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Higher urea output in China could hit fertilizer firms negatively

The importance of supply

Supply is one of the factors that affect prices. When the supply of nitrogenous fertilizers such as urea increases more than demand, competition intensifies, which leads to lower selling prices. On the contrary, when supply reduces, competition becomes less intense—a positive effect on prices.

China Urea Output 2013-08-14Enlarge Graph

Urea output remains higher since the start of the year

Urea output in China stood at 2.82 million metric tonnes in July. Although the indicator has fallen from a record high of 3.03 million metric tonnes in June, output remains higher than the beginning of the year. Lower coal prices (which fell from $90 per metric tonne to $72 based on McCloskey’s steam coal price in Newcastle, Australia) have made Chinese producers much more competitive in the global market.

China Urea Operating Rate 2013-08-16Enlarge Graph

New capacity additions drove utilization lower

Earlier this month, we mentioned the possibility of lower urea output based on falling urea prices in China and in the operating rate. But it seems much of the decline we’ve seen in operating rate is due to new capacity additions. This is problematic because according to CF Industries’ recent presentation, world’s capacity utilization is expected to fall due to new capacity in China in 2014 and 2015—see Why Agrium Inc. suspending capacity addition will affect other producers (Part 3). While China’s export tax is an additional factor to consider, if China itself is having trouble with excess urea supply, then the government may reduce the tax or increase the low export tax season that typically follows from July to November to help these producers.

Heightened risk if coal prices remain low

Because the United States is still a net importer of nitrogen fertilizer, proximity to U.S. farmers will continue to benefit nitrogenous fertilizer producers such as CF Industries Holdings Inc. (CF), Agrium Inc. (AGU), Rentech Inc. (RTK), and Terra Nitrogen Company LP (TNH). But as long as coal prices remain low, there’s heightened risk that they will have to sell their goods at lower prices, which has a negative impact on sales, earnings, cash flow, and share prices. This will also negatively affect the Market Vectors Agribusiness ETF (MOO).

Continue to Why Chinese producers are driving nitrogenous fertilizer prices down (Part 1) to learn more about this theme.