Fertilizer markets aren't what they used to be. For most of the past 30 years demand was so stagnant, fertilizer seemed downright boring. Phosphate prices resembled the flat line on a deceased patient's heart monitor.
Mines operated below 65% capacity. Two dozen nitrogen fertilizer plants folded in the U.S. after natural gas prices—the major cost of ammonia fertilizers—flared briefly in the 1990s. After that debacle, surviving manufacturers decided they could source cheaper natural gas overseas and import nitrogen fertilizers instead.
Of course, that was then. Today, fertilizer companies can't mix the stuff fast enough.
Fencerow-to-fencerow crop production is stressing the once-sleepy fertilizer supply chain. Global phosphate use alone could increase 13% and potash, 18% from 2006 to 2008, according to the International Fertilizer Industry Association. That is the equivalent of adding another United States to world demand in just three years, observes Mosaic, the giant fertilizer manufacturer.
If this clip continues, "there will be more than just spot fertilizer shortages," says Dan Froehlich, Mosaic's director for agronomy. "Some fertilizer companies are sold out through March, and it doesn't matter if you could pay $1,000 per ton, it's just not available."
Just since the beginning of January, diammonium phosphate (DAP) prices in Tampa have jumped to $850 per metric ton—up from about $250 a year earlier.
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While phosphate could be the most troublesome element, other fertilizer analysts reported that St. Louis potash prices jumped from about $200 per ton to $420 per ton in the same time period, and urea from $300 to about $400.
With this much instability in markets, "dealers are pulling their hair out," says Keith Swanson, who advises fertilizer dealers for CHS, the Minnesota-based cooperative.
"The risks [that] dealers have—everybody has—have been enhanced," says Swanson. And how manufacturers, dealers and farmers choose to handle that risk could have profound effects on U.S. agriculture. That includes how many dealers survive the price turmoil, how willing America's farmers are to shoulder the bill and how fast supplies can expand.
Swanson sees three threats on the horizon now:
1. Higher price risks mean unacceptable exposure if dealers carry inventory season to season. A sudden drop in U.S. grain prices could leave dealers with inputs that growers can't afford to apply.
2. Abnormally short supplies inside the U.S. and abroad leave very real risks of inability to deliver fertilizer on a timely basis this spring. Areas more remote from terminals or river transport, such as the Upper Midwest, remain the most vulnerable.
3. A bidding war in commodity markets is leaving dealers with huge uncertainty over the ultimate acreage shift between corn, wheat and soybeans. Last year saw more acreage substitutions than any year in U.S. history. So without firm orders from farmers, dealers are having difficulty gauging spring needs.
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When markets moved only $10 or $15 a ton from season to season, there wasn't that much risk to holding inventory. "Now, a wrong bet and a $150 or $200 swing can wipe out a dealer or another co-op," says Froehlich of Mosaic.
"Armageddon for the fertilizer industry is a scenario where a dealer buys $800 fertilizer and it drops to $400 two months later," agrees FCStone fertilizer analyst Ryan Sherwood. So right now, dealers are shifting as much risk as possible to farmers by requiring cash forward payment, he notes.
Until recently, farmers saw little value in early orders, but spot anhydrous shortages last fall may have changed their minds. In January, CHS dealers received record orders for fall 2008 deliveries. Some buyers wanted to secure stocks for 2009 crops, but no manufacturer will go out that far, Swanson says.
"One of the things I tell dealers is that there is a lot of farmer disbelief [about fertilizer shortages and supply problems]. But it's one of those times that there really is a wolf in the den," Swanson adds.
So don't expect any quick supply fixes from manufacturers. Mosaic expects phosphate prices to remain "fairly high for the next 18 to 24 months," says Froehlich.
To reopen a now-idled phosphate mine in Florida would require an outlay of more than $1 billion, he adds. No company is going to spring for that kind of cash to fix a short-term problem.
Like a lot of farmers, fertilizer executives—and their banks—remember that over the past 100 years, grain prices suffered from boom and bust scenarios.
E X T R A: Want to know more? CLICK HERE to download these informative charts.
Terra Industries, the nitrogen fertilizer company based in Sioux City, Iowa, recently reported that sales of urea ammonium nitrate and ammonium nitrate were up 20% last year, a major factor in the company's financial turnaround in 2007. The company expects sales to remain strong in the first half of 2008 despite steep price increases, thanks to record levels of customer prepayments.
Overseas nitrogen fertilizer production will gradually ease supply shortages, as Middle East oil producers add infrastructure. But only Terra has announced plans to reopen one of the nation's 25 mothballed nitrogen fertilizer plants, with start-up at its Donaldsonville, La., ammonia plant to launch in the third quarter of 2008. This facility had last ceased operations in December 2004.
"If [many] of the closed facilities could come back they would have by now, as the fertilizer manufacturing margins have been extraordinary for nearly two years," says Swanson.
"That [most] haven't can be attributed to a variety of reasons: very old, inefficient plants; views of management that current high manufacturing margins are relatively temporary; and time and expense to reopen a shuttered facility is not worth it for short-term benefit," Swanson adds.
"There's just too much demand for crops and too much demand for a static commodity-like fertilizer," says Swanson. For the coming season, global manufacturers are not going to overwhelm the market with supply, he tells dealers. "If there's any potential for fertilizer prices to go lower in 2008, it would be because of a demand event—i.e., a much bigger switch than expected of corn to soybeans."
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Help for Hedging Input Costs
Growers' inability to hedge inputs such as fertilizer, outside of simple forward contracts a few months in advance, remains problematic.
No futures contract exists for fertilizers at the moment, and conventional over-the-counter contracts require individuals to prove they have a minimum of $10 million in assets and $1-million net worth, according to FCStone's Ryan Sherwood. Usually, that's too rich for farmers' balance sheets.
Hurley and Associates, a Charleston, Mo., marketing consulting service, has recently launched a method of hedging diesel, natural gas and other energy products on a scale that might attract more farm operators. It hopes to expand into a fertilizer program next.
Until now, one problem with the futures market is that oil contracts alone are sized at 42,000-gallon minimums. That's too big for 1,000-acre grain farms that might use only 5,000 gallons a season, says Ed Case, senior consultant with Hurley. That flaw also discouraged participation in fertilizer futures in the past. By aggregating interested parties, Hurley and its broker FCStone can effectively give smaller producers the same hedging capacity as middlemen or manufacturers.
"There's no minimum size to the contract, but each participant has to understand the strategy and be willing to bear the cost of the strategy," Case says. Using a long hedge options strategy means a producer would only be out the cost of the option, and the intent is to take the contract all the way to expiration.
The risk manager can structure the deal by buying a call option or by buying a forward contract with a put option, but in either case these are maximum price contracts.
Case emphasizes that the new hedging products are still playing out, but a few farm customers have already given the product a try. In late 2007 the crude oil market was trending higher. If it broke $100 per barrel, analysts feared it would approach $150 next.
"Since the market was already trading at historically high levels, we were looking for a break in price to scale in purchases," says Case. "Basis on diesel was very attractive at the time, so we fixed forward contracts and eliminated the risk of the market going to $150 per barrel. But we created the risk of not being able to participate in a price break.
"Incorporating a put option strategy allowed us to add value to our position if the market went down. Buying a call option was an acceptable alternative if you weren't able to do a fixed forward contract at the time."
While such over-the-counter products remain in their infancy, farmers' need to reduce input risks should make them a popular item. "They show a lot of promise," Case says.