A Report from the Economic Research Service United States Department www.ers.usda.gov of Agriculture WRS-0702 August 2007 Impact of Rising Natural Gas Prices on U.S. Ammonia Supply Wen-yuan Huang Abstract The volatile and upward trend in U.S. natural gas prices from 2000-06 has led to a 17- percent decline in the Nation’s annual aggregate supply of ammonia. During the period, U.S. ammonia production declined 44 percent, while U.S. ammonia imports increased Contents 115 percent. Also, the share of U.S.-produced ammonia in the U.S. aggregate supply of ammonia dropped from 80 to 55 percent, while the share from imports increased from Introduction ........................1 15 percent to 42 percent. Meanwhile, ammonia prices paid by farmers increased from $227 per ton in 2000 to $521 per ton in 2006, an increase of 130 percent. Natural gas is Background ........................3 the main input used to produce ammonia. Additional increases in U.S. natural gas prices could lead to a further decline in domestic ammonia production and an even greater rise Impact of Natural Gas Prices on Ammonia in ammonia imports. Prices ................................5 Keywords: Natural gas and ammonia prices, ammonia supply, nitrogen fertilizers Effects of Natural Gas Prices on Ammonia Producers .........................6 Acknowledgments Effects of Rising Natural Gas Prices on Farmers .....................10 The author thanks the Fertilizer Institute, the International Center for Soil Fertility and Future Sources of Agricultural Development, and the National Gas Company of Trinidad and Tobago Ammonia Supply in Limited for providing data used in this study. The author also thanks the following indi- the United States ............12 viduals for their helpful suggestions: Stan Daberkow and Greg Pompelli of USDA’s Economic Research Service and James Duffield of USDA’s Office of Energy Policy Summary and Implications ......................15 and New Uses, and Harry Vroomen, the Fertilizer Institute. The author also thanks John Weber for editorial assistance and Wynnice Pointer-Napper for the other graphics and References ........................17 layout. Any remaining errors are the author’s. Approved by USDA’s World Agricultural Outlook Board Introduction Nitrogen is vital to a plant’s ability to develop proteins and enzymes, which, in turn, help the plant grow to produce food, feed, and fiber for animal and human consumption (Kramer). The importance of nitrogen fertilizers to U.S. agricul- ture is evidenced by its rising use over time. From 1960 to 2005, annual use of chemical nitrogen fertilizers in U.S. agriculture increased from 2.7 million nutrient tons to 12.3 million nutrient tons (fig. 1). This increase is considered to be one of the main factors behind increased U.S. crop yields and the high quality of U.S. agricultural products (TFI (d); Hallaway). In 2005, U.S. agriculture used 22.15 million tons of chemical fertilizer nutrients (nitrogen, phosphate, and potash), of which nitrogen accounted for 56 percent. About 42 percent of total nitrogen used during the period was attributed to production of corn (ERS(c)). Among crops, corn accounted for the largest share of nitrogen use, followed by wheat. Total nitrogen costs for U.S. production of corn in 2005 and wheat in 2004 were $2.98 billion and $0.9 billion, respectively. Nitrogen costs contributed to the largest operating expense for both corn and wheat producers. Nitrogen application accounted for 18 percent of the operating costs for corn producers and about 30 percent of the costs for wheat producers (table 1). In the coming years, projected increases in U.S. ethanol production from corn grain are expected to boost demand for nitrogen. Additional corn acres are expected to be planted at the expense of soybean acres because of more favorable returns for corn production than soybean production in 2007 (ERS (a)). Moving from soybeans to corn production may require additional ammonia to provide nitrogen for corn production and may lead to higher ammonia prices. Because natural gas is the main input used to produce ammonia, which, in turn, is the main input used to produce all nitrogen fertil- izers, the volatile and upward-trending price of natural gas in recent years Figure 1 U.S. plant nutrient consumption Mil. tons 14 Nitrogen (N) 12 10 8 6 Potash (K2O) 4 Phosphate (P2O5) 2 0 1960 65 70 75 80 85 90 95 2000 05 Fertilizer year Note: Fertilizer year runs from July of the preceding year to June of the year indicated in the chart. Source: USDA, Economic Research Service using data from AAPFCO. 1 Impact of Rising Natural Gas Prices on U.S. Ammonia Supply / WRS-0702 Economic Research Service/USDA has affected the price and supply of ammonia, and, thereby, the supply and price of nitrogen fertilizers, which is a great concern to U.S. agriculture. This article analyzes the impact of natural gas prices on the U.S. ammonia supply and assesses future U.S. ammonia supplies. Table 1 Costs of nitrogen use in U.S. production of corn (2005), cotton (2003), soybeans (2004), and wheat (2004) Item Corn Cotton Soybeans Wheat Nitrogen consumption (1,000 tons) 5,959 508 156 1,957 Nitrogen application rate (pounds per acre) 138 92 26 90 Average nitrogen price (dollars per pound) 0.25 0.23 0.23 0.23 Nitrogen cost (million dollars) 2,980 234 72 900 Nitrogen cost per acre (dollars) 34.50 21.16 5.98 20.70 Operating costs for crop production (dollars per acre) 193.48 304.29 81.77 70.83 Nitrogen share of the operating cost (percent) 17.83 6.95 7.31 29.22 Source: USDA, Economic Research Service using data from ARMS 2003-05 (Agricultural Resource Management Survey) (ERS (b) and ERS (c)). 2 Impact of Rising Natural Gas Prices on U.S. Ammonia Supply / WRS-0702 Economic Research Service/USDA Background Until around 1920, the supply of nitrogen for crop production depended entirely on limited natural sources of nitrogen, mainly from animal and vegetable waste. In the 1920s, chemically processed nitrogen became avail- able through the development of the Haber-Bosch process of using natural gas to synthesize ammonia (American Chemical Society). Since then, synthesized ammonia has been the main source of chemical nitrogen fertil- izers for use on crops. Ammonia is the main input source for all nitrogen fertilizers. Ammonia, which contains 82 percent nitrogen, is the main source for nitrogen in various types of fertilizers used in crop production. Ammonia can be directly applied to soil as fertilizer or it can be used as a raw material to produce nitrogen fertilizers, such as urea, ammonia nitrate, and nitrogen solutions. It also can be used as a raw material to produce more complex fertilizers, such as diam- monium phosphate (DAP) and monammonium phosphate (MAP), which are two main phosphate fertilizers used by farmers for crop production. Furthermore, when combined with phosphoric acid and potassium chloride, ammonia and its derivatives are the basic material used in the formulation of various mixed fertilizers containing nitrogen, phosphate and potash, which are used extensively by farmers. Thus, a change in the price of ammonia often leads to changes in the prices of all nitrogen fertilizers. Ammonia and its derivatives have a diverse mix of nonfertilizer use. Ammonia is used as an antifungal and a preservative for some crops. Its derivative urea is used extensively as a source of protein in livestock feeds for ruminating animals. Ammonia is also used in the manufacture of plastics, fibers, and chemicals in various industries (Kramer). In 2005, nonfertilizer use accounted for 11 percent of U.S.-produced ammonia. Alternative systems are used to deliver ammonia. Most plants that produce ammonia continuously are located near the source of natural gas in the South (Gulf region) and the Southwest (fig. 2), while most nitrogen fertilizers are consumed in the Corn Belt within a very short timeframe in the fall and in the spring. To bridge these geographic and seasonal gaps, alternative distribution and storage systems, comprising pipelines, barges, and railways, move and handle large volumes of fertilizer products from domestic production sites in the South to the consuming regions further north (Mahan; Klindworth). 3 Impact of Rising Natural Gas Prices on U.S. Ammonia Supply / WRS-0702 Economic Research Service/USDA Figure 2 U.S. ammonia production plants, 2005-06 Corn Belt Capacity (1,000 tons) 35 - 500 501 - 1,000 1,001 - 2,250 Source: USDA, Economic Research Service using data from IFDC. 4 Impact of Rising Natural Gas Prices on U.S. Ammonia Supply / WRS-0702 Economic Research Service/USDA Impact of Natural Gas Prices on Ammonia Prices Natural gas is the primary raw material used to produce ammonia. Approximately 33 million British thermal units (mm Btu) of natural gas are needed to produce 1 ton of ammonia. Natural gas accounts for 72-85 percent of the ammonia production cost, depending on the size of the ammonia plant and the price of ammonia (TFI (a)). Ammonia prices were weakly correlated with natural gas prices before 2000, but became strongly correlated after 2000. Following the deregulation of the natural gas market in the 1980s, monthly average prices of natural gas were relatively stable over the period 1985-99, ranging from $2 to $4 per mm Btu, with a standard deviation of $0.5 per mm Btu (fig. 3). In the same period, monthly average ammonia prices were rela- tively stable, except in 1994-97. The price correlation between natural gas and ammonia in this period (1985-99) was weak at 0.17 to 0.07 (table 2). Ammonia prices in this period were influenced mainly by ammonia demand. For example, the price peaks from 1994 to 1997 stemmed from the high demand for ammonia that exceeded production capacity, as more acreage was planted to corn following price increases due to strong export demand.