Why coal prices will help nitrogenous fertilizer producer stocks

Market Realist

Fertilizer trends recap, September 23–27 (Part 10 of 10)

(Continued from Part 9)

The significance of coal prices to the fertilizer industry

To make nitrogenous fertilizers, manufacturers need coal. While most of the world uses natural gas as an input, 80% of China’s plants use coal. As one of the costlier producers of the fertilizer used to support plant growth, fluctuations in coal prices can have a significant impact on global prices. The higher the coal price, the better it is for other fertilizer producers that don’t use coal.

Future curve is upward-slopping

One way to assess whether coal is expected to rise is through a futures curve. This is a curve that depicts the price that buyers, sellers, and traders of coal are willing to negotiate at specific dates in the future. Coal price for December contracts recently exchanged at $80 per mt (metric tonne). That figure is expected to rise in 2014. An upward-sloping curve, when near-dated prices are priced below future prices, suggests that the industry expects coal prices to rise. Conversely, when the curve is downward-sloping, it reflects an expectation of lower prices.

Coal price: One of the worst performers

The coal industry has been one of the worst performers in the global equity market this year. Companies like Peabody and Alpha Natural Resource have performed poorly in the wakes of increased supply from Australia and Indonesia and weak electricity consumption growth during the first half of the year in China.

The impact of higher coal prices on selling price

A rising futures curve reflects a cut in coal supply or an increase in coal demand. As we’ve seen recently, economic growth in China appears to be stabilizing. The upward-slopping curve could suggest supply cuts. This will increase fertilizer prices in China and make Chinese producers less competitive in the global market.

A higher fertilizer price will have a positive impact on the selling prices and revenues of manufacturers like CF Industries Holdings Inc. (CF), Terra Nitrogen Company LP (TNH), Agrium Inc. (AGU), and, to a much lesser extent, Potash Corp. (POT), holding everything else constant. This also applies to the Market Vectors Agribusiness ETF (MOO).

Caution warranted

However, caution is warranted because as long as Indonesian or Australian currencies remain weak, there are few incentives for producers in these countries to cut output, given the higher revenues that they’ll receive when converting selling price (which exchanges via the US dollar) back into their own currencies.

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