon prices, he should ask himself, what happens when prices start to go down? After all, such high salmon prices clearly do not support higher demand for salmon," said Skeivys in emailed comments.

While it will take some time for higher prices to hit consumers, he predicts it will happen, "and the demand is likely to drop afterwards."