Why Fertilizer Investors Should Pay Attention to Cost Curves
Managing the cost of production is key for a commodities business (MOO). Cost of production can impact the realized prices of fertilizers and, in turn, impact the profitabilities and valuations of fertilizer companies. These companies include PotashCorp (POT), Mosaic (MOS), Intrepid Potash (IPI), and CF Industries (CF). Let’s dig down more deeply.
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Steep versus flat cost curve
In the above chart, we’ve compared a flatter cost curve with a steeper cost curve. As in other commodity businesses, market prices for the agricultural chemicals business are set by supply and demand.
When the demand (x-axis) increases (moves to the right), the cost per product ton increases. The increase occurs because the producer with a higher cost of production comes online to meet the additional market demand. The producer that comes online, known as the marginal producer, sets the market price, which is represented by the price ceiling.
However, when the cost of production declines, the cost curve flattens, and the marginal producer can produce at a lower cost. Market prices for the commodity fall and squeeze the margins.
Profitability in 2016
The profitabilities of most fertilizer companies in 2016 were marred by a flatter cost curve. It became non-sustainable for some players to continue producing at higher operating rates. Prices had fallen significantly as a result of oversupply caused by marginal producers. As a result, some companies rolled back their production by idling their manufacturing plants.
In the next part, we’ll look at the profitabilities of some fertilizer companies.