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Just-in-time fertilizer

Jul 1, 2006 12:00 PM
By David Hest


THE TIME when fertilizer dealers will be able to reliably supply customers who want to book fertilizer just before they need it is coming to an end.

Dealers, their hands forced by industry changes beyond their control, see the writing on the wall and are beginning to make plans to require customers to commit to purchases well in advance of their needs. Growers unwilling to book ahead will face the risk of not being able to buy fertilizer when they need it.

In addition to rethinking fertilizer sales strategies, retailers are taking a new look at hedging and other strategies to counteract the increasing risk they face in procuring fertilizer.

That's the picture of a changing fertilizer marketplace painted by Bruce Vernon, head of crop nutrients marketing for Agriliance. “With the price volatility the way it is, nobody is going to put fertilizer out in the marketplace just hoping somebody will buy it later,” he says. “Out of necessity, the farmer will have to take on some of this risk.”

Caught in the middle

Dealers are caught in the middle between manufacturers and distributors on one side and growers on the other. Over the past couple of years, distributors have pulled back from informal sales agreements that allowed fertilizer to be booked without the legal teeth to enforce follow-through if the market price fell. Instead, distributors have required retailers to make legal commitments to back purchases.

“The level of risk came at us a lot faster than it did dealers and farmers because of our position in the supply chain,” Vernon says. “We had to make changes in the way we did business.”

To help reduce the inherent risk of new purchase requirements, retailers have been telling customers they will have to begin booking ahead or suffer the consequences. But growers have been reticent to change their buying habits. Steady nitrogen fertilizer price declines since record highs early last winter have emphasized the risk of adopting the new approach — and made it harder to swallow.

“Our customer hasn't had an availability issue, but that is what we are facing down the road,” says Doug Wright, purchasing manager for Mid-Kansas Cooperative, Moundridge, KS, a large agricultural retailer in central Kansas. “Until they feel that crunch, they are just going to hear this warning as a sky-is-falling threat. We don't know when we will be in a position of having fertilizer supply interrupted, but we think it will happen.

“The manufacturer and the distributor cannot afford to cover the price risk in fertilizer,” he adds. “Now the retailer has the risk of having the product to supply the customer, assuming it hasn't been forward contracted.”

Dodging a bullet in 2006?

According to Vernon, a fertilizer shortage was narrowly averted in 2006. “This year it didn't break, but it was set up to,” he says.

Sales started slow last winter because of high prices following domestic natural gas disruptions from Hurricane Katrina. Sales didn't start moving until late January and February, when the U.S. price of natural gas fell and nitrogen prices began to drop. Because buying was delayed, distributors and dealers, who are increasingly dependent on imports from the Middle East and elsewhere, weren't able to procure enough supplies to handle normal fertilization rates.

“There would have been a shortage if farmers had applied normal N rates,” Vernon says. Early estimates show that nitrogen utilization will be down 10 to 12% this year, with phosphorus and potassium down 20 to 25%.

Urea that arrived in the U.S. on the tail end of the application season — just in the nick of time had farmers followed normal fertilization practices — has ended up being re-exported.

Behind the change

A number of factors are behind what Vernon and other industry insiders see as the need to change fertilizer-buying practices. These factors include growing worldwide demand for fertilizers, as well as high U.S. natural gas prices, which have reduced domestic nitrogen manufacturing capacity and increased dependence on imports by the U.S.

Volatility of U.S. natural gas prices is a third critical factor, since natural gas is the major component in nitrogen fertilizer and world fertilizer prices are pegged loosely to the U.S. natural gas market.

Because of increased price volatility and the resulting higher risk of loss of value of inventories, manufacturers and distributors have tightened sales practices in recent years. Instead of having ample supplies on hand for anticipated needs, they have held back on booking fertilizer until it has been sold. The potential for shortages emerges when these changes are overlaid with longer lead times to procure fertilizer than in the past — between 45 and 75 days from loading from a plant in the Middle East to major distribution facilities in the Midwest.

“In the past, we had ‘just-in-case’ inventory,” Vernon says. “We've gone from ‘just-in-case’ to ‘just-in-time.’ It is hard to do just-in-time with a bulky product like fertilizer.”

“We have been telling our customers that the domestic fertilizer industry is going the way of crude oil,” says Wright, the Kansas ag retailer. “We are an import-dependent country. We have to begin to procure supplies months in advance for this system to work.”

Hedging tools needed?

Wright says dealers may need to work on ways to offer hedging tools to help both themselves and growers manage the price risk on contracted fertilizer.

“We are exploring new ideas for minimizing risks on fertilizer input costs both for our business and to make them available to our customers,” he says.

Hedging tools currently aren't widely available and aren't very attractive. Because of a lack of liquidity, Chicago Mercantile Exchange fertilizer futures contracts, though available, aren't practical. The large international Direct Hedge Exchange, based in Switzerland, isn't workable for many retailers, much less a grower, given its 5,000-ton contract size, Vernon notes.

Wright and his company have examined hedging using natural gas options against anhydrous ammonia purchases. The company also has looked at over-the-counter option strategies that might allow them to bundle fertilizer purchases and price protection in a single product. But neither approach is ready for prime time at this point.

“The manufacturer and the distributor cannot afford the risk of manufacturing and buying fertilizer unless it is sold,” Wright says. “Now retailers have to take on that risk to have the product to supply to the customer. If retailers haven't forward contracted with the customer, or hedged their risk some other way, the risk to us is immense.

“After the beating farmers and the industry took this spring on forward contracts and the devaluation in the marketplace, we have got to find a way to do this.”

Nitrogen price outlook

Volatility is the only thing certain about nitrogen prices

VOLATILITY THAT led to last winter's post-Katrina nitrogen fertilizer price run-up — and falling prices this spring and early summer — makes forecasting prices a challenge.

By the time you read this, a Katrina-like event may have jolted the market or may be just around the corner. Or prices, which had been flagging for months when this was written, could continue to soften.

Volatility is a huge challenge for virtually all the players involved in the fertilizer market. That's because the potential for dramatic changes in the value of inventory makes decisions to manufacture or procure fertilizer risky, says Bruce Vernon, Agriliance director of crop nutrients marketing.

And volatility is not going away anytime soon. “We believe that the extreme volatility we have seen in the past year is the new ‘normal,’” Vernon says. “It isn't a one-year situation.”

Vernon says, in the coming months, nitrogen prices again will be highly volatile. “We are one event from turning eroding prices around on a dime: one hurricane, an unfortunate geo-political event, an inordinately hot summer that drives up natural gas prices,” he says. “If we don't get that single event, prices will keep eroding for some time.”

In mid July, as the Israeli-Hezbollah conflict in the Middle East began to heat up, U.S. domestic natural gas prices were becoming more volatile but had not increased enough to affect the softening nitrogen market.

Three new urea plants in Egypt, Saudi Arabia and the United Emirates have come online in recent months, well ahead of schedule. Together, the plants have the capacity to export about 2 million metric tons of urea, enough to help keep urea prices soft, despite continued growth in world fertilizer demand. Unless, of course, unexpected events intercede.

Soft nitrogen prices are likely to put additional pressure on domestic fertilizer manufacturers. They may respond by curtailing production or permanently shuttering plants. This would bring supply and demand back into tighter balance, until the next round of urea plants now under construction or on the drawing boards begins production. Ahalf-dozen urea plants — mostly in the Middle East — are scheduled for completion by the end of 2008. They will bring an additional total annual capacity of between 4 and 5 million metric tons to the marketplace.

Risk assessor

Agriliance introduces a new program for managing fertilizer market risk

By David Hest

AGRILIANCE WILL begin offering a new program this fall to help dealers better cope with more volatile fertilizer markets. It also hopes the program will help retailers to interest their customers in making advance fertilizer purchases.

The program includes a new service to help dealers assess and manage risks associated with buying and merchandising fertilizer, plus a grower version of its Crop Nutrient Exchange (CNX) for dealers to offer to their customers. CNX is an online buying tool for ag retailers that offers up to 600,000 tons of fertilizer daily at various locations for immediate delivery, or delivery up to 14 months in the future. All major nutrients — except ammonium nitrate — are available.

One of the incentives for participating in the program will be access to the grower version of CNX. It will give individual dealers their own sophisticated online store to market current and forward fertilizer inventories. Agriliance hopes that offering the new service will motivate growers to buy fertilizer earlier.

Bruce Vernon, head of crop nutrients marketing for Agriliance, says the risk-management portion of the new service provides a critical first step for dealers to better understand their ability to tolerate the risks in the fertilizer market. Dealers who participate in the program will use an online tool to assess their financial and emotional tolerance to risk.

The patent-pending Web-based program, which was developed by Agriliance, incorporates business assessment tools and practices from other industries and applies them to fertilizer. Participating ag retailers will work with an individual “risk advisor” to assess buying trends versus needs. The goal is to develop fertilizer procurement strategies that recognize and minimize risk.

Because the software is Web based, the retailer and the risk advisor will be able to look at the same information and perform “what-if” analysis of many strategies, Vernon says. “This program isn't a crystal ball and it doesn't guarantee that you are buying at the low,” he says. “It takes a systematic approach that will reduce risk.”







 

SEFP ATE




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