GCC Fertilizer producers fail to cultivate profit

Arabian Oil and Gas investigates why the region's export based fertilizer industry's is struggling to turn a profit, despite growth in demand

Supply capacity is outstripping demand and crushing profit margins in the Urea market.
Supply capacity is outstripping demand and crushing profit margins in the Urea market.

With low Urea prices and tiny profit margins to contend with, some MENA producers are beginning to turn their backs on the fertilizer industry, as global capacity outstrips demand for the regions nitrogen based products.

The Middle East is responsible for producing around 37% of the world’s Urea based fertilizers. With few arable industries of its own, the region’s fertilizer industry is geared towards exports. Almost half of the Urea based fertilizers produced in the Middle East are exported abroad, a trend that is set to continue as the world’s population grows.

“Middle Eastern fertilizer producers will soon make significant contributions to the global food banks. By 2030, the world will need to feed an estimated 2bn more people, so fertilizers will be crucial in ensuring that these individuals have access to edible, sufficient and nutritious food,” said Dr Abdulwahab Al-Sadoun, secretary general of the GPCA.

The GCC’s fertilizer sector is growing quickly. Regional capacity now stands at 42.7mn tonnes per year, while production levels increased by 4% between 2013 and 2014. Global fertilizer market grew by just 1.7% for the same period.

However, the region’s key fertilizer producers are struggling to turn a profit, as regional and global supply surpasses demand, driving down Urea prices and profit margins.

Some of the region’s biggest players are starting to question the wisdom of continuing to produce fertilizers over the coming years. The Petrochemical Industries Company (PIC), the downstream arm of oil and gas giant Kuwait Petroleum Company (KPC), is in the process of drawing up plans to exit the fertilizer market altogether.

“There is a greater profitability in petrochemicals than in fertilizers, especially in the olefins and aromatics,” said Assad Al Saad, chief executive officer of PIC.

If PIC do opt to exit the fertilizer industry, it could be done via a programme of privatisation or by closing their refineries altogether. The decision would need to be reviewed by PIC, KPC and Kuwait’s Supreme Petroleum Council before it could be ratified and implemented. However, the very fact that IPC is considering pulling out of the fertilizer industry is a sharp indicator of how difficult it can be to turn a profit.

The crux of the problem is global: international supplies of Urea are dramatically outstripping demand.

“Whereas we have seen demand rise by between 1.5% and 2% per annum, supply has outpaced that for some time. At the moment we are looking at a compound annual growth rate in Urea supply capacity of around 6-7%,” said Allistair Wallace, senior consultant, CRU, speaking at the Fifth GPCA Fertilizer Convention, in Dubai.

There are a number of international factors in play that are having a direct bearing on the Middle East’s profitability in the Urea business.

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Additional capacity was being added to fuel increased demand from India and China, whose rapidly expanding populations demanded huge volumes of Urea for crop fertilization.

“Those demand trends from India and China have eased but we haven’t seen that same easing in capacity development,” explained Wallace.

The excess glut of unsold product is leading to market oversupply and is weighing heavily on prices. At the start of 2014, Urea prices were down around $290 per tonne compared to prices of almost $500 per tonne in 2010, 2011 and 2012.

Between 2009 and 2014 30mn tonnes of Urea capacity has been added to the global total. Analysts are predicting this capacity increase to continue in the short to mid term.

“Looking at plants that are in the process of being built or that have secured financing, we estimate that a further 30-40mn tonnes of Urea capacity will be added by 2019. That’s a lot of Urea and we certainly don’t expect demand to increase by anywhere near that rate,” said Wallace.

Analysts believe that such a surge in capacity must lead to lower operating rates, lower pricing and, ultimately, market rationalisation measures.

“It seems clear that there must inevitably be some degree of market rationalisation in the years to come. How much and at who’s behest, we are still unsure,” he said.

As difficult as it is for Middle Eastern producers to compete in an oversupplied market, the message from industry experts is this: things could be a lot worse.

Producers have tried to boost profitability by investing in production capacity in low cost regions. However, these low cost regions often carry a higher element of risk and some of the world’s superfluous capacity is being nullified by war and geo-political point scoring.

Ukraine is one such region that is having a significant impact on global Urea prices. Ukraine has 2 massive Urea plants located in its Eastern Donbas province, a flashpoint for the ongoing conflict with Russia. These two plants have been closed for the majority of 2014 and have removed 2mn tonnes of Urea supply from the global marketplace.

In retaliation for Russia’s decision to withhold gas supplies, Ukraine has banned Russia from using its pipeline network to export Ammonia to Europe. Simultaneously, Nitrogen plants in Western Ukraine have switched to producing Ammonia instead of Urea in an attempt to capitalise of the absence of Russian Ammonia in the European market place.

Analysts forecast that Ukraine will continue to under deliver to the tune of 2mn tonnes of Urea over the next 12 months. Were it not for this mitigating factor, Urea prices would be even lower than they are today.

As the situation in Ukraine shows, the Middle East’s fertilizer producers are at the mercy of factors outside of their control. China is the world’s biggest producer of Urea and the actions it takes have a knock on effect on markets around the world.

China is in the process of streamlining its taxation system for exports of Urea, which it is hoped will smooth out Urea supply from China. Under the previous system, China imposed a prohibitively expensive export duty for the first six months of the year, and waved it in the second half, creating a high and low season for exports.

“Unfortunately, this system was being abused by Chinese producers who exploited warehousing and inventory systems to create huge stockpiles of Urea, custom cleared during the permissible export season and then shipped during the off season,” said Wallace.

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This sporadic flooding of the market had a chronically destabilising effect on global Urea prices, making it harder for producers in the Middle East to accurately forecast their bottom line and build sustainable, long term plans of attack.

Since 2013, China has simplified its taxation system and is expected to continue to refine it in 2015. This will help to stabilise Chinese production levels.

“They have flattened the differential between the high season and the low season. In the high season, when Chinese farmers are using Urea, the export tax would stand at around $7 per tonne plus 15% of the net export value. In the low season it becomes a flat tax of $7 per tonne. This has improved things. We are seeing a much more even flow of Urea out of China but it is still a very distorting factor,” said Wallace.

The new taxation regime will lead to short term capacity growth in China. However, the good news for Middle Eastern producers is that analysts see an end to Chinese capacity growth by 2019.

“We are looking at 100mn tonnes of Chinese Urea being operational by 2019, when the expanding capacity tapers off. That’s a growth rate of 7.6% between 2012-2016,” he said.

Just how low Urea prices can go will in all likelihood be dictated by China. One ray of hope for Middle Eastern producers is that Chinese Urea production is based almost exclusively on coal gasification. The price of coal has been tipped to rise significantly in the coming years, which could help to push up the price of Urea giving profit margins a boost.

“I think it’s good for the nitrogen industry because over the next five years we are forecasting coal prices to increase significantly. The coal market has been oversupplied for the past 5 or 6 years. We’ve had some pretty dramatic oversupply coming from Australia, coupled with a fall in demand in China. We are not expecting demand to increase in China but we are expecting other Asian nations to pick up the slack,” he said.

In real terms, this rise in coal prices will push up China’s production costs and increase the price per tonne of Chinese Urea. This in turn could give the Middle East an opportunity to increase its profit margins.

“In 2014, Chinese Urea cost around $245 per tonne. By the time you transport that to the port and pay taxes, you are looking at closer to $280-$290 per tonne by the time it is loaded onto the ship.

“We are forecasting an increase in the base price to $280 per tonne in 2019. Once you factor in the proposed 100 Chinese Yuan export tax, you are looking at a figure of around $330 per tonne,” said Wallace.

The Middle East could be given even more breathing room if China decides to implement a proposed 30% export duty.

“If we factor in 30% duty we come up with an export price of $380 per tonne when it is loaded onto the boat and ready to be exported. That is much, much higher than the current price we are seeing in 2014. So with 30% duty that’s about $100 per tonne higher than today’s rate. With the flat tax of 100 Chinese Yuan per tonne it is only $50 per tonne higher than today.

By 2019, the industry’s profit margins will be safeguarded by the increased Chinese floor price. If Middle Eastern producers can endure five more lean years, greater profitability could be on the cards in the years to
come.

Factbox:
- 37% The Middle East is responsible for this much of global Urea production.
- $290/tonne Urea prices at the start of the current production year.

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