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Why a dim coal outlook is negative for global urea producers

Part 6
Why a dim coal outlook is negative for global urea producers (Part 6 of 7)

Upside for urea looks dim, but downside may also be limited

Limited upside

As we’ve seen in the previous articles of this series, the current supply glut in the seaborne market in China means limited upsides for coal price appreciation. Since coal prices set the floor for global urea prices, we could view this as a negative for CF Industries Holdings Inc. (CF), Agrium Inc. (AGU), Terra Nitrogen Company LP (TNH), CVR Partners LP (UAN), and the Market Vectors Agribusiness ETF (MOO) on the basis that it puts a cap on return prospects. How about the downside?

China Coal Cost CurveEnlarge Graph

Could coal prices go lower?

Ongoing consolidation and weak demand growth could continue to add downward pressure on coal and nitrogen fertilizer prices, as we discussed. Macquarie Research suggests marginal costs to deliver thermal coal to customers fell to around 550 to 600 renminbi per metric tonne in China last year, which is equivalent to $88 to $97 per metric tonne. With prices of coal at Qinhuangdao, China’s largest coal port, currently at ~$100 per metric tonne (see the last article in this series), prices could fall a bit more.

Some positive fundamentals

Given that ~300 million metric tonnes of coal suppliers have costs above $88 per metric tonne and further expansions from lower-cost producers, which will push some high-cost producers to the right side of the chart, coal prices might not fall significantly. Peabody Energy Corporation, one of the largest publicly traded coal producers in the world, also recently noted that the cost of mining coal in China has been rising by more than 10% a year as companies have to mine deeper to excavate coal while labor costs rise.

Limited new supply additions

In the seaborne market, Greg Sullivan (deputy chief executive of Australian Coal Associations) recently said most Australian thermal coal miners need prices above $100 per metric tonne, and coking coal miners require about $160 per metric tonne to make an internal rate of return of 15%. While this means seaborne suppliers aren’t likely to expand capacity unless coal prices rise, which would be long-term positive, remember that the industry is currently facing a supply glut.

Coal prices could fall a bit more in the near term if China doesn’t go into a crisis. There are signs that coal prices may not fall a lot over the long term, but upside prospects are limited. These drivers are somewhat unfavorable for global urea prices and the nitrogenous fertilizer producers mentioned earlier.

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