Why oil affects fertilizer price
In a competitive industry like the nitrogenous fertilizer industry, the marginal producer’s cost sets the industry floor. These producers are the most expensive manufacturers to supply the product at that time. When the marginal producer’s cost rises, so does the industry’s. On the other hand, falling costs will result in lower industry prices.
Brent oil is on the rise
On October 30, a barrel of Brent crude (the international benchmark price) settled at ~$109.48 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 and some production shutdowns in the Middle East in late summer. However, they’ve come down from recently as production resumed and geopolitical tension eased.
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 pegged to oil—unlike publicly traded nitrogenous fertilizer producers like CF, POT, AGU, and TNH. 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 produce.
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, which largely use 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 and urea prices in China stay low, or China’s supply remains excessive, prices for nitrogenous fertilizers will tread weakly. But if China’s excess supply falls or coal price rises to a level such that the marginal cost producer switches to the more expensive Eastern European producers, we can expect ammonia and urea prices to rise as well. 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).
© 2013 Market Realist, Inc.