To say the global fertiliser industry is complex is an understatement. Fertiliser supply and demand criss-crosses several otherwise quite distinct commodity sectors, including not just agri-commodities, but also energy and mining.

The fortunes of fertiliser are therefore tied to those of all other major categories of commodity, in terms of price, demand and supply. The consequence is that the variables that govern the price of crude oil feed into the fundamentals of fertiliser.

Nitrogen fertiliser has come into the spotlight recently when the price of gas fell 30% without any fall in the price of nitrogen. But as gas makes up 75% of ammonia production costs, nitrogen fertilisers have a critical relationship with natural gas and crude oil prices.

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But looking at how CAN and Urea prices have doubled over the past two decades shows that there has been a paradigm shift in how fertilisers are priced. The market has moved away from a cost plus margin model to one that is determined by the demand and what the market can bear. As fertiliser demand has picked up around the world, pricing-power has swung back more in favour of global producers.

The Irish Farmers Journal reports from the IFA’s fertiliser conference, where experts showed why fertiliser prices remained high. As it emerged that European farmers were paying the highest prices for nitrogen in the world, they also questioned the overall structure of the European fertiliser industry, raising competition and tariff issues.

Fertiliser costs increasing on farm

Rowena Dwyer, IFA chief economist, said that expenditure on fertiliser at a national level has increased from €350m in 2001 to €565m in 2014 - despite a 28% fall in fertiliser usage. She added that while all farms have been impacted, tillage farmers have been worst affected. According to the Teagasc National Farm Survey, fertiliser costs per hectare have almost doubled (up 82%) since 2001, while grain prices have only increased 7% in the same period. She added that despite a 30% fall in the average wholesale gas price, nitrogen fertilizer prices have increased by upwards of 7%.

Producer concentration

Maximo Torero from the International Food Policy Research Institute said there has been little attention paid to the global producers and that the industry has become highly concentrated.

He outlined that the top five countries control more than 50% of global production capacity, while the top four firms generally control more than half of the capacity in each of those countries.

Torero said there would be significant benefits to increased competition. He claimed there was a direct linkage between producer concentration and price.

EU policy is protecting producers

Nikolay Mizulin, Mayer Brown, a legal firm specialising in international and EU law, blamed issues on the supply side and said the easiest and quickest solution to correct the price differential between inside the EU and outside was simply to remove the EU import tariff.

This “anti-dumping tariff”, currently set at 6.5%, adds up to €20 to a tonne of CAN coming from Russia. However, he said the duty was not the direct issue as Russian producers could absorb the tariff due to their low gas cost. He said the key issue is that the EU is more interested in keeping the current market structure intact.

He said that the tariffs direct the industrial policy of the EU and the member state in the direction of protecting the producers. By removing the tariff, imports would be allowed to flow in and reduce the internal EU price. But he argued that the fertiliser producers are against this and they occupy the top spots as lobbyists in Europe, ahead of the big oil firms and the tobacco companies.

The producer view

Jacob Hansen, head of Fertilizers Europe, the body representing European fertiliser producers, outlined a number of reasons fertiliser prices remain high despite the fall in gas prices. He likened the linkage to that of cereals and pigmeat – when the price of feed comes back to the pig farmer, there is a time lag before the price of pigmeat falls.

Incentives

Producers make fertiliser 24/7 and have limited storage capacity and therefore give incentives to customers at a lower price out of season. This helps distribution and logistics but means there is a lot of fertiliser in the system that is not linked to the gas price on the day of purchase.

He also said that China has come onto the global market and is now exporting nitrogen. The Chinese make their fertiliser from coal and this is causing a break in the clear linkage between gas and fertiliser prices. He outlined that scrapping the 6.5% import tarriff would have little or no effect on reducing prices as it only applies to Russia. The Ukraine tariff will be lifted in December this year.

He expected that by mid-to-late summer, European producers will reduce prices, but did not know by how much as this would depend on supply and demand.

EU a nitrates market, the world a urea market

Urea is popular in warmer climates and accounts for more than half of the world’s nitrogen market. Yet in the EU, it accounts for less than a fifth of the nitrogen market as nitrates dominate. Meanwhile, in Ireland, Urea accounts for less than a sixth of the nitrogen market.

EU is dependent on imported gas

Europe must import gas, making it an uncompetitive place to produce nitrogen. Coupled to this, EU production does not cover consumption, meaning 20% of its fertiliser needs must to be imported every year.

Industry is becoming more consolidated and market-orientated

In the past, the fertiliser industry was affected by state funds driving investments from a food security point of view rather than from a business point of view, and by weak fertiliser companies that existed as part of government-owned enterprises or conglomerates. As state involvement is declining and, as conglomerates are cleaning up their portfolios, there is a trend towards consolidation and more financial discipline across the whole industry.

Gas price spread across regions

Soaring natural gas prices until mid-2008 and exploding demand for fertiliser led to a shift in nitrogen production to countries and regions where natural gas is cheap and plentiful.

In recent years, there has been a significant spread between low-cost gas regions outside Europe such as Russia and the US. This has created a significant cost advantage for fertiliser plants located in these regions. Russians have a dual pricing system on gas where they sell at a low (effectively zero) price to themselves and sell at a price four times the amount to the EU.

Most new supply is coming from countries such as Algeria, Libya, and Qatar – all natural gas producers.

Economics of supply and demand

In general, when demand is low, there tends to be a “supply-driven” fertiliser market in which the established price floor indirectly determines fertiliser prices. This price floor is set by the producing region with the highest natural gas prices. Historically, the highest gas prices have been in western Europe. When fertiliser demand is high, there is typically a “demand-driven” market with fertiliser prices above floor prices for highest cost regions – as we have now.

As gas price declines, Yara profits rise

Yara, Europe’s largest nitrogen producer, saw its first-quarter earnings (EBITDA excluding special items) increase 50% to €676m compared to the same period last year. Revenues increased 28% to €3.3bn. Profit margins (EBITDA) were 21%. The strong performance was mainly driven by lower gas costs and a stronger US dollar. Yara’s average European gas and oil cost fell 33% below first quarter 2014. Yara is predicting European energy costs for the second and third quarter to be 19% lower than a year earlier. As a result of the solid profit and margin growth, the Yara share price has increased by more than 40% in the past year.

Concentration

The EU has more than 100 fertilizer producers (including blenders) compared to 900 in the world. In the past, each country had a fertiliser factory – Ireland had IFI. While there are still a number of national fertiliser factories, overall the number of producers in Europe remains relatively high.

In mining (Potash and Phosphorus), there are very few with less than five operating in the EU. This compares to more than 25 across the world. While this may appear concentrated, it is similar to all other mining sectors in the world, which have become very concentrated.

While a weaker euro and lower gas prices have improved the relative competitiveness of European fertiliser capacity, the benefits are not being passed back along the chain.

Producer margins have increased at a time when agri-commodities prices have fallen. This is leading to a clear disconnect between fertiliser prices and the price of farm produce.

Ultimately, fertiliser prices are supply and demand driven. But supply is being distorted as producers now have options to export outside of the EU, to as far as South America due to strong prices.

Premium

The fact that CAN is of higher quality than Urea will mean there will always be a premium. How high this is depends on local prices and exports.

Because of the supply deficit in Europe, there is no pressure on producers to reduce prices. Ultimately the market will adjust and right now it looks like new season pricing will reflect the lower gas cost.