CF Industries Holdings, Inc. (CF) Earnings Call Transcript & Summary

Okay. Welcome back. And it's a pleasure for me to host the CF management team here. I have Tony Will, CEO; and Chris Bohn, CFO; and I have Bert Frost, Chief Commercial Officer. These 3 guys have been working together for probably 15 years now. It's quite a team, and we have lots to talk about here and very excited to have you all up here today. Do you want to make any opening remarks? Or do you want to get right into this?

Why don't we dive right in?

Okay. So certainly, there's many, many sources of supply disruption in nitrogen in the world right now. And maybe we start off this discussion on the supply side. And we can maybe start with the high natural gas prices in Europe. Where do you see that portion of the world supply of nitrogen right now? What fraction does that represent of global supply and we start with Europe first.

So I'm going to rewind the clock just a little farther than that, and then I'm going to pass it over to Bert to talk about Europe. But when we think about supply disruption, we go all the way back to this time last year, where we were experiencing winter storm Uri in the U.S. And that took a big chunk of domestic production offline for the better part of a month in a lot of cases, follow that up with an unusually high amount of turnarounds on a global basis that happened in nitrogen because there were so many turnaround events that were pushed forward out of 2020 given the COVID situation and the desire not to bring 500 contractors on site, potentially exposing your workforce to COVID. And so we had more turnarounds than we had ever had in 2021, and I think that was pretty representative of the industry as a whole. Then you get into September, and we've got Hurricane Ida that comes through and takes the Gulf Coast South line for the better part of 3 weeks. And that's just in the U.S., right? So the U.S. probably lost across that maybe 2 million tons of urea equivalent production at least, if not more than that. And now we get into the fourth quarter, European gas goes to $30, $40 an MMBtu, and there was a big chunk of time where you had 11 million tons of ammonia capacity off-line or curtailed in Europe for at least 2 months. That's 11 million tons on an annualized basis. But that represents a pretty sizable percentage of total global supply side. And then some of that started coming back on, but not on a full basis. So I can speak about the U.K. We have 2 plants there. One of them remains offline today. The other one is operating. I think the same thing with places like Kleen and the Netherlands where you've got 2 million plans, ones on, ones off and a number of the RF facilities and so forth. But why don't you go ahead and pick it up at this point in terms of what's going on right now real-time with gas.

And just to further your comments in recent history, I'm going back 20 years. Never has supply and demand operated in concert as they are today where lack of supply and high demand with 7 and $10 wheat and basically across the commodity spectrum, very healthy prices for the output. And when you throw into the supply, China having export restrictions now Russia with export restrictions but probably being curtailed in some different ways, you have this limiting factor in the suffering of Ukraine is the humanitarian side of that, but the European impact on supply is pronounced with what Tony said with Romania being down, Croatia being down different plants. And so it will be difficult, I believe, for the European continent to source the needed nutrients for this planting season. That's why you're seeing Egyptian urea today at $830 where last week, it was $600.

But I think for those that did not hedge forward on natural gas, it is very difficult to run a plant in Europe today at $50 an MMBtu. Forward hedge positions were available. If you go back a month at high $20s to $30 an MMBtu, that's not available anymore. And so if you're unhedged or as those hedge positions roll off, I don't think those plants can continue to operate in this gas cost environment.

I agree. I think that is the salient point. Okay. So what incremental supply is now even further removed from -- that was sourced from Russia? When you look at supply, the country that's, for me, the placeholder of Russian sourcing is Brazil. And the impact to Brazil today is stark because traditionally, they would be transacting with farmers for fallout their spring application, our call, which would be August, September, October. That hasn't taken place and that supply is not moving, and there have been vessels that are either being declared for majeure or not shipping. And so -- and sugarcane gets planted or it gets applied fertilizer April, May, June time frame. That's ammonium nitrate. That's about 1.4 million tons. That's almost 100% supplied by Russia or that area. And so the constraints today and then you could move forward with what can happen with yields or what can happen with stocks use ratios of grains and oilseeds, it's something that the world needs to be aware of. And that's why in terms of impacts on pricing, Europe's going to have to either be bid in some of these high-cost producers are going to be bid in and then what is going to happen with sanctions out of Russia in ability to supply all question marks.

Or you just light apply despite the fact that you've got very high grain prices you may run into a time-constrained window here where there's just not enough supply.

And then one more source of supply disruption and that's China. Do you have a view on how long that export ban is withheld and whether it might continue again next fall?

Yes. I mean I think, clearly, it's through June. The intent is pretty clear to make product available and affordable for the domestic market. And I think embedded in that question is what happens to gas price in Europe. And if you continue to see gas price north of $30 an MMBtu, that means you're talking about AN price north of GBP600 or call it $700. It wouldn't surprise me to see that export ban extended. The idea being, I think they want to keep price well below $500 that the world is charging [ $700 ] or above based on where gas cost is in Europe, I think you could easily see the export ban extended.

I agree. You've seen -- we've seen several different Chinas over the last 20 years from the emergence of an encoding powerhouse to becoming an exporting powerhouse to being 35% of the world's supply at 13 million tons of exportable tons and then ramping down to 4 million tons to now putting on an export ban, taking away the subsidies for freight and electricity. And so I think we're seeing a different China and a very forceful government response to high prices to keep food inflation within the country sustainable to your Chinese consumer. I don't think they care about, for example, Indian supply, which has been the predominant export location for Chinese production.

The U.S. had pretty hefty imports of nitrogen in the fall is what's your assessment of the spring season in the U.S.? Is there going to be adequate supply?

So when you look at North America, Canada and the United States, principally, yes, we were ahead on imports for urea and UAN. And one of the reasons why we brought the trade case was that activity that was taking place from Russia, and we'll see what the results are of that and when the final ruling comes out in June. But we were ahead on imports, and we have been running at max capacity. As Tony said, we brought forward turnarounds did more turnarounds in 2021. We have a normal turnaround rotation this year. So planning on high production rates, and we at CF believe that we can supply the North American demand for sure of UAN. And I think the retail sector is on pace to have supply for planting and planting on time, but there has been some delays with farmer transaction or retail transactions. And I think with the unrest that's going on and lack of probably additional supply to the United States, it could be tight come April.

I think the other issue that potentially compounds that given the delay in some of the purchasing that's going on is a strain on the logistics system because now you're talking about compressing the window of time for which you're moving all of that material farmers waiting until sort of the last minute to buy. And as we all know, there's big inflation and difficulty getting truckers. You're seeing potential labor unrest with some of the Class I railroads. And I think that really further amps up the potential for disruption if people don't get off the dime and begin buying and moving product.

But generally, when we see that logistical disruption is when we're able with our network to move the product, get the product to where it needs to be.

That plays very well for us given our end market production and our end market terminaling and warehouse and such efficient.

And when you think about the demand side for nitrogen and global grain production, there's some disruption here with Ukraine and Russia as well. Do you see a commensurate level of less demand in 2022? Or is that not likely?

I think demand is very strong. When you have $7 corn prompt, $10 wheat, $17 soybeans, these are all prompt prices. Amazing values, fertilizer is not the constraint. But I do look at -- when 30% of the world's wheat is exported from Russia and Ukraine and 25% of the world's corn comes out of that region. And you're a Ukrainian farmer today and the diesel depots have been blown up or you're going to have access to diesel even to plant? And where is that fertilizer going to come from? And are you going to take your cash and put that into a crop that's going to be harvested months later, but you're not sure if a tank will roll through your farm or not. So there are so many questions right now outside of just export bans and restrictions and costs and risks that I think are driving today's grain market, which then puts North and South America in a very solid position and need to produce at maximum rates, which will then drive fertilizer demand.

And so that's why as we look forward, this is not a 2022 phenomenon. This goes out through '23 and very likely into '24, where global core springs stocks to use are really pressured relative to historical levels.

Okay. So what do you do with this capital?

Well, I didn't think that question was coming. I think as we've talked about before, our capital allocation policy really is the same as it has been. We look for projects that provide high return that work within our wheelhouse that really work on our core competencies. And you can look at that just recently with the dehydration and compression projects that we announced at Donaldsonville and Yazoo City. And even the green ammonia project at Donaldsonville. Prior to that, some of the acquisitions we've done on the minority shares of groups we've had in expansion projects. So we'll continue to look at those, look at acquisitions where we can find them. I think some of the issues we find with doing acquisitions are one geographically, as Bert and Tony have mentioned, when you look at what just happened geopolitically and then energy spreads globally, North America seems to be the better place to be in some other areas, you can't even get cash out. And then secondly, we would like to do acquisitions because when you're not disrupting the S&D balance, it's already tight. But additionally, you have free cash flow coming right away. So I think we'll continue to look at those, Steve, along with maybe additional as we do see demand growing, maybe evaluating some greenfield or brownfield expansions at some point. But right now, when you look at 2021, we generated $2.2 billion of free cash flow. We're coming into '22 with everything that Tony and Bert have talked about in a much stronger market. So we realize there's going to be a portion of that -- a significant portion of that has to be deployed back. And generally, how we've looked at doing that is through share repurchases, driving down our share count, even driving down the aggregate fixed charge of the absolute dividend cost by doing that. So that's something that we'll continue to do. As we've talked about on our earnings calls, we'll do a ratable component of it, just the amount of cash that we're generating right now. And then we'll be opportunistic. You don't have to look far and you can see the volatility in our shares because of a barge that traded in Nola for $500 when the market is still strong. So you may see some periods where we have higher cash balances, but we realize that we'll be going into the market a little deeper when we do see those opportunities.

And let me just elaborate on that a little bit. So you look back into the fourth quarter, and we deployed $490 million of share repurchase because we looked at where the shares were trading. We looked at the strength of the cash generation of the business. We've looked at where we thought 2022 and 2023 were headed and felt about -- there was a significant value opportunity sitting in our shares for our longer-term shareholders. And so we went in, in a very strong way that effectively finished up the previous share repurchase authorization. The board authorized a new $1.5 billion program. And it's against that new program that, as Chris mentioned, there's both a ratable component and sort of open to buy in a very opportunistic way that a number like that is certainly doable by us, and we're looking to really capitalize on just continuity kind of drops in the share price that don't reflect the fundamentals of the business and can really reduce returns for our longer-term holders.

Is there enough of a net import position of U.S. nitrogen that you could debottleneck without risking the U.S. market?

Yes, why don't you talk about aggregate in the quarters.

In terms of the import size, we're over 5 million tons of urea imports per year. And UAN has been running at 2 million to 2.5 million tons per year and ammonia, obviously, is imported also up to the pipe and at different locations in the coast. And so that's the supply. Do you want to talk about?

So, yes, so a long way of saying we could debottleneck our plants or even add another couple and the North American marketplace would still be in a nitrogen deficit situation requiring to bid imports in.

And I think when you look at it on a structural basis, you have to remember that gas is now a different market than it was even a year or 2 ago. The traded LNG ton or value today at $50 into Europe is going to drive, I think, investments in Qatar and other places over and above a urea plant. And so the other issue is, as an end market producer of nitrogen, the cost at, let's say, $4 of Middle Eastern gas, transporting that to Nola, putting it on a barge up the river, on a railcar into the Midwest is probably $100. So on a gas basis, you're talking another $4. And so we do have an advantaged base. So even if it were to be domestically focused or export focused to expand.

Well, I think that's the other thing. It's not just the agricultural side, but the industrial side of the business has grown quite a bit too, whether it be through DEF or nitric acid or even just ammonia itself. So we're seeing expansion not just in the historical agricultural area.

Yes. I recall last summer, maybe it was your second quarter call, I don't remember when exactly it was when there really was a change in the market where you started taking orders early summer, at least by mid-summer for the supply chain restock and versus the prior half a decade where it seems like nobody really wanted to buy in the summer months. Do you expect that to happen again? Or are you already starting to see interest in post the spring season?

Well, there's always an interest to buy at low prices. And so what I expect to happen is that inventories will be as low as we've ever seen because the communication from the retail sectors, they don't want to have high-priced inventory coming out of spring. And so there will be a logistical need, which we talk about every year to refill on a logical basis, that system. And we have our own terminals and access to the pipeline on ammonia. And so that we will take care of that side. On the UAN and urea, we rely on our retail and wholesale partners to do that. And so there will be a reset in July, and we think it will be very attractive based on these SMB fundamentals that are going to continue on through 2022 and probably into 2023 and '24.

I think what was surprising in retrospect, it is the shape of the pricing curve as you look back over 2021 because historically, what you see is escalating price as you get through Q1 and kind of peaks midway through Q2, and then it starts softening as you get into Q3 and then maybe start strengthening again in Q4. Last year, it was very different. We kind of came up a little bit in Q1 and Q2. And then as we got into Q3, instead of it rolling down, it actually accelerated, which drove the buying behavior that you're talking about. One of the things that we're seeing today is at current values, which we think still represents a very good value for farmers, given where the price of grain is, there is not the same level of appetite to buy $800 urea than there was a year ago because a year ago, it was an $800 urea. So I think the market is expecting some sort of a reset position, as Bert talked about, the channel partners that we've got are trying to drain everything out of inventory and then rebuild beginning at a different price point. But part of that also depends upon what's going on with Russian exports, Chinese exports, the price of gas in Europe. All of those factors are ultimately going to set where pricing of our products settle out, and that may be lower and it may not be.

Interesting constraint on that is we are still trading below international parity in the United States. We are today and have been the lowest priced nitrogen market in the world. And there are opportunities for us to export in that environment because of the preponderance of tons that are in Louisiana at our Donaldsonville location. And so we're going to arbitrage those options when we come out of spring to see what's best. Is that because of the trading activity down in NOLA that has caused what you just described that the U.S. is a -- it's not a period to the rest of the world and that -- some inappropriate behavior going on down there. You might have hit on the top point. Yes, we do believe that there -- in the absence of a dynamic market, which is a lot of demand pulling and a lot of conversations and actual transactions. In the absence of that, there are a few players who will trade amongst each other, a barge or 2. And because we're a transparent market that then gets communicated to the publications and that gets a price set -- and then some publications publish at different times and different prices. And so yes, it does create an opaque almost market, and there are times we just have to be patient and [indiscernible].

A very low liquidity a very low... Transaction. I also think the other reason that you see NOLA tend to trade a bit below international parity is during periods of a year where you can't find the same level of liquidity elsewhere in the world, Noah is a very liquid market. And so it's easy to bring an extra cargo in, find buyers for it and ultimately get cash for the cargo. So to Bert's point, we're evaluating that. We're looking at export opportunities at better netbacks. And ultimately, these things will balance out.

Maybe jumping over to the green and blue options that you've brought out a couple of years ago and have been pursuing a couple of things I wanted to ask you about it. One being given just nitrogen pricing is at such a higher level than it was when you rolled out the -- that initial electrolyzer project at Deville, has that led to maybe less interest now than you might have had back then? Is there less interest now because of the commodity prices just so much higher?

No, if there's any less interest. In fact, it is a core tenet of our strategy to decarbonize our network. And I think the role that carbon capture and sequestration plays is important for our existing assets. And I think as we look forward, the ability to gain expertise and capability in green ammonia production is also very valuable for us. I think given where the price of hydrogen is and even the price of ammonia today an investment in incremental capacity despite the fact that green ammonia production is dramatically higher than conventional gas-based production is still very profitable at these kind of levels. And so we're moving forward with all haste to try to bring that incremental production capacity online because we need every ton we can make.

And is it fair to say that the rate limiting step for your blue project to carbon capture and then sequester at the 2 facilities down in the south. Is the rate-limiting step that downstream Class 6 injection well that has to get permitted and so forth. Is that holding you up? Or do you have options to go say via enhanced or recovery?

Yes. We have options, and the limit area is not the ultimate disposal or the injection site for the CO2. It's the ordering of the equipment and the installation of the dehydration and compression. You're talking about very large vessels, pretty substantial power draw to be able to move 2 million tons of CO2 out of that facility. But our expectation is that we'll be in a position to announce something here pretty soon around disposal of that and what we're going to do with it. And to your point, Steve, in the near term, EOR is absolutely a viable option for us.

Anybody want to jump in here with a question?

Why isn't now the time to build a greenfield nitrogen fertilizer facility in the U.S.? It seems like a good time to do that. And then if you did decide to do it, how long would it take and what's an estimate, how much it would cost?

Yes. So it's one of those things that we certainly look at, but it's about 4.5 to 5 years from the time you decide that you want to build it to go through kind of the FEED study, the front-end engineering and design study and then get into equipment ordering and construction. So that's -- the relevant question is much more what's the marketplace going to look like 4.5, 5 years from now? And what does that look like then for the next 10 afterwards. So those are the things that we're thinking about. And then the question for us really is, would you build a conventional fertilizer plant the way that we did back in 2015? Or would you build a purpose-built kind of blue ammonia project and not do all of the upgrades on it. We actually think that there's going to be a fair bit of new demand from sources that are not traditional for low-carbon ammonia, whether it's co-fired with coal and combustion for electricity generation in Korea and Japan, whether there's marine applications for zero carbon propulsion systems. There's a number of discussions that we're having with potential partners -- and we think that the thing that might gate the development of alternative demand sources is the supply side. So as we look at bringing on our blue ammonia production from carbon capture and sequestration at our existing facilities, we also think maybe it would make sense to evaluate a new blue ammonia plant as opposed to a fully integrated fertilizer plant. So those are the kinds of things that we're thinking about. I don't have current up-to-date numbers on what a new ammonia only plant would be, but I would guess circa $2 billion to do a green field ammonia only plant for a world-scale plant in somewhere in the Gulf Coast. That is a wild as swag, but it's...

But I think the difference is just even the infrastructure from a typical fertilizer plant to what Tony is describing here is a blue ammonia plant is going to be different. The storage that we have for urea, the unit train capability, all that, you'd be looking at something that would be export oriented. So I think the costs are going to be -- you can't really look back if we were to do something like that similar to '15 and say, boy, those projects cost tax and it will cost tax back this time because it would be something I've looked.

Yes, it would be a different plan entirely.

Okay, fellows. We're out of time. Please join me in thanking the CF team.