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Yara bets on low US nat gas prices in Terra deal

The deal gives Norway’s Yara a large presence in the lucrative US corn belt — a huge market for nitrogen-based crop nutrients like ammonia, urea and UAN. And natural gas is the primary raw material used in the production of these fertilizers.

The United States outpaced Russia last year as the world’s largest gas producer for the first time since 2001, largely due to the emergence of unconventional gas plays like the Marcellus shale in Appalachia and the Barnett shale in Texas.

US natural gas reserves are up by a third since 2006, mainly due to the growth of unconventional gas production from shale gas, found in fine-grained sedimentary rock. Currently, estimated reserves are sufficient to supply the US market for nearly 100 years at present rates.

Yara noted that this has led to ‘structural changes’ in the US energy markets, making the acquisition of Terra and its large US manufacturing base more attractive. The deal also cements Yara’s position as the world’s largest producer of nitrogen-based fertilizers.

‘With all the natural gas that has been found recently in the U.S., the expectation is essentially that natural gas prices should stay stable, or come down a bit,’ said Broadpoint AmTech analyst Edlain Rodriguez.

In any event, most analysts contend that in the near-term natural gas pricing in the US will remain, at the very least, competitive with European pricing, giving U.S.-based producers an edge due to lower transportation costs.

NITROGEN MARKET

Nitrogen, phosphate and potash are the three main macro nutrients used in fertilizers across the globe. Nitrogen production is a highly fragmented at the global level and investors view consolidation in the sector as a positive.

Currently, about 50 percent of the nitrogen-based nutrients used in the North America are imported. While Agrium , CF Industries , Potash Corp , privately held Koch Industries and Terra account for more than 75 percent of domestic production in the region.

The Terra deal will make Yara the largest nitrogen player in North America, with a market share of about 30 percent. It could also prompt further consolidation in the sector.

‘A stand-alone strategy looks inherently more challenged now in our view post the Yara-Terra combination,’ TD Newcrest analyst Paul D’Amico, said in a note to clients.

Yara’s global ammonia market share will be about 8 percent versus 2 percent for the second largest competitor, while its production capacity for UAN, a mix of urea and ammonium nitrate, will be four times larger than its next largest competitor.

D’Amico argues that this could increase the likelihood that CF Industries engages with Agrium, but a deal between the two is still far from certain.

Calgary-based Agrium has been locked in a year-long battle to acquire US rival CF, which itself only recently withdrew its hostile bid for Terra.

The three-way merger battle and a spate of other deals and rumors have kept investors glued to the typically staid fertilizer sector, which has seen shares soar amid the commodity boom and collapse during the economic slowdown.

INCREASING DEMAND

A sharp decline in fertilizer demand in 2009, is expected to be followed by a healthy rebound in 2010 and beyond, as farmers scramble to replenish soil nutrient levels.

Yara is betting on a strong rebound, and its acquisition of Terra could significantly boost its earnings if markets begin to tighten.

Moreover, while farmers can skip potash and phosphate applications for a year, nitrogen usage is non-discretionary for corn production and the United States is the world’s largest corn grower.

Ammonia pricing in North America has already begun to climb ahead of the spring planting season. Some analysts expect prices to reach as high as $450 a tonne, from the current $370 levels.

‘If our view of a gradually improving fertilizer market comes through, this aggressive expansion investment looks sure to pay off handsomely for (Yara’s) long-term investors,’ Carnegie Securities analyst Henrik Sinding, said in a note to clients.