A tale of two fortunes: the MENA nitrogen market

The Middle East and North Africa (MENA) region has long held the illustrious position as the most competitive nitrogen producer in the global market, driven by low production costs and geographical advantage in exporting to key import destinations. But how is this changing in light of the recent overhaul in global energy markets?

With relatively modest local consumption of fertilizers in the region, producers in the Middle East and North Africa have developed a sizeable export industry over time, driven by two key benefits that favour the region. The first is geographical location – with nitrogen producers having the advantage of being able to export products both east and west of the Suez Canal. Moreover, the abundance of low-cost energy feedstocks for nitrogen production in the region allows producers to have some of the lowest production costs in the world and, in turn, reap the highest rewards.

There has been a spate of changes within many of the countries in regards to energy pricing and policy in recent years due to a variety of factors, including the downward trajectory of oil since 2014 and the upward pressure of state fixed gas prices. Despite these changes, the region remains one of the lowest cost producing regions in the world.

Global energy as the underlying driver

The global energy market has fundamentally changed in recent years, and further change is on the horizon. Perceived global energy scarcity has given way to a new era of energy abundance due to the growth of newly advanced developing economies and technological innovation in the oil and natural gas industry, giving rise to shale gas and LNG trade.

The collapse of global oil prices, from a high of US$108/bbl in July 2014 to below US$30/bbl in January 2016, has been one of the most important global developments. This sharp fall is broadly similar to the magnitude of price volatility in the mid-1980s, when OPEC members reversed earlier production cuts, and after the financial crisis in 2008 – 2009. However, the difference between these two events and the current cyclical weakness is noteworthy. The collapse of oil prices in the mid-1980s was mainly supply-driven, while the slump in 2008 – 2009 was due to a collapse in demand. The most recent price decline has been driven by a mix of the two, and has resulted in oil prices remaining lower for longer than initially expected.

These drivers are forecast to keep oil prices below US$60/bbl until at least the end of 2017. Given demand growth is stalling, the significant inventory overhang will take time to clear, and most energy analysts agree that the energy market will take longer to rebalance.

Natural gas continues to hold a significant share of the energy market, especially in the Middle East, where the market is geared towards the exploitation of their abundant gas resources. In 2015, global natural gas consumption increased by 0.2% year-on-year to reach 3.1 billion t oil equivalent. This was driven by a 5.4% year-on-year increase in US gas production in 2015, the world’s largest gas increment. Recent shale gas discoveries, in particular, has boosted natural gas consumption as an affordable feedstock for nitrogen production.

Energy reform in light of falling oil revenues

Regulated gas pricing for nitrogen producers is common in the MENA region. Despite the fact that market-driven gas prices have fallen considerably since 2015, there is a very different story as far as regulated gas prices are concerned. Outside fluctuations in local exchange rates, which tend to result in lower gas costs in US dollar terms, gas prices that are regulated have begun to experience upward pressure as governments look to monetise their energy resources. In the Middle East, the Saudi government increased its gas price from US$0.75/million Btu to US$1.25/million Btu effective 1 January 2016. In North Africa, Algeria indicated higher gas prices in a regulation document published in December 2015. Oman is set to continue to increase gas prices at 3%/yr, while other countries in the Middle East, such as Bahrain, plan to increase gas prices by US$0.25/million Btu until the price reaches US$4/million Btu. In Egypt, higher gas prices are being offered on the development of new gas fields, which will be reflected in industrial user prices. For example, the Egyptian government announced in late 2015 that it would increase the prices paid to Italian ENI for new discoveries, notably from the recent gas discovery Zohr, by over US$2/million Btu to US$4 – 5.88/million Btu.

Despite the increasing costs in the region, the producers still have some of the lowest production costs among all global nitrogen producers. As Figure 1 shows, the region remained at the low-cost end of production costs in 2016, and while various other producing regions have seen cheaper feedstock costs, very few can match the cost competitiveness of the lowest cost Middle Eastern and North African producers.

Saudi Arabia

Saudi Arabia is the largest nitrogen fertilizer producer in the Middle East and is self-sufficient in terms of natural gas consumption due to the abundance of domestic resources. Saudi Aramco, the state-owned oil and gas company, is the main supplier of natural gas to the fertilizer sector and supplies the country’s largest nitrogen fertilizer producer, SAFCO. SAFCO uses methane gas as a feedstock supplied by Saudi Aramco under a long-term contract.

Energy-intensive industries including the nitrogen fertilizer sector, were supplied natural gas at a state-fixed price of US$0.75/million Btu between 1998 and 2015. However, the Saudi government pushed up the state-fixed gas price to US$1.25/million Btu beginning on 1 January 2016 to tackle issues on limited gas production and increasing fiscal deficits, which have been hit hard by a slump in global oil prices. The new state-fixed gas price has increased nitrogen production costs in Saudi Arabia, although producers remain some of the most competitive worldwide.

Nitrogen producer SAFCO reported that higher feedstock costs, including electricity and fuel gas costs, would increase production costs by 8% in 2016. Nevertheless, feedstock costs to nitrogen producers in Saudi Arabia remain lower compared with other nitrogen producing countries globally, and in the Middle East and Africa region, indicating that Saudi nitrogen producers will keep their competitive position in the global nitrogen market even with the increased gas prices.

There are some growing concerns for the government’s fiscal performance following the fundamentally weak oil prices seen as of late-2014, which are likely to see Saudi Aramco move towards a more balanced business model and monetise its natural resources. In addition, in June 2016, Saudi Aramco announced its intentions to coordinate an IPO that could accelerate the de-regulation of the country’s gas market and result in increasing feedstock costs to nitrogen producers.

Iran

The natural gas sector in Iran is controlled by the National Iranian Gas Co. (NIGC) and the National Iranian Oil Co. (NIOC). Feedstock for natural fertilizer production is subsidised in Iran as it accounts for a significant share of non-oil production. Nitrogen fertilizer producers in Iran received natural gas for domestic production at US$0.4/million Btu until 2010, the lowest gas price in the Middle East and Africa. However, since mid-2010 the Iranian government implemented price increases to relieve the burden caused by its pricing regime. The gas price for heavy industrial users rose gradually and reached US$2.8/million Btu in 2016. The cost of producing gas in Iran in 1H16 was estimated at around US$4.3/million Btu to US$5.4/million Btu, meaning that the gas is supplied to fertilizer plants under the cost of production.

There is a possibility that natural gas prices in Iran will become more competitive on the back of its increasing gas production and exports, following the lifting of sanctions in 2016. However, noticeable changes in gas prices will be contingent on construction of new gas pipeline infrastructures and executions of gas projects and the size of the subsidy guaranteed by the government.

Qatar

State-owned petroleum company Qatar Petroleum (QP) manages oil and gas activities in Qatar, including exploring, producing and domestic and international sales of oil and gas. QAFCO, a joint venture among Industries Qatar (75%), Fertilizer Holdings AS (10%) and Yara Netherland BV (15%), receives its feedstock gas from QP.

The pricing of natural gas for domestic use is subsidised and set according to a fixed starting price and escalated according to a consumer price index or industrial product price. Qatar has been under pressure to reform its subsidy system due to its increasing fiscal deficits following a slump in global oil prices in 2014.

Egypt

Egypt faces a shortage of natural gas supplies due to a lack of investments, especially after oil prices crashed in 2014, leading the country to turn from a net energy exporter to a net importer. Nitrogen producers have been subject to significant gas curtailments of up to 30 – 40% over the last few years.

The Egyptian government has been trying to meet its domestic gas demand through various measures, including increasing LNG imports, liberalising the gas sector and expanding gas production. Despite limited gas supplies, deliveries to domestic nitrogen producers are expected to improve, as in 2016, the government agreed to prioritise the supply of natural gas to fertilizer plants, providing about 90% of contractual gas.

The Egyptian government has been encouraging foreign firms to invest in Egypt’s gas fields to achieve its targets of a 30% increase in natural gas production by 2019. The Zohr field in Egypt is considered as a key project to increase the country’s gas production. The Italian oil and gas company, Eni, plans to start production at the Zohr field by the end of 2017.

The gas price to nitrogen producers is still largely regulated and centralised by the Egyptian government. That is, much of the gas supplied by the government to state-owned nitrogen producers is at a lower price than at which it is purchased. However, the government has recently pledged to cut its subsidies in order to reduce the financial burden on the state. Egypt’s gas subsidy budget is expected to be only US$3.9 billion in 2016 – 2017, after being cut from US$18.2 billion in 2013 – 2014.

The Egyptian government offers preferential gas pricing formulas to domestic nitrogen producers in comparison to nitrogen exporters. The gas price to nitrogen exporters is often a urea price-linked formula, which in 2015 ranged from US$3.5/million Btu to US$4/million Btu, and according to local sources, the prices are likely to remain in the same range in 2016.

In the short to medium term, changes in natural gas prices in Egypt are expected to be heavily linked to whether gas production expansion plans will unfold to cover its fast-growing domestic demand and reduction in gas imports. This will eventually affect government budgets for industrial subsidies, including energy-intensive industries.

Algeria

Algeria’s natural gas production has steadily declined since 2008 as its mature gas fields have been depleting. Gross natural gas production remained steady at around 83 billion m3 between 2014 – 2015 on the back of resumed operations at Algeria’s In Amenas gas facility.

With a slowdown in its natural gas production, pressure on the Algerian government is building to increase natural gas production and satisfy its long-term contractual obligations to export natural gas to Europe. However, several projects are delayed due to a lack of foreign investment related to civil unrest, and the government’s pricing mechanism.

The estimated Algerian gas price to fertilizer producers in 1H16 was US$2/million Btu, meaning domestic fertilizer producers benefited from favourable gas prices under the subsidised system. The gas price to nitrogen producers in Algeria has historically fluctuated in the range of US$0.5/million Btu to US$0.7/million Btu between 2007 – 2014, which is far lower compared with other countries in the Middle East and Africa.

The outlook for production economics in the MENA region

A key factor determining how the nitrogen cost curve will look in the coming years is the future international cost of energy and how this affects nitrogen production feedstock costs in each producing location. The general consensus that global energy prices will remain low in the next three to five years is reflected in the cost position of a number of nitrogen producers. Regions with regulated energy price mechanisms are forecast to experience gradually higher nitrogen unit production costs, as the countries will continue to decrease their energy subsidies in light of lower oil and gas prices.

Figure 1. Despite general downward shift in nitrogen production costs around the world in the past 2 – 3 years, MENA producers still remain some of the lowest cost producers in the world.

The recent collapse of oil and gas prices over the last 18 – 20 months has put a burden on the economies of nations reliant on oil, and Integer note a growing trend of countries moving away from subsidised gas pricing, as shown by recent development in Egypt and Oman. Several countries have acknowledged fiscal deficits that are directly related to the subsidisation of energy prices, such as Algeria, particularly considering increasing competition brought about by LNG trade. Egypt was the first country to implement gas price increases, followed by Oman and, more recently, Saudi Arabia revised its state-fixed gas price in 2016. Other countries in the MENA region are expected to follow suit, however, many nitrogen producers in the Middle East and North Africa continue to pay government-regulated gas prices for their feedstock, and gas pricing usually includes measures to make feedstock more affordable for industrial consumption.

This article was originally published in World Fertilizer magazine. To receive your free copy, click here.