Global agricultural markets are strong. The FAO food price index have reached record levels, surpassing the previous peak in 2008, while agricultural commodity prices increased from the second half of 2010, leading into 2011. These developments have been driven by both strong demand prospects and concerns over agricultural supply levels in the wake of weather-related setbacks in several countries, including China, Argentina and Australia. The increases in price indexes are driven by a broad range of agricultural products, a situation which serves as a strong incentive to increase land productivity.
Improved agricultural prices have led to a significant increase in fertilizer demand. Nitrogen fertilizer deliveries in Western Europe were up 13 percent for the first half of the 2010/2011 season, but remained four percent behind the levels of the 2007/2008 season. To match the 2007/2008 season, deliveries in the second half of this season would need to be 20 percent higher than last year. First half deliveries in the USA have also increased strongly compared to last season, though they lag the historically strong 2007/2008 season.
The supply of nitrogen fertilizer is limited. With price levels currently high, the global nitrogen fertilizer industry outside China is already running at full capacity. Furthermore, no new export capacity is expected to start up early enough to supply current season demand.
Taxes and prices
China has levied a 110 percent urea export tax, effective from the beginning of December 2010 through the end of June 2011. Nonetheless, export volumes remained high in December 2010, coming primarily from bonded warehouses. Lower production and higher exports have led to a 25 percent drop in urea deliveries to the Chinese domestic market in the second half of 2010. It is hard to see this drop being sustainable, supporting strict export policy enforcement for the remainder of the season.
Nitrate fertilizer prices have increased substantially in early 2011, and Yara’s operations are running well, improving earnings prospects. Nitrates continue to command a price premium over urea due to the agronomic benefits. In 2010, premiums returned to normal as the high inventories and overcapacity seen in 2009 were no longer present.
Based on the strength of nitrogen prices, Yara aims to run its fertilizer production facilities at full capacity. The company will add production capacity in 2011, with the urea expansion in Sluiskil expected on-stream in June and the Qafco-5 ammonia and urea start-ups expected in the final quarter of the year.
There is significant potential for high price volatility in the markets for agricultural commodities, where supply is limited and customers have low sensitivity to price changes. More weather-related setbacks of agricultural production could further increase short-term fertilizer demand, while a significant drop in agricultural prices, e.g. in the event of improved harvest prospects, could induce a temporary slow-down in fertilizer deliveries.
However, a substantial harvest increase in the 2011/12 season will be required merely to stop the decline in inventories that has been driven by the 2010/11 harvest shortfall. Global grain production must increase by almost five percent to avoid further inventory drops, and the latest reported crop progress has not been supportive of such an increase.
A majority of Yara’s dry raw material purchases are re-negotiated annually. While these costs are typically recouped in Yara’s finished fertilizer sale prices over time, the company expects to record a smaller negative impact in its 2011 results compared to 2010, partly as a result of rising phosphate rock prices during 2010.
Yara’s energy costs are projected to increase significantly from 2010 to 2011, based on current forward markets for oil products and natural gas. However, the likely cost increase should be more than offset by higher fertilizer pricing levels.
Unrest spread in the Middle East and North Africa following the revolts in Tunisia and Egypt in early 2011. Consequently, crude oil prices have risen. This has in turn increased the cost of the one third of Yara’s European oil and gas purchases that are directly linked to crude oil rates. The Libyan JV, Lifeco, has temporary stopped production as a result of the unrest.