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Prepared Witness Testimony The House Committee on Energy and Commerce
Natural Gas Supply and Demand Issues
Full Committee on Energy and Commerce
Mr. Robert C. Liuzzi
On behalf of The Fertilizer Institute, CF Industries, Inc. is pleased to have the opportunity to discuss the urgent situation currently facing the U.S. fertilizer industry. The volatility and level of U.S. natural gas prices, virtually unprecedented in the history of our country, has resulted in the permanent closure of almost 20% of U.S. nitrogen fertilizer capacity and the idling of an additional 25%. This situation threatens to destroy an efficient U.S. industry and displace the thousands of workers who support it. Congress must pass a comprehensive energy policy that addresses both the supply and demand aspects of the natural gas market. This is crucial to the long-term survivability of the U.S. fertilizer industry. The Fertilizer Institute (TFI) represents fertilizer from the plants where it is produced to the plants where it used - and all points in between. Producers, retailers, trading firms and equipment manufacturers, which comprise TFI's membership, are served by a full-time Washington, D.C., staff in various legislative, educational and technical areas as well as with information and public outreach programs. As a general background, CF Industries is a farmer-owned cooperative and is one of the largest nitrogen fertilizer producers and marketers in North America. The Company is headquartered in Long Grove, Illinois. CF operates world-scale production facilities in Donaldsonville, Louisiana, and Medicine Hat, Alberta, Canada. In Louisiana, CF currently employs 507 full-time and contract workers. This facility accounts for $46 million a year in wages and $8 million in sales and property taxes. During a normal production year, the facility converts approximately 78 million MMBtu of natural gas into 2.25 million tons of ammonia, 1.75 million tons of urea, and 2.15 million tons of UAN. The Complex has a daily requirement of over 200 million cubic feet of natural gas as a feedstock and fuel. CF and its Member cooperatives account for approximately one-fourth of the nitrogen fertilizers applied in the United States and approximately one-third of the nitrogen fertilizers applied in the primary growing areas of the Midwest. The Company also mines and manufactures phosphate fertilizers in Hardee County and Plant City, Florida. Through its eight Member-owners, CF's nitrogen and phosphate fertilizer products reach one million farmers and ranchers in 48 states and two Canadian provinces. My purpose today is to discuss the devastating impact that the high level and unprecedented volatility in natural gas prices is having on both the fertilizer industry and the American farmer. To fully understand why increased and volatile natural gas prices are creating such fundamental difficulties for the nitrogen fertilizer industry, a basic understanding of our products and manufacturing process is necessary. Natural gas is the primary feedstock in the production of virtually all commercial nitrogen fertilizers in the United States (Figure 1). And it is important to be very clear about this: natural gas is not simply an energy source for us; it is the raw material from which nitrogen fertilizers are made. Our production process involves a catalytic reaction between elemental nitrogen derived from the air with hydrogen derived from natural gas. The primary product from this reaction is anhydrous ammonia (NH3). Anhydrous ammonia is used directly as a commercial fertilizer or as the basic building block for producing virtually all other forms of nitrogen fertilizers such as urea, ammonium nitrate and nitrogen solutions, as well as diammonium phosphate and mono-ammonium phosphate. Natural gas is also used as a process gas, an energy source, to generate heat when upgrading anhydrous ammonia to urea, but this use is minor compared to our use of natural gas as a raw material. Natural Gas + Air Anhydrous Ammonia (CH4) (N2) (NH3) Because natural gas is the only economically feasible raw material used in producing nitrogen fertilizers, it is by far the primary cost component. Today, in the case of ammonia, natural gas accounts for 90 % of the total cash cost of production (Figure 2). Given this heavy reliance on natural gas, the volatility of natural gas prices continues to have a devastating impact on the domestic fertilizer industry. This can be clearly demonstrated by comparing natural gas costs, production costs and U.S. nitrogen fertilizer operating rates. As you are well aware, natural gas prices began to steadily increase during calendar year 2000, rising from an average of $2.36 per MMBtu in January to over $6.00 per MMBtu in December, 2000 and to a record $10 per MMBtu in January 2001 (Figure 3). In turn, this forced fertilizer production costs to unprecedented levels. Ammonia production costs, for example, spiked up from approximately $100 per ton to $170 by June 2000, to $220 per ton in December, and to an average of over $350 per ton in January 2001. Not surprisingly, the industry began to shut down production in response (Figure 4). By the end of December 2000, the U.S. nitrogen operating rate fell to below 70 % of capacity. By the end of January 2001, operating rates dropped to an all-time low of only 46%. To put this into perspective, the average U.S. operating rate during the 1990s was 92 % (Figure 5). Following this natural gas spike, gas prices began to moderate and by mid-2001 had fallen back to historic levels. In response, idled capacity in the U.S. quickly came back on-stream, and the industry operating rate climbed to just under 90 % of capacity. Unfortunately, the lower natural gas prices and higher operating rates were short-lived. By mid-year 2002, natural gas prices once again began to slowly escalate until February 26, 2003, when spot natural gas prices suddenly spiked to a record high of over $20 per MMBtu. Although natural gas prices again quickly moderated, they have remained well above historic averages. Gas prices over the last month, for example, have been trading in the $5.50-$6.50 range - approximately 150 % above the 1990s historic average of $2.40. The sharp rise in natural gas prices and the resulting curtailment of U.S. fertilizer production also has had a dramatic impact on fertilizer prices throughout the marketing chain and, in particular, at the farm level. Nitrogen prices at the farm level, for example, jumped this year to near-record high levels. According to USDA data, the U.S. average farm-level price for ammonia jumped this spring to $373 per ton compared to an average spring price last year of $250. Similarly, urea prices have climbed from $191 to $261 and UAN prices from $127 to $161. This translates into an increase in cost to a typical Midwest corn farmer of $10 to $15 per acre (Figure 6). Unfortunately, there appears to be no end in sight. According to Department of Energy (DOE) Secretary Abraham, current stocks of natural gas are low due to a combination of cold weather and declines in both domestic production and net imports. The 696 billion cubic feet of gas in storage this spring represented the lowest level since 1976, when the Energy Information Agency began keeping records. Storage has increased since that time, but it is still only half the level of a year ago, and 42 % below the previous five-year average. According to most industry analysts, the current tight inventory situation will likely keep natural gas prices at extremely high levels throughout the remainder of this year and into next year. Absent a substantial long-term reduction in natural gas prices, the U.S. nitrogen fertilizer industry and, therefore, farm-level supply is at serious risk. Of the 20 million tons of ammonia capacity that existed in the U.S. prior to 2000, approximately 3.5 million tons have already been permanently closed. According to a recent study completed by Fertecon, (Figure 7) the world's largest fertilizer consulting company, another four million tons is at risk of closing within the next two years. In addition, it is anticipated that the remainder of the industry will likely operate on a "swing basis." That is, plants will only run when natural gas prices are low enough and/or fertilizer prices are high enough that producers can, at a minimum, cover their cash costs of production (Figure 8). So what does all of this mean to American fertilizer manufacturing and for U.S. agriculture? To fully answer that question, it is necessary to provide some additional background information. Since the 1940s, when commercial fertilizers were introduced into the market on a large-scale basis, farm demand for nitrogen fertilizers was always supported by a large, efficient, domestic fertilizer industry. During the 1990s, for example, approximately 70-75 % of the nitrogen fertilizers consumed by American farmers was supplied by domestic production with another 15 % supplied from nearby Canadian plants. The remaining 10-15 % of the volume was sourced from offshore suppliers (Figure 9). At the heart of the domestic fertilizer industry are production facilities designed to manufacture fertilizer products annually at full capacity. Many of these facilities are located near the source of raw materials but far from the major consuming regions. Furthermore, it is important to understand that most U.S. nitrogen fertilizer is consumed within a very short time frame in the fall and spring application seasons. As a result, an extensive distribution and storage infrastructure has been developed over the years to bridge this geographic and seasonal gap to ensure that American farmers would have adequate supplies at the right time. This system is specifically designed to move and handle large volumes of product from domestic production sites to the major consuming areas. Thus, the distribution and storage infrastructure is purposely integrated into the domestic production system to ensure efficiency, economies of scale and reliability of supply. Domestic fertilizer manufacturing facilities have historically provided top-paying jobs and additional employment opportunities in local communities. According to a recent Baton Rouge Advocate article , jobs in chemical manufacturing are at the top of the pay scale among Louisiana manufacturers. The average chemical industry wage in February was $25.23 per hour, with a 44.2-hour workweek producing $1,115 per worker per week, compared to a general manufacturing wage of $17.63 per hour or $756 on a 42.9-hour workweek. Chemical industry jobs also have a high multiplier effect. In East Baton Rouge Parish, for example, each chemical job is estimated to support another 4.6 positions in the overall job market. A scenario of continued high natural gas prices will undoubtedly lead to more U.S. plant closures and abandonment of marginally profitable infrastructure in rural communities. While higher volumes of imports will fill part of the potential loss in U.S. supply, domestic production and distribution must remain viable to fully meet farmer demand. Because the current distribution and storage system within the U.S. was constructed around a U.S. supply base, there is limited infrastructure to off-load, store and transport larger and larger volumes of imports. The lack of infrastructure is particularly apparent for anhydrous ammonia, which requires refrigerated or pressurized tanks, pipelines, railcars and barges. Massive new investment and considerable lead-time will be needed if the existing infrastructure assets are left permanently stranded. Much like the proposed improvements to liquefied natural gas infrastructure, restructuring the domestic fertilizer distribution system to efficiently handle adequate levels of imports will be on a decennary time scale. The answer is not simply to say that we will just rely on imported fertilizer. Increased reliance on imports would also result in a considerable increase in the potential for supply and price volatility. The vast majority of the U.S. industry was constructed to meet U.S. demand. Offshore supply, on the other hand, was largely constructed to opportunistically compete in a world market. In other words, putting aside unfairly traded product, cargoes are generally sold and shipped to those international markets that will yield the highest netback prices. Imports are also subject to changes in world economic conditions, fluctuating exchange rates and political and/or policy changes in other countries. Moreover, increased U.S. reliance on imports will not result in lower prices for U.S. farmers. Nitrogen fertilizers are a fungible commodity product for which prices are set by supply/demand conditions and, therefore, by the cash costs of the marginal producer. Under a continued environment of high natural gas costs, the marginal supplier to the market will be the U.S. producer. Consequently, higher import volumes will not translate to lower prices to U.S. farmers. High natural gas prices present the most serious threat to the fertilizer sector, and to farmers in general, since the energy shocks of the 1970s. The fertilizer industry believes it is imperative that the U.S. develop a comprehensive and balanced energy policy - one that encourages the development of additional supplies and, at the same time, promotes the efficient use of a variety of energy sources and technologies. More specifically, the fertilizer industry stresses that the most effective measure to deal with high natural gas prices over the short-term are incentives and other regulatory measures that will reverse decades of artificially induced demand for natural gas over other fuel technology for electric power generation. Congress itself is among those who share in the responsibility for this problem, as the requirements of the Clean Air Act have made it increasingly difficult to permit, construct and enlarge the nation's coal-fired plants. Where the nation once relied on coal for the lion's share of its electric power, over 90% of all new power plant construction intends to rely on natural gas. Recent proposals to impose further rules on mercury and CO2 emissions will only add to the burden of coal-fired generators and hasten the move to natural gas. This, of course, will cause a tremendous new demand to be placed on the existing gas supply base, ensure high prices into the foreseeable future, and threaten the viability of the domestic nitrogen fertilizer industry - an industry, unlike the electric power industry, that does not have an alternative to natural gas. Accordingly, any legislation passed by this Committee should ensure that all coal, nuclear and hydroelectric plants are able to operate safely at their full capacity, and that incentives are provided and obstacles removed to ensure that new coal and nuclear facilities are constructed. The fertilizer industry also supports a thorough review of those policies that severely restrict oil and gas production on multiple-use federal lands and large portions of the continental shelf. We believe that access to these reserves can be substantially beneficial towards meeting the Nation's energy needs without compromising other legitimate interests. For those of us in the fertilizer industry, "the future is now." We encourage this Committee, the Congress, and the Bush Administration to continue to aggressively look for ways to even further expedite projects which not only increase supplies, but also help get supplies to the fertilizer industry in the near term. We think bold, creative initiatives are needed. In fact, we understand that domestic supplies are being found which cannot get to market because the delivery systems are just not there. Anything that this Committee, the Congress and the Administration can do to expedite the creation of new modes of delivery for untapped domestic natural gas supplies or to facilitate imports can help our industry in the immediate future. This can take the form of new pipelines and even more innovative solutions such as encouraging the development of the maritime transportation of natural gas in the form of compressed natural gas or CNG. Specifically, I would like to commend this Committee and the Congress for its efforts just completed last year to facilitate the importation of new supplies of natural gas by enacting provisions of the Maritime Transportation Security Act of 2002 that created deepwater natural gas ports. This is an important first step in helping to increase natural gas availability in the United States and help to bring supply and demand back into better balance. There is a deep-water port project right off the Louisiana coast that can come on-stream sooner rather than later because of its unique history. Freeport-McMoRan Sulphur LLC's permit is to be submitted in the next few months to the Coast Guard and other agencies for regulatory approval. Freeport is currently working to convert this massive offshore complex that once produced sulfur, to a deepwater natural gas port. The "Main Pass Energy Hub," will offload LNG from tankers and re-gasify the gas on the platforms formerly used for sulfur production. Since the facility is located on a giant salt dome - two miles across in diameter-Freeport envisions providing major storage facilities for the re-gasified gas in salt caverns created and accessed by wells drilled from the existing platforms. The Department of the Interior would regulate the storage, in offshore salt caverns, of natural gas produced from outside the waters of the Outer Continental Shelf (OCS); thereby enabling Freeport to store imported gas in salt caverns underlying OCS waters. In addition to this unique project and to substantially increase the supply of natural gas in the market, we urge that Congress encourage the development and acceptance of the maritime transportation of natural gas in the form of compressed natural gas or CNG. As opposed to LNG, where natural gas (methane) is cooled and stored as a liquid, the CNG gas remains in the gaseous phase and is stored under such pressure so that it is compressed. This enables the transportation and storage of a much greater volume of gas. Although the technology of maritime transport of LNG has become accepted for use in the waters of the United States, the technology of maritime transport of CNG is now under review. The potential for the acceptance of maritime transport of CNG to increase natural gas supplies is tremendous because it is less expensive and is within shorter distances than LNG to transport and re-gasify. Its acceptance will enable the production and delivery to market of a gas produced in federal waters of the Gulf of Mexico that would otherwise be uneconomical to produce. Such gas may either be found underlying the shallow waters of the Gulf of Mexico where it is economically "stranded" due to distance from a pipeline. It may be associated with oil produced in the deep waters of the Gulf of Mexico, but is likewise stranded due to distance from a pipeline. As the oil is produced, the associated gas is pumped back into the geological formation from which it came due to the uneconomical nature of the process. The Department of the Interior has informed OCS producers that they may return this gas to the reservoir as long as they have a plan for producing it sometime in the future. The delivery of this gas, as well as gas produced from elsewhere nearby in the Western Hemisphere will be made economical with the approval of CNG transport in U.S. waters. We urge the acceleration of efforts to approve the use of this technology in U.S. waters. We are in no position to be an expert on Freeport's project or any other specific project underway. Regardless, we must urge the Congress and the Administration to take a very close look and consider expediting permits for any project that can help save our industry and the jobs that we create. We are very excited about potential projects that would enhance the supply of gas coming to our Nation on an expedited basis. In summary, the fertilizer industry believes that a balanced and comprehensive energy policy is not only long overdue, but also essential to the long-term viability of this strategic sector. It is also crucial to the American farmer, given that almost one-third of U.S. crop production is derived from nitrogen fertilizer (Figure 10). Thank you for the opportunity to discuss these issues with you today. We look forward to working with you over the next few months, and I would be pleased to answer any questions you may have on the fertilizer industry and natural gas pricing issues.
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