Tuesday, April 10, 2018

CVR Partners - Nitrogen Fertilizers

OVERVIEW

CVR Partners is a variable distribution master limited partnership that makes and sells nitrogen fertilizers in the United States.





In an oversupplied and rational market, as currently, the marginal cash delivered cost of nitrogen fertilizers should determine their market price. 



In an import dependent market like the United States, the marginal cash delivered cost of nitrogen fertilizers is determined by two elements:

  • the marginal importer's feedstock cost; and
  • the marginal importer's cash cost to insure, transport, and store the fertilizer product.


and therefore, given CVR Partners' 2017 product mix and $3 Henry Hub gas price:



note: "CAFD" = cash available for distributions, i.e. dividends.

Or, assuming for the sake of argument that (a) the natural gas price faced by the marginal importer is $9/mmbtu; and (b) CVR Partners' product mix reverts back to its historical pattern:

 and therefore:



Investors motivated to look two or four years ahead may find that the feedstock cost faced by marginal importers is likely greater than $9/mmbtu equivalent. 

For example, translating Chinese lump anthracite producers' feedstock equivalent pricing yields the following translation:


Alternatively, as demand growth absorbs the capacity added in the last few years and as capacity utilization rates rise, the list of marginal producers will increasingly include older European plants that are less efficient at converting natural gas into nitrogen:



So at $70/barrel Brent oil one might expect $7.50/mmbtu natural gas prices in Europe. But the older plants consume 35% more gas per ton of nitrogen so the $/mmbtu on an equivalent basis is $7.50 x 1.35 = $10. And so on.

THESIS

That was the overview and what follows is the investment case for CVR Partners at the price that it is trading at today.

This is what the relationship between importers' marginal cash delivered cost and CVR Partners' average selling price ("ASP") looks like for anhydrous ammonia ("ammonia") and for urea ammonium nitrate ("UAN"):





The contention of this write up is that the gap between fair values and actual ASPs, representing as it does cash variable costs borne by financially motivated agents is not sustainable and will close. 

This series of charts is a useful additional clue as to the peculiarity of the situation in 2017.  



 
CVR Partners' 2017 performance would have looked like this in the absence of  the logistics gap:



I have set aside the associated improvements in urea and nitric acid pricing for the sake of simplicity.

95 million in distributions should be good for >$10 unit prices.

RISKS

The risks to this thesis are NAFTA-dissolution and China trade war related. Mexico is the principal consumer of US corn and China is the principal consumer of US soybeans. A trade war with either country will likely disrupt nitrogen fertilizer trade flows and may prolong the time required for the logistics gap to close.

China's response to a tariff war may be to allow the yuan to devalue. That would flatten the cost curve so that the longer term upside potential outlined in the "overview" section above would be reduced.

On the other hand, a potential opportunity outside the scope of this write up is the development of a Chinese ethanol industry which would cause a substantial increase in corn, and therefore, nitrogen demand.



USEFUL RESOURCES

Weekly ammonia and urea prices at the US Gulf Coast http://www.mosaicco.com/resources/3185.htm

Quarterly AN and Urea prices at Black Sea ==> quarterly implied UAN price at Black Sea (using the formula 45% AN plus 35% urea): 
http://www.eurochemgroup.com/en/downloadcentre/

Monthly urea and UAN prices in the US interior
https://marketintel.intlfcstone.com/MIPublic/Home.aspx?secid=158

Anything put out by CF Industries is worth paying careful attention to.

9 comments:

  1. https://www.dropbox.com/s/6ccx9r6npue221y/Simple%20Model%20for%20upload.xlsx?dl=0
    Should be downloadable. Let me know if it's not.
    Entering values in the yellow cells should spit out sensitivities. Beware GIGO.

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  2. Additional data source for those interested in what's going on in China -- i.e. everyone
    http://www.stats.gov.cn/english/pressrelease/index.html

    Fortnightly release titled "Market Price of Important Means of Production in Circulation" presents domestic urea prices (metric tonne) and coal prices.
    So. for example, thelatest bulletin reports anthracite at RMB 1324/t and urea at RMB 1972/MT
    Urea at RMB 1972/MT translates to ~$280 per short ton. Etc

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  3. Glad to see a new post! Really appreciate your ideas and analysis.

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  4. I am so happy you are back. I missed your posts!You are one of the most independent minds in the value investing arena.

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  5. Yara Q1 2018
    https://www.yara.com/investor-relations/reports-presentations-2018/

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    Replies
    1. Thanks for sharing, red. From my ignorant point of view, most interesting was slide 16 on the slowing capacity additions in the medium term (and possibly the first question/answer). Do you think China will be able to fill demand in 2020/21, say? And if so, at what cost?

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    2. Well I think one can retrace China utilization rates to come to a first approximation of the incentive price for increased Chinese production. And then fine tune it by adjusting for increased electricity rates, decreased rail transport subsidies, increased environmental compliance costs, higher ocean freight rates, increased labor costs, and so on. And, of course, the sheer cash cost of restarting idled plants. CF's presentations over the last, say 8 quarters, are good sources for this.

      I think it would be very hard to come up with an incentive price that is lower than RMB 1800/st or RMB 1985/MT for urea, all things considered.

      Of course that's separate from the main thrust of the investment case for the North American fertilizer producers. NA urea prices, for example, are currently (April 2018) $57/st below what would be parity with Chinese prices.

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  6. Hey red,
    I thought I'd share Bruce Berger's video on CVR:
    https://youtu.be/EJRKItfFC7M

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    Replies
    1. I watched it. Thx for posting. I'd caution that he has more things wrong than right -- the causes of oversupply, CVRP's cost structure, ete etc. I'd recommend to anyone interested in this stock that they simply read the S-1s for the cost structure and read through CF's materials for an understanding of the industry dynamics.

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