Ukraine Nitrogen Fertilizer Export Threat Overdone, Buy CF Industries

 |  Includes: AGU, CF, POT, RNF, TNH, UAN
by: Chris Damas

Word that the Ukrainian government was on the verge of negotiating a lower natural gas price for its imports from Russia hammered U.S. fertilizer stocks yesterday, particularly the nitrogen-leveraged producers such as CF Industries (NYSE:CF) and Agrium (NYSE:AGU), which dropped sharply

The Ukraine gas contract news was a surprise to the market because as recently as July Russian Prime Minister Putin declared that “the Russian price formula for gas was universal for all countries," and Ukraine was ‘no exception."

The Ukraine had traditionally been a major exporter of both ammonia and urea, but signed on to a high natural gas contract with Russia in 2009, in effect, curtailing much of the domestic nitrogen production industry. See here.

It didn’t help that CME corn futures were down sharply yesterday (down limit on some months at one point) and the DJIA dropped over 200 although it rallied to close down 135.

I considered the down-draft in corn attributable to the ongoing negative macro news coming out of Europe. There was no new fundamental reason for the sell-off in corn. Corn is seasonally weak just after harvest.

Although the Ukrainian/Russian agreement is not a “done deal," it looks likely the price of gas will drop to the $220-230/m3 range ($6.23-$6.51/mcf) from an estimated price of $400/m3 this quarter $11.33/mcf). See here.

The natural gas contract tied prices to crude oil which has been rising. Ukraine had paid $296/m3 in Q2 and about $350/m3 in Q3.

Russia and the Ukraine were once the top exporters of nitrogen fertilizers and industrial ammonia in the world.

In 1994, they exported a combined 10 million tons of urea and ammonia. In mid-1995, natural gas, the main cost input for ammonia and urea, was extremely low for these countries at $0.92 for Russia and $1.90 in the Ukraine.

Things have changed dramatically since that time.

Although Russian ammonia production was estimated at 10.4 million tons of 131 million world-wide in 2010, Russian and Ukrainian dry urea exports have been subject to U.S. anti-dumping tariffs for the past few years.

According to CF Industries, these U.S. anti-dumping duties fpr these imports were renewed for five years this week, significantly increasing the cost of imports from Russia and the Ukraine.

The Ukraine was estimated to have produced only 3.3 million tons ammonia in 2010, down from 4.2 million in 2009.

According CF Industries CEO Steve Wilson at a major fertilizer conference this morning, only 1 million incremental tons of urea would now be dropping from around $12 to the lower price which he estimated at $6.50/mmBTU.

Wilson said 70% of the Ukrainian production was already getting this lower price so the incremental increase of lower cost ammonia was not large in comparison to the strong demand for nitrogen fertilizer.

Here’s my take on the situation. The Ukrainian situation is a medium term negative, but in the short-term, the Ukrainian gas contract won’t make any difference to Spring 2012 profits for nitrogen fertilizer producers such as Agrium, CF, CVR Partners (NYSE:UAN), Rentech Nitrogen (NYSE:RNF) or TNH (NYSE:TNH).

1) Current U.S. natural gas prices dropped dramatically in November and are now at $3.37 on the December near month futures. Summer 2012 natural gas is trading at only $3.71. And mid-continent U.S. producers receive discounts on gas versus NYMEX pricing. So North American ammonia producers such as CF Industries and Agrium are enjoying a little over half the gas cost of even the forecast new Ukrainian price.

2) None of the incremental product that conceivably could be exported to the U.S. will make it here until spring, as the fall application season is already underway.

3) It is unlikely any imported ammonia will make its way to the U.S. Corn Belt because there is just no extra pipeline, tanker, rail or other infrastructure for importers to utilize to get it there. In fact, any imported ammonia showing up in the U.S. Gulf Coast will be a boon to phosphate producers such as CF Industries, which once imported ammonia from the Ukraine to use in its Florida phosphate operations.

4) It should be noted that dry urea is the most easily exported nitrogen fertilizer in seaborne trade, but is not necessarily the best fertilizer for application in the U.S. Urea is not as plant accessible as ammonia or nitrate. So growers in the U.S. often prefer ammonia, especially in the fall, but also a UAN solution, which is a mixture of liquid urea and ammonium nitrate solution.

5) It should be noted that U.S. ammonia production has been declining, and according to the USGS, was only 8.29 million tons in 2010, versus consumption of 13.3 million tons. The bulk of the imports were from Canada (Agrium supplying its own phosphate plants), and Trinidad (see below). Therefore the ammonia market has been tight in the U.S., with Tampa contracts settling at $705/mt recently.

6) Disruptions in ammonia and/or urea supply can occur from other producers. We saw Yara International lose its Libyan production due to the civil war. We need to check to see if that will be coming back soon. And we saw Agrium have to shutdown MOPCO in Egypt this week.

A concern to us is the possibility that the ongoing curtailments of natural gas (and hence ammonia) production in Trinidad could end soon.

According to Potash (NYSE:POT) CEO Bill Doyle at the same fertilizer conference, the Trinidadian shortfall in ammonia could soon be ameliorated.

This is also good news for CF Industries, which has a 50% interest in the Point Lisas ammonia complex in Trinidad.

More of a concern to U.S. producers of ammonia and urea would be a major Greenfield plant or a major Brownfield expansion at existing plants in the U.S.

PCS Nitrogen is also a major nitrogen fertilizer producer in the U.S., and is taking its Geismar, LA, ammonia plant out of mothballs to compensate for the lack of Trinidadian imports, and also to capitalize on the strongest domestic ammonia margins experienced in years.

In the upcoming fifth and final part of our Seeking Alpha report on “Terra Nitrogen vs. CVR Partners, Which is The Better Fertilizer Investment?” we’ll list the incremental ammonia supply that could be coming on line in the U.S. and North America in the near to mid term.

So far, everyone has said no plant will be built as long as the EPA has its plan to not only measure but also cap and trade green house gas emissions from new sources of pollutants. It should be noted that ammonia and urea plants are major sources of carbon dioxide and nitrous oxide, both GHG’s, as well as traditional critical air contaminants such as NOx. No one wants to be in a position to have to permit a new plant.

We are buying CF Industries and we actually bought some yesterday in the low $153 area. It is currently trading at $156.41 up $8.

Disclosure: I am long CF, UAN.