Uncertainty in global stock markets hit a new high after China unexpectedly devalued its currency a couple of weeks ago. Commodities have been hit the hardest, with prices of oil and key metals plunging to multi-year lows. The fear arises from the fact that a cheaper yuan will make imports for China—one of the largest consumers of key commodities—expensive, thereby hurting demand.
While that highlights problems from the demand side, it’s the supply side of the equation that could hurt an agricultural commodity company like Agrium Inc. (TSX:AGU)(NYSE:AGU). If China is among the largest consumers of metals, it is also among the larger producers of nutrients like nitrogen. That’s where the problem lies.
Urea prices heading south…
Prices of urea—a key nitrogen-based fertilizer—have been under tremendous pressure in recent years because of an imbalance between global demand and supply in the industry. China is largely to blame thanks to increasing low-cost urea exports from the nation.
Nitrogen producers in the U.S. turned hopeful when the Chinese fertilizer industry association increased the export floor prices for urea earlier this year. Unfortunately, whatever little urea prices had gained were wiped out as a delayed spring season in the U.S. hurt demand.
…even as supply continues to head north
China accounted for nearly 30% of global urea exports last year. Since the recent devaluation of yuan makes exports cheaper for Chinese fertilizer producers, larger quantities of Chinese urea could get dumped into North American markets. Agrium projects the yuan’s devaluation to lower costs for Chinese urea producers by US$8 per tonne.
What’s worrisome is that besides China, producers in other parts of the world are also boosting urea capacity. CF Industries—North America’s largest nitrogen fertilizer producer—gave out these key statistics during its recent earnings call:
- Urea exports from China projected to exceed 12 million tonnes in 2015.
- Five million tons of new urea operating capacity outside China is projected to come online this year. That will be the largest ever annual volume increase in nearly three decades.
Needless to say, surging global capacity could continue to cap urea prices in coming years.
Why Agrium needs to worry
While Agrium gets a larger part of its revenue from the retail side of its business, which comprises seeds and crop protection products, its wholesale or fertilizers business is the more profitable of the two. Within wholesale, nitrogen is Agrium’s primary product, as shown below:
Given that Agrium downgraded its full-year earnings-per-share outlook to US$7-7.50 from US$7- 8.25 in Q2 because of lower-than-expected potash and phosphate prices, any slowdown in the urea markets could be a big blow.
Investors should watch the developments in China closely, because its move to devalue its currency could roil global nitrogen markets in the long run, posing a threat to Agrium’s top and bottom lines.
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Fool contributor Neha Chamaria has no position in any stocks mentioned.