Revisiting The Economics Of Fertilizer
The fertilizer business is fascinating, and it is ever-changing. People have a lot of questions about fertilizer, especially folks in the dealer market. Most want to know why things happen in the fertilizer market, and from a distance, it can sure appear like some of these things don’t make a lot of sense.
But most of the things that happen in the fertilizer market are fairly logical. They may not be predictable, but they are logical. And a lot of this has to do with the characteristics of the business.
Now I don’t know if it’s a characteristic or an after-fact, but there has been extreme price volatility in fertilizer recently. I would posit that fertilizer is the most volatile commodity out there, especially nitrogen-based fertilizers. With respect to grain, we had the worst drought since the mid-1950s and urea this past year was more volatile than even corn.
So you can ask, given these facts, what is the fertilizer market going to do in 2013? Everybody can probably give you an opinion or a reason, and they may feel strongly about that opinion. But when you are dealing with the most volatile commodity, don’t be surprised if the folks that tell you what’s going to happen are wrong.
An International Business
One of the characteristics of the fertilizer business is it’s gone from a domestic to international one. That means that the supply chains are longer, and that adds to the price volatility. So if we get into the season and suddenly the market realizes that there is not enough supply to meet the demand, the longer supply chain means that the prices have to go a lot higher than they otherwise would.
So there’s a transition from a domestic business to a global business. And it really transitioned in the mid-1990s through the 2000s, with most of that transition happening during 2007 and 2008.
It is a big characteristic of the business — and a very important one that people tend to forget — that this is a seasonal business. The gas stations out in the world sell gas to customers every day because people need to fill up their vehicles. But you don’t need fertilizer every day. I will say that there is more buying and selling of fertilizer every day then there used to be, but it is still a seasonal business, and you can go through a long period of deferring any decisions to buy.
I would argue that the seasonal nature of the fertilizer business and the volatility that we’ve seen play off one another.
Consider 2008, for example. In July, corn prices hit $7.50 per bushel. Ammonia hit $1,200 per ton, wholesale. DAP hit $1,200 per ton. But by January 2009, those prices were half that, headed to one-quarter of those highs. This kind of volatility is an extreme example, but illustrates what can happen in a short span of time.
The Risk Factor
This kind of volatility has caused an environment in the fertilizer business that leads to a lot of risk. That has driven a lot of fear and deferred buying. Potential buyers are saying: “I’m not going to do anything today. I just want to wait.”
But when you have all that deferred buying going on, you can get into a situation like we did in 2012, when urea imports had been light going into the spring season. Suddenly, from February to early April, the wholesale price of urea doubled. That doubling was caused by the fact that people were doing early planting, needed urea quickly and couldn’t defer buying it anymore. They had to buy. And this caused major, major market volatility.
Another characteristic of today’s world is information is easier to find. You can all check your smartphones and see what crude oil or natural gas prices are doing at this moment. But you can’t do that with fertilizer. You can talk with your dealer or local rep, but there’s no one place where that fertilizer price is at, because there is no risk management in fertilizer. This leads to more volatility.
The bottom line is fertilizer is a very volatile market.
A Broken Natural Gas Connection
If you go back to the mid-2000s, nitrogen-based fertilizer prices used to tie to those for natural gas. Today, a lot people come to me and ask: “Joe, if natural gas prices have dropped from $13 just after Hurricane Katrina in 2005 to $3.40 right now, why in the world has nitrogen fertilizer pricing gone the opposite way?”
In the early 2000s, the pricing for nitrogen was being driven by the cost of the product and natural gas prices. But from 2006 forward, the price of ammonia and urea was not being driven by the cost of natural gas. It was being driven by the profitability of agriculture.
So you might ask the question: “Doesn’t that mean the industry is taking advantage of a strong agricultural market?” We have gone through a transition where, in the early 2000s, cost-push was driving nitrogen fertilizer prices. The price was very closely related to the price of natural gas.
But in 2006 and beyond, demand around the world in places such as Brazil and China for nitrogen fertilizers has outstripped the supply, so the prices are now set by demand pull. And part of the reason for that is we import much more nitrogen fertilizer into North America today than we ever did in the past.
I would argue that we are getting into a period where natural gas prices and demand pull won’t be the market price drivers for fertilizer. We are raising the capacity for all fertilizer products, so we should have much lower prices for fertilizer in relation to grain then in the past.
But going forward, fertilizer pricing is going to be a lot more complicated. Grain prices are very strong. Farm economics are very good. But fertilizer is not following along in lock step with these things. So it makes it difficult to predict where prices are headed next.
The big thing from here will be the supply response. In the U.S., new capacity is coming on-stream, and it is being super-charged by the very low natural gas prices feed by the shale revolution. I’m not sure if that means we might get to a point where this country is no longer a big importer of nitrogen fertilizers, like it was back in the 1980s, but it could happen.
Now it’s easy to focus on the supply side of any market. You can quantify it, you can look at inventory and make some kind of forecast. And from this perspective, it probably means we will have lower fertilizer prices compared to grain then we’ve seen in a while.
But what we also have to consider is how much demand for fertilizer is there around world? Here in the U.S., there was very good demand for phosphate and potash fertilizer this past fall. We also didn’t think, because of the drought, we would have been able to get down as much ammonia as we did, but it turned out to be a very strong fall for anhydrous ammonia.
So we are seeing this strong demand for fertilizer domestically. Now around the world, demand is off some in places such as India. But generally around the globe, demand for crop nutrients is strong because grain economics are very, very good.
Macro-economic factors are always some things that could come into play and affect fertilizer. For instance, as the Euro currency has strengthened vs. the U.S. dollar, the Europeans have started buying fertilizer.
Another thing to consider is natural gas availability in the Middle East. Egypt is a country with a lot of natural gas and nitrogen capacity built during the past 10 years. But the country is suddenly running into tight natural gas supplies as its economy keeps growing. So Egypt is looking at importing natural gas to keep pace.
So these kinds of macro-economic factors can affect the price of fertilizer, and they can affect it dramatically. And even with this extra supply coming on, you can still get into a situation at any given moment in this business where you end up with a supply constraint. And when you have a market like this, where the demand side is so good, paying more isn’t an issue. If customers have to pay an extra $50 per ton to get what they need, they’ll pay it. If it’s an extra $100, that’s no problem either.
That is what happened during 2012. We had a supply constraint, as the market had not imported as much fertilizer as it should have. But there were good crop economics, so the customers paid more to get what they needed.
So going forward the next two or three years, the biggest factor in the fertilizer market will be the new supply coming on-stream. But just because there is more supply coming, don’t be surprised to see a note from your fertilizer dealer that prices are going up.
Demand is still very strong. And when you run into these kinds of bottlenecks, the fertilizer markets react in a big hurry. And with these strong farm economics, the demand is going to continue.
The best thing to do for ag retailers is to have your grower-customers sell their grain and buy their fertilizer at the same time, locking in price and demand. That’s the best approach that I can think of to hedge some of this market’s inherent risk.