A Heyday In The Heartland

Welcome to the corn vs. soybean smackdown, part two. Soybeans ceded the first round when an early 2007 spike in corn prices prodded farmers to snap up corn seed and dedicate more acres to corn instead of soy.

The result: a record-breaking corn crop. Soybean markets slid from surplus into shortage.
Now soybeans are back and badder than ever. Both corn and soy prices are spiking, once again, to record levels. But short supplies have driven soy prices way beyond expectations, leaving farmers struggling with a lucrative dilemma.

"I can't get a good feel for what farmers in Iowa are going to do," said John Sawyer, Extension Soil Fertility Specialist with Iowa State University. "They are, in essence, clamoring to be planted to soybeans and corn both."

Fertilizer producers benefit either way. Corn demands more fertilizer than soy or wheat. But price competition among the grains, stoked largely by federal supports for ethanol production, has bled generously into fertilizer markets.

Farmers typically spend 25% of their operating budget on fertilizer. With corn, soybeans and now wheat tacking on 100% price increases, fertilizer makers have jacked-up prices to suit. In addition, increasingly scant supplies of potassium and phosphate, two of the three key fertilizer components, are pushing record prices even higher.

Recovering harvests overseas could ease soy and wheat prices. But demand and price pressure on corn, so far, remains intense. A bumper crop, as in 2007, normally produces a fat carry-over. But this year's 1.5 billion bushel carry-over remains at the low end of the optimum range.
"We've never had a year where we produced a record crop and had prices go up," said Rick Tolman, executive director for the National Corn Growers Association. "That's because we are in a demand-driven situation with ethanol."

1. Business
There are three basic fertilizer components: nitrogen, phosphate and potassium. Canada is a huge supplier of potassium and phosphate to the U.S. Morocco accounts for 99% of the 2,300 tons of phosphate rock imported to U.S. markets. Production of the natural gas-based ammonium nitrates is increasingly centered in Trinidad and Tobago, off the coast of Venezuela.
A shift is under way in the types of fertilizers most likely to benefit from gains in commodity prices. Producers focused on nitrate production -- CF Industries (NYSE:CF - News), Terra Industries (NYSE:TRA - News) and Terra Nitrogen -- are likely to surrender some pricing power.

Increasingly tight supplies are giving an upper hand to potassium and phosphorus miners and producers.

Potash Saskatchewan (NYSE:POT - News), the largest player in the group by market capital, divided its $5.2 billion in 2007 revenue evenly among the three lines.
Agrium (NYSE:AGU - News) pulled more than half its $5.8 billion in revenue last year from phosphates.
Jacob Bout with CIBC World Markets, in his 2008 outlook, called 2007 "the year of nitrogen."
"We believe 2008 will be the year for phosphate fertilizer," the report said. "We expect potash and phosphate prices to peak in mid-2009, while nitrogen prices should moderate through 2008 into 2009."

Name of the Game: Low-cost production and distribution. Access to raw materials is fast becoming key to the phosphate and potassium segments.

2. Market
Figuring commodities pricing and fertilizer demand has traditionally meant looking at consumer and industrial demand, international supply balances and global weather patterns. But those fundamental measures don't explain today's vertigo-inducing corn, wheat and soybean prices.
"The prices certainly seem to be higher than what the fundamentals today suggest," said economist Jerry Norton, of the USDA's World Agricultural Outlook Board.
Hedge funds and other speculative investors have poured into commodities markets, adding demand, driving prices and making price forecasts more cloudy.
"Now you're also having to deal with this investment money: how much it may or may not be inflating the current corn price levels and what the long-term prospects are for that to continue," Norton said.

3. Climate
Fertilizer company stock prices have broken down steeply from highs notched early this year. Potash Saskatchewan rests 9.5% below its Jan. 15 record. Mosaic (NYSE:MOS - News) was off 12%. Terra Nitrogen slumped 20%.

But the group's fundamentals still outpace nearly all others.

Potash's Q1 outlook calls for a 123% EPS gain. Mosaic is looking to skyrocket 1,640%. Analysts expect Agrium to settle at a 248% EPS increase for Q4 when it reports on Wednesday.
Views are extremely consistent across most of the group, but there's a shift in favor of companies with a focus on potassium and phosphates because of increasing tightness in the supplies of those minerals.

4. Technology
A whiplash in demand for phosphate and potassium -- from extremely low levels in 2006 to historically high, and rising, levels -- has squeezed a slow-moving supply chain.
Phosphate and potassium, typically called P & K, after their chemical symbols, come from mines, which require an average five to seven years to bring into production.
Producers faced oversupplies two years ago, but now find themselves behind the demand curve.
Phosphates shot to $300 and then to $400 a ton last year, and are now on track to break $800. Potassium prices also spiked, helped by the shut down of a Russian mine due to flooding.
Out of 50 billion tons of potential phosphate rock reserves worldwide, the USGS estimates the U.S. holds only 3.4 billion tons. Morocco owns 21 billion, China has 13 billion. All are keen to closely manage the resource.

Global consumption of phosphate rock is projected to grow 2.3% a year. But that rate of growth could increase due to demand for biomass used in biofuel production.
Farmers are harvesting larger shares of the plant rubble left after harvest -- a natural source of potassium and phosphate when turned back into the soil. The loss of that natural fertilizer means more P & K demand.
"If we get into more biomass removal," Sawyer said, "that need is going to increase."

5. Outlook
The future for corn and fertilizer prices remains startlingly strong. Under normal circumstances, the question would be, "How high can prices go before demand falters?" The difference in the current scenario: federal ethanol requirements (see related story, this page).
An even bigger column of smoke on the horizon: China. The country, with 1.3 billion mouths to feed, has been reducing corn exports for a decade. This puts increasing pressure on world corn markets.

The U.S., which traditionally exports about 20% of its annual crop, is seeing growing overseas demand. Commodities markets -- and fertilizer producers -- are increasingly aware of the potential for a vast increase in competition.

In 2008, China plans a temporary grain export tax to keep its domestic supply at home. The tax also aims to dampen its record-setting inflation in food prices.
The common speculation, the NCGA's Tolman says, is that if China has normal weather it will probably hit a break-even point 20his year in terms of production and use, which would mean either modest imports or exports.

"Either one will have a big psychological effect on the market," Tolman said.
Upside: Ethanol, weak overseas crops and growing demand from China promise ongoing, monumental demand for fertilizer-hungry corn crops.

Risks: Ag-inflation is in overdrive as speculative futures trading helps drive corn and soybeans beyond price levels indicated by fundamental demand.

Ethanol, the primary driver for the rise in corn demand, may be nearing a price collapse. The result may or may not cut into fertilizer prices.