Big News for Natural Gas Is Big News for This Industy

The price of natural gas seems far more newsworthy than the price of nitrogen fertilizers, but the two are tied closely together. Here is what to expect in the earnings from fertilizer companies when the price of natural gas fluctuates.

Jun 24, 2014 at 12:57PM

The media is buzzing with natural gas news, ranging from the effects of global warming initiatives on the industry to reports of Russia cutting off their supply of natural gas to Ukraine. Meanwhile, the fertilizer industry sits quietly behind the forefront of the natural gas dominance, remaining highly dependent on both domestic and international natural gas pricing.

Potash Corp (NYSE:POT), Agrium (NYSE:AGU), and CF Industries (NYSE:CF) are among the biggest players in nitrogen-based fertilizer, and their near-term futures depend on the natural gas news that has recently been widely broadcast.

Two factors to watch
Determining the effects of natural gas prices on the overall nitrogen fertilizer market is fairly simple. Natural gas is by far the most expensive 'ingredient' in the making of nitrogen-based fertilizer, and thus the price of natural gas and natural gas futures plays directly into the operating expenses incurred by fertilizer producers.

The first and most easily understood factor is the domestic price of natural gas. Lower natural gas prices in North America translate to lower production costs of ammonia. Through large purchase agreements, the largest fertilizer producers are somewhat buffered from the ups and downs in natural gas pricing, but higher natural gas prices over the long run will not favor fertilizer companies, which lower natural gas prices can help to expand their margins.

Announcements like the proposed U.S. Environmental Protection Agency's Clean Power Plan, which calls for substantial cuts in carbon emissions by 2030, may lead to natural gas power plants continuing to replace coal power plants and have a secondary impact on the fertilizer industry. The announcement spurred initial increases in natural gas futures pricing, though the proposal would not substantially change natural gas consumption in the short term and natural gas consumption may be tempered over the long term by renewable energy sources growing to fill the changing power sector. Nonetheless, if domestic natural gas futures increase in response to such announcements and projected demand, margins could be tightened for fertilizer producers.

The second and slightly more convoluted factor is international natural gas pricing, particularly in the now sensitive Ukraine region. Nitrogen commodity prices have historically been established by Ukrainian producers, and the price that these producers pay for natural gas plays a critical role in the price that they set for their ammonia-based products. In general, if natural gas prices increase in Eastern Europe, fertilizer prices will follow suit.

Three months ago the Russian-Ukrainian dispute led to questions on the persistence of relatively affordable Ukrainian sourcing of natural gas from Russia. The move by the Russian company Gazprom, the world's largest extractor of natural gas, to cut off natural gas supplies to Ukraine answers many of the lingering questions as to how long Ukraine can maintain affordable sourcing of Russian gas supplies.

While Ukraine does have its share of natural gas reserves, the country's consumption outweighs its production, and a cut-off of Russian supply will inevitably spur higher natural gas prices, particularly when the winter approaches and seasonal demand grows. Further complicating the Ukrainian natural gas situation is the presence of significant reserves believed to be in the Black Sea off of the Crimean coast. High natural gas prices, even if some agreement could be reached between Ukraine and Russia, are the ongoing reality for the region, and if the commodity pricing continues to be set by Ukrainian producers, the price of nitrogen fertilizers will be on the rise.

The takeaway
Ukraine has significant natural gas reserves, but its consumption of natural gas still far overshadows the country's production, thus necessitating significant imports from Russia. The natural gas trade between Russia and Ukraine has always been a sensitive entity and has encouraged speculation about rising prices, but Gazprom's move to cut off supplies to Ukraine is now substantive evidence that natural gas prices in the region will push higher. Domestic natural gas costs may also be on the rise, but the trend will be tempered in comparison to that in Eastern Europe.

Accordingly, expect to see small increases in the operating expenses for nitrogen fertilizer companies due to rising domestic natural gas costs paired with larger increases in their sales revenue through higher commodity pricing set in Ukraine. It may still be a while before the effects take hold, but the tie between natural gas and nitrogen is too tight for the fertilizer industry to not be affected by big news in natural gas.

Do you know this energy tax "loophole"?
You already know record oil and natural gas production is changing the lives of millions of Americans. But what you probably haven’t heard is that the IRS is encouraging investors to support our growing energy renaissance, offering you a tax loophole to invest in some of America’s greatest energy companies. Take advantage of this profitable opportunity by grabbing your brand-new special report, “The IRS Is Daring You to Make This Investment Now!,” and you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.

Shamus Funk owns shares of CF Industries Holdings. The Motley Fool owns shares of CF Industries Holdings and PotashCorp. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at www.fool.com/podcasts.

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to www.fool.com/podcasts, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.

 


Compare Brokers