Judging from second-quarter 2018 earnings results across the industry, it appears fertilizer markets are finally finding their footing after years of suffering from severe imbalances between supply and demand. Market dynamics for all three major agricultural nutrients -- potash, phosphate, and nitrogen -- are improving. Progress is still slow, but at this point, investors are just happy that it's progress.

Although market health is improving, investors might not want to get too comfortable. There's a potentially huge technology risk on the horizon that few fertilizer companies seem to be acknowledging, let alone preparing for. That could be a problem because, if the new technology works as intended, then global fertilizer demand likely will be permanently sabotaged. They may not be on the radars of investors today, but next-generation biotech products called microbials could threaten huge parts of the fertilizer industry.

A man holding a plant seedling and soil in his hands.

Image source: Getty Images.

What are microbials -- and why should investors care?

Microbials are essentially probiotics for plants. A plant's root system can feast on a buffet of water and a wide range of nutrients present in the soil. However, much like humans, plants are unable to break down or process all the available nutrients without help from friendly bacteria or fungi. These microbes happily colonize a plant's root system (or the human gut) to feed themselves and, in turn, feed the plant (or the human). They can also improve overall plant health by protecting against agricultural pests, therefore serving as a natural defense against fungus, insects, and worms.

Turns out, the symbiotic relationship contained within the agricultural biome can be greatly improved. Scientists can scour farmland for the best soil microbes, isolate them, study them in automated laboratories, select the best performers, grow them in large fermentation tanks, and coat them onto plant seeds. Farmers plant the seeds as they normally would, and reap the naturally protective qualities of biology -- all while greatly reducing or eliminating the need for traditional inputs like chemical pesticides and synthetic fertilizers.

Furthermore, as more and more microbials are developed, they'll be licensed and cross-licensed among major agricultural technology companies, just as genetic traits are today. That will allow farmers to customize the seeds they purchase to suit their farm by simply stacking microbials. It might all sound a little too good to be true, but microbials were a $2-billion-a-year industry a few years ago -- and the competition has really heated up since then.

A gloved-hand holding up a petri dish used to isolate soil microbes.

Image source: Getty Images.

The niche industry for microbials exploded onto the scene when Monsanto, now part of Bayer (NASDAQOTH:BAYRY), signed a $600 million collaboration agreement with global industrial biotech leader Novozymes. The partnership became the BioAg Alliance, which today has products aimed at increasing yield for corn and soy and providing protection against nematodes for soy. The first products were capable of increasing corn yield by 4 bushels per acre (and early tests for some showed increases closer to 10 bushels). That compares quite favorably to the average annual yield increase of 1.9 bushels per acre for American corn farmers since 1986.  

For fertilizer producers, the devil is in the details. The yield-boosting microbials from Monsanto and Novozymes work by making the agricultural biome more efficient at capturing nitrogen from the soil. Most plants rely on soil microbes for all nitrogen uptake by default, but the inefficiency of the process requires synthetic nitrogen fertilizers to be applied in copious amounts. How do microbials change that?

Well, agtech companies think it's possible to improve the nitrogen cycle at the root level by enough to eliminate the need for nitrogen fertilizers altogether. Considering nitrogen fertilizer manufacturing consumes 1% of global energy and is responsible for 3% to 5% of global carbon emissions, the environmental benefits of microbials could expedite their adoption. But it won't stop with the BioAg Alliance or nitrogen fertilizers. 

Despite gobbling up Monsanto, Bayer has formed a microbials alliance of its own with synthetic biology unicorn Ginkgo Bioworks. The pair's joint venture, Joyn Bio, is first taking aim at the nitrogen cycle, but more microbials will be on the way. Up to 98% of all potassium in soil is unavailable to plants, which creates the need for the global potash fertilizer industry. So it might not be difficult to guess at the next high-value targets being developed.  

A tractor spreading fertilizer on a field.

Image source: Getty Images.

The risk to fertilizer stocks

It doesn't take much of an imagination to realize what the success of microbials would mean for leading fertilizer producers such as Nutrien (NYSE:NTR), CF Industries (NYSE:CF), and Mosaic (NYSE:MOS). Consider how dependent these businesses are on each of the three major agricultural nutrients:   

Metric

Nutrien

CF Industries

Mosaic

Market cap

$35.5 billion

$11.5 billion

$12.2 billion

Dividend yield

3%

2.5%

0.3%

Nitrogen, sales volume guidance, 2018 (metric tons)

10.3 million to 10.7 million

11.6 million in first half of 2018

No nitrogen production

Potash, sales volume guidance, 2018 (metric tons)

12.3 million to 12.8 million

No potash production

8.3 million to 8.9 million*

Phosphate, sales volume guidance, 2018 (metric tons)

None given

No phosphate production

8.3 million to 8.9 million*

*Excludes South American subsidiary Mosaic Fertilizantes. Source: Yahoo! Finance, SEC filings.

The rise of microbials is coincidentally timed with the improving global fertilizer markets. All three companies reported strong year-over-year revenue, earnings, and cash flow growth in the first half of 2018 as a result of more balance between supply and demand and higher selling prices. But if next-generation biotech products reduce global demand for fertilizer products, then there's really only one viable path forward: Fertilizer producers need to begin investing in biotech tools.

To date, no fertilizer manufacturers have publicly commented on the risks posed by microbials, let alone publicly explored partnerships or investments. But there may be hope for shareholders.

Nutrien has begun building a digital agriculture platform with acquisitions of software companies and (hint hint) a major soil analytics lab. That shows that management is at least open-minded about the future of the industry and the impact of innovative technologies. And it might even suggest that the world's top fertilizer company is quietly positioning itself to the threat posed by microbials. Nonetheless, there's a long way to go. 

A businessman sitting at a table looking through large binoculars.

Image source: Getty Images.

Investors should pay close attention to this technology's rise

It's still relatively early for microbial products, but investors shouldn't dismiss the potential or the incredible amounts of capital being invested to develop these next-generation biotech tools known as microbials. After all, the benefits provided to farmers by biotech genetic traits allowed mirobials to gain over 90% market share for corn, soybean, and cotton in a span of less than two decades. If microbials deliver on their potential in a similar fashion, then it could pose an existential risk to fertilizer producers in a similarly short period of time. 

That would be problematic for fertilizer manufacturers such as Nutrien, CF Industries, and Mosaic, and especially for their nitrogen and potash businesses. While all major producers are still focused on recovery, it might be time for them to begin dedicating capital and management bandwidth to the potential impacts of microbials.

Maxx Chatsko has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.