Urea decisions and markets

James Hillcoat (email)

Despite grain prices representing historical highs, many are concerned about the large increases in input prices. Urea has jumped from $400/mt to over $1,500/mt. Glyphosate from $5/L to $18/L. These increases understandably create concern around costs of production, particularly around the diminished returns of staple farm inputs. But that doesn’t mean there isn’t a return.

Whilst grain prices are inflated, due to the ongoing fundamentals of supply and demand on grain markets, similar factors continue to cause disruption to fertiliser markets. There is a good opportunity for favourable business margins in 2022 but it is time to think strategically around fertiliser investment, particularly when targeting increased protein.

Input prices have been soaring and not all of this is down to Russia-Ukraine alone. Shipping costs as well as rising energy prices, in general, combined with high demand, predate war in Ukraine. This can be tracked back to the start of the COVID pandemic that set input prices on course for records to fall. Of course, the war in Ukraine has exacerbated this issue. In many cases, fertiliser was actually tracking back in price but that was short-lived once Russia moved in. Russia is the world's biggest fertiliser exporter, and export restrictions have been implemented on fertiliser, and gas, to ‘unfriendly countries’. This is not helpful when 70% of Australia’s fertiliser requirements are through imports. Once again, the average Aussie farmer now finds themselves at the leading edge of a geopolitical world war.

The drivers of inputs are largely outside of our control, however there does remain some sway with how we use inputs to retain influence over our bottom lines. This is particularly true when looking at urea applications for additional yield or additional quality later in the year. Thinking strategically around fertiliser decisions is now crucial where returns are much tighter than previous. However, with grain prices at all-time highs, as well as decent sub soil moisture in many areas, the decision to skimp on fertiliser in place of yield may not be the best business option. Assuming it takes around 40kg of N required to generate an extra 1t/ha of wheat yield (conditions allowing), that still generates a 3:1 return at $1,600/mt urea. Viewing the crop’s potential is important but, at the same time, don’t compromise it.

Quality, on the other hand, is more sceptical and margins are much tighter. Assuming around 10kg of N per tonne to increase protein by 1% at $1,600/mt urea requires a grade spread of around $35/mt to breakeven.

Yield beats quality hands down.

To make a decision we must have a view around where we think the price may be as well as grade spreads. The fact is we are in a very tight environment for grains. Whilst rain in North America will assist their spring crop development, it won’t be a complete game changer globally. Demand remains high and global dynamics with Russia/Ukraine have changed the game considerably in the past two months. Will this change by harvest? Maybe. Will it be a complete dampener on prices and send us back to the low $300’s for wheat? Unlikely. The supply and demand situation globally is very tight and fundamentally set for a higher price environment for the next 12 months at least. With strong pricing, the targeted investment in urea for yield does offer some scope for good return.

Grade spreads are a different kettle of fish. It is true that the world's supply of high protein wheat has been more compromised, but this doesn’t make the investment in urea for protein an easy justification. Generally speaking, wheat becomes wheat over time and budgeting for grade spreads is difficult. Early fixed spread contracts are generally poorer to higher protein but spreads on higher protein can get better, particularly closer to harvest. A general rule of thumb for a protein budget is ASW at -$15/mt, H2 at +$10/mt to +$15/mt and H1 at +$20/mt to $25/mt. So, increasing from APW to H2, for example, and getting $20/mt still won’t be a good return when we needed $35/mt to pay for our extra application. Of course, these can change depending on seasonal outcomes but, either way, fertilising for quality is much more marginal. With Australia on course for a good season nationally we can expect a profile of lower protein grain. This may mean that ASW spreads widen in relation to APW. This may create a case for trying to keep quality, but the line will be very thin. We can essentially accept a $35 spread to ASW and still be no worse off. Accepting a lower price for quality but fundamentally getting more yield will be an obvious winner in many cases.

Cost of production is key to profitability. Cost of production is influenced by cost control but, perhaps more importantly, it is offset by income driven through yield and price. The need to be strategic with inputs is paramount but don’t forget the opportunity that still presents in this market.