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

Hello to everyone joining us today. Up next, we have CF Industries presenting. Joining us will be Martin Jarosick, their VP of Investor Relations. CF is the world's premier pure play nitrogen producer. And nitrogen prices have been quite a run recently with global energy prices going up a lot and geopolitical tensions kind of impacting the market. If you have any questions on the line, please turn them through, and we'll have them addressed with Martin. And I guess we're just going to pop right into Q&A, right, Martin?

Yes, absolutely.

Okay. So obviously, I think you know the first thing I'm going to ask you, the most topical event right now is what's happening with Russia and Ukraine. Can you just provide some more higher level, broader thoughts on some of the market impacts that we're seeing on the nitrogen and ag markets and where CF is seeing some of the biggest impacts today? And let's kind of take it from there.

Right. So it's a tragic event, and it's impacting a lot of different parts of the agricultural value chain. I think starting with grains. Russia and Ukraine are large grain-producing regions and large exporters. Russia, I think is the largest exporter of wheat. And Ukraine is large in many products, including corn, I think fourth largest in corn. So it's -- those 2 countries are important contributors to global food. And I think you're seeing that in the commodity prices, the uncertainty about how much will actually be planted in the Ukraine with all of the disruption that comes with the armed conflict, what can get planted, what can get harvested and what can make its way out into the global marketplace. So I think that's the kind of the first level of impact on agricultural markets. And then when you get down into the fertilizer space, Russia and Ukraine are both exporters of nitrogen products to the rest of the world. And there's clearly a disruption in the movement of those products. And so that's going to impact Brazil with -- they get most of their ammonium nitrate from Russia. So now they're looking for a source of ammonium nitrate. There are several players that get a lot of ammonia out of Russia. They are now -- they're trying to find new sources of supply for that ammonia. So -- and so -- yes, and then the impacts on natural gas prices in Europe has pushed it to some pretty extreme levels. I think when I looked earlier this morning, it was about $60 in MMBtu for natural gas in Europe, which is an incredibly expensive way to make ammonia and nitrogen products. So that's having an impact on the economics of producing in Europe. And it's hard to say where that's all going to go. I think the forward curve is just looks like it's high for a long time. I don't see the normal seasonality that you expect in an energy forward curve. So there's just a lot of uncertainty there. And we had a lot of plants shut down in Europe, fall when the -- when we first jumped into like the $25 BTU range and nitrogen prices didn't really keep up and they eventually have -- they caught up to that level. Now we stepped up to a new level of gas, and it's to be determined whether prices will move up or whether that capacity will shut down. You'd imagine most people are hedging a certain amount of their gas. And we typically hedge what we have committed to sell. And so any fresh orders would need to be taken at replacement value at today's gas value. And so that doesn't give a lot of length to the production outlook for Europe.

So what is that marginal cost that you've seen to, like let's say, call it, $40, $50, $60, like what is that marginal cost versus the prices that we're seeing in the market today? And are you hearing from many of the European producers potentially considering shutting down because maybe they're not able to get the prices that they need or maybe even they may not even [ build ] the gas that they need?

It's -- I mean, if you look at $40 MMBtu gas, you need probably 35 MMBtu to make ammonia and 25 to make -- or a little less than 25 to make urea. So that's just the gas value is higher than current product values coming out of Egypt. And so something is going to give. I mean, we ourselves have 2 plants in the U.K. One has not run since mid-September. The other has been running based on the CO2 contracts that were revised or renegotiated in September and October. And also on gas pass-through for nitric acid and ammonia, there's enough of that to keep one of our plants running. So I think each plant will have kind of an individual assessment of what is their sales opportunity if you're a more industrially focused plant and you already had gas pass-through contracts. Now it's a matter of can your customer afford to pay that price to make whatever product they're making as you pass that gas through. So it is -- I mean, these are levels we've never seen in Europe. So it's uncharted territory as far as where all this goes, as far as the production coming out of Europe.

And as we move through the year, how do you expect that marginal cost to be set? Will it still be Europe throughout most of this year? Or could we see as some of the experts come back from China? And does that maybe set the market as we kind of move into the seasonal lull? Or is it different this year? Because like we've seen in prior years, India had just cut on tendering and prices didn't quite come down as what people thought.

These -- I'll start with India. Okay. They've kind of been behind the 8 ball. They've been behind on their buying program since early 2021. With the first couple of tenders, they kind of -- they didn't take very much products hoping for a lower price, and then the price went up and they still didn't want to take products. And they kind of got behind a bit. And so you saw them tender through '21 deeper than they have in a long time. They stayed in the market tendering and we expect that they'll probably later this month, they'll announce a tender for April delivery. So not very much of a break. They normally may stop in October and kind of sit out of the market until a March tender for April delivery. So they got to tender all the way through their traditional off period. And we don't see a reason why or an ability for them to just stop and they need the products. They don't have the inventories. Unless there's a weather reason like a core monsoon that impacts their ability to plant and fertilize, the demand for grain is there. The value on the output side is definitely supportive of planting as much as you can and fertilizing as much as you can. So don't really see India backing out of the market. Traditionally, the Northern Hemisphere kind of off-season is summer, kind of the July, August, September. And -- but we're going to end -- probably everyone in the world is going to end with really low inventories because you don't want to carry high-priced inventory into the next season. So the amount of inventory out there is going to be really low. So the restocking cycle will probably have to start a little bit sooner than average. But that's still -- I mean, traditionally, we do get a low in activity in that -- kind of in the third quarter. That's traditionally our lowest price period as far as the prices that we realized. It's also when we do the preponderance of our maintenance. So we have the lowest amount of production and tons available for shipment during that period. And so we'll see how this season goes. I mean it's -- we haven't had a quite a what normal season in a couple of years. 2021 was not normal by any measure. Third quarter prices were meaningfully higher than second quarter prices. That's the first time that's happened in a long time. 2020 was equally as unusual because of COVID. We had a period in the summer where gas was cheaper in the U.K. and in Europe than it was in North America, which is clearly an anomaly. So it's been 2 years since we had a normal year, not sure '22 is going to be a normal -- not setting up to be a normal year either.

Right, right. And so I think just going back to the Chinese exports, does that change any of the views kind of going into Q3? Or is that just that there's just not enough tons coming out to kind of balance out the market there?

Yes. So when we look at what have the Chinese been doing with their industry -- we're not talking about the where is Chinese government, how they have been shaping the industry into what purpose is urea production as part of the Chinese economy. You go back a decade, it was a source of GDP growth, employment growth, export growth that all came generally with funded losses and lots of subsidies. That attitude around that type of growing that type of business really shifted. And so you've seen a deemphasis on commoditized energy-intensive businesses out of China. So since 2016, pretty much all the subsidies have gone away. The industry is expected to be somewhat self-sufficient. And you've seen like this last winter, basically a ban on exports, and that was for 2 reasons. They wanted the price available to the Chinese farmer to not reflect the international price. They wanted it something somewhat lower. And so there are periods where Chinese price has been half, the domestic price has been half of the international pricing, and that's where it is today. It's less than half. And that's exactly what the central government wants. They want stable prices for their farmers. They want a high fertilization rate, high yield on what they're going to plant this spring. The exports restrictions are in place probably until -- I think they're officially in place until the end of June. We do expect tons to come out. Don't expect a huge glut of tons to come out because until the domestic customer has completed their applications, what we observe is all the tons are being oriented towards domestic production. They're not heading to the ports and getting stacked up, ready to go on a vessel as soon as the export doors are kicked open. We would expect exports to come out once spring is completed and all the applications have been complete. But then that's traditional that they would export most in the kind of in the off-season. And then I think we'll be right back into an emphasis on building domestic supply for Chinese farmers at a reasonable price. And what you've seen with central government is they're not really focused on what the -- allowing the domestic urea industry to capture those high prices because that doesn't really benefit China as a whole. It benefits that company that is able to sell product at a much better price. But at least behind is all the pollution and water consumption and they're really taking a valuable resource and have limited resource in Chinese coal when you're exporting it to the benefit of farmers and other parts of the world. And I don't really think that that's going to be emphasized when things loosen up and you do see exports come out later this year in this summer.

Right. And I think you made some good points, especially today with the focus on food security and just grain prices going up globally, that's going to be top of mind for the government as well in managing.

Absolutely. When you look at what the restrictions you had -- restrictions that was prior to conflict of Ukraine, in Russia, Egypt and China, those are all restrictions put in place for the express purpose of making sure physical supply was available for those domestic industries and that it was available at a price did not basically pass on food inflation into the channel. Because in all of those markets, it's a controlled -- so in Egypt and Russia, the gas is basically government-sponsored and so it's subsidized. So they have a stake in saying, we're going to limit the price. We've given you subsidized gas. We're going to cap your opportunity to sell outside of the domestic market until you've satisfied the domestic customers at a reasonable cost that doesn't pass on that inflation. And the same thing in China. The Chinese control the price of coal, and therefore, it's essentially a subsidized or capped. It's a managed product and the export ban is basically there to prevent the product from flowing out to capture higher prices when the emphasis is on supplying domestic farmers.

And we've also been hearing with the Russian exports, they've had difficulty securing services, banking, insurance. They haven't been sanctioned yet, but it sounds like they've had difficulty with maybe deliveries. Are you seeing that as well? Are you seeing customers turning away from Russian product just because of challenges actually being able to pay or receive them and maybe just risk mitigation?

I think that's exactly right. If you can't get a vessel to pull into port, so the vessel will go and the insurance company won't provide insurance on the vessel, it's not going to pull in and load up. And so you have seen in Brazil, a lot of force majeure on both nitrogen products and potash products. So you're seeing it already in your -- it's going to be interesting to see how that all develops, but where that -- does that product actually physically make its way out or does it not. But in the near term, it's -- if you were expecting a vessel to arrive, I mean there were vessels that were on their way to Canada, which I believe at this point, cannot dock. So they can't offload. And I believe the U.K. may have done something similar. And so it's a pretty uncertain -- it's an uncertain activity now. So if you're counting on supply from Russia to meet your needs over the next few months, you're probably not sleeping very well.

And I guess, just long term, what sort of assumptions [indiscernible].

You're breaking up just a little bit there, Andrew.

Sorry about that. So just in terms of your longer-term assumptions that, obviously, the situation is impacting the nat gas markets. Do you have different longer-term assumptions now in that gas? And how does that change your views in CF's on where nitrogen prices go longer term?

I mean it's…

The curve -- it's a curve right in, but it may not tell us whether it might be 5 years from now, for example.

That's exactly right. I mean the current gas situation in Europe really is only about 6 months old. It was in September when you see solid gas prices run up into the mid-20s. And then they have certainly and today, much higher than that. So it is to a relatively new phenomenon. We've seen the kind of the short-term impacts. But the long-term impacts, I think when we look at the differentials between the gas-producing regions, so Middle East, North Africa, North America and then the consuming regions, they've been low for roughly the last decade until just recently. And we would expect those margins -- those differentials to be wider going forward because what they're saying -- what they're signaling is there needs to be more capital investment in bringing in on-demand energy into these energy-efficient regions. So Europe and Asia, we'll continue to need and try to source more natural gas. And so that means a lot of activity and a lot of capital has to be put into place in order to meet that need. And without enough differential between the landed price and the kind of the load price, then those projects don't move forward. So that would -- I don't have a specific number for you, but we expect wider margins between Europe and Henry Hub and Asia and Henry Hub than we've seen in the past, which is -- which means that structurally, a steeper cost curve than you may have seen over the last decade.

Right. Right. Just maybe turning to UAN a little bit here. We have seen the initial kind of duties coming in for CBDs and antidumping. The UAN is trading at a very high premium versus urea, maybe not as much today as it was a couple of weeks ago. How do you see that relationship kind of evolving over the next few years? Do we see a premium that's maybe similar to what the CBDs and antidumping are implying on like a nitrogen basis, essentially? Or how does that evolve over time?

Well, I think where we are in the process, we -- so prior to 2018, you saw a premium -- across the whole year, you'd see a typical premium just using the green markets down on Bloomberg or roughly $20 kind of a urea equivalent ton for UAN, which reflects that there's additional capital that's invested to produce UAN. So it's a little bit -- it's more capital-intensive than producing urea and their agricultural and operational benefits to the farmers for -- when they incorporate UAN into their nitrogen plan, that should reflect a higher value for UAN. And then when you look at '18, '19, '20, you see a deficit during that period. So UAN traded at a discount over those entire periods. And then that -- we've brought our trade case because of the subsidies and the dumping that we were observing. And each step of the way, that case has been substantiated through the findings -- and they're preliminary at this point. We'll see what happens this summer when the final rulings come out. So it's too soon to predict what the impact would be. But our hope would be that we end up in an environment where UAN has an appropriate premium over time compared to urea to reflect the capital investment and the ergonomic and operational benefits. So we'll see what happens. I think we'll know more in this summer.

Okay. Okay. So more to come. Low-carbon ammonia, the blue ammonia capacity that CF is adding, that's coming up in the next couple of years pretty -- it's actually pretty soon when you think about it. Is there anything you can share in terms of the discussions with your partners? Obviously, the blue ammonia is coming and you're seeing a lot of developments on the use case, but we haven't really seen any sort of like offtake or any sort of specific like a demand for it that's really come up like anything specific. So anything you can share around that, that'd would be interesting for us, I think.

Sure. So we are moving forward with the investment that we need to make to be able to sequester CO2 because we already capture the CO2. And in our Donaldsonville plant, we have started work on the dehydration and compression because you do need to get a little bit of water vapor out of the CO2, you need to condition it, and then we need to press it down to a liquid and then it's ready to be shipped either for in its recovery uses or for permanent sequestration, which would need a Class 6 permit permitted well in order to do sequestration. But -- so we're on track with our construction efforts. When it comes to the demand side, we have a lot of discussions. It's also within scope of our MOU with Mitsui. They are part of the effort in Japan to develop ammonia co-firing with -- in co-fired power plants to bring down the CO2 intensity per megawatt hour of electric generation in Japan. And so at this point, the Japanese are running kind of operational or commercial scale testing in a co-fired power plant. So I think that's probably the -- that's something that's pretty well in development as far as moving down that path of co-firing ammonia with coal. In South Korea, they're looking at the same thing. So that's probably the nearest term use case for clean energy, for ammonia clean energy uses. Shipping industry is doing a lot of work on looking at ammonia as a way of meeting the 2030 and 2050 IMO targets for decarbonization of shipping. That's probably a little bit longer dated, but there's a lot of good work, both in the kind of the supply chain side and also on the engine development side. And we participate in multiple efforts for shipping. And the use case of ammonia as a carrier for hydrogen, where you disassociate the ammonia at some -- at a far off destination and kind of get it back to hydrogen, it's probably a longer use case. It's probably -- there's more development necessary to bring that to full commercialization. So over the -- call it, over the next 2 decades, there's a lot of potential growth for ammonia for clean energy with those 3 use cases. And then there's the potential to see basically blue and green versions of the products that we make for agriculture that can develop. I think that's -- you need a market that has a more explicit pricing on carbon or a mechanism for rewarding the farmer for their practices that lead to carbon sequestration in the soil. So there's more work to be done there, but that's another avenue for potential uses for blue and green ammonia.

Okay. Okay. And just one question that we've got here is given some of the recent press speculation around acquisitions in the nitrogen space, could you please comment on whether now is a good time for some strategic M&A for CF?

I think we always are looking at opportunities to add capacity to our network. The advantage of M&A is -- you don't disrupt the S&D balance. It's immediate. You don't have that 4- to 5-year construction period. But it's got -- you've got to be able to acquire the asset at the right price. There often is a second check that you have to right to potentially invest in the asset to get it up to the operating condition and standard that we would like to see for all of our assets. And then the synergies have to be significant enough to provide a risk-adjusted return on that product. So we always look at that. It's -- we just don't often find all of those things lining up at the same time. Our last major acquisition was in 2010.

Right. Okay. That makes sense. I think that's all the time we have today. Thank you, Martin, for sharing all your thoughts on the nitrogen market and on CF. And anyone on the line, if you have any questions, feel free to send them through and we'll pass them on to the company. Thanks, Martin.

Thanks, Andrew. Appreciate it.