Why oil affects fertilizer price
In a competitive industry like nitrogenous fertilizer, the marginal producer’s cost sets the floor for the industry. These producers are the most expensive manufacturers to supply the product at that point in time. When the marginal producer’s cost rises, so does the industry’s. On the the other hand, falling costs will result in lower industry price.
Brent oil on the rise
At the end of September 30, a barrel of Brent crude (the international benchmark price) settled at $108.37 at ICE Europe—the largest regulated energy futures exchange in Europe. Prices for Brent crude have been on the rise since April this year due to improving economic activity across the globe.
Historically, prices for ammonia (and other nitrogenous fertilizer products) have followed movements in oil. That’s because the Eastern European producers were the most expensive producers. These producers used natural gas resources that are pegged to oil. Plus, when oil prices rise, so does the cost of shipping.
Why is it the marginal cost producer?
If prices are set above the marginal cost producer, competition will drag industry prices down to the last producer that can supply the product without incurring a loss. But if prices are set below the marginal producer’s cost of production, then prices must rise for the marginal supplier to be able to sell.
The relationship between oil and fertilizer prices fell
But since the beginning of this year, the relationship between the two collapsed, as the marginal cost producer switched from Eastern European producers to Chinese producers that largely used coal to produce nitrogenous fertilizers. As coal prices fell, these producers set the price for the global market.
What does this mean for fertilizer stocks?
As long as coal prices remain low, prices for nitrogenous fertilizers will stay low. But if coal prices do rise back to what they were earlier in the year, we can expect ammonia prices to rise back to above $600. They stood at $448 per metric tonne at the end of September.
This move would have a positive impact on nitrogenous fertilizer revenues and the earnings of companies and ETFs like CF Industries Holdings Inc. (CF), Potash Corp. (POT), Agrium Inc. (AGU), Terra Nitrogen Company LP (TNH), and the Market Vectors Agribusiness ETF (MOO).