Why natural gas price affects fertilizer earnings
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 the 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 rose higher lately
On October 16, natural gas price stood at $3.85 per MMBtu (million British thermal units), representing an increase of at $3.60 per MMBtu. This reflects an increase of about 18% since August’s low.
Prices for natural gas have risen since August, as late summer heat kicked in, which was preceded by an extended period of cooler-than-normal summer weather across the United States this year. A lower-than-expected rise in inventory figures, reflecting higher demand or lower supply, had pushed natural gas prices higher recently.
Traders, analysts, and energy professionals are now looking ahead at the winter season. A colder winter can jack up electricity demand and cause natural gas prices to rise. Conversely, if the upcoming winter is warmer than usual, then natural gas prices will likely stay low—or even fall further.
US natural gas price down, profitability rises
Lower natural gas prices are positive for nitrogenous fertilizer producers that have operations in the United States. While the cost of North American producers is falling, wholesale ammonia and urea prices are more dictated by more expensive fertilizer producers in China and Eastern Europe. So falling natural gas prices in the United States have driven margins higher over the past three years, making investors wealthy.
Impact on fertilizer stocks and ETFs
As long as natural gas price stays low, fertilizer stocks and ETFs like CF, TNH, AGU, POT, and the Market Vectors Agribusiness ETF (MOO) will benefit. Some fertilizer stocks do hedge, so it’s often preferable to look at medium- to long-term price movements in natural gas rather than short-term movements. Given that natural gas price is already low, we’re unlikely to see a substantial impact on earnings via lower gas prices over the long term.