The shift away from fertilizer gas is beneficial for companies that have an advantage in producing urea from coal

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Shift from fertilizer gas to alternative fuels benefits companies that use coal as a raw material for urea production. Author/Source: China Agri-Materials Network. Date: November 24, 2016. Clicks: 36. The liberalization of prices for gas used in fertilizer production has increased the production costs of urea made from gas, which is beneficial for companies that use coal as a raw material. Recently, the prices of urea, acetic acid, and melamine have risen, and Hualu Hengsheng has benefited the most from this. We estimate that Hualu Hengsheng’s EPS for 2016 to 2018 will be 0.73 yuan, 0.83 yuan, and 0.97 yuan respectively, with corresponding PE ratios of 16X, 14X, and 12X. We maintain a “strongly recommended” rating. Event: Recently, the **National Development and Reform Commission issued a notice deciding to fully liberalize the prices of gas used for fertilizer production. It is required that, starting from November 10, 2016, prices for gas used in fertilizer production be fully liberalized and determined through negotiation between supply and demand parties. Fertilizer production gas is encouraged to enter trading platforms such as oil and gas trading centers, where prices are determined through market transactions, thereby ensuring transparency in pricing. There is a shortage of domestic natural gas, resulting in insufficient operation of urea plants powered by gas and poor profits: Domestic natural gas consumption is high, but the supply is insufficient. In 2015, domestic natural gas production was 135 billion cubic meters, imports were 61.4 billion cubic meters, and consumption was 193.2 billion cubic meters; the reliance on imported natural gas exceeded 30%. The shortage of natural gas in the country has led to insufficient operation levels for urea manufacturers that use gas as a raw material, resulting in low profits. The fertilizer businesses of listed companies such as Lutianhua, Chuanhua Shares, Jianfeng Chemical, and Huajin Shares, which are involved in the production of urea, have been operating at a loss for a long time. Rising urea prices create a favorable time window for the conversion to fertilizer gas: Since 2013, in order to optimize the allocation of natural gas resources, market-based reforms have been gradually implemented for domestic natural gas prices; the prices for shale gas, coalbed methane, gas produced from coal, liquefied natural gas (LNG), as well as for direct supply to users other than fertilizer manufacturers, have all been liberalized. Fertilizers are important agricultural inputs; therefore, the price of gas used for fertilizers was not deregulated in 2015 along with the prices for other direct customers. Currently, the price of gas used for fertilizers is significantly lower than that for other direct customers, which results in natural gas producers having little incentive to supply gas to fertilizer manufacturers, leading to low utilization rates of the urea production facilities that use gas. Recently, urea prices have stabilized and started to rise. Taking the ex-factory price of small-grain urea produced by Hualu Hengsheng as an example, it has increased from 1,120 yuan per ton in August to 1,400 yuan per ton at present, a rise of 25%. The improved profitability of urea manufacturers creates a favorable timing window for the conversion to fertilizer gas production. With rising gas prices, the profit prospects for urea produced using gas are concerning. In the short term, once the pricing of gas used in fertilizer production becomes market-based, the cost of natural gas for this purpose will increase. Taking the gas fields in Sichuan and Chongqing as an example, the current price at the wellhead for gas used in fertilizers is 0.92 yuan per cubic meter, while the price at the wellhead for gas supplied directly to industries is 1.505 yuan per cubic meter. If these two prices become equal after the price reform, then the cost of gas used in fertilizer production will rise by 0.585 yuan per cubic meter. Given that producing one ton of urea requires 600 to 800 cubic meters of natural gas, the cost of producing one ton of urea via this method will increase by 350 to 450 yuan. In the long term, despite recent increases in urea prices that help to offset some of the rising costs associated with gas prices, the situation in China characterized by an abundance of coal and a shortage of gas will persist. Urea manufacturers that rely on gas as a raw material will continue to be constrained by insufficient supplies of natural gas, resulting in uncertain long-term profitability for these companies. It is favorable for coal-based urea; Hualu Hengsheng, which has strong cost control capabilities, is recommended. Currently, the domestic urea production capacity is around 82 million tons, of which coal-based and gas-based urea production capacities are approximately 60 million tons and 22 million tons respectively, while the consumption of urea is 55 million tons. In the future, the profit prospects for urea produced from natural gas are bleak; if some of the production capacity using natural gas is phased out, it will improve the supply-and-demand balance in the urea industry, which will be beneficial for urea produced from coal. Hualu Hengsheng has a production capacity of 1.8 million tons of coal-head urea. The company leads in gasification technology, features low consumption per unit of product, and possesses strong cost control capabilities; if the price of urea increases by 100 yuan, the company’s EPS will increase by 0.09 yuan.