NATURAL GAS AND AMMONIA PRICES
HOW HIGH IS HIGH?
Prepared by Richard A. Brock & Associates, Inc.
(January 5, 2001) To state that natural gas prices have exploded to the upside would be the understatement of the year. A year ago natural gas prices were trading in the low $2/mmbtu's and this month they have spiked to levels above $10! This past summer, many of you in the western Corn Belt were concerned about the high cost of irrigation (most irrigation pumps are run on natural gas) and now those costs look "cheap" compared to today's levels. Heating costs for homes on natural gas this winter will likely triple for the average homeowner. The obvious question-where are prices headed to from hem and what would be the impact on another key cost for all of us-anhydrous ammonia.
Supplies Are Tight
As of right now, the importance of gas supply is being over-shadowed by the weather and demand concerns tied to the unprecedented gas prices. However, as the heating season winds down in another couple of months, the visibility and importance of supply contributions will increase dramatically. Gas production has been relatively level in a period of increasing demand. More importantly, gas production has risen to nearly the level of our production capacity, which is what is putting a very tight squeeze on supplies and prices in the near term. But as is the case in almost all commodities that are impacted by supply/demand ratios, the laws of economics have not been repealed! Keep any commodity price high enough, long enough and someone will find a substitute and/or production will increase dramatically. That will happen with natural gas.
In looking at domestic supplies, in the United States gas-oriented rig counts hit record levels in mid-December. More significantly, drilling activity during the month of December was increasing steadily in key gas producing areas. Unfortunately, even these modest increases are not enough to keep up with demand.
Temperatures so far this winter are already 9% colder than normal. Obviously, this is going to sharply increase the demand for natural gas. The chart showing the U.S. working gas storage levels being far below where they were at any time during the last three years also shows a vivid example of why there is a current supply/price squeeze. But where can cuts in usage come from as a reaction to these overpriced gas levels? Primarily, you can expect big cuts in usages from the electric generation industry and other industries where a switch can be made from natural gas to diesel-powered generators.
Total U.S. Working Gas Storage Levels
Source--AGA; Michael Rothman, Merrill Lynch Global Energy Team
The Bottom Line: This, like almost any other market, will over-react to the upside. There certainly is no way of telling exactly if or where the top will occur in natural gas prices. You can count on the probability, however, that it will occur relatively soon. This is a classic supply-driven bull market and supply-driven bullish news gets built into prices very early, which means early price peaks.
What Does This Mean For Gas Prices?
To anticipate natural gas prices or related products getting back to levels of a year ago would be irrational. With natural gas prices now trading near the $10 mark, to look for levels in the $4 to $5 range by this coming spring is certainly within reasonable levels of expectation. This is not a time to be locking in prices for fuel needs for the spring.
Natural Gas Continuous Monthly
What About Ammonia?
This is an even more important issue to most of you. For the last several years, we have all become accustomed to paying $200/ton or less for anhydrous ammonia, and now we are staring at $350 plus per ton. What does the squeeze on natural gas prices and supplies mean for anhydrous ammonia? First, let's look at some facts. According to the U.S. Department of Commerce, 17.34 million short tons of ammonia were produced in calendar year 1999, with 88% of this total going to produce fertilizer.
At $2.19/mmbtu, the cost of producing a ton of ammonia is about $100, with gas being 72% of the total cost. At $6 the cost of production rises to about $229. We are now at about $10--don't even bother to get your calculator out! Ammonia producers have few alternatives in this situation. Either they can produce at a loss or cutback on production. There is some of both going on right now.
Many of you have been told by suppliers that you may or may not even be able to get anhydrous ammonia this spring. Some companies are pushing that you lock in both price and quantity right now--but absolutely no guarantees on the quantity. The fact of the matter is, many of these companies have already cut back some on production, and many are still waiting for gas prices to drop before increasing production. The trouble spot here is unless natural gas prices do drop, those touting that supplies are going to be tight and/or in some areas nonexistent--unfortunately may be correct.
The bottom line is this. Although I hate to put it in these terms, no one knows for sure what's going to happen in a market this volatile. But one can say with reasonable certainty that if natural gas prices don't start dropping very soon, anhydrous ammonia availability is going to become even tighter and prices are going to move much higher. At current price levels, the odds of paying somewhere between $400 and $500 a ton for ammonia are not that low. If natural gas prices go on the skids within the next couple of weeks and get back into the $6 range, there are going to ample supplies of both available by the spring.
The other side of this argument is the impact on planted corn and soybean acreage this spring. The market is already anticipating a very large shift from corn to soybeans. Keep natural gas prices where they are today and the shift may be even more severe. For farmers in the western Corn Belt, faced not only with the tight supplies cost, high prices for ammonia, but also with high irrigation costs, there is no question that we could see some dramatic shifts. Are new-crop soybeans overpriced right now? That could be the case.
What To Do
This is actually too risky and too volatile a situation to sit back and do nothing. While we believe that the odds of natural gas prices plummeting sometime between now and spring are high, that may not be translated into a significant increase of anhydrous ammonia production or decline in prices by then. This is one of those situations where it would probably pay to split the decision--get something bought now. No one says that you have to book 100% of your remaining anhydrous ammonia needs. But what about booking 50% and getting the price locked in. The situation could get worse before it gets better, and right now that looks like the scenario to follow. When in doubt-buy part of your needs and hope you are wrong.
January 5, 2001 Richard A. Brock & Associates, Inc. 2050 West Good Hope Road, Milwaukee, Wisconsin 414-351-5500