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Why a dim coal outlook is negative for global urea producers

Part 2
Why a dim coal outlook is negative for global urea producers (Part 2 of 7)

How China’s manufacturing activity affects global urea prices

Coal prices

As we pointed out in the last article in this series, coal is widely used as a feedstock to produce nitrogen fertilizers in China, which currently sets the floor price for urea. So, indirectly, coal prices will affect U.S. producers. Investors in nitrogen fertilizer stocks or ETFs such as CF Industries Inc. (CF), Terra Nitrogen Company LP (TNH), CVR Partners LP (UAN), Agrium Inc. (AGU), and the Market Vectors Agribusiness ETF (MOO) benefit from following trends in coal prices.

How China's manufacturing activity affects global urea pricesEnlarge Graph

Economic activity

A key factor that affects coal price is economic activity—for China in particular. Coal prices rose throughout much of the latter half of 2013, driven by improved economic prospects in China. Although coal comes in different grades (see A handy investor guide to Arch Coal), prices have closely moved together in the past, because they’re largely driven by high-level factors such as economic growth and industrial output. Prices are also based on our assumption that different ranks of coal are somewhat substitutable to each other.

Manufacturing PMIEnlarge Graph

Weakening manufacturing

Despite improvements since mid-2013, manufacturing activity over the past two months has been lackluster, with the manufacturing PMI (purchasing managers’ sentiment index) showing consistent declines. The overall index fell from 51.4 in November to 50.2 as of February 2014. Numbers above 50 signify expansion, while those below 50 reflect possible contraction.

As economic growth weakened, so did coal prices. Prices of steam coal at Newcastle, Australia (a major coal exporter), fell from $84.60 per metric tonne to $74.30 per metric tonne on March 7, 2013. Anthracite prices in China have started to roll over, and they now sit around $126 per metric tonne.

If manufacturing activity in China continues to slow, coal prices will be negatively affected over the medium term. But if manufacturing activity picks up, coal prices could rise and support global urea prices. The latter case would be positive for nitrogen fertilizer producers’ revenue and earnings.

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