Fertilizer prices ease but is affordability a thing of the past: A deep dive

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One could argue that the history of mankind is really a history of food systems. Humanity has come a long way from the days of hunter-gatherers and foragers.

In millennia gone by, settlements were highly dependent on their proximity to food sources, immediate geography, and seasonal variations.

All that has changed drastically, and in our modern world, these factors are much less significant. Commercial agriculture and global supply chains have overcome these issues to a large extent.

One of the key ingredients in this mix is the role of fertilizers. Post the second world war, this industry exploded in reach, supplementing naturally-occurring nutrients in every corner of the world.

To cater to (or some would argue, actually drive) the sharp rise in global population, nitrogen-phosphorus-potassium (NPK) has become synonymous with the global food system.

Yara International, a Norwegian chemical giant, notes that essential plant nutrients augmented with fertilizers are estimated to produce 50 per cent of global food output today, and are central to nutritional security. 

These also influence the quantum and characteristics (such as climate-adaptive, and disease-resistant) of the crop itself.

In a similar vein, estimates suggest that 3 billion people or nearly half the world’s population depend on fertilizer-grown produce.

Today though, the much-hailed scientific marvel has met a daunting geopolitical adversary, which threatens to upset the apple cart altogether.

The link between natural gas and fertilizers

Natural gas is a key component in fertilizer production and accounts for 70% of the costs in the case of nitrogenous fertilizers.

With natural gas prices turning nearly vertical this year, costs exerted a tremendous strain on producer margins.

As per a report issued in October 2022 by the Farmers Business Network, over the past twenty-four months, US natural gas prices skyrocketed 400%.

Incredibly, this is nothing in comparison to what has happened in Europe, where rates exploded higher by over 3000%, highlighting the sheer dependence on Russia for gas and energy products.

The rise in prices

The global fertilizer industry is worth $185 bn and exports around $85 bn.

Only a handful of countries possess the resources, technical know-how and capital to produce fertilizers on an industrial scale. China is the largest global supplier.

Depending on the statistics used, Russia’s reported share of global fertilizer production varies between 10% to 15%. It accounts for 14% of urea, 10% of phosphates and 21% of potash traded on international markets.

The EU is also a sizeable manufacturer, having an 8% share of the global production of nitrogen fertilizers, while supplying 3% and 6% of phosphate and potash, respectively.

The first thing that comes to mind when thinking of the extraordinary surge in energy costs is – “oh, it’s Russia.”

Although the recent geopolitical turmoil has had a seismic effect on the market, the natural gas space was already facing substantial pressure as early as mid-2020.

Source: US FRED, Investing.com

According to the Federal Reserve Bank of St. Louis, major disruptions date back to the covid outbreak, where labour shortages meant gas production plummeted, and weather anomalies such as deep freezes in the American south further slowed drilling.

A number of other factors contributed to the manic rise in gas prices including speculative buying, high demand by authorities looking to build robust inventories to weather even higher prices, globally elevated freight rates, as well as US rail strikes and union work stoppages.   

Adding to the pressure, widespread drought has meant that the US supply chain has been gravely delayed by historically low levels of water in the Mississippi River and other waterways.

With western sanctions tightening a noose around trade, Russian minister Denis Manturov confirmed that fertilizer exports fell 7% during 2022 H1.

While decision-makers may have assumed that such measures would inevitably increase pressure on Russia, forcing Putin to withdraw from Ukraine, this was an unlikely outcome from the start, and certainly not one to be expected any time soon.

Moreover, the galloping prices in commodities this year meant that several Russian entities were turning a profit, while the average person in the European bloc and other regions was struggling under crushing inflation.

Most recently, the explosions in the Nord Stream pipelines have meant Russian gas supplies to Europe have all but ceased, accounting for a mere 8% of the bloc’s supply compared to 40% prior to the invasion earlier this year.

Prices in Asia are high too and may continue to stay elevated if the region suffers a cold winter.

In response to the severe tightness in the natural gas market during the past year, fertilizer input costs surged, led by ammonia which is derived from natural gas.

Source: World Bank

In the graph below, we can see the effect of the above on international prices of DAP, TSP and Urea. These are highly correlated with natural gas prices and make up a bulk of the fertilizer trade.

Source: University of Nebraska, World Bank Commodity Price Index

Both DAP and Urea contain ammonia as feed. TSP is a phosphorous fertilizer but is energy-intensive, and heavily reliant on natural gas.

Dismantled production

The dramatic rise in natural gas since mid-2020 has had a twin-pronged effect in Europe, which was hit very badly due to its reliance on Russian energy products (as seen in the Dutch TTF data).

First, producer margins have evaporated, forcing several fertilizer manufacturers to shutter their operations or deeply cut back on volumes.

The CRU Group, a business intelligence company specializing in commodities, estimates that this amounts to a staggering 70% of total production in the region.

Source: Independent Commodity Intelligence Services (ICIS) as of 13th October 2022

This could represent the possibility of the onset of a lasting shift in Europe’s role as a key global player in the production of fertilizers.

Secondly, with natural gas prices severely elevated, and fears that countries will not be able to provide sufficient electricity to light their cities and keep homes warm, the closure of industrial units has been encouraged in some cases.

To drive down demand (and prices) for natural gas, EU energy ministers agreed to reduce peak electricity consumption by 5% during peak hours.

In a bid to manage the oncoming winter, EU decision-makers also purchased available highly-priced natural gas to strengthen national inventories which stand at between 90-100% of total capacity today, at the cost of industrial activity.

Maximo Torero, the chief economist at FAO noted,

This will switch the EU from being a key exporter to an importer, putting more pressure on fertilizer prices and consequently affecting the next planting season.

Alexis Maxwell an analyst at Green Markets, concurs,

Europe needs fertilizers and importing is their next best option, but that will be a severe logistical challenge…Global spare nitrogen capacity is tight after two years of surging demand.  

Further, China, the world’s foremost phosphorous fertilizer exporter instituted limits on international shipments which may extend well into 2023, while Ukraine has suspended fertilizer exports till year-end.

Then why the sudden price relief?

Despite these many factors, both natural gas and fertilizer prices have eased in the previous weeks, although they are well above year-ago levels.

The World Bank’s Commodity Price Data (known as the Pink Sheet), saw the natural gas index moderate from an all-time high of 454.04 in August 2022, to 389.94 during the month of September.

The decline has been fuelled by strong LNG arrivals to top up national reserves in Europe and elsewhere, prevailing mild autumn weather, optimism that another comparable supply shock is unlikely, the UK’s move to restart fracking, the resurgence of the nuclear narrative and rising interest rates leading to demand destruction.

Speculators that were betting on the surge in natural gas prices have been cashing out following the spectacular returns registered this year.

Gauges for fertilizer prices have also begun to weaken, with urea prices in a New Orleans index moderating a significant 3.2% last week. This measure has eased for a month now.

Source: Bloomberg

Other than the drop in natural gas prices, the decline comes as both US and Brazilian farmers have stopped placing orders after they overbought earlier in the year on expectations of fertilizer prices heading even higher.

Yet, prices are so high that not everyone believes fertilizers will be affordable.

For one, the levels of unsold inventory are unclear, since there are reports of excess fertilizers being re-exported in some countries.

A farmer, Jeff Thompson felt,

The next task is getting fertilizer…It’s crazy expensive — getting it is going be tough and it will drag into next spring too.  

With monetary tightening and an improvement in international logistics, the FAO’s Food Price Index also slowed down.

Source: FAO

The IMF’s World Economic Outlook estimated that a 100-basis point increase by the Federal Reserve could reduce global cereal prices by approximately 13% with a lag of one-quarter.

As output prices began easing, farmers aimed to reduce fertilizer use and alter planting decisions to manage expenses.

For instance, in the United States, corn, wheat, rice and soybean operations incur costs of 36%, 35%, 15-20% and 10%, respectively in terms of these inputs.

With the cost of growing food in the US set to rise by a historic high of 18% in 2022, farmers have reportedly begun to roll-back fertilizer use as well, which will drag down yields and reduce food supply in the coming months.

Following lower crop prices, the Brazilian National Fertilizer Association estimates that fertilizer imports will be down 5-7% this year.

Maxwell confirmed that,

Global ammonia, phosphate and potash demand are all down year to date.

This could even force a shift towards agricultural crops requiring lower fertilizer inputs.

With the Mississippi drying up and freight delays set to persist, Josh Linville, Director of Fertilizer at StoneX, cautioned,

…a loss of 200,000 to 250,000 tons of product…That is a very big number… The market could see a lot of growers looking to buy nitrogen in the spring and the market could struggle to meet that demand.

Thus far, traders have largely ignored this possibility as being a serious threat, although Linville concedes that loss estimates may be conservative at this time.

Critically, with Russia threatening to not extend the Ukraine deal (which I had written about in a deep-dive here) when it expires next month, more tightness could be in store for global fertilizer markets.

Markets will closely watch developments in this space, and we can expect some volatility in prices in the coming weeks.

Global ramifications

Sri Lanka is a case in point of the devastating effects that a breakdown in fertilizer supplies can have on food production. In April 2021, the country haphazardly shifted away from the use of synthetic fertilizers, contributing to spiralling food inflation.

Source: Tradingeconomics.com

Staple foods including rice, wheat and lentils, saw a dramatic move in prices, while production of commodities such as tea and coffee, crucial for foreign reserve earnings plummeted.

You can check out an earlier article I wrote on Invezz describing some of these issues.

Although food and fertilizer prices may have fallen, for the time being, the low gas inventories post-winter and reduced fertilizer manufacturing capacity will likely mean prices will have to head higher in the new year.

The treemap below shows the share of countries in fertilizer imports.

Source: Observatory of Economic Complexity

Emerging economies such as Brazil, India, Thailand, Indonesia, Vietnam and Turkey may find their food security at risk once the new sowing season begins.

China, which is also a sizeable importer, may be able to tide over the shortages somewhat owing to its large stockpiles of food grains and other commodities.

Brazil, Mexico and Indonesia also import over 20% of their fertilizers from either Russia or Belarus and may be forced to diversify elsewhere, squeezing global markets.

Source: USDA

The Food and Agriculture Organization also noted that several African nations such as Ghana, Ivory Coast and Mauritania bought fertilizers from Russia, amounting to anywhere between a quarter and half of their supply.

However, with the ongoing geopolitical turmoil, flows have petered out, leaving much of the continent in a dire state.

African Development Bank President Dr Akinwumi A. Ade warned in a May speech,

Africa faces a fertilizer shortage of 2 million metric tons this year. We estimate it will cost about $2 billion dollars – at current market prices – to source new fertilizer to cover the gap…If we don’t mitigate this shortage rapidly, food production will decline by at least 20%.

Despite the urgency faced by the people in many of these countries, European Commission officials opposed the expansion of Africa’s home-grown fertilizer capacity since,

…(this) would be inconsistent with the EU energy and environment policies.

Saloni Shah, a food and agriculture analyst at the Breakthrough Institute, labelled Europe’s attempts to block such projects while expanding its own fossil fuel infrastructure as,

…hypocritical.

For its part, the EU has been unable to find a consensus solution among its 27 member states, with the issue of natural gas price caps being particularly controversial, and may even end up dissuading imports.

With Germany’s decision earlier today to roll out an independent targeted package worth 200 bn euros for energy subsidies, we could see friction rising in the bloc, while fertilizer producers at home could come online sooner than in other places.

Opportunities

The ongoing shortage of fertilizers, and production crunch in Europe, offers several import-dependent African countries a rare opening to build self-reliance and capture market share across the global fertilizer market.

For instance, Algeria, Mozambique and Nigeria have large natural gas reserves, and Morocco, South Africa and Tanzania enjoy sizeable phosphate deposits.

Although deploying the necessary capital may not be easy, this could prove to be a golden opportunity for these economies.

Secondly, with inflation still rising and central banks tightening, and the DXY standing at 113, dollar exports would prove invaluable for developing countries if they could get fertilizer production off the ground.

Potential social unrest

If natural gas prices continue to remain high in the new year, food production will become immensely challenging in many parts of the world.

Even in the UK, the British Meat Processors Association states that as fertilizer production is rolled back, UK Co2 supplies will also drop, affecting food and beverage industries, as well as total meat output.

To keep prices in check, and maintain natural gas reserves for production next year, countries around the world, especially in Europe and Asia can only pray for a mild winter.

With 6%+ inflation hitting four-fifths of countries across the globe, rising unemployment and the very real possibility of a prolonged recession, Torbjorn Soltvedt, Principal Political Analyst at Verisk Maplecroft, pointed to the possibility of,

…a new era of civil unrest.

Source: Verisk Maplecroft

According to the above study, 101 countries saw a rise in civil unrest between Q2 and Q3 in 2022.

If energy and subsequently food supplies become costlier, the probability of wide-reaching social tension and large protests will intensify in many of these areas.

Although it is facing many of its own problems today, Enrico Colombatto, professor of economics at the University of Turin, believes that Beijing may be tempted to take advantage of this situation and provide financial support to strategically important developing countries.

Western countries will have a difficult time diverting already strained resources for international causes with a disillusioned voter base at home.

Investments to alleviate global shortages in energy, fertilizer and food will likely remain scarce, particularly in developing economies, potentially extending the crisis.

Outlook

The positive takeaway from the fertilizer price curve is that we may have seen the peak already.

However, in my view supply disruptions will persist and prices will remain elevated in the natural gas, fertilizer and food markets, particularly as the Ukraine-Russia conflict shows no sign of letting up.

In the very near term, prices may ease further, following favourable weather and stronger inventories.

Uncertainty around the Ukraine-Russia deal will likely lead to volatility in the markets in November. In the event that talks fall apart, prices will likely go through the roof.

Moving into next year, the danger of sharp supply squeezes remains.

For instance, EU natural gas may get perilously low with Leon Izbicki of Energy Aspects estimating that this may reach 18% of reserve capacities in case of severe global winter.

Unless there is a miraculous turnaround in relations with Russia, its supplies will be largely out of the picture, refiling stocks would prove difficult in such a scenario, keeping energy costs high and fertilizer plants from reopening.

In emerging markets, with the essentials under threat, governments would be wise to invest in production capacity at home, where possible.

With Chinese, Russian and Ukrainian exports of fertilizer and movement of freight along the Mississippi expected to be capped in 2023, fertilizer markets will only get tighter.

The IMF estimates that a 10% rise in fertilizer prices will lead to a 7% increase in cereal prices after one quarter, suggesting that if fertilizer prices do indeed rise, we should not expect food affordability to return any time soon.

Moreover, as the possibility of a monetary policy pivot rises, fuel and food costs will only head higher, making matters very difficult for the average household. 

Although trends in 2023 are very much a mystery, in my view, we could expect elevated prices and supply shortages in the essentials for some quarters yet.

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