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). 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. 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. 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.