Why bottoming urea prices are positive for fertilizer producers
Fertilizer prices: Influential to revenues
The price of fertilizer is a key metric that influences fertilizer companies’ revenues. This is especially true for nitrogenous fertilizer producers because demand for their products, such as ammonia and urea, is more price inelastic compared to demand for potash and phosphate, as farmers must reapply them year-over-year to help plants grow. Whether prices increase or decrease by 50%, farmers won’t change their purchase behaviour by much. This makes price a significant factor that affects income and share prices.
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Urea prices possibly bottoming
While we saw an overall increase in urea prices from 2009 to 2011 and have generally moved sideways in the second half of 2011 and 2012, urea prices have fallen since the beginning of April 2013. At the end of September, prices for urea sold in the United States stood at $336 per mt (metric tonne), reversing the recent first two weeks of decline. The last two weeks of data show that urea prices may be close to bottoming. US Granular Barge prices have historically led or moved along with companies’ average selling prices, which are announced during quarterly earnings (see below).
Supply: A primary factor driving wholesale pricees
Because demand is fairly price-inelastic, significant changes in urea prices are largely driven by changes in supply. And since urea trades globally, prices depend on worldwide factors such as marginal production cost and production capacity. In the past few years, Europe and China were the marginal producers.
Chinese producers drove world prices down
We can attribute the large decline we’ve seen since April to lower production costs in China. While ammonia and urea are usually made using natural gas, 80% of China’s available capacity uses coal (which is more expensive to produce). As coal has fallen since 2011 due to larger increases in supply relative to demand, production costs fell in China.
However, it was only when coal prices fell below ~$115 per metric tonne (including ocean shipping costs) this year that Chinese producers became really competitive in the world market, with operating capacity rising from a historical average of just ~75% to as high as 90% recently. As a result, the shares of fertilizer producers like CF Industries Holdings Inc. (CF), Agrium Inc. (AGU), Terra Nitrogen Company LP (TNH), and Yara International ASA (YARIY) were negatively affected earlier this year.
Expectation over the medium-to-long term
Urea prices could be bottoming around the world as Chinese farmers return to purchase fertilizers for next year and if coal prices don’t fall further. However, coal prices will still be a main factor that determines whether prices return to the levels seen in 2012 over the long term. If prices do stay at ~$350 per metric tonne, which is what they were back in mid-2010, then companies’ earnings could miss analysts’ estimates. The share prices of CF, AGU, YARIY, TNH, and the VanEck Vectors Agribusiness ETF (MOO) could be hit if this isn’t priced in.