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Fertilizer Makers: High Natural Gas Prices Will Affect Farmers' Decisions on Spring Planting

October 17, 2005
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While CF Industries Holdings, Inc. suffered no damage to its Donaldsonville, LA nitrogen fertilizer complex during hurricanes Katrina and Rita, its business will be off in the fourth quarter due to the high cost of feedstock natural gas. And its greatest challenge could come in the spring if farmers decide to cut back on planting because of high fertilizer costs.

"Performance in the fourth quarter of 2005 and in 2006 will be determined by the overall demand for the company's products, the cost of natural gas, and other factors. The effects of sharply higher energy and fertilizer costs on farmers' plans for next spring cannot be determined at this time," said Stephen R. Wilson, the company's chairman and CEO in a press release last week.

The Louisiana plant operated at 72% of capacity during the third quarter, compared to 93% in the third quarter of 2004. Fourth quarter operations are expected to be off even more due to "unprecedented natural gas costs," operating at 50% of capacity compared to 100% a year ago.

"Fertilizer prices are at all time highs," Wilson said. There is no alternative to using nitrogen fertilizer, he said, but farmers can make the decision between corn and beans. Growing corn takes more than twice the amount of fertilizer it takes to grow beans. Wilson, answering questions in a teleconference with analysts, said he believed farmers would be waiting to make their decisions based on a number of factors, including the price of fertilizer and the estimates of the prices they will be able to get for the commodities at the end of the growing season next year.

The farmers and the distributors will not be able to wait too long to place orders, however, Wilson said, because inventories are low. The harvest isn't completed, but after that...."there's a chess game going on; are prices up or down? But the pipeline is pretty empty and they can't wait as long as they have in the past. There's not just uncertainty, there's anxiety."

A global producer of nitrogen products, Terra Industries Inc., has lowered the utilization of each of its North American plants by 10% in response to the run-up in natural gas prices following Hurricanes Katrina and Rita.

President Michael Bennett Monday, speaking during a webcast conference, said the company's five North American facilities were operating within the "ballpark" of 90% of capacity. "We can't really throttle down much below 80-85% without shutting [a] facility down."

"The gas market is telling us right now [that] it doesn't want us to burn as much gas and we're responding to that," he told analysts. Bennett estimated that Terra Industries' North American plants typically consume 100 Bcf of natural gas annually. A $1/Mcf hike in the price of gas adds approximately $14-15 million to the company's gas bill.

Due to the high price for natural gas, Bennett said the Sioux City, IA-based company does not plan to build inventories of nitrogen. The price of gas for November delivery closed at just under $13/Mcf Monday. He speculated that gas prices would have to drop to about $10/Mcf for his company to "minimally" break even on nitrogen sales.

"Until prices for nitrogen products would achieve a level that would allow us to generate satisfactory gross margins, what we aren't going to do is burn high-cost gas to build inventory," Bennett said. "At this point in time, we don't think that the natural gas market has really settled into a stable range. We saw this sharp run-up over a period of two weeks. Over the last three days, we've seen the market come off pretty substantially...We think it's just a little bit too early to call" the direction of gas prices.

On Friday, Terra Industries reported that at Sept. 30, it had supply contracts, financial derivatives and other instruments that fixed the purchase price for about 11% of its next 12 months' North American and United Kingdom natural gas needs. It also said it has collared most of its forward positions. Outstanding collar transactions at Sept. 30 were approximately 9% of Terra's next 12 months' North American and United Kingdom gas needs, the company said.

Terra said its forward purchase contracts at Sept. 30 fixed prices of future gas needs at $60.9 million below published forward prices at this time. However, the gain was largely offset by $42.8 million in losses on outstanding call options, the company noted.

CF Industries second nitrogen fertilizer complex, located in Medicine Hat, AB, Canada, has continued to operate at scheduled rates, taking into account scheduled turnarounds. However, given market uncertainties, this complex is also expected to operate at reduced levels in the fourth quarter. The company expects to meet all customer shipments with the reduced operations, supplemented by product purchases.

CF Industries' Forward Pricing Program (FPP) helped protect its earnings despite the high costs of feedstock through the third quarter, Wilson said. Under the FPP strategy, as customers place forward nitrogen fertilizer orders, the company buys natural gas futures contracts, effectively fixing the cost of the natural gas used to produce those orders and locking in a substantial portion of the margin on the related sales.

But, "the FPP's buffer of pre-hurricane gas pricing is not expected to benefit our fourth quarter and 2006 business to the same extent as in the third quarter. We are continuing our efforts to cope with this high-cost environment, which will adversely impact the company until natural gas prices return to more reasonable levels," Wilson said.

Approximately 1 million tons, or 63%, of CF Industries' fertilizer sales in the third quarter of 2005 were booked under the FPP, versus a comparable total of approximately 700,000 tons, or 40%, of fertilizer sales in the third quarter of 2004.

As of September 30, 2005, FPP bookings for the fourth quarter of 2005 stood at approximately 1.1 million tons for the company's nitrogen and phosphate fertilizer businesses, compared to slightly more than 1.2 million tons at the same time in 2004.

For 2006, FPP bookings as of the end of September stood at approximately 220,000 tons, compared to nearly 900,000 tons at the comparable point last year.

"Our Forward Pricing Program is obviously only effective in reducing margin risk to the extent that our customers are willing to make commitments to purchase our products at the offered prices. The 2006 FPP booking level reflects the uncertainty that exists in the fertilizer market and the understandable hesitancy of many customers to make commitments in this volatile natural gas pricing environment," Wilson noted.

Besides its forward pricing strategy CF Industries also purchases finished nitrogen fertilizer products, when advantageous; reducing its operating rates at the Donaldsonville plant. It also has rescheduled planned turnarounds at its phosphate fertilizer operations in Central Florida to coincide with hurricane-related downtime at Gulf Coast refineries which produce sulfur.

"These initiatives, have permitted CF Industries to mitigate the near-term impact of the recent natural gas price escalation and other storm-related problems," Wilson explained.

CF Industries' gross cash and short-term investments were approximately $315 million at September 30, 2005, and its $250 million senior credit facility, which is subject to a borrowing-base formula, remains undrawn. The company's current liability for customer advances was approximately $185 million, and long-term debt was approximately $4.2 million at the end of the third quarter.

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