Circulation: NFU Members Date: 25 th May 2012 Ref: Contact: Tel:

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1 Page 1 Circulation: NFU Members Date: 25 th May 212 Ref: Contact: ben.ellis@nfu.org.uk Tel: May 212 Nitrogen Briefing Introduction This briefing examines the main drivers in the straight nitrogen market, focussing on the two main straight nitrogen products used in the UK: Ammonia Nitrate (AN) and Urea. The price for any product depends on factors including supply, demand and stocks which should be reflected in prices for the export trade. Supply and therefore price can also be influenced by the floor price for the key cost of production, in the case of nitrogen (N) fertiliser this is the energy (usually natural gas) cost. Geopolitical factors such as such as bilateral trade agreements, state buying and product subsidy, trade defence on imports, export tariffs and exchange rates affect price and the buying habits of consumers whether influenced by tradition or perception also play a role in how markets have developed. Finally the consolidation of the supply industry and the continued lack of true transparency affect the degree to which farmers as consumers become price takers on a domestic market. Summary The UK farming principally relies on AN as a nitrogen source, despite urea being a far more popular fertiliser across the world, having a lower cost per kg nitrogen and the potential for a better breakeven ratio even considering volatilisation. Reasons for this include the established AN manufacturing base in Western Europe and the agronomic assistance received from AN suppliers. Unusually the price of Urea is currently higher than the price of AN, this has been led by strong demand from the US. The general direction of travel in the price of urea is matched by AN. However, the AN pattern of a lower start price and gradual increase throughout the year is not closely reflective of the movements in global urea price. This suggests a pricing strategy for AN in the UK and EU which is aimed at influencing demand rather than following the global nitrogen markets. There has been a high level of consolidation in the AN manufacturing industry in Western Europe, inelasticity of demand for nitrogen and reluctance of farmers to switch products when faced with higher prices. A more transparent market place with more regularly updated publicly quoted figures would help farmers to assess the market better and forward prices for fertiliser (as available to our competitors in the US) would allow farmers to use financial instruments to help manage volatility. If farmers were more willing to switch products when presented with cheaper substitutes, they may regain some of their buying power. Production Although there has been lots of discussion about new season prices for nitrogen being available, production of nitrogen is generally not linked to the seasons. Nitrogen production depends on access to a cost effective supply of energy and a host of market driven and global political factors.

2 Page 2 World urea production is estimated at around 67.8 million tonnes of nutrient N per year and world AN production is estimated to be 14 million tonnes of nutrient. Production of nutrient N in each region is set out below using data from the International Fertilizer Industry Association (IFA). Although there has been lots of discussion about new season prices for nitrogen being available, production of nitrogen is generally not linked to the seasons. Nitrogen production depends on access to a cost effective supply of energy and a host of market driven and global political factors. World urea production is estimated at around 68.8 million tonnes of nutrient N per year and world AN production is estimated to be 14.5 million tonnes of nutrient. Production of nutrient N in each region is set out below using data from the International Fertilizer Industry Association (IFA). Nutrient N production by region ( s t) Urea AN West Europe 3.4% 1.9% Central Europe 2.% 7.5% E. Europe & C. Asia (Russia and the FSU) 7.7% 35.% North America 6.6% 18.3% Latin America 3.4% 3.9% Africa 4.% 6.% West Asia (Middle East) 1.8% 1.6% South Asia (India) 18.9%.9% East Asia (China) 43.% 12.% Oceania.4% 3.9% In the last decade, China has almost doubled its urea production to 3 million tonnes per year, however its consumption has increased to almost the same degree and much of the urea produced remains within that country. Exports Around a quarter of world urea production is traded globally between countries and only around 22% of AN produced around the world is exported. However, as with international cereals markets, it is the product which is traded that drives the world price. The regions which drive this trade are the Middle East, which accounts for 32% of all exports of urea and the Eastern Europe and Central Asian region (essentially Russia and the FSU) which account for 61.4% of the world AN export trade and 2% of urea exports. To put the trade of these products into context, exports of urea amounted to around 4 million tonnes of product in 21, whereas there was around 9 million tonnes of AN globally traded. The export trade is not especially transparent. Prices depend on the last deals done for cargoes and this data is only generally available through subscription services. Stocks Stock levels of nitrogen are very difficult to estimate. There are no open and transparent figures available in the same way as figures are available for estimated cereals stocks.

3 Page 3 Consumption Global estimated consumption of urea and AN is set out below using 29 figures from the IFA. Urea AN Estimated consumption per Product Nutrient % total Product Nutrient % total region ( s t) nutrient nutrient West Europe 7,756 3, % 4,977 1, % Central Europe 2,511 1, % 3,9 1,37 9.4% E. Europe & C. Asia 2,718 1,25 1.8% 1,286 3, % North America 12,998 5, % 7,278 2, % Latin America 8,146 3, % 3,132 1,49 7.5% Africa 3,588 1, % 3,63 1,26 7.4% West Asia (Middle East) 5,134 2, % 1, % South Asia (India) 36,483 16, % % East Asia (China) 66,442 3, % 5,164 1, % Oceania 1, % 1, % UK farmers buy approximately 2.2 million tonnes of straight N product each year. Around 65% of this is generally in the form of AN At least 1.1 million tonnes of AN is produced in the UK o This equates to approximately 48% of the total UK market for straight N product or 65% of the straight nutrient N % AN Urea UAN Other The rest of the market is made up of imported AN, urea, UAN, CAN and miscellaneous other straight nitrogen sources. A significant proportion of nitrogen is also applied in NS and NPK blends. The chart above shows the proportion of fertiliser usage by farmers in the UK based on nutrient N from the British Survey of Fertiliser Practice. The UK is unusual in its reliance on AN relative to urea. Globally, AN only accounts for around 6% of world straight nutrient N consumption against urea which accounts for over 68%. The UK is the third largest consumer of AN in the world but we rank only 41 st in our consumption of urea, putting us 21 st as global consumers of straight nutrient nitrogen, according to IFA figures for 28.

4 Page 4 The fact that over half of the UK consumption of straight nutrient nitrogen is home produced by one manufacturer, the relatively low volumes of AN globally traded as direct substitutes and the general reluctance to change nitrogen source from AN makes UK farmers into AN price takers. How the price UK farmers are offered AN for is arrived at depends on two factors, the floor gas price and the cost of the main substitutes for UK AN: imported AN and urea. Gas price The fuel stock for AN production in the UK is natural gas with the benchmark price for this being the European natural gas cost. The majority of urea is produced by regions that generally benefit from lower energy costs such as China, Russia and the Former Soviet Union, North America, India and the Middle East. Natural gas costs in Europe are far higher than the main neighbouring nitrogen exporting areas of Russia and the FSU, the Middle East and North Africa. To combat some of this inequality, trade defence measures are used against fertiliser producers in countries which the EU deems to benefit from state subsidised gas. Gas price drivers would only come in to play when global urea prices drop below the costs of production in Europe. As European manufacturers have a higher cost of production than their main competitors outside Europe they must either charge more for their product and risk losing market share or shut down facilities until the situation improves. We are not anywhere near those levels currently and as nitrogen prices have outstripped the rises in gas cost and have continued to rise even when the gas price has fallen, therefore gas prices cannot be seen as the main driver for the increased nitrogen price. Fertiliser price In the absence of pressure from gas prices, UK AN is priced against urea, the cheapest and most widely traded competing product. If AN is priced too highly against urea, farmers will be provided with a strong incentive to switch products and market share will be affected. Conversely, if it is priced too low manufacturers will not be optimising their return from the market which does not make sound business sense. The is no incentive to the manufacturer to be uncompetitive. The availability of generally cheaper sources of imported AN also provide another substitute although the prices on imported AN usually closely track both the UK AN price and global urea price. Supply/Demand for Urea has been led by: Demand from the US with farmers there intending to plant a record Maize harvest this year. Supply of Urea has been limited due to the economic sanctions on Iran, combined with the unstable political situation in North Africa and the Middle East forcing new production facilities to be slow to come on line. Supply/Demand for AN has been led by: Increasing demand due to the rise in price of Urea. Shipments of Eastern European AN have reduced as producers cater for home markets. This will result in most U.K supply of AN coming from home producers. Demand is also affected by the weather, if the weather is too dry farmers may not spread at all and save the fertiliser for next season, this could force prices lower.

5 Jan-7 Apr-7 Jul-7 Oct-7 Jan-8 Apr-8 Jul-8 Oct-8 Jan-9 Apr-9 Jul-9 Oct-9 Jan-1 Apr-1 Jul-1 Oct-1 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Cost /Tonne Natural Gas $MMBTU Page 5 April on-farm UK AN price is c /t, with imported AN approximately 5/t cheaper. This is slightly below on-farm spot prices last April of 325 per tonne (AN) and is lower than the average price at the start of the season last year at 319(AN). This is unusual and is likely to have been caused by pricing from major producers being too high last June. There is currently high volatility in the Urea market with recent on-farm spot prices to rising to /t. The price per kilo of Nitrogen from Urea is now /kg compared to.89-.9/kg from Ammonium Nitrate. Urea price is used as a benchmark as it is far more widely traded globally and represents, for most farmers, the most viable immediate substitute to AN. In this way, it has a similar substitution effect as maize prices do in the wheat market. These substitution factors should help to keep UK AN prices in check despite the UK now only having one nitrogen producer. However, this depends on the willingness of the UK farmer to switch products and the perceived value of UK AN over its substitutes Urea, AN, Natual Gas Prices Jan 7-May Urea (Granula Urea) Bags AN (Bags-UK) Millers Wheat (HGCA) Natural Gas (World Bank GEM Commodities Natural Gas Europe) Source: UK AN Prices in Sterling (Dairyco (Farmbrief)), EU Natural Gas in $ World Bank.

6 Jan-7 Apr-7 Jul-7 Oct-7 Jan-8 Apr-8 Jul-8 Oct-8 Jan-9 Apr-9 Jul-9 Oct-9 Jan-1 Apr-1 Jul-1 Oct-1 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Pence/Kg Page 6 Assessing value To examine the relative values we need to look at the cost of nitrogen in pence per kg. The chart below shows that the costs of both principal sources of nitrogen have increased in the last two years. The difference in the cost of nitrogen between AN and urea has grown from 2 to 18p/kg over the same period, leaving granular urea looking a better buy than AN on a p/kg supplied basis. Even equating for a potential 2% loss to volatilisation, on a raw value basis, urea has become more attractive, shown by its increasing use on farm in the past two years Price/Kg Urea Price/Kg AN Difference in price (AN-U) Source: DairyCo (Farm brief) Along with an assessment of the comparative value of AN and urea, it s important to take a view on whether both sources of fertiliser represent value for money based on recent history. The chart below shows how the break even ratio of granular urea and AN against the UK ex farm wheat price has changed in two years. This ratio reflects the kilos of grain needed to pay for 1 kg of nitrogen fertiliser using spot prices for fertiliser and wheat and assuming no forward selling of grain.

7 Page 7 8:1 7:1 Break Even Ratios on Spot Prices 6:1 5:1 4:1 3:1 2:1 Urea Break even Ratio AN Break Even ratio 5:1 Ratio RB29 1:1 NB: Ratio plotted against Millers wheat (HGCA) price Although the AN price has doubled from June 29 to a projected June 212 figure of 3t, the break even ratio against wheat of the two points in time is broadly similar but with Urea offering a slightly better ratio. In the same time frame, granular urea has again become better value for the cereal farmer when compared to AN. The green line in the chart above represents the 5:1 benchmark figure that the cereal application calculations in RB29 are now based on. Above and below this line you are recommended to adjust levels of nitrogen to achieve the optimum N application rate. Buying strategies in the UK market The consolidation of suppliers and reduced credit terms available since 28 has left many farmers feeling that their power as buyers have been reduced. It is therefore worth exploring the nitrogen buying options available to farmers and their opportunity to reduce risk and manage volatility. When talking about purchase quarters, we have used the AN manufacturers buying season which in this case runs from June to May each year. Time of purchase As we appear to be wedded to buying AN in the UK and given that it generally follows the same overall price fluctuations as urea, the time of purchase is the main method that farmers have to manage their fertiliser purchase risk. The chart over the page on the left shows that in eight out of the last ten years the cheapest prices available for AN have been in the first quarter of the fertiliser buying season (June to August). 8 The only years when buying later would have achieved a cheaper product were 22, although buying before Christmas was still advantageous; and 28, when prices collapsed from their peaks as demand was stifled. /t Urea FOB Yuzhnyy Q1 Q2 Q3 Q4

8 Page 8 /t UK on farm AN The general trend each year has been for the AN market to start slowly and build up in price as the season progresses. This has the effect of pushing people into committing early to obtain a good price and secures an order book for the manufacturers for production until Christmas. Although the general pricing of AN and urea is comparable, international urea prices do not always appear to follow quite the same trend in the year of starting low and consistently increasing to the end of the season. This became apparent when urea price fell this spring but were not matched by a corresponding fall in AN prices. Q1 Q2 Q3 Q4 This disparity between AN and urea within years suggests that the price of AN in the UK is managed rather than truly following the market. One of the reasons for this is due to the unwillingness of farmers to more readily change product to achieve the best price, although the lack of transparency and consolidation of supply of AN in the UK and Western Europe undoubtedly plays a role. Based on international FOB prices (chart above right), the fourth quarter (from March to May) has been the best time to buy urea, but only in four out of the last ten years. In all other years, the best prices have been distributed evenly between all of the other quarters. Although on average cheaper prices have been achieved for urea in the first half of the buying season (June-December), the picture is far more mixed than it is for AN. If farmers were ready to switch and break the buying season habits, the disparity in prices in the year could present a risk management opportunity for farmers, however the cost of nitrogen in p/kg and the breakeven ratio must be carefully considered throughout. In practical terms, time of purchase for farmers is often determined by two factors: ability to pay and storage space. The fertiliser trade has moved in recent years to reduce payment time and, in many cases delivery time to the month of purchase meaning that farmers need both the space and funds in order to buy early at lower AN prices. Loans are available through companies such as ING and with the price movements of AN between opening season and closing season price in recent years, the cost of finance from various sources would have been justified in order to take delivery early. Fertiliser is an expensive commodity and if you don t have the space to store it properly, you are pushed into taking delivery when dry and secure storage space is available. On many livestock farms this is at or after Christmas when significant volumes of straw have been moved to clear shed space or hard standing to take fertiliser. For this reason, many livestock farmers end up buying when AN is near its peak price and some relatively suffer some of the highest nitrogen costs. Forward prices Whilst it can be said that watching the international urea market closely will help achieve the best possible price in the season, this is not an easy task.

9 Page 9 Forward prices for nitrogen are not published and no transparent mechanism or exchange exists to allow farmers to track the market in the same way that the cereals market can be judged. There is also no immediate tracking mechanism offered by Defra or AHDB to assist farmers with buying decisions. The lack of forward prices and general market transparency for the end consumer of fertiliser have an impact in several ways. Farmers are unable to follow the market accurately and in many cases rely on the market information they receive from the person trying to sell them the product. Forward prices cannot be used to plan fertiliser purchases against grain sales, leaving arable farmers unable to rationalise the price of their largest variable cost against output. Livestock farmers are not able to enter the market with any degree of certainty and in most cases must wait until mid-season before entering the market. In the US, farmers are offered forward purchasing model where the fertiliser manufacturer fixes the price of natural gas (the principle cost of AN production) at the same time as they quote a fertiliser sale price to the farmer. This then allows the farmer to fix his fertiliser price (the single biggest variable cost for an arable farm) against the wheat price. This arrangement is offered up to twelve months forward. There is nothing to stop EU manufacturers offering such a service to farmers as the ICE Commodities Exchange offers natural gas prices for up to seven years forward. There would undoubtedly be a cost as futures prices are almost always in advance of spot prices, but it would be another way for farmers to manage the volatility they face in the fertiliser market. It would also be another way for manufacturers to get committed tonnages on to the order books early. However, up until now, the idea has had a frosty reception from EU fertiliser producers concerned that if the market drops they will be put under pressure to drop the prices on contracts taken out and if there is a problem with production they will be put in a difficult position to satisfy orders already committed.