Natural gas is the most important input material for making nitrogen-based fertilizers such as ammonia and urea. In 2014, natural gas represented 52% of the costs for producing nitrogen fertilizers at CF Industries (CF). Naturally, if natural gas prices decline and if nitrogen fertilizer prices remain stable, CF stands to gain.
Natural gas prices decline
Over the years, prices of natural gas have declined, as you can see in the chart above. CF Industries’ natural gas costs appear to be below the Henry Hub natural gas prices. CF Industries hedges 70% of its natural gas requirements, which locks the price of natural gas and protects the company from abnormal spikes. For example, in 2013–2014, CF Industries was able to keep its average cost at $4.03 per MMBtu, compared to $4.72 per MMBtu in the market. This may explain why CF Industries’ cost is lower than the market.
One of the main reasons why natural gas prices have fallen is because of the increasing natural gas stockpile. Year-to-date, the prices of natural gas fell 19% as a result of a glut in supply. Currently, the average prices of natural gas are ~$2 per MMBtu. However, the EIA (the U.S. Energy Information Administration) prices to lift in 2016. It estimates an average price of $3 per MMBtu in 2016.
If the nitrogen fertilizer prices fall further and natural gas prices rise, it will certainly put pressures and estimates for earnings of the company.
To mitigate this risk, investors can access fertilizer companies through ETFs such as the VanEck Vectors Agribusiness ETF (MOO), which invests 18.4% of its holdings in CF Industries, Mosaic (MOS), Agrium (AGU), and Potash Corporation (POT).