Did natural gas prices of $4.00 per MMBtu cause TNH’s recent fall?

Market Realist

Why did Terra Nitrogen Company stock drop 10% more? (Part 4 of 9)

(Continued from Part 3)

The expense factor

On the expense side, natural gas price is the primary variable that often affects the earnings of nitrogenous fertilizer producers like Terra Nitrogen Company LP (TNH), CF Industries Holdings Inc. (CF), Potash Corp. (POT), and Agrium Inc. (AGU).

Low U.S. natural gas

The shale gas boom has made natural gas prices in the United States so cheap that prices have fallen to $2.00 per MMBtu (million British thermal units) in early 2012. In part, 2012′s low natural gas price was driven by low electricity demand and higher-than-normal inventory figures due to a much warmer winter. As things normalized, natural gas prices rose to roughly $3.50 per MMBtu.

Weather-related factors

Last winter’s colder-than-normal winter had driven prices up to about $4.20 per MMBtu. Likewise, the recent winter storm has moved natural gas prices higher, touching $4.35 per MMBtu in December 13, 2013. But prices fell recently on speculation that a warmer U.S. winter could limit demand for the heating fuel, which may sound odd for those in the Northeast region, considering how cold it’s been.

Hedging activities

While these companies do hedge natural gas price fluctuations by getting into contracts that allow them to buy natural gas at certain price in the future, expectations of higher natural gas prices often result in higher hedging costs or higher negotiated natural gas prices. If natural gas prices are expected to rise, then the market could be projecting higher natural gas prices and lower earnings over the next few months. If managers expect natural gas prices to fall, though, they may decide not to hedge.

Volatile short-term price movements

Although long-term trends in natural gas prices will affect stocks’ long-term performances, short-term drivers can lead to volatile movements in near-term price. This is because people often think what has happened recently will likely carry on. There’s a tendency for that to happen, but it doesn’t always.

TNH, in particular, is more sensitive to fluctuations in natural gas prices, because most of its costs are natural gas prices due to its MLP structure. So a percent change in natural gas price will have a larger impact on its earnings than it will for other companies like CF, AGU, and POT. If natural gas prices remain high, then the recent sell-off is correct. But if it isn’t over the medium term, perhaps investors spooked needlessly. This outlook also applies to the Market Vectors Agribusiness ETF (MOO) that invests in multiple agriculture-related companies.

Continue to Part 5

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