China’s export policy
Industry experts often show ex-China global urea capacity utilization because China’s export tax makes domestic producers’ urea more expensive for international buyers. So if we assume that China isn’t a large player in the global urea market, because its products are more expensive than other foreign suppliers, we can look at the world as if China didn’t exist. But what if the export tax changes?
New capacity additions
Over the next few years, new capacity will be added to China’s domestic urea market (see the first article of this series for a chart). This new capacity should have lower production costs, with much more favorable economic returns compared to existing plants. Otherwise, why would people invest? So perhaps these new plants are designed to use thermal coal rather than anthracite coal, which (over the past two years) has cost firms less to produce urea. In 2014, urea produced from thermal coal is expected to cost roughly $275 a ton, compared to cheap anthracite costs of $300 a ton (see the chart above).
At this moment, China’s operating rate is just about ~70%. A few years ago, it was closer to 80% and above. As new capacities come online, let’s assume the average cost of production will fall along with utilization rate, which would likely push fertilizer prices further down. If there’s an industry supply glut, the government may reduce its export tax.
Little to no export tax?
For 2014, that’s what the government did. Due to abundant supply and lower fertilizer prices, the government set a lower export tax for 2014 during peak and off-peak seasons. Urea exports will be taxed at 15% of value plus a fee of $6.55 per ton during the peak season, while exports will be charged $6.55 per ton during the off-season. Although a tax cut of 15% isn’t much compared to the drop from last year (~77% tax during peak season), it will still negatively affect CF Industries Holdings Inc. (CF), Terra Nitrogen Company LP (TNH), CVR Partners LP (UAN), Agrium Inc. (AGU), and the Market Vectors Agribusiness ETF (MOO) if proposed.
What’s the probability of this change? We don’t know for sure—especially since agriculture security plays an important role for China. But given how the government is taking a slew of reforms to open up its domestic industries, it’s possible.
To learn more about investing in fertilizer stocks and ETFs, check out the Market Realist series Potash overview: Expanding on indicators driving stocks like POT.