Those of us who cover commodities at Wall Street Daily have written many times about the revolution of cheap U.S. shale gas – and how far-reaching its impact has been.
A recent proposed merger demonstrates the influence of shale gas on multiple sectors… including fertilizers.
Two companies – CF Industries (CF) and Norway’s Yara International ASA (YARIY) – are working on a $27-billion deal that, if agreed to, will create the world’s largest producer of nitrogen fertilizer.
With both companies set to benefit, could this unusual pairing be the start of a new trend?
Cheap Shale Gas: The Key Ingredient
Here’s how this all works…
Natural gas is used in the Haber process, which captures nitrogen (a key component of plant growth) from the air to create ammonia. That ammonia is then used to make fertilizer.
It’s easy, therefore, to see why Yara is so smitten with CF. After all, cheap shale gas means fertilizer businesses can become even more profitable.
In fact, thanks to low-cost U.S. shale gas, CF’s profit margin in its nitrogen fertilizer division was a whopping 52% in 2013. In contrast, Yara’s profit margin was only 9.2% thanks to higher-cost European natural gas.
Not surprisingly, Yara is anxious to get in on the shale gas gravy train in the United States.
In May, the company announced plans to build an ammonia plant in Texas in conjunction with German chemicals giant BASF SE (BASFY). But a deal with a major U.S. producer of nitrogen fertilizer is really what Yara wants and needs.
Of course, this isn’t a one-sided relationship. CF also benefits from Yara’s vast geographic reach, as Yara manufactures fertilizer in more than 50 countries and distributes to more than 150.
Finally, this deal is a real plus at a time when Chinese nitrogen fertilizer makers are threatening to ramp up their exports, including to the United States. After all, China produces about half of the world’s nitrogen fertilizer.
A Look Ahead
The key takeaway for investors is that this proposed merger may be just the start of a flurry of activity in the nitrogen fertilizer sector.
First, bear in mind that, unlike other fertilizers, nitrogen doesn’t stay in the soil and must be re-applied every year by farmers. Demand, therefore, is steady.
Second, shale gas costs in the United States should remain low relative to the rest of the world. For example, the bountiful output from the Marcellus shale recently pushed the spot natural gas price at the Dominion South trading hub in Pennsylvania to about $1.57 per million BTU. That’s down 60% in the last six months alone!
This cheap gas, according to Mark Gulley of BGC Financial, is already translating to $12.7-billion worth of new fertilizer plants that are set to start producing by 2020 in the United States.
Even if the CF-Yara deal falls through, look for each company to find other, similar dance partners.
And “the chase” continues,