Natural gas is a major raw material input in the production of nitrogenous fertilizers, such as urea and ammonia, ranging from 40% to 70% of cost of goods sold. A higher natural gas price increases the cost of goods sold and compresses margins. This in turn lowers earnings and free cash flows for firms such as Agrium Inc. (AGU), Terra Nitrogen Company LP (TNH), CF Industries Holdings Inc. (CF), and Potash Corp. (POT).
Natural gas price declines due to seasonality
On July 15, the Henry Hub Natural Gas Spot Price, a benchmark for natural gas traded in the United States, stood at $3.67 per MMBtu (millions of British thermal units). The benchmark natural gas price has fallen from a recent peak of ~$4.30 per MMBtu in April, as the longer-than-usual cold weather came to an end. As a result, inventory level (which was falling at a faster rate compared to the past because of the cold weather) turned around (see the chart at Why natural gas prices remain depressed, with no help from storage report).
Lower coal prices have also contributed to lower natural gas
Falling coal prices have also put a ceiling on natural gas prices, since utility companies will switch to using more coal as a source of electricity, as opposed to using natural gas. Lower coal prices, guided by China’s lower economic growth outlook, have made coal more competitive as a fuel for electricity. So, while we saw an increase in the share of natural gas electricity use due to cheaper natural gas prices in 2012 relative to coal, we’ve seen the opposite trend over the past few months, with coal’s share rising from ~32% to ~40% while natural gas fell from ~33% to ~26%.
Natural gas prices to remain capped because of China
Although the recent hotter-than-normal temperatures would support more electricity use, and therefore natural gas demand as well, China’s uncertain economic growth outlook will keep coal prices low in the short to medium term, even though coal producers may cut production due to falling profitability. According to the U.S. Energy Information Administration (EIA), coal-generated electricity is expected to increase from last year’s 37.4% of total electricity output to 40.1%, while those using natural gas will fall from 30.4% to 27.6%.
Learn more about natural gas prices and their significance
To read more about natural gas price outlook and why it will affect nitrogenous fertilizers, continue to Why natural gas price affects nitrogenous fertilizer stocks (Part 2), which will follow later today.
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