Fertilizer International 496 May-Jun 2020
31 May 2020
Covid-19 & fertilizers: 5 things you need to know
COVID-19 PANDEMIC
Covid-19 & fertilizers: 5 things you need to know
CRU’s Laura Cross guides us through the current Covid-19 crisis and flags up the unique risks faced by the fertilizer industry as the pandemic unfolds.
The Covid-19 pandemic has widespread implications for commodity markets, and fertilizers are no exception. The agricultural sector has been caught between a range of conflicting drivers – from the essential nature of food production, to the need to contain the spread of the pandemic. Agriculture has also been hit by volatile foreign exchange rates and the impact of macroeconomic uncertainty on food and biofuels demand. Ultimately, this has started to trickle down and fundamentally affect the cost economics of fertilizer production and the engines of demand.
The increased uncertainty brought about by the Covid-19 pandemic means there are numerous risks to be aware of, many of which are unique to the fertilizer industry. While history tell us that fertilizer demand has proved resilient to prior economic shocks, the industry is not immune to a collapse in the financial system.
The implications for industry financial performance in 2020 – both upsides and downsides – are also mounting, amid an increasingly complex financial markets backdrop. The upside of an already weak fertilizer price environment is better affordability for farmers. This, when coupled with strong crop acreage expectations for 2020, puts demand fundamentals in a robust position for the year ahead, across all the nutrients.
Yet counteracting this, in the first-quarter of 2020 alone, the economy has already needed to contend with:
- A significant shock to the Chinese market
- The spread of Covid-19 westwards and its classification as a pandemic
- The Brent Crude oil price nosediving below $20/bbl
- A subsequent collapse in global financial markets and company share prices.
So, what does all this pandemic-induced turmoil mean for the fertilizer market in the coming years? Five unique risks faced by the industry, in our view, are outlined below.
1. Fertilizers are sheltered from near-term economic turbulence, but not immune to recession risks.
Most governments have now classified fertilizers as essential goods, allowing deliveries to farmers to continue despite extensive lockdowns throughout the world. Covid-19 could influence fertilizer markets – and fertilizer demand more specifically – via several mechanisms. People must eat regardless of whether the economy is in an up or down cycle. But the prospect of slower economic growth and the threat of a prolonged global recession can impact fertilizer demand in other ways.
The long-run relationship between nutrient demand and global economic growth is shown in Figure 1. This shows that fertilizer consumption is relatively inelastic to changes in global economic growth, with historic analysis of previous recessions reinforcing this point. Nitrogen demand is the most inelastic, followed by phosphates and then potash. For the most part, this shields global fertilizer demand from recessionary impacts, relative to other commodity markets. Longer-term demand prospects for all three nutrients remain robust, in CRU’s view, albeit with some downside risk to demand in the next crop year.
The effects of the pandemic on the spring season in the northern hemisphere have been limited so far. Farm margins and credit availability are at relatively healthy levels, with planting intentions mostly ‘lockedin’ despite Covid-19 disruptions. However, beyond this spring season, Covid-19 and its economic repercussions pose a threat to fertilizer markets in three main ways: agricultural commodity price declines, currency devaluations and declining feedstock prices.
2. Crop prices are exposed to commodity cycles, adding delayed bearish sentiment to 2021 demand expectations.
Negative sentiment is combining with expectations of much slower economic growth to create fears over commodity price declines. This is weighing on agricultural commodity prices, especially when coupled with prospects for another large southern hemisphere harvest and a significant rebound in US acreages.
Crop price signals for corn, soybeans and wheat are weakening. Falling crop prices and a potential decline in underlying agricultural demand could dampen fertilizer demand from farmers in the 2020/21 agricultural season. Statistical analysis of previous recessions show that agricultural prices are exposed and closely track commodity cycles. A recession in 2020/21 is therefore likely to mean lower crop prices, particularly for soybeans and wheat, given the relative oversupply in these markets. The downside risk for corn prices is capped by a declining global stocks-to-use ratio and tighter market fundamentals.
The outlook for fertilizer demand beyond the immediate northern hemisphere spring season is subject to considerable risks, these being heavily weighted to the downside. Record acreages and high yields in the US this fertilizer season could result in US corn inventories ballooning to more than three billion bushels by the end of the 2020/21 crop year. This would be even more likely if demand for corn is capped by lower ethanol consumption in the US (Figure 2) and Brazil, driven by reduced economic activity and lower feed demand, the latter linked to livestock/meat price declines.
Fertilizer demand in the fall season will certainly be negatively affected if the above scenario transpires and corn prices decline. In addition, the significant devaluations of the Russian rouble and Brazilian real give the main grain-exporting rivals to the US a cost-advantage. This, in turn, lowers the odds of a strong recovery in US grain and oilseed exports – a key driver of fertilizer demand sentiment.
Despite the relative optimism over demand in the first-half of 2020, there are still some pockets of concern in the near-term – one of these being potash sales into Southeast Asia. Extensive palm oil plantations, mostly located in Indonesia and Malaysia, account for a large slice of MOP consumption. That means changes in the crude palm oil (CPO) market affect Southeast Asian demand for potash and influence its pricing.
Southeast Asian MOP demand contracted 21 percent year-on-year in 2019. Nevertheless, high CPO prices towards the end of last year had spurred hopes of a rapid rebound in 2020. Instead, the macroeconomic impacts of the Covid-19 pandemic have wiped out almost all the gains CPO prices made in late 2019. Potash purchasing activity across the region has also slowed to a crawl in recent weeks, exacerbated by restrictive measures placed on the movement of people and goods as Covid-19 cases have risen rapidly.
3. The energy market backdrop is as important as ever.
A triple collapse – in oil prices, industrial consumption and key exchange rates – has distinct downside effects for fertilizer feedstocks. This is especially true of nitrogen producers, as spot gas prices in Europe and the US, along with coal prices in China, continue to decline. A drop in cargo shipments and lower bunker costs (these accounting for around 50 percent of freight costs) are likely to maintain pressure on freight rates.
The unprecedented decline in the US WTI crude oil price in April has raised the prospect of meaningful cutbacks in US oil output. This will result in a drop in associated gas production, tightening the natural gas balance and potentially raising the Henry Hub gas price above current forecasts. However, this is countered by an increasingly shaky energy demand outlook as the Covid-19 pandemic takes effect.
Oil prices are now expected to stay in the $15-$25/bbl range during the second-quarter of 2020 as we move through the trough in demand. Despite this, only about 30 percent of the nitrogen cost curve is now linked to the oil price. China, India, and a few other countries East of Suez still buy at an oil-indexed gas price, meaning these select countries will benefit from lower feedstock costs if the lower oil price is sustained. This 30 percent does not include producers supplying the marginal price-setting tonnes but will change the shape of the nitrogen industry cost curve.
The gas price paid by most nitrogen producers is instead government-regulated and not linked to the oil price. Oil and gas markets are also largely decoupled. The declining oil price is therefore expected to have a limited impact on spot gas prices. Gas markets are already oversupplied, and as a result prices are expected to continue declining in 2020.
A global glut of natural gas has seen prices plunge in the US, Europe, and Asia in the last two years as a wave of liquefied natural gas (LNG) hit the market (Figure 3). In the first four months of 2020, the Covid-19 pandemic has dented natural gas demand due to industrial outages and travel restrictions. The mild winter in the northern hemisphere has added even more pressure on prices. It has also left European storage sites almost full, which will translate into record low injections this summer.
These bearish fundamentals mean that spot gas prices are forecast to continue to slide until they reach a point where it no longer makes financial sense to sell into the European market. CRU does not expect a meaningful recovery in gas prices until 2021, this being contingent on:
- Demand recovering by the fourth-quarter of 2020
- Marginal LNG exports being cut back in the US
- A degree of discipline in Russian pipeline export volumes.
CRU forecasts the TTF Europe Hub Price to average $2.90/MMBtu in 2020, down from $4.45/MMBtu in 2019 (Figure 3). The consensus view is that the gas price floor in Europe is quite difficult to call, with a significant risk of the TTF falling below $2/MMBtu and staying there in 2020. This is likely to happen if swing LNG exporters do not pull back – and, more importantly, if the Covid19 enforced lockdown in Europe remains in place until the third-quarter of 2020.
This upshot of all of this is substantially lower production costs for nitrogen producers in Western Europe, now positioned in the first-quartile of the urea exporter cost curve, a dramatic overhaul from the region’s traditional cost economics. It also means that Eastern European producers – previously in the last-quartile of the exporter cost curve – now have lower costs too, with an increasing number of producers in this region paying a gas price that is tethered to the TTF spot hub price.
Furthermore, the lower oil price has an impact on fertilizer costs in countries such as Russia, where the exchange rate is linked to the price of oil. The Russian gas price, being rouble-denominated, will also lower nitrogen feedstock costs in equivalent US dollars. This makes Russian nitrogen producers more competitive in the international ammonia market where exports via the Black Sea play an important role in price-setting.
Marginal costs in the urea market, meanwhile, continue to be set by coal-based Chinese exporters. Although not being affected directly by lower oil prices, they are also seeing their costs decline as a result of an oversupplied coal market.
This energy market backdrop also affects sulphur supply. The sulphur market started 2020 with weak demand and oversupply, with projections of further supply growth. The Covid-19 outbreak has reset both supply and demand expectations, although the dent in supply, particularly from oil refining, is now expected to be most severe.
Oil refining has been hit by both a reduction in product margins and, more importantly, by a collapse in oil product demand. Much of the refining sector had originally adopted an approach of business-as-usual during the first-quarter of 2020. But that sentiment has now shifted.
The global view of the contraction in oil demand in 2020 has been shifting rapidly as the Covid-19 outbreak has evolved. The most recent forecast by the US energy agency EIA estimates global oil demand to decline by around five percent year-on-year for 2020. These demand losses are, however, expected to mostly occur during the second-quarter. The EIA’s estimate of 101 million barrels per day (Mbpd) oil demand in 2019 is forecast to fall to just 85 Mbpd in April 2020. Sulphur production from oil refining will track these falls in oil consumption. This will significantly tighten sulphur supply in Europe, US, and Japan/South Korea in 2020’s second-quarter.
4. Currency fluctuations are driving a cost and affordability shift.
In March 2020, the global economy suffered the dual shock of the Covid-19 contagion and an oil price collapse. As governments implemented stringent restrictions on the movement of citizens, and while Saudi Arabia and Russia battled over oil market share, foreign capital that had previously flowed into developing nation economies during 2019 suddenly retreated. As investors fled to traditional safe havens, such as gold or US government bonds, many of the major developing nation currencies depreciated sharply against the US dollar.
Changes in foreign exchange rates impact fertilizer production costs and fertilizer affordability. The industry is heavily exposed to four major economies: Brazil, Russia, India and China – commonly referred to as the ‘BRIC’ economies. All four are major producers and consumers of fertilizers. The volatility in foreign exchange rates in these countries could significantly disrupt the market’s underlying price support, as production costs in US dollars are lower for BRIC exporters. Fertilizer importers in BRIC countries, meanwhile, face higher prices in local currency.
In terms of both capacity and demand, the BRIC economies account for nearly 50 percent of the key fertilizer industry products across nitrogen, phosphate, and potash markets (Figure 4). For individual fertilizer products, the impact of shifting exchange rates will vary depending on its geographical supply and demand structure.
As Covid-19 and plunging oil prices have rocked the global economy in 2020, local currencies in key fertilizer production and demand regions have depreciated rapidly. Three of the world’s largest fertilizer markets – Russia, India and Brazil – have witnessed some of the most profound currency devaluations. For domestic fertilizer producers in these countries, weaker local currencies can boost their margins by lowering operating costs in US dollars, but only those integrated with raw materials will be able to take full advantage.
In key fertilizer importing regions, local currency depreciation affects affordability by raising purchase costs. This exerts a downwards pressure on both fertilizer demand and US dollar-denominated fertilizer prices. While isolated currency depreciation, in a single or a select few countries, can work to the benefit of producers, widespread depreciation forces prices downwards as cost floors decline and import prices in local currency rise.
5. India has been one of the hardest hit fertilizer markets due to Covid-19 lockdown.
On the supply side, the Covid-19 outbreak in China caused temporary production losses due to quarantined labour, supply chain disruptions and other restrictions. Fertilizer production in China is, however, now reportedly back to normal levels. Indeed, following the end of China’s domestic application season in mid-May, exports from the country – a marginal producer – are expected to ramp-up, pressuring nitrogen and phosphate fertilizer prices.
At the time of writing, most countries outside of China are implementing national lockdowns to varying degrees. But this appears unlikely to significantly disrupt fertilizer supply and logistics globally. Instead, because most governments have classed fertilizers as essential goods, major supply chain disruptions have been largely avoided.
India has been a key exception to this. The strict Covid-19 lockdown on the subcontinent led to logistics bottlenecks and, ultimately, widespread plant closures and low utilisation rates. As one of the most crucial centres of global demand for nitrogen and phosphate fertilizers, a slowdown in domestic Indian production has implications for the global market. We consider these in detail below.
India began three weeks of lockdown on 25th March, later extended into May. The limited manpower and logistic bottlenecks that happened as a consequence of this have halted operations at many industrial production sites. While fertilizers have been classified as essential commodities, and DAP, NPK and urea plants continue to operate, low utilisation rates are acting to limit productivity. As well as this, at least eight of India’s major ports have been closed at some point under force majeure, a measure likely to herald further supply chain disruption.
India is a major producer of urea, DAP and NPK fertilizers. As of April, eight of India’s 13 DAP production units and 14 of its 17 NPK production units were idle as a result of lockdown measures. We expect those phosphate plants still operating to continue to run at low utilisation rates, hampered by logistics issues and labour shortages, until lockdown measures are eased. Six of India’s 32 urea plants were also idle in April due to lockdown measures. CRU has calculated domestic fertilizer production losses based on whether India’s lockdown lasts one, two or three months (Figure 5).
Supply-side disruption is only half the story. India also faces the risk of demand destruction as a result of Covid-19, counter to previous expectations of a strong fertilizer demand outlook for India in 2020. Prior to the pandemic, CRU’s view was that Indian fertilizer consumption would be strong in 2020 – building on its resilient 2019 performance in what was generally a poor year for global fertilizer demand.
Across the major products, Indian fertilizer demand reached a record 57.7 million tonnes in 2019. This was underpinned by a strong rise in urea and DAP consumption last year. Demand remained robust through the secondhalf of 2019 due to high monsoon rainfall late in the season. MOP was the only fertilizer to see a decline in consumption last year, linked to the lower affordability of potash and product substitution. NP/NPK sales, in contrast, were buoyed by improved affordability, particularly for high-value fruit and vegetable crops.
At the time of writing, we forecast a marginal downward correction in total Indian fertilizer demand for 2020 – a fall of 1.2 percent year-on-year to 57.0 million tonnes – with the caveat that Covid-19 disruption remains a significant downside risk.
Looking ahead
In summary, the fertilizer market is currently in a state of flux as governments, producers, retailers and end-users make adjustments in response to the pandemic. So far, the fertilizer industry has dealt with the Covid-19 contagion remarkably well, given the possible supply-chain disruptions resulting from lockdowns. This remains an unfolding and evolving crisis, however. All eyes, therefore, will now be on the resilience of the market over the next 12-18 months.
