What happened with gas shouldn't have been a surprise. As far back as 1998, factors were building that no one took notice of… the handwriting was on the wall.
The upcoming growing season doesn't look good with USDA predicting $1.85 corn, says CF Industries' Glen Buckley.
“But when you look at the balance, we're actually in a very good situation with corn once we get past the excess supply. The problem we have in corn isn't a demand problem, it's supply. If you look at yields as percent of normal, for the last five years we've had nothing but one bumper crop after another,” says Buckley who spoke at the Arkansas Crop Management Conference in Little Rock held Jan. 29 through Feb. 1.
History shows there's never been five straight years of record or near-record crops, says Buckley. “We've never had a five-year block when we've been that far above trend.”
If you look at demand, the 1999 numbers are all near-record. Farmers are looking at very strong demand for 2000. And Buckley thinks in terms of exports and industrial use, USDA's numbers are low.
“This year, we're looking at a total use of over 10 billion bushels. So what this tells us is that even if we have normal yields — just an average crop — we're looking at declining inventories and significantly stronger prices.”
What's interesting, is this holds true not only for corn but also for nearly all other grains as well, says Buckley. On a worldwide basis, we're not in a surplus situation.
“Corn prices are not so low because of world supply and demand, but because of the United States. All the inventory is held in this country. And since we dominate the market, when we have the inventory our price is going down as well as the worlds'.”
So what's expected for 2001? With the low corn prices, high production costs and many farmers — particularly in the Midwest — going beans after beans, we're looking at around 77 million acres of corn, says Buckley. If those acres produce average yields, we're looking at a fairly tight balance.
Overall, if one looks at all eight major crops, it's expected “some 2.9 million acres will be taken out of production,” says Buckley.
What does that mean for fertilizer? Well, it isn't particularly good news.
What's going to happen with phosphorus and potassium? With high nitrogen prices, what are farmers going to do — particularly ones that are financed by banks that'll only allow a certain amount of inputs? Will they cut nitrogen? Buckley doesn't expect to see many doing that. The alternative is to cut phosphorus and potassium.
“And that's what we're afraid is going to happen.”
Virtually every nitrogen-based fertilizer product costs over double the price from a year ago. This last year has been “an incredible run,” says Buckley.
Why? The same reason that's been given for weeks: natural gas prices. A year ago, prices were at $2.30 for gas — which had held for almost all the 1990s. The January contract price at one time was $9.98.
What has this done to the cost structure? With $9 gas, manufacturers went from a cash production cost of nitrogen at $100 per ton to over $300 in two months.
With that high of a cost, the industry faced a serious situation in both December and January. Not only were manufacturers not covering total cash costs, they weren't even covering gas costs.
What happened with gas shouldn't have been a surprise, but was, says Buckley. In fact, if you look at what happened as far back as 1998, there were factors starting to build that no one took enough stock of. The handwriting was on the wall, but it was missed.
The low oil and gas prices of 1998 resulted in no one putting money into exploration or production. No new wells were being built. To some extent, without those new wells the problem wasn't showing up in the market. The reason for that was the nation was in the midst of three warm winters in a row.
So the problem was masked because even though production was dipping, the demand wasn't there, says Buckley.
Then, last spring, gas prices suddenly went from $2.80 in May to $4 in June. The industry started to recognize the shortfall at that time. Inventories began tightening because of power generation.
“Over the last three years, we've seen a phenomenal increase in the amount of natural gas used to produce electricity. The reason for that is supply and demand.
Supply and demand
“On the supply side, the Clinton administration, through executive order, took all new reserves off the market. The reserves off the coast of California, Alaska and the western part of the country were off-limits.”
On the demand side, because of Clinton policies and EPA regulations, the United States ended up with a situation where no one could afford to build anything other than gas-fired power generation plants. With EPA regulations, trying to build a plant that uses oil or coal is virtually impossible, says Buckley.
So, the power plants wanted the gas, got it, and prices jumped. Then winter hit and November and December, if combined, were the coldest on record. Because people want warm homes, gas supplies became even shorter.
“When we got into mid-1998, rate counts show new wells being drilled dipped precipitously. Typically, in an average month 800 new wells will be drilled. We dropped to 419,” says Buckley.
On top of that, existing wells' productivity dropped. The highest productivity of a well comes during its first couple of years. After that, it tapers off.
No one could predict that the existing wells' productivity would decline much faster than anyone anticipated, says Buckley. Part of the reason for that is new wells being drilled were in existing reserves. Instead of going to new reserves, gas was being pulled from the same area. Productivity declined.
“On demand, power generation in particular wanted the gas. The thing about gas is not much is carried in inventory. Any small change means prices are easily affected.
“At the end of December, people were looking at reports that by March we'd be down to half-a-trillion cubic feet in inventory. That's extremely low. We should end the cold period of the year, as in 1999, at 1.5 trillion cubic feet.” But things changed in the last week of January.
With $8 or $9 gas, the fertilizer industry virtually shut down. The domestic industry went from an average operating rate of over 90 percent to somewhere under 50 percent.
For a bit of perspective, the industry normally operates in the 90 to 95 percent range. In fact, in 1995, the industry actually went over 100 percent of capacity, says Buckley. But when we got into this fertilizer year, the average was only 67 percent during the first half.
Not only does this hit the cost side, the industry also couldn't compete with imports.
“Ammonia cash cost delivered to the United States in January 2000 shows the U.S. producer was able to compete. Then, in January 2001, we weren't even in the ballpark. The cost for domestic producers was more than double that of anyone exporting into this country.”
Buckley says where this market goes will continue to depend on gas prices. On Jan. 29, gas in February was trading at $6.57. Three weeks prior, that same gas was trading for over $9.
Buckley says for a typical nitrogen producer, $9 gas means it'll cost $328 per ton of fertilizer. Gas at $7 will cost the producer $265 per ton. With those prices, producers can run and make a profit. Production is coming back into play.
“If we get back to $9 gas — if all of a sudden a blast of arctic air means more gas used for heating — we're going to see the industry shut right back down again. But if that doesn't happen, and $7 gas cost holds, operating rates should go up.”
What does that mean in terms of inventory and supply?
“I would have guaranteed you a week ago that we were looking at shortages in the Midwest by April or May. Now, it doesn't appear that'll happen.
“A month ago, we were looking at a severe production cut, low inventories and maxxed-out imports. We can't take much more imports than we have — even with a shortfall of several million tons.”
Something Buckley hears many questions about is bringing in more imports. In the case of ammonia, the United States is already shipping in record imports — 5.2 million tons.
“But the thing with ammonia is bringing it in takes specialized equipment. The industry wasn't set up to deal with large ammonia imports. Typically, the U.S. ammonia producers were able to satisfy demand. Almost 70 percent of imports went to Florida alone. There's just no infrastructure built to handle massive imports.”