Natural Gas: Domestic Nitrogen Fertilizer Production Depends on Natural Gas Availability and Prices
Published: 2003-09-30T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Natural gas is the most costly component used in manufacturing nitrogen fertilizer. Therefore, when natural gas prices increased in 2000-2001, U.S. companies that produce nitrogen fertilizer reported adverse financial consequences resulting from much higher production costs. Concerns also arose that the nation's farmers would face much higher nitrogen fertilizer prices and that there might not be an adequate supply of nitrogen fertilizer to satisfy farmers' demands at any price. Responding to congressional concerns, GAO undertook a study to determine (1) how the price of natural gas affects the price, production, and availability of nitrogen fertilizer and (2) what role the federal government plays in mitigating the impact of natural gas prices on the U.S. fertilizer market.
section_title: What GAO Found
paragraphs: Higher natural gas prices have contributed to higher nitrogen fertilizer prices and reduced domestic production. The following figure shows the relationship between natural gas prices and the farmer price for nitrogen fertilizer. Higher gas prices in 2000-2001 also led to a 25 percent reduction in domestic production of nitrogen but, despite this decline, the supply of nitrogen fertilizer was adequate to meet farmers' demand in 2001. Demand was met because U.S. nitrogen production was supplemented by a 43 percent increase in nitrogen imports and a 7 percent decrease in agricultural consumption of nitrogen fertilizer. The federal government does not set natural gas prices, and it has a limited role in managing the impact of natural gas prices on the U.S. fertilizer market. Three federal agencies--(1) the Federal Energy Regulatory Commission, (2) the Commodities Futures Trading Commission, and (3) the Energy Information Administration--are responsible for ensuring that natural gas prices are determined in a competitive and informed marketplace. Moreover, the federal government has no role in controlling fertilizer prices, but the U.S. Department of Agriculture (USDA) does monitor developments in the agricultural sector, including fertilizer markets, that could affect farmers. Also, in 2001, USDA collected additional survey information in response to concerns about the price and availability of nitrogen fertilizer.

section_title: Letter
paragraphs: Nitrogen, the plant nutrient and fertilizer component most widely applied  by American farmers, is essential for maintaining the high yields achieved  for major crops such as corn, wheat, and cotton in this country. Natural gas  is a key component in the production of nitrogen, and the cost of natural  gas can account for up to 90 percent of nitrogen fertilizer production costs.  When natural gas prices in this country increased in late 2000 and early  2001, U.S. fertilizer producers reported financial losses resulting from the  significant increase in their costs of producing nitrogen fertilizer. These  higher production costs also made it difficult for U.S. producers to compete  with foreign nitrogen fertilizer producers, who could buy natural gas at  lower prices and export their products to the United States. At about the  same time, concerns arose that the nation’s farmers would face much  higher nitrogen fertilizer prices—and even that there might not be an  adequate supply of fertilizer to satisfy farmers’ demand at any price. Such  an outcome was considered possible if U.S. fertilizer producers were  forced to significantly decrease their production, because in recent years  domestic producers have supplied more than one-half of the nitrogen  fertilizer used by American farmers. According to fertilizer industry  officials, higher natural gas prices in 2003 are again having a negative  financial impact on the U.S. nitrogen fertilizer industry, threatening to  irreversibly cripple it.
In this context, you asked us to determine (1) how the price of natural gas  affects the price, production, and availability of fertilizer and (2) what role  the federal government plays in managing the impact of natural gas prices  on the U.S. fertilizer market. To address the first issue, we examined  government and industry price data pertaining to natural gas and nitrogen  fertilizer to determine how nitrogen fertilizer prices, both major market  spot pricesand retail prices paid by farmers, behaved when the price of  natural gas increased in 2000–2001 and again in early 2003. Specifically, we  determined the extent to which a correlation exists between the price of  natural gas at the Henry Hub and prices for three major types of nitrogen  fertilizer products: anhydrous ammonia, urea, and urea ammonium nitrate  (UAN). We selected these three products because they are widely used by  American farmers. We also examined data obtained from the Department  of Commerce and industry sources to determine how nitrogen fertilizer  production behaved when natural gas prices spiked in 2000-2001 and the  results of a U.S. Department of Agriculture (USDA) survey aimed at  determining how farmers reacted to higher fertilizer prices in 2001. To  determine how higher natural gas prices have affected the supply of  nitrogen fertilizer, we obtained the results of a second USDA survey aimed  at determining the availability of fertilizer. In addition, we analyzed  sources, supplies, and consumption of nitrogen from fertilizer years 1996  through 2002. To address the second objective, we reviewed the  responsibilities of federal agencies relevant to the natural gas and fertilizer  markets and their efforts to monitor and collect information on these  markets. We also reviewed relevant documents provided by agriculture and  fertilizer industry representatives and interviewed these officials to obtain  their views on what actions, if any, the federal government should take to  mitigate the effects of high natural gas prices on the U.S. fertilizer market.  We performed our review from February through August 2003 in  accordance with generally accepted government auditing standards. A  detailed description of our objectives, scope, and methodology is contained  in appendix I.
subsections: section_title: Background
paragraphs: Natural gas is a key feedstock in the manufacturing of nitrogen for which  there is no practical substitute. Manufactured nitrogen—also known as  anhydrous ammonia—is used as a fertilizer itself and is also the primary  building block used to manufacture all other nitrogen-based fertilizers.  Some of this nitrogen also is used for industrial purposes such as  promoting bacterial growth in waste treatment plants, making plastics, and  as a refrigerant. U.S. manufacturers supplied almost 14 million tons of  nitrogen during fertilizer year 2002 and an additional 7 million tons were  imported. Fifty-six percent of the total nitrogen supply was consumed by  U.S. agricultural demands. Since natural gas is the most costly component  of nitrogen, the profitability of the U.S. nitrogen fertilizer industry depends,  to a large degree, on the price of natural gas in the United States. As we  reported in December 2002,  natural gas prices can be volatile, and small  shifts in the supply of or demand for gas are likely to continue to cause  relatively large price fluctuations. In addition to facing a volatile natural gas  market, which sometimes leads to price spikes, America’s nitrogen  fertilizer producers must also compete in a marketplace where many  competitors pay much lower prices for natural gas. For example, industry  data show that recently, when the U.S. market price for natural gas was $5  per mmBtu, lower gas prices were available to nitrogen fertilizer producers  in other parts of the world. The price of gas in the Middle East was 60 cents  per mmBtu; in North Africa, 40 cents; in Russia, 70 cents; and in Venezuela,  50 cents. According to The Fertilizer Institute (TFI), fertilizer products  operate in a world market, and U.S. prices are influenced by numerous  variables other than the price of natural gas in the United States.
U.S. General Accounting Office, Natural Gas: Analysis of Changes in Market Prices,  GAO-03-46 (Washington, D.C.: Dec. 18, 2002).
section_title: Higher Natural Gas Prices Have Contributed to Higher Nitrogen Fertilizer Prices and Reduced Domestic Production but Have Not Affected Availability of Fertilizer
paragraphs: Because the cost of natural gas accounts for such a large percentage—up  to 90 percent—of the total costs of manufacturing nitrogen fertilizer,  nitrogen fertilizer prices tend to increase when gas prices increase. When  gas prices increased in 2001 and 2003, prices for nitrogen fertilizers  increased throughout the marketing chain. The higher natural gas prices in  2001 also led to higher production costs for the U.S. nitrogen fertilizer  manufacturing industry and resulted in a significant reduction in the  amount of nitrogen produced in this country that year. Despite this decline  in the production of nitrogen, supplies of nitrogen fertilizer were adequate  to meet farmers’ needs in 2001 primarily because of a significant increase in  imported nitrogen.
subsections: section_title: Natural Gas and Nitrogen Fertilizer Prices Are Closely Related
paragraphs: Higher natural gas prices have contributed to higher prices for nitrogen  fertilizer throughout the marketing chain. When gas prices increased  significantly in 2001 and 2003, spot market prices, as well as the prices  farmers paid for fertilizer, increased for all three nitrogen-based products  included in our analysis—anhydrous ammonia, urea, and UAN. Further, the  high prices seen in 2001 could have been even higher, if the volume of  fertilizer imports had not increased to compensate for the reduction in  domestic production of nitrogen. The relationship between gas prices and  fertilizer prices was the strongest for anhydrous ammonia, at least in part,  because anhydrous ammonia contains the highest concentration of  nitrogen of the three fertilizer products—82 percent—and natural gas is by  far the most costly component used in manufacturing nitrogen. Anhydrous  ammonia is the nitrogen-based fertilizer used most often in the United  States, and is also the primary building block for urea and UAN. As shown  in figure 1, prices for anhydrous ammonia and natural gas prices moved  closely in relation to each other during the period from January 1998 to  March 2003. When gas prices increased or decreased, the spot market price  for ammonia tended to follow the same trend. More specifically, both the  price of natural gas and the price of ammonia peaked in January 2001 and  again in March 2003. Closer review of the data shows that the monthly  price of natural gas in January 2000 of $2.52 per mmBtu had risen 1 year  later to $10.16 per mmBtu, an increase of 303 percent. Over the same time  period, the price of anhydrous ammonia rose from $119 per ton to $290 per  ton, an increase of 144 percent.
Although there is a strong correlation between natural gas prices and nitrogen fertilizer  prices, many other variables influence the supply and demand market forces that ultimately  determine fertilizer prices. In addition, U.S. companies that produce nitrogen use various  purchasing techniques to manage their natural gas price risks; therefore, they do not  purchase all their gas at the prevailing market price. than anhydrous ammonia: 46 percent and 32 percent nitrogen, respectively.  Because urea and UAN prices reflect lower nitrogen concentrations, they  did not always move in direct relationship with natural gas prices. For  example, in May 1998, urea prices increased to $162 per ton, while gas  prices remained basically flat.
Moreover, the prices of nitrogen fertilizer can differ depending upon how  much further along the marketing chain prices are recorded. For example,  as shown in figure 3, the price for anhydrous ammonia in the Mid Cornbelt,  where this fertilizer is primarily used, was higher than the price in the U.S.  Gulf. This difference reflects the cost of transporting the ammonia from the  Gulf, where it is produced, to the Mid Cornbelt. Also, changes in the price  of nitrogen fertilizer can lag behind changes in natural gas prices,  depending upon where in the marketing chain prices are recorded. For  example, as shown in figure 3, the price for anhydrous ammonia in the Mid  Cornbelt peaked in February 2001—about 1 month after natural gas prices  spiked that year. Other increases and decreases in the price of Mid  Cornbelt ammonia lagged behind natural gas price changes on other  occasions. We believe these lags reflect the time associated with  transporting the fertilizer from its point of origin to the farmers who  ultimately use the product.
Retail prices for nitrogen fertilizer, or those prices paid by farmers, also  tend to rise sharply when natural gas prices increase. As shown in figure 4,  the USDA-reported farmer prices for nitrogen fertilizer reflected the  natural gas price spikes that occurred in January 2001 and March 2003.  However, the 2001 spike in fertilizer prices lagged behind the increase in  gas prices by about 1 month. The February 2001 price for nitrogen fertilizer  was about 79 percent higher than it was the previous year.
Furthermore, according to USDA data, the average U.S. farm-level price for  nitrogen fertilizer during the spring, when farmers’ demand for nitrogen  fertilizer is the highest, tracked natural gas prices. Specifically, the April  monthly price for natural gas increased approximately 84 percent from  April 2000 to April 2001. Over the same time period, the April farm-level  price for anhydrous ammonia increased 76 percent from $227 to $399 per  ton. By April 2002, gas prices had decreased by 39 percent, and ammonia  prices had dropped by 37 percent from the previous year’s level. In April  2003, the price of natural gas was again higher, increasing by 48 percent,  and the average farm-level price of anhydrous ammonia followed this trend  by increasing 49 percent. However, it is difficult to determine the extent of  financial harm farmers suffered because of increased fertilizer prices in  2001. A USDA study directed at determining how corn farmers responded  to higher fertilizer prices in 2001 found that about 34 percent of the  responding producers of corn—a crop that requires large quantities of  nitrogen fertilizer—purchased a majority of their nitrogen fertilizer at  prices that were set prior to January 2001 and, therefore, were not affected  by the sharp rise in fertilizer prices that year. Further, these producers were  among the largest corn-producing farms and applied the most nitrogen  fertilizer per acre. Eleven percent of the corn producers that responded to  the USDA survey reported adjusting their nitrogen application rates or  practices in response to higher prices, and the remaining 55 percent of  respondents—generally smaller corn farms that applied the least amount of  nitrogen fertilizer—reported they took no action in response to higher  nitrogen fertilizer prices in 2001.
section_title: Higher Natural Gas Prices Had Financial Consequences for U.S. Nitrogen Fertilizer Producers and Led to Reduced Production
paragraphs: The sharp rise in gas prices in 2001 had financial consequences for the U.S.  nitrogen fertilizer manufacturing industry because of the sharp increase in  their production costs. These higher production costs, which could not be  recovered through higher fertilizer prices, led to plant closures and a  significant reduction in domestic nitrogen production. According to  industry data, several companies that manufacture nitrogen fertilizer  reported decreased revenues or financial losses in 2001, and each cited  higher natural gas prices as contributing to or causing the financial  consequences. For example, one large interregional cooperative that  produces nitrogen fertilizer for U.S. farmers and ranches reported a loss of  more than $60 million in 2001. The company’s 2001 annual report cited high  natural gas prices as a primary reason for the financial loss.
Industry data obtained from the International Fertilizer Development  Centershowed that between January 2001 and June 2003, eight U.S.  nitrogen fertilizer manufacturers permanently closed their plants, and a  ninth plant had not operated since 2001. Industry officials also told us that  natural gas prices in 2003 have remained well above historic averages and  are continuing to exact a financial toll on the domestic nitrogen fertilizer  manufacturing industry. These officials cite the fact that, in June 2003, the  U.S. industry was operating at only 50 percent of capacity as evidence of  this toll. Further, they said the industry has suffered through several years  of extreme financial hardship, caused in part by higher gas prices driving  up production costs and foreign competitors who have access to less  expensive natural gas and, if gas prices in this country remain relatively  high, more U.S manufacturers are likely to curtail nitrogen production, and  some could permanently shut down their plants.
The production and consumption of fertilizer is often measured by the  amount of nutrient content in the fertilizer applied. For nitrogen fertilizer  products, the primary nutrient that is measured is nitrogen. Manufacturers  supply nitrogen that is consumed in both the agricultural and industrial  sectors. Table 1 below provides estimates of nitrogen supply and demand  in the United States over the last 7 years, including the nitrogen nutrient  content in fertilizer products consumed by the agricultural sector. As the  price of natural gas, the key component in the manufacturing of nitrogen  spiked in 2001, nitrogen production fell. As shown in table 1, U.S.  manufacturers produced 25 percent less nitrogen in 2001 than in 2000.
section_title: Imports Have Helped Maintain Availability of Nitrogen Fertilizer
paragraphs: Despite the significant decline in domestic production of nitrogen in 2001,  supplies of nitrogen fertilizer were adequate to meet farmers’ demand that  year primarily because of an increase in imports. USDA collected  additional survey information from April to June 2001 to determine  whether farmers were facing problems in obtaining nitrogen fertilizer. The  results of this survey show that the supply of nitrogen fertilizer was  adequate to meet farmers’ 2001 demand. As shown in figure 5, while  nitrogen fertilizer supplies were below normal in several states in April  2001, they had returned to normal levels in all but one state by June of that  year. Nationally, nitrogen fertilizer supplies were at 92 percent of normal  levels in early April 2001, while only 12 states reported supplies at less than  90 percent of normal levels. Only two states—Pennsylvania and New  Jersey—reported supplies at less than 80 percent of normal levels.  However, by early June nitrogen fertilizer supplies were at 97 percent of  normal levels nationally, and all but one state reported supplies at 95  percent or more of normal levels. By June 30, 2001, USDA officials  concluded that there were sufficient supplies of nitrogen fertilizer, and they  stopped the survey. Furthermore, USDA did not conduct a similar survey in  2003, when gas prices and fertilizer prices again increased, because it was  unaware of any concerns about the availability of nitrogen fertilizer.
The results of USDA’s survey are consistent with our analysis, which found  that although domestic production of nitrogen declined 25 percent in 2001,  the overall demand was met primarily because imports increased by about  43 percent. As shown in table 1, nitrogen imports increased from 6.3 million  tons in 2000 to approximately 9 million tons in 2001. Although most  nitrogen fertilizer imported into the United States has for the past several  years come from Canada, the amount of nitrogen fertilizer imported from  Canada decreased by almost 13 percent in 2001. On the other hand,  nitrogen fertilizer imports from Trinidad Tobago, Venezuela, and Ukraine  increased by 19 percent, 59 percent, and 469 percent, respectively, in 2001.  The price of natural gas in these three countries was considerably lower  than the price of gas in the United States; thus, fertilizer producers in these  countries were able to produce nitrogen fertilizer at much lower costs than  domestic producers.
Table 1 also shows that domestic agricultural consumption of nitrogen  decreased from 12.3 million tons in 2000 to 11.5 million tons in 2001—or  about 7 percent. At least part of this reduction can be attributed to the  impact of higher fertilizer prices on the country’s farmers. For example,  according to USDA’s survey aimed at determining how corn farmers  responded to higher fertilizer prices in 2001, 11 percent of responding  farmers reported they adjusted their nitrogen fertilizer rates or practices in  response to higher nitrogen fertilizer prices that year. About 80 percent of  these farmers reduced their nitrogen fertilizer use by an average of 23  percent.
section_title: Federal Government Has a Limited Role in Managing the Impact of Natural Gas Prices on the Fertilizer Market
paragraphs: The federal government has a limited role in managing the impact of  natural gas prices on the domestic fertilizer market. For example, the  government does not determine the price of natural gas; however, two  federal agencies—the Federal Energy Regulatory Commission (FERC) and  the Commodity Futures Trading Commission (CFTC)—play important  roles in promoting competitive natural gas markets by deterring  anticompetitive actions. In addition, the Energy Information  Administration (EIA) is responsible for obtaining information about and  analyzing trends in the natural gas market that are used by industry and  government decision makers. As with natural gas, the federal government  does not set or control prices for nitrogen fertilizer. However, as part of its  overall mission, USDA does monitor developments in the agricultural  sector that could affect farmers. Regarding the fertilizer market, USDA  collects, analyzes, and disseminates information on fertilizer prices and  uses and, in 2001, collected additional information on the supply of  nitrogen fertilizer and how higher fertilizer prices affected farmers. Lastly,  USDA provides insurance and commodity price support programs to assist  America’s farmers in managing risks associated with crop yields and  revenues.
subsections: section_title: Federal Role in the Natural Gas Market Is Focused on Ensuring a Competitive Marketplace
paragraphs: As we reported in December 2002, in today’s deregulated market the  federal government does not control the price of natural gas. However, two  federal agencies are responsible for ensuring that natural gas prices are  determined in a competitive marketplace. Specifically, FERC plays a major  role in overseeing the natural gas marketplace to ensure that prices are just  and reasonable and free from fraud and market manipulation. Similarly,  CFTC exercises regulatory oversight of natural gas derivativesthat are  traded on federally regulated exchanges, such as the New York Mercantile  Exchange, to protect traders and the public from fraud, manipulation, and  abusive practices.
Following the price increases that occurred in the natural gas market  during 2000–2001, both FERC and CFTC initiated investigations into  possible fraud or manipulation. In August 2002, FERC reported that it had  found indications that several companies may have manipulated spot  prices upward for natural gas delivered to California during 2000–2001. In  March 2003, FERC reported that it had found evidence of manipulation of  both electricity and natural gas markets, and that spot market gas prices  were not produced by a well-functioning competitive market. FERC staff  made several recommendations to FERC commissioners aimed at  correcting the deficiencies they found in the electric as well as the natural  gas market. In a statement before the National Energy Marketers  Association on April 4, 2003, the Chairman of CFTC acknowledged that the  commission had imposed monetary penalties and filed complaints in  federal court against several companies in connection with false reporting  and attempts to manipulate natural gas prices and operating an illegal  futures exchange. The Chairman also said that CFTC was actively engaged  in other energy sector investigations, and further charges might be filed.
Following the price spike that occurred in the natural gas market in  February 2003, FERC and CFTC again undertook investigations of possible  market manipulation. On July 23, 2003, they issued a joint statement saying  that neither investigation had identified evidence of market manipulation.  FERC concluded that gas prices had risen in apparent response to  underlying supply and demand conditions and in a manner consistent with  those conditions. CFTC said that it found nothing that suggested  manipulative activity in the natural gas futures and options market during  the week of February 24, 2003.
A third federal agency—EIA—analyzes energy price movements and  provides market information that gas industry analysts use as an indicator  of both supply and demand. For example, in May 2002, EIA began reporting  estimates on the volume of gas in storage, which is a key predictor of future  natural gas prices. EIA also provides weekly and monthly updates on the  natural gas market and special reports on various issues affecting the gas  market. In its August 2003 energy outlook, EIA reported that gas prices at  the Henry Hub, one of the largest gas market centers in the United States,  fell below $4.70 per mmBtu during the last week in July 2003. This was  considered significant because these prices had been considerably above  $5 per mmBtu on a monthly basis since the beginning of the year. However,  EIA advised that gas prices are at risk for volatility and industrial users who  rely on spot market purchases for their gas, such as nitrogen fertilizer  producers, face the greatest risk of higher natural gas prices.
section_title: Federal Role in the Fertilizer Market Is Limited
paragraphs: The federal government does not control prices for nitrogen fertilizer, and  nitrogen fertilizer products imported from other countries are generally not  subject to U.S. trade restrictions, such as quotas and tariffs.However, as  part of its overall mission, USDA does monitor and report on developments  in the agricultural sector that could affect farmers and offers certain  programs to help farmers manage the risks associated with crop yield and  revenues. The National Agricultural Statistics Service (NASS) collects  information on agricultural acreage, production, stocks, prices, income,  and information on fertilizer prices and uses. For example, the annual  Agricultural Chemical Usage report provided by NASS includes  information for targeted crops by major producing states on how much and  what type of fertilizer was applied per acre. NASS also reports monthly  price indices for three major fertilizer types—nitrogen, phosphate, and  potassium—and actual prices paid by farmers for several fertilizer  products in April of each year.
In addition to its routine surveys, USDA collected additional information in  2001 about nitrogen fertilizer availability and prices. According to officials  from the Office of the Chief Economist, this information was collected  because Congress and others had raised concerns about higher natural gas  prices and the possible impact these prices would have on the availability  and price of fertilizer. In order to collect this information, questions were  added to USDA’s ongoing Crop Progress survey aimed at determining the  availability of nitrogen fertilizer in 2001 and to the Agricultural Resource  Management Survey to determine how corn growers responded to the  higher nitrogen fertilizer prices that occurred in 2001. The results of this  additional survey information are discussed elsewhere in the report.
USDA also offers insurance and commodity price support programs to help  farmers manage risk associated with crop yields and revenues, but it  currently does not offer similar programs to cover the risks associated with  farm production costs, such as the cost of fertilizer. For example, in 2002,  USDA’s insurance program covered crops valued at $41 billion, and  commodity price support payments have averaged more than $10 billion  per year since 1996. According to USDA officials, the agency does not offer  insurance to cover the risks associated with farm production costs because  these risks tend to be small compared with the risks associated with crop  prices. Since a farmer’s income per acre from a crop equals the crop price  times the yield, changes in either crop price or yield are directly and fully  reflected in a farmer’s income. As shown in table 2, crop prices can change  significantly over time and from year to year. From 1996 to 2001 the  average price of corn declined by $.98 per bushel, or 35 percent, and  average corn prices declined by $.61 per bushel—24 percent—from 1997 to  1998. Overall, from 1996 to 2001, average corn yields increased only 11  percent—from 130 bushels per acre to 144 bushels per acre. In addition,  while national average yields are relatively stable from year to year, the  actual yields for individual farmers can vary significantly from year to year  as a result of natural causes, such as weather conditions and the extent of  loss caused by insects and diseases.
In contrast, a farmer faces fewer risks with costs of production because  these costs tend to remain stable from year to year. As shown in table 3,  total production costs per acre for a corn farm remained relatively stable  from 1996 through 2001, and changes in different cost categories often  offset one another. For example, although average fertilizer costs increased  by $8.68 per acre from 2000 to 2001, this large increase was offset by a  decrease of $8.24 in fuel, lube, and electricity costs. Other production costs  also decreased and, as a result, total production costs decreased by $3.84,  or about 2 percent.
Similarly, although USDA provides information to farmers through the  Cooperative State Research, Education and Extension Service to help them  participate in farm commodity futures markets, there is relatively little  information regarding farm production costs, such as fertilizer. According  to a state extension service official, the extension service has issued  several publications that provide information on farm commodity futures  markets because farmers are generally familiar with these markets and  have access to the information needed to participate successfully in these  markets. However, the extension service generally does not encourage  farmers to participate in futures markets involving farm production cost  items, such as fuels, because farmers are not as familiar with these  markets. Instead, farmers generally use various prepayment methods to  control the costs of items used in producing crops.
section_title: Observations
paragraphs: Natural gas is the most costly ingredient used in manufacturing nitrogen  fertilizer products. However, the price of natural gas can vary significantly  in different markets throughout the world. Unfortunately for domestic  nitrogen fertilizer manufacturers, the price of natural gas in the United  States can far exceed its price in other parts of the world. As a result,  domestic manufacturers are at a competitive disadvantage when domestic  natural gas prices rise. Manufacturers can close plants in response to  periodic price spikes and resume production when prices drop again, but  higher prices sustained over the long term may result in more permanent  curtailment of domestic production.  In the past, farmers’ needs for  fertilizer have been met by increases in imports when domestic production  has been curtailed, as it was in 2001. However, it remains to be seen how  well the market will respond to further reductions in the domestic  production of nitrogen fertilizer that may be caused by more sustained  higher natural gas prices in the future. Earlier this year, increased natural  gas prices once again caused higher production costs for the nation’s  fertilizer manufacturing industry, which in turn contributed to a reduction  in the amount of nitrogen being produced and an increase in nitrogen  fertilizer prices. Although it is too early to determine whether these higher  gas prices will have the same adverse effect on the fertilizer manufacturing  industry as higher gas prices did in 2001, some within the industry contend  that continuing higher gas prices are threatening the industry.
section_title: Agency Comments
paragraphs: We provided USDA and TFI with a draft of this report for review and  comment. We received oral comments from USDA and TFI officials, who  agreed with our facts and observations.
As agreed with your office, unless you publicly announce the contents of  this report earlier, we plan no further distribution until 30 days from the  report date. At that time, we will send copies to the USDA Secretary, The  Fertilizer Institute, and other interested parties. We also will make copies  available to others upon request. In addition, the report will be available at  no charge on the GAO Web site at http://www.gao.gov.
Questions about this report should be directed to me at (202) 512-3841. Key  contributors to this report are listed in appendix II.
section_title: Objectives, Scope, and Methodology
paragraphs: In our study of the natural gas and nitrogen fertilizer markets, we  determined (1) how the price of natural gas affects the price, production,  and availability of nitrogen fertilizer and (2) the federal government’s role  in managing the impact of natural gas prices on the U.S. fertilizer market.
To address these objectives, we reviewed pertinent documents and  obtained information and views from a wide range of officials from both  the federal government and the private sector. We interviewed staff and/or  obtained information from the Department of Agriculture’s (USDA) Office  of the Chief Economist, Economic Research Service, National Agricultural  Statistics Service, and Cooperative State Research, Education and  Extension Service; the Department of Commerce; the Department of  Energy’s Energy Information Administration; the Federal Energy  Regulatory Commission; the Commodity Futures Trading Commission; and  the International Trade Commission. We also discussed the relationship  between the natural gas and nitrogen fertilizer markets with  representatives from various industry organizations, including The  Fertilizer Institute (TFI); the International Fertilizer Development Center;  the American Farm Bureau Federation; Agrium Incorporated; CF  Industries, Incorporated; and Terra Industries, Incorporated.
To determine how the price of natural gas affects the price of nitrogen  fertilizer, we examined industry-supplied natural gas prices and industry, as  well as government, price data for nitrogen fertilizer and determined how  fertilizer prices behaved when gas prices increased in 2000–2001 and again  in 2003. We determined the extent to which a correlation existed between  the price of natural gas and prices for three nitrogen fertilizers, anhydrous  ammonia, urea, and urea ammonium nitrate, which were included in our  analysis because they are widely used by American farmers. We compared  natural gas and nitrogen fertilizer prices for the period January 1998  through March 2003. More specifically, we obtained industry prices for  natural gas at the Henry Hub from Global Insight (USA), Inc. We selected  Henry Hub prices because this market center is one of the largest in the  country and often serves as a benchmark for wholesale natural gas prices  across the country. We obtained monthly spot prices, or the current cash  prices at which nitrogen-based fertilizers are sold at various locations, from  an industry source—Green Markets: Fertilizer Market Intelligence Weekly.  Green Markets, a Pike & Fischer, Inc., publication, collects independent  spot price quotes for 19 fertilizer commodities every week. Our analysis of  the market data included fertilizer prices at two major market locations: (1)  the U.S. Gulf Port, whose prices are considered the benchmark for fertilizer  prices in North America, and (2) the Mid Cornbelt, where large quantities of  nitrogen fertilizer are used. In addition, we compared the relationship  between the prices paid by farmers for nitrogen fertilizer and natural gas  prices. To do this, we calculated the monthly prices paid by farmers for  nitrogen fertilizer. We used the April prices paid by farmers for anhydrous  ammonia, urea ammonium nitrate (32 percent nitrogen solution) and urea  (46 percent nitrogen). Since these prices are reported only once a year in  April, we applied the monthly prices paid index for nitrogen fertilizer  published by USDA to the April prices in order to calculate a monthly price  for nitrogen fertilizer. We did this by using the appropriate weights,  supplied by USDA, for each of the fertilizer components (anhydrous  ammonia, urea ammonium nitrate, and urea). The index for nitrogen  fertilizer is based on the Producer Price Index series (PPI) and appropriate  subcomponents from the Bureau of Labor Statistics. The April fertilizer  prices are obtained by survey from establishments selling fertilizers to  farmers.
To determine the effect of natural gas prices on domestic nitrogen fertilizer  production, we examined nitrogen inventory, production, and consumption  data obtained from government and industry sources from 1996 through  2002. These data (shown in table 1) reflect the estimated quantity of  nitrogen in the United States, including the nitrogen nutrient in several  fertilizer products—anhydrous ammonia, ammonium nitrate, ammonium  sulfate, aqua, nitrogen solutions, urea, and other nitrogen materials. The  estimated nitrogen production, imports, and exports were derived from the  Department of Commerce, Bureau of Census, quarterly report Inorganic  Fertilizer Materials and Related Products (MQ325B). The inventory data  were taken from a TFI report, Fertilizer Record, which reflects the results  of a TFI monthly survey of domestic nitrogen fertilizer producers. The  agricultural consumption data were derived from reports filed by fertilizer  users with state fertilizer control officials. These reports are tabulated by  the Association of American Plant Food Control Officials, Inc. (AAPFCO)  and TFI and published by TFI in Commercial Fertilizers. Because of the  incompleteness of the state fertilizer consumption reports, an unknown but  significant amount of missing data, particularly for the most recent year,  are imputed based on historical information by AAPFCO and TFI. The  estimates described above were used in this report for several reasons.  First, the estimates of total supply and total demand, which reflect the  combination of data from several independent sources, differ only slightly.  Second, the trends in consumption from the trade source are consistent  with those in the related Census Bureau series. Third, these data are widely  used by companies that produce nitrogen fertilizer. In addition, we  reviewed financial reports and other industry documents that describe how  the nitrogen manufacturing industry responded to higher natural gas prices  and interviewed industry and government officials to obtain their views  and comments.
In determining the effect of higher natural gas prices on the supply of  nitrogen fertilizer, we relied primarily on the results of a USDA survey on  fertilizer availability in 2001. According to USDA officials, they added  questions concerning nitrogen fertilizer supplies to the ongoing Crop  Progress survey because this was the most efficient and reliable survey  vehicle available on short notice. USDA asked respondents to report on the  adequacy of nitrogen fertilizer supplies that were available to producers in  their area. Although the responses were subjective, those people providing  the responses are widely respected as the most knowledgeable about  agricultural situations in their respective counties. The results of the survey  questions used to gather information on the availability of nitrogen  fertilizer were presented in the National Agricultural Statistical Service’s  Crop Progress report dated June 4, 2001. We also examined data contained  in our supply and demand table (table 1) to determine sources, supplies,  and consumption of nitrogen fertilizer over the 7-year period ending in June  2002.
To determine what role the federal government plays in managing the  impact of natural gas prices on the U.S. fertilizer market, we reviewed the  responsibilities of federal agencies regarding the natural gas and fertilizer  markets and their efforts to monitor and collect information on these  markets. We reviewed relevant documents provided by agriculture and  fertilizer industry representatives and interviewed these officials to obtain  their views on what actions, if any, the federal government should take to  mitigate the effects of high natural gas prices on the U.S. fertilizer market.  We also reviewed relevant documents and interviewed USDA and state  extension service officials regarding how farmers manage the risks  associated with their production costs and the federal government’s role in  assisting farmers in managing these risks. Finally, we reviewed the results  of a USDA analysis of the 2001 Agricultural Resource Management  Survey, which was used to gather information on how American farmers  who grow corn responded to the higher nitrogen fertilizer prices in 2001.
The results of this analysis were presented in the USDA, Economic  Research Service’s Agricultural Income and Finance Outlook report dated  September 26, 2002.
We performed our review from February through August 2003 in  accordance with generally accepted government auditing standards. While  we did not independently verify the accuracy of natural gas and fertilizer  prices and other data obtained from industry sources, we did compare  these data with other relevant data to ascertain the reasonableness of the  data we used. We also interviewed knowledgeable government and  industry officials to determine the reasonableness of the data and our use  of them. We determined that the data were sufficiently reliable for the  purposes of our report.
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