Dynamic changes in the competition for fertilizer

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Major changes are occurring in the U.S. fertilizer industry. One is the change in composition of crops and the more robust commodity market, which has caused an increase in fertilizer demand.

Second is the dramatic reduction in the price of natural gas, a primary input for fertilizer manufacturing. This change varies regionally and gives advantages to fertilizer plants in lower-cost natural gas states.

Another change is in competitive pressures. A number of new groups are looking to enter the industry, and some plants are looking to expand.

We analyzed the spatial competition in the U.S. fertilizer sector and tried to determine the likely future spatial distribution of production and flows of nitrogen fertilizer.

The industry has been dominated by a few major firms that will have to confront a number of new entrants in the market. There are at least 12 to 15 (some claim 25) new fertilizer plants being proposed in the U.S., with each costing about $1.5 billion or more.

This industry has a number of important structural characteristics that impact competition and conduct. Domestic manufacturers have to compete with imports, demand is volatile, and firm processing functions have high fixed and low marginal costs.

Through the years, fertilizer use has increased substantially in the U.S. and use in other countries also is expanding. Fertilizer demand varies across crops and geographically, which has important implications for spatial competition.

The expansion of corn production in the northern Plains is a major source of new demand.

Traditionally, the industry has been dominated by a few large players mainly in Oklahoma, Louisiana and Texas, and a few plants in the Midwest. The industry imported significant amounts of fertilizer to meet its needs, with nitrogen fertilizer imports amounting to 57 percent of consumption. Gulf imports are in the area of 13 million tons, mostly in the form of dry and ammonia that primarily funnel through Louisiana and Texas.

Imports and domestic prices are volatile and impact domestic plant utilization.

Urea prices in the gulf have ranged from $100 to $200 per ton in the early 2000s to a peak of more than $800 in 2008 and nearly that level again in 2012. Since then, prices have declined to the $300 level. It is important to note that, in contrast to price relationships within the U.S., import prices have little relationship to U.S. or international natural gas prices. Also, the correlation between prices in the gulf and those at export origins, such as Trinidad, Russian or Black Sea ports, are very low.

Fertilizer manufacturing has tremendous economies of scale. Fixed costs are high and marginal costs low, and decline with increases in output. The dominant input cost is natural gas, which is 50 percent or more of the manufacturing costs, so access to low cost natural gas provides an important advantage for plants.

Indeed, it is partly the escalation in U.S. domestic oil output that is resulting in an increase in the variability of natural gas prices among regions. Prices are lower in states such as Louisiana, Texas, Oklahoma and North Dakota, which provide plants in those areas with production advantages.

The breadth and scope of the new entrants in this industry is important. Since 2011, there have been many announcements about new plants, with each producing 1.1 million to 3.7 million tons per year.

The characteristics of the new plants are important. Some plants are expanding (CF Industries, Agrium and Koch); some are established cooperatives (CHS) or newly formed cooperatives (Northern Plains Nitrogen); some are regional energy firms (Dakota Gasification and Mississippi Power); and some are offshore firms expanding into U.S. markets (Eurochem).

Each plant has differing goals. Plants in existence would seek to expand and pre-empt new entrants. The cooperatives view this as a means to better serve their grower customers in a more vertically integrated system. Energy companies are looking for a use of their outputs. Offshore entrants are looking for opportunities to serve the U.S. market and potentially export fertilizer to other countries, including China.

Our model shows the distribution of fertilizer production, as well as flows from production areas to meet county level demands. The most valuable (lowest cost) origins for U.S. processing are primarily in Louisiana. Several locations in Wyoming, Iowa, Georgia, Nebraska, Kansas and North Dakota also would be positive.

While there are up to 25 proposed fertilizer projects, these results indicate that not all would be viable. This is particularly true if all were built, in which case many would operate at substantially less capacity. In a model specification that required any new plant to have a capacity utilization rate of 75 percent or more, the results change. In this case there would be only a few new plants, including those in Louisiana, Iowa and North Dakota.

Given these new plants, there would be substantial changes in the flow and distribution of products. Generally, these changes would result in reduced long- haul rail shipments. This possibly means that shorter-haul rail shipments would be competing with trucks.

Rail volume would decrease in some routes. Results indicate that imports and shipments from import ports probably will decline and mostly be replaced by domestically produced products. Of particular importance is the prospective reduction in rail shipments from the Texas gulf.

The implications of these results are important. For growers, the results should be viewed as positive. The combination of new fertilizer plants producing at a lower cost ultimately will result in lower fertilizer costs and probably less volatile prices because, in part, the fertilizer will be produced with more stable domestic natural gas that is declining in value. The implications for the fertilizer industry probably are more dramatic. This is an industry characterized by volatile demands and large-scale manufacturing, which have high fixed and low marginal costs. Further, the nature of the entrants/expanders is such that they have differing motives for entry.

In the end, current fertilizer operators will face new plants that are more diverse in several respects. These reasons all suggest that there probably will be more new plants than needed, so they will be operating in a market with volatile demands and declining marginal costs. The impact of this would result in suppliers seeking to differentiate their products and distribution systems to seek competitive advantages.

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