Fertilizer manufacturers often compete on costs. As such, it is helpful for analysts and investors to seek out regions where natural gas, a main component of nitrogen-based fertilizers, prices are low. Firms that operate in lower cost regions will often benefit with improved margins, taking in more profits and free cash flows.
North America is Enjoying Lower Costs for Ammonia Production
The chart above shows the margins for ammonia (a basic nitrogenous fertilizer) for Europe and North America on the left. On the right axis, it shows the cost advantages of US nitrogenous fertilizers over that of Europeans. Cost estimate calculations are taken from Bloomberg. Since 2009, manufacturers in North America have enjoyed increasingly lower costs for ammonia production than their European peers.
Shale Gas has Contributed to Lower Natural Gas Prices in U.S., While Europe Lagged
This is because while natural gas prices fell in the United States, natural gas prices rose in Europe. Since 2005, shale gas has made it easier for firms in the United States to tap natural gas reserves that were previously unreachable. That has lowered prices for natural gas in the United States. On the contrary, contracts for natural gas in Europe are mostly pegged to Brent crude oil for historic reasons. While Exxon Mobil (XOM) tested the possibility of discovering and developing shale gas in Poland back in 2011 and 2012, the company recently ended the program due to geopolitical risks.
Continued Cost Advantage in United States is Positive for U.S. Firms
For now, it seems US will continue to benefit from lower natural gas prices. This is positive for companies like CF Industries (CF), Agrium, Inc. (AGU) and Terra Nitrogen Company (TNH) in the US. Consequently, the Global X Fertilizers / Potash ETF (SOIL), an ETF that invests in leading fertilizer producers worldwide, would also benefit from this trend.