Recommendation: Focus on urea prices, not higher operating rates
How operating rates affect prices
Operating rates are one measure that affects supply. When operating rates rise, the supply of nitrogenous fertilizers such as urea can outpace increases in demand. This can have a negative impact on fertilizer prices as competition intensifies. On the contrary, when operating rates fall, they can have a positive effect on prices via tighter supply.
Operating rates rose in September
For the month of September, the operating rate for Chinese plants that manufacture urea rose from 75% in August to 78%. Traditionally, analysts often view a higher operating rate as a positive sign regarding the industry’s fundamentals. This is because when demand rises, manufacturers will often increase output, which will push operating rates up. Sometimes, sales prices will also rise if the marginal cost to suppliers due to additional demand is higher.
When is a higher operating rate negative?
However, there are cases when higher operating rates can negatively impact industry revenue and earnings. This can occur due to lower production costs and industry competition heating up, which is what we’ve seen during the first half of 2013, as Chinese producers enjoyed lower coal prices and became the price setter for global urea prices. As a result, the higher operating rate had a negative impact on the share prices of fertilizer stocks like CF Industries Holdings Inc. (CF), Agrium Inc. (AGU), Terra Nitrogen Company LP (TNH), and Potash Corp. (POT), which manufacture nitrogenous products, as well as the Market Vectors Agribusiness ETF (MOO).
Follow changes in urea prices
Although operating rates fell two months ago, the drop was driven more by additional capacity rather than lower production. September’s increase likely reflects higher output, which can negatively impact urea prices over the short term if demand doesn’t rise. But as farmers are soon expected to purchase more fertilizers in China as export taxes rise again, the increased output could be absorbed and support urea prices. Follow urea prices, and use the operating rate to develop an understanding of what’s happening in the industry.