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SUPPLY, DEMAND
AND NATURAL GAS
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What do they tell us about fertilizer?
By Nancy Jorgensen
If you live in rural America, chances are you don’t use much natural gas. Generally, suppliers deliver natural gas via pipeline to homes and businesses in urban centers. When you fire up your furnace this winter, your fuel probably comes from a white tank out back filled with liquid propane (LP), a by-product of both natural gas and oil processing.
But natural gas may affect you more than you realize. For nitrogen fertilizers, “natural gas has the largest impact on production costs—it’s about 70 to 90 percent of the cost,” according to Kathy Mathers of The Fertilizer Institute.
When American grain growers look back on 2008, they will remember strong returns, but also sharply higher prices for inputs such as fertilizer. 2008 also brought high natural gas prices.
“During 2007 and 2008, farmers saw a rapid run-up in fertilizer prices to record highs, followed by lower prices in late 2008,” according to a March 2009 article in USDA’s Amber Waves publication. During the 12 months ending April 2008, nitrogen prices increased 32 percent, phosphate 93 percent, and potash 100 percent. “This price surge in 2008 was due to strong domestic and global demand for fertilizers, low fertilizer inventories, and the inability of the U.S. fertilizer industry to adjust production levels.”
Fertilizer prices dropped in 2009. But why did prices pop a year ago, and what does the future hold?
Supply, demand and energy
An important part of the answer lies in the cost of natural gas. But overall, last year’s higher fertilizer prices represent a textbook case of supply and demand, according to the Amber Waves article’s authors Wen-yuan Huang, William McBride and Utpal Vasavada. They pin much of the blame on higher global demand for food and ethanol, which led to a greater need for fertilizer.
Booming demand for ethanol in the U.S. and meat from corn-fed livestock worldwide prompted farmers to grow more corn in recent years. Corn requires more fertilizer than competing crops such as soybeans—and farmers use a lot of nitrogen to pump up corn yield. “Among major U.S. field crops, corn uses the most fertilizer,” the Amber Waves trio said. Corn growers spend 43 percent of their input costs on fertilizer, while wheat growers spend more than 30 percent.
Nitrogen’s share of all fertilizer used by farmers has been expanding for some time. USDA data shows that in 1960, nitrogen made up 37 percent of all fertilizer consumption in the U.S.; its share grew to 58 percent in 2007.
“Nitrogen markets are more volatile than phosphate and potash markets,” said Amber Waves. “Volatility in the price of natural gas—a basic input in the manufacture of nitrogen—contributes to swings in nitrogen prices…Prices of natural gas, which is used to produce ammonia, the main input in all nitrogen fertilizers, rose more than 550 percent over the last 10 years. Between June 2007 and June 2008, natural gas prices increased more than 65 percent.”
One of the authors, Wen Huang of USDA’s Economic Research Service (ERS), recently outlined the historic long-term relationship between natural gas and ammonia. “A 1 percent increase in the natural gas price is associated with a 0.8 percent increase in the price for ammonia,” he said. “However, this relationship was disrupted between March 2008 and May 2009 due to volatile demand for ammonia. Ammonia reached $880/ton in Sept. 2008 and dropped to $120/ton [freight-on-board at Gulf ports] in Jan. 2009.”
Global trade affects fertilizer
Just 3 to 5 percent of natural gas in the world goes toward fertilizer production, especially nitrogen fertilizers, according to Ken Nyiri, a principal consultant with British Sulphur Consultants. While fertilizer demand doesn’t move natural gas markets, natural gas prices do affect fertilizer costs.
Kathy Mathers, vice president of public affairs for The Fertilizer Institute (TFI), a trade group for the fertilizer industry, thinks that supply and demand affect fertilizer prices more than the cost of natural gas. Still, she explained how natural gas prices recently affected fertilizer. A few years ago, along with other energy prices, natural gas markets went so high that they drove U.S. fertilizer plants out of business. That further tightened the world supply of fertilizer.
“Before that, the U.S. was a world-class producer of nitrogen,” she said, adding that the U.S. now imports more than half of its nitrogen needs.
Nyiri sketched this picture of the global nature of the relationship between natural gas and nitrogen. Nitrogen plants usually locate close to a low-cost source of natural gas or near to fertilizer markets. Natural gas remains relatively plentiful throughout the world, but since it’s a gas, it’s not as easy to transport as liquids like petroleum. In the U.S., pipelines transport most of our natural gas. We’re importing more, but it must be condensed and liquefied before it can be loaded onto ships. While ships can take weeks to get to the U.S. market, the ability to ship liquefied natural gas brings more options to nitrogen manufacturers. Today, six liquid natural gas ports exist in the U.S., and three to four more are being built.
Once manufactured, nitrogen fertilizers can be transported as a solid in the form of urea, ammonium nitrate, ammonium sulphate or ammonium phosphates, or as a liquid in the form of urea ammonium nitrate.
No matter what its form, nitrogen was impacted two years ago when increasing world demand and the threat of short supplies heated up energy prices of all types. Even before that, about a decade ago, competition for natural gas kicked up a notch as the electric industry began building more natural gas-fueled power plants.
“[These] turbines are significantly less expensive to build compared to coal and nuclear plants,” said James Revis, director of the Energy Technology Research Center at the Electric Power Research Institute. They also burn cleaner than coal and generate electricity quickly during peak demand times. Revis added that gas consumption for electricity increased almost 50 percent between 1998 and 2008, and today, about 30 percent of the nation’s gas consumption goes toward electricity production.
The future of natural gas What does all this mean for natural gas prices in the future? Natural gas for industrial use peaked at more than $12 per million BTUs in Aug. 2008. In late Sept. 2009, natural gas futures markets rose from the October price of about $4 per million BTUs to about $6 for Jan. 2010, and more than $7 for Jan. 2011.
As any farmer who uses futures markets to sell grain can attest, futures prices don’t always correlate to the price that commodities attract when eventually sold on the spot market. But according to Nyiri, “the price for natural gas could easily go up several dollars next year if the economic recovery is strong.”
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Retailers hold little sway as manufacturers consolidate
Mike Boland, an agricultural economist with Kansas State University, recently wrote an online column that explained fertilizer price volatility. “Fertilizer manufacturers are becoming increasingly concentrated,” he said, and listed just six companies that manufacture fertilizer for U.S. markets, either in the U.S. or via imports. “Concentration does not imply lack of competitiveness because there are economies of scale and size in this industry. But it does help change the competitive landscape.”
Farmer-owned cooperative retailers like MFA, Boland added, own a growing share of the retail agribusiness industry “because they can often better provide a local solution for a producer.” However, he said, “Agricultural retailers have little or no negotiating ability with wholesalers who are pushing supply chain risk back onto the retailer and they in turn, are pushing some of that risk back onto producers who at the end of the day are probably in the best position to manage that with revenue assurance tools provided by Congress.” Boland directs the Arthur Capper Cooperative Center at Kansas State University.
Farmers apply fertilizer in the spring and the fall, and producers usually make decisions close to planting time, he added. Partly due to more nitrogen being imported by ship, “Retailers must buy six to nine months in advance with no opportunity to hedge,” Boland said. “That brings a great deal more risk once a retailer takes a position.”
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Still, that’s less than half what gas drew at its peak.
Huang expects natural gas prices to stay relatively low for several reasons.
U.S. consumption has been declining because of the economy.
Current inventory exceeds the five-year average for 2004-2008 and continues to be on pace to exceed the all-time high.
U.S. production is increasing because of increases in gas production from shale and other new sources.
“Given the current slow economic recovery, the demand for natural gas is expected to be soft and the price will stay low, unless extremely cold weather occurs in early winter,” Huang said.
Regarding new sources, experts have predicted a drop in conventional natural gas production for years now. But each year, non-traditional sources bridge the gap. Production of these new sources, including tight gas, shale gas and coal-bed methane, continues to rise thanks to emerging, less-expensive technology.
For example, the U.S. stores a large amount of tight gas, where gas lies trapped in tight geological formations. In the past, this type might require eight wells per square mile. New technology, as explained in The Oil Drum, an online industry newsletter, allows for one well per square mile, with legs slanting out to the side of a single well cap before dropping straight down.
Beyond non-conventional resources, TFI believes that conventional gas, such as that found offshore, could be further developed. “From our perspective, we’re more concerned with demand than available supply, and we believe policy can have a much greater impact on the issue,” Mathers said.
The future of fertilizer prices
Since there’s no futures market for fertilizer, we called on industry experts to forecast nitrogen prices. “Current low natural gas prices will make it cheaper to produce ammonia in the U.S.,” Huang said. However, he added, the U.S. has a limited capacity to produce ammonia. “Although there is a large ammonia inventory in the U.S., if current trends of declining production and imports continue, a tight ammonia supply can be expected for next spring.”
Like most economists, he hedges his bets. “The relatively low ammonia price may increase demand for ammonia. However, expected low crop prices may reduce demand.” He projected relatively low corn prices given a current large inventory and good harvests forecast for this fall.
U.S. fertilizer use will also be tied to global food demand, Huang added. “A recent decline in the U.S. dollar may lead to increasing demand for U.S. commodities,” he said. “Corn prices and the ratio of corn prices to soybean prices are key factorsthat determine the demand for nitrogen in the U.S.”
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Fertilizer by the numbers
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2007
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2008
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U.S. expenses
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$17.7 bil.
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$22.5 bil.
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Avenage per farm
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$8,057
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$10,265
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MO expenses
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$650 mil
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$790 mil.
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Average per farm
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$6,030
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$7,315
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Source: USDA NASS
Expenses for fertilizer, lime and conditioners.
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His final word: “Ammonia prices are expected to increase moderately if there is no surge in corn prices.”
USDA’s Amber Waves article also warns that the global economy, weather events or changes in fertilizer trade could cause fertilizer price increases.
Another way to predict fertilizer prices is to look at past cycles. To illustrate, Nyiri uses the example of urea, a solid form of nitrogen fertilizer. “It costs $1.3 billion to build a world-scale ammonia/urea plant, so during low prices, no one will build new capacity,” he said. “It takes three to four years to build a new plant, and the fertilizer price cycle takes about eight years. Prices peaked in 2008, so they’ll go down for three to four years, and then they’ll go back up again to justify building new capacity.”
While TFI’s Mathers declined to project the future cost of fertilizer, she went back to her assertion that supply and demand impact cost more than anything else. Over the short term, she predicts a demand recovery.
“U.S. demand projections show that fertilizer consumption was down by 17 percent last year for nitrogen, and even more for phosphate and potash,” Mathers said. “Farmers may be growing soybeans instead of corn to reduce fertilizer consumption, but at some point you have to start rebuilding nutrient reserves in the soil with phosphate and potash or you’ll see a major impact on yields.”
Cap and trade may hike fertilizer prices
Meanwhile, the U.S. House of Representatives has proposed cap and trade legislation that may affect fertilizer and other energy-related prices for farmers. “We believe that if passed, it will drive more consumption to natural gas, which will drive prices up,” says TFI’s Mathers. “That could have a negative impact on fertilizer producers in the U.S.” At press time, the Senate had not yet considered the legislation.
Haber and Bosch rocked our world
Early in the last century, two German scientists named Fritz Haber and Carl Bosch invented a process using high heat and high pressure to combine hydrogen and nitrogen to form ammonia. The process, usually fueled by natural gas, revolutionized the world’s ability to produce food.
Until then, farmers relied on a limited amount of nitrogen from natural sources. Most of it came from saltpeter, also used to make gunpowder. Occasional guano discoveries quickly disappeared.
Jürgen Schmidhuber, a world-class scientist from Germany, says that these two Nobel Prize winners “probably had a greater impact than anyone in the past 100 years, including Hitler, Ghandi and Einstein.”
In 1910, four years before Haber and Bosch invented their process, the world had 1.7 million people, according to estimates by the U.S. Census Bureau. Today, global population has boomed to 6.8 billion, and the bureau expects more than 9 billion by 2050.
“Billions of people would not even exist without it,” Schmidhuber says of the Haber-Bosch process. “And our dependence will only increase.”
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Missouri Sen. Kit Bond recently asked the Food and Agricultural Policy Research Institute (FAPRI) at the University of Missouri to study the effect of the House’s proposed legislation on Missouri crop production costs. The study, released in July, showed that on average, dryland corn costs would increase by $10.03 per acre in 2020, a rise of 3.2 percent. Soybean costs would rise less as they depend less on energy costs. Admittedly, the FAPRI study doesn’take into consideration payments that farmers may collect as a result of the legislation—you’ll likely be rewarded for growing crops that lower greenhouse gases.
TFI’s Mathers added a final note to the fertilizer outlook. Manufacturers are exploring ways to make plant food more efficient and more environmentally friendly, such as timed-release products. “Our members are asking, ‘How can we develop smarter fertilizers?’” she said.
As you can see, a multitude of factors determine fertilizer prices. Until last year, natural gas prices historically correlated with nitrogen fertilizer prices, and natural gas prices look to be relatively stable over the next year. But the law of supply and demand may play an even greater role in the future of fertilizer costs. While a number of things could change, overall, USDA and other industry forecasters project relatively stable or moderately increasing fertilizer prices for the next year or so. But then again, no one predicted last year’s price spike.
