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.
Falling urea prices
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 July, prices for urea sold in Europe and the United States stood at $315 and $325 per metric tonne, respectively. This equates to a ~22% drop from the start of the year.
Supply factors driving prices
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 world-wide factors such as marginal production cost and production capacity. In the past few years, Europe and China were the marginals producers.
Chinese producers now more competitive
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 cost) this year that Chinese producers became really competitive in the world market, with operating capacity rising from a historic average of just ~75% to as high as 90% recently. As a result, shares of fertilizer producers like CF Industries Holdings Inc. (CF), Agrium Inc. (AGU), Rentech Inc. (RTK), and Yara International ASA (YARIY) were negatively affected earlier this year.
Expectation over the medium to long terms
From a technical standpoint, however, urea prices may bottom around $300 per metric tonne, above prices seen for most of 2010. Although we’ve seen coal prices rebounding, the recent decline in operating rate (capacity utilization) in China, which suggests domestic manufacturers are cutting output, adds to the possibility of a bottom. If urea prices do bottom, it would be positive for AGU, RTK, YARIY, and CF. This would also support the VanEck Vectors Agribusiness ETF (MOO).
World urea price is an indicator that influences the key fundamentals of fertilizer stocks, and it’s an important component of the series Why Chinese producers are driving nitrogenous fertilizer prices down (Part 1).