Food Prices and Fertilizer Markets

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Publisher(s): IFA, Paris, France, 8 December 2008

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Food Prices and Fertilizer Markets

Factors influencing the variations in fertilizer market conditions

Recent concerns over the adequacy of global food supplies and consumers’ food costs have spawned an interest in better understanding the role of fertilizers in agricultural and food production. This overview is meant to provide a short introduction to major aspects of fertilizer market dynamics and an analysis of the factors that drive the trends in fertilizer market conditions.

Fertilizers are a main component of sustainable agriculture

Agriculture is by nature a high risk economic sector, in particular due to its dependence on climatic conditions. It is today facing additional challenges, such as: population growth, changing dietary habits, limitations to cropping area expansion, and climate change. Used together with on-farm sources such as manures and crop residues, fertilizers provide the nutrients that farmers need to grow plentiful, high-quality crops to meet the world demand for food, feed, fibre and biofuels (1) . In many countries, the soils have been depleted of essential nutrients and crop yield growth rates have been decreasing because of imbalanced fertilization and suboptimal application rates. In addition, the increased consumption of animal protein, fruits and vegetables requires extra productivity to prevent expansion of farming to fragile ecosystems. Both factors call for sustainable intensification relying on a better use of fertilizers and other nutrient sources to maintain soil fertility and increase yields, while minimizing the impact on the environment.

Growing incomes, biofuels and low grain stocks push agricultural commodity prices upward

The underlying reason for increased fertilizer demand is growing incomes in developing countries, which trigger better diets and changed food preferences, thus increasing the demand for agricultural goods. IFA’s analyses show that South and East Asia are anticipated to account for some two-thirds of increasing fertilizer use in the next five years. Brazil also has a significant share.

In addition, growing interest in biofuels has pushed demand for fertilizers upwards. IFA estimates that up to 2.5% of global fertilizer consumption is used to grow biofuel crops. This additional demand emerged rapidly when fertilizer profit margins were relatively small.

Over the past ten years, world cereal demand mostly exceeded production, thus leading to record low and declining stocks-to-use ratios (see graph below).

Agricultural commodity prices drive fertilizer use

Investing in crop inputs, such as fertilizers, to increase yields and crop quality carries some risk, because farmers generally buy fertilizers on credit that is repaid only when their harvests are sold. Therefore, the price that farmers expect to receive for their output influences their decision to invest in fertilizers in the pre-planting season. Studies (2) have shown that the price of agricultural commodities has a greater influence on farmers’ decisions to invest in fertilizers than does the price of fertilizers.

For this reason, rising market prices of agricultural commodities tend to pull fertilizer demand upward. This graph shows that the prices of major cereal crops started rising before fertilizer prices. Similarly, crop prices started to decline before urea and DAP prices in the second half of 2008.

Underinvestment in production capacity leads to tighter markets

Fertilizer prices had been more or less flat in real terms for at least 15 years until their sharp increase in the first half of 2008. The same was true for prices of agricultural commodities, which, as mentioned above, are a major determinant of the level of fertilizer consumption. Low return on investment combined with political complacency after decades of cheap food prices, contributed to limit investment in agriculture and fertilizer production.

As a result, fertilizer capacity expansion – which requires a significant injection of capital (1.5 to 2.5 USD billion) and up to five to eight years of lead time – has not kept pace with demand. Fertilizer markets will remain tight until this gap is closed, especially since production capacity has been operating at or near record levels.

When medium-term forecasts for fertilizer demand started to indicate higher growth rates several years ago, the investment level did increase. But the sudden interest in biofuel production along with the rapidly rising incomes of large population groups (such as China) raised demand for agricultural output – and thus fertilizers – even faster than predicted. In addition, building materials, equipment and manpower being in such great demand, construction costs have risen and timeframes for bringing new capacity online lengthened. Crucially, the fertilizer industry’s revenue stream must be adequate to make these necessary investments possible. This is a challenge in uncertain economic times.

Farm-gate prices are influenced by many factors

The delivery price that farmers pay for fertilizers depends on a number of factors, many of which are not directly related to fertilizers. These include inland transport costs, taxes, administrative costs, mark-ups by intermediaries and many others.

This graph illustrates the difficulties faced by African farmers, especially those in landlocked countries (like Mali). Numerous transaction costs make fertilizers more expensive in Africa – where soil fertility is declining at alarming rates – than anywhere else in the world. Consequently, few farmers in the region can afford to replenish the nutrients removed from their fields by each crop and lost to erosion. This is a major factor in declining agricultural productivity in Africa.

Energy and mineral commodities prices impact fertilizer costs

The energy, mineral and mining sectors have experienced similar price trends, but they have been under less scrutiny because their products are not directly linked to food production. It is, however, important to note that these sectors are interrelated. Fertilizer production consumes approximately 1.2% of the world’s total energy on an annual basis. By far, the main energy requirement is the fuel and feedstock requirements for ammonia manufacturing, equal to some 94% of the industry’s total energy consumption. For economic and environmental reasons, natural gas is the primary hydrocarbon feedstock in ammonia synthesis, from which almost all nitrogen fertilizers are derived. Nitrogen fertilizer production being such energy-intensive, high fuel costs consequently drive up fertilizer production costs. In addition, energy prices also affect the cost of shipping bulky fertilizers and their raw materials around the globe.

Tariffs on fertilizer exports reduce available supply

Major fertilizer exporting countries have been implementing export taxes (tariffs and other measures) on fertilizers in order to provide adequate access to their farmers at relatively low prices. These actions may exacerbate an already tight supply situation by inducing a reduction in the availability of fertilizers in the international market.

Conclusion

The recent volatility in agricultural and fertilizer prices is a reflection of a combination of factors:

• global grain market conditions;
• extreme uncertainty on crude oil prices;
• global economic weakness, in addition to the widespread credit crunch;
• depressing global freight conditions; and
• variations of the US dollar exchange rate.

All these cyclical effects have shadowed the secular trends of rising food demand, underpinned by a steady growth and resilient low stock-to-use ratios. This is not a short-term phenomenon caused by weather-related supply shocks, but rather a longer-term paradigm supported by sustainable demand pull factors. Volatility is, thus, expected to persist until new capacity is available.

(1) Plants require large quantities of nitrogen (N), phosphorus (P), potassium (K) and sulphur (S), but another 9-16 micronutrients are also necessary, depending on the specific crop. Every harvest removes nutrients from the soil. By replenishing these nutrients, fertilizers help safeguard soil fertility and make it possible to keep producing bountiful harvests.

(2) F. Bel, G.D. d’Aubigny, A. Lacroix and A. Mollard (2004) “Fertiliser taxation and regulation on nonpoint water pollution: a critical analysis based on European experiences”. International Journal of Water, vol. 2, no. 4, 2004, pp. 247-266.

J. Poulisse (2007) “Increased Fertilizer Use Opportunities and Challenges for Food Security in Sub-Saharan Africa”, presented at the 13th AFA International Fertilizer Forum. 6-8 February 2007. Sharm El-Sheikh, Egypt.

Used together with on-farm sources such as manures and crop residues, fertilizers provide the nutrients that farmers need to grow plentiful, high-quality crops to meet the growing world demand for food, feed, fibre and biofuels. Plants require large quantities of nitrogen (N), phosphorus (P), potassium (K) and sulphur (S), but another 9-16 micronutrients are also necessary, depending on the specific crop. Every harvest removes nutrients from the soil, and fertilizers help replenish them, thus safeguarding soil fertility and making it possible to keep producing bountiful harvests. Recent concerns over the adequacy of global food supplies and the final food costs facing consumers mean that many people are trying to better understand fertilizer production and the related economics. This overview is meant to provide a short introduction to major aspects of fertilizer economics.