Overview of China’s Urea Market

Urea has a wide range of applications. Its main use in agricultural applications is to act as an effective neutral nitrogen fertilizer. Industrial uses of urea are rapidly growing owing to its wide applications, as raw materials for the synthesis of polymers are necessary for producing formaldehyde resin, which is then used to manufacture plastics, coatings and adhesives. Urea can also be used in cosmetics as a moisturizer and it is a common ingredient in skin care and personal care products, such as face cream, shampoo, hair conditioner and hand lotion. Urea also has pharmaceutical applications. For instance, it can be made into ointments for external use. It also functions similarly to sorbitol as osmotic diuretic, and is commonly used in denaturing and solubilizing proteins.

Based on the particle size, urea products in general can be categorized into granular urea or prilled urea. Granular urea (large granular) has particle diameters generally ranging from 2 mm to 4 mm while prilled urea (small granular) has particle diameters generally ranging from 1 mm to 2.8 mm. Large granular and small granular urea contain the same amount of nitrogen, but large granular urea is more resilient to crushing. Small granular urea’s softer and smaller particles make it more vulnerable to damage caused by handling and more apt to absorb moisture in humid environment.

For agricultural application, large granular and small granular urea products have similar fertilizing value, and end users’ preferences are primarily driven by habits and practices. For example, modern farming economies generally prefer large granular urea, while small granular urea is more popular in Asian countries such as India and China as it dissolves faster. However, the demand for large granular urea for agricultural purpose is likely to grow in tandem with the modernization of farming technology in China. For industrial application, urea is widely used for the manufacture of different products, including, among others, adhesives, plastics, coatings, cosmetics, and pharmaceuticals. Both large granular and small granular urea are adopted, depending on the traits of purity, ease of transport and storage needs of different downstream industries. Urea manufacturers are often involved in the production of methanol, which is produced during the production process of urea.

Urea Production Capacity, Production Volume and Consumption

China had the largest urea production capacity globally from 2011 to 2016. The country’s urea production capacity was around 35.5 million tons in 2016, representing approximately 40% of the world’s total urea production capacity. It is estimated that China’s total urea production capacity will shrink from 2016 to 2021 at around 29.8 million tons in 2021. In terms of production volume, China’s urea production volume has grown from 24.6 million tons in 2011 to 28.5 million tons in 2016, at a CAGR of 3.0%. In 2016, the average utilization rate of urea production facilities in China is approximately 67% and outperformers can reach approximately 75% or above. The production capacity of China’s urea industry, as well as other second industry sectors, normally refers to the designed capacity. Nevertheless, it is a general case for China’s second industry sectors that the annualized designed capacity exceeds the designed capacity, which may result in a higher production volume than the designed production capacity in certain periods. Therefore, it is not unusual to observe that the expected production volume exceeds the expected designed capacity in 2021.

Agricultural use of urea as fertilizers and for the production of fodder continues to be major downstream application of urea products in China. From 2011, the consumption volumes gradually increased before peaking at 27.1 million tons in 2013, and then dropped to 24.1 million tons in 2014 with a slight rebound to 24.5 million tons and 24.8 million tons in 2015 and 2016, respectively. Agricultural demand is expected to maintain a mild growth from 2016 to 2021 and the total consumption volumes of urea is expected to reach approximately 27.5 million tons in 2021. Industrial consumption observed a rapid growth from 2011 to 2016 at a CAGR of approximately 10%. In 2016, it accounted for around 24% of the total domestic urea consumption volume, and such proportion is expected to increase to around 32% in 2021. Key applications include, amongst others, the manufacturing of adhesives for wood panels, as well as the production of melamine for coatings, and plastics and nitrification. Overall, urea’s industrial applications in China market are continuously expanding and developing. Based on the above estimated consumption volume, the Company forecasts a growth in the demand for urea in the future.

Urea production is broadly categorized into coal-based and gas-based production. Although the end products are identical, coal-based and gas-based urea producers adopt different raw materials, production facilities, and production processes for the production of urea. Coal-based urea producers generate synthesis gas by processing coal, with coke and liquid products being the by-products, while gas-based producers generate synthesis gas by processing gas, with acetylene and prussic acid being the by-products. On the one hand, since China has abundant coal resources but is in shortage of natural gas and oil, coal is the major source of energy in China. Thus, approximately 76% of the total urea production capacity utilizes coal-based production in China in 2016. On the other hand, China’s major gas-based urea producers are primarily located in the Southwest region of China based on the distribution of natural gas reserves. Due to the relatively high cost of transportation, the major consumers of those gas-based urea producers are also located in nearby regions. Nevertheless, gas price has been gradually increasing because of limited natural gas supply in recent years, thus creating significant cost pressure for gas-based urea producers and driving down the total production capacity and production volume of urea from this region. Coupled with continuous declining of the price of urea in recent years, some small and medium-sized gas-based producers are loss-making. This situation is expected to persist owing to the limited supply of natural gas, thus pushing these small and medium-sized gas-based producers out of the market. Therefore, the share of gas-based urea capacity is expected to further drop in the forecast period while coal-based production is expected to remain the mainstream production in China due to, amongst others, the abundance of coal resources, limited natural gas and oil resources and reforms of related legislations which indirectly benefitted coal-based production.

China’s urea production capacity has observed a surplus in recent years as the industry is undergoing upgrade and transformation. The surplus in production capacity is mainly from gas-based urea producers, which constitutes around 24% of total urea capacity in China in 2016. From the supply side, the phasing out of outdated facilities takes time while new urea production facilities continue to come into operation. The demand side has maintained a relatively stable momentum, primarily because urea consumption remains largely dominated by agricultural use which represents approximately 76% of total urea consumption in China, and this downstream market is relatively mature and stable. To alleviate the short-term over-capacity of urea production, China Government has adjusted relevant policies to support export growth. For example, the MOF had adopted a new tariff policy on 1 January 2015 with a flat export tariff of CNY 80 per ton. Furthermore, on 19 December 2016, the State Council promulgated the Tariff Adjustment Plan 2017 (2017年关税调整方案) which came into effect on 1 January 2017, under which the flat export tariff of CNY 80 per ton for urea products was abolished. The 13th Five-Year Development Plan for Nitrogen Fertilizer Industry laid out objectives of a limited nitrogen fertilizer production capacity at around 61.0 million tons and a higher capacity utilization rate of more than 80% by 2020. As a result, 3.4 million tons and 3.0 million tons production capacity of synthesis ammonia and urea, respectively, are estimated to be closed down by 2016. By 2020, this amount of closed-down urea production capacity is expected to reach 13 million tons. Shandong Province, Shanxi Province, Henan Province, and Inner Mongolia Autonomous Region, four key regions in the North China, constitute China’s largest urea production cluster. The aggregate consumption volume of urea in these four regions accounts for approximately 70% of their own urea production in 2016, and the remaining 30% of urea produced was supplied to other regional markets in China (covering more than 20 regions and districts) or exported overseas. The urea industry is undergoing upgrade and transformation, whereby outdated and inefficient capacity is expected to become obsolete and eliminated. Both China Government and the industry have been taking measures to substantiate the progress of such upgrade and transformation. In July 2015, China’s Ministry of Industry and Information Technology issued the Instructions to Promotion of Transformation and Development of Fertilizer Industry (the”Instructions”). According to the Instructions, China fertilizer industry was experiencing a key transformation period and only industry upgrade and transformation could relive production capacity surplus, adjust industry structure, propel the upgrade of products’ quality and structure, and enhance innovation ability. Following the Instructions, the industry made a development plan laying out that during the 13th five-year period, the objectives are a limited nitrogen fertilizer production capacity at around 61.0 million tons and a higher capacity utilization rate of more than 80% by 2020. The impacts brought by these measures are expected to occur gradually in the forecast period, and the rebalance of urea supply and demand is expected to support the rebound in urea price. Great progress has been achieved in reducing surplus in urea capacity in China, and from 2015 to 2016, total urea capacity in China decreased from 37.8 million tons to 35.5 million tons. Meanwhile, in terms of production capacity, the market share of small-sized producers further decreased from approximately 12% in 2015 to approximately 9% in 2016. For above reasons, during the forecast period, the price of urea is likely to rebound and maintain an upward momentum in the forecast period from 2017 to 2021.

Major Drivers of China’s Urea Market

China’s urea industry is undergoing major transformation, with the main objectives of

reducing production capacity surplus, adjusting industry structure, propelling the upgrade in product quality and structure, and enhancing innovation ability. China government issued a series of policies in support of the above objectives, including the Instructions to Promotion of Transformation and Development of Fertilizer Industry (关于推进化肥行业转型发展的指导意见) issued by China Ministry of Industry and Information Technology on 20 July 2015, the Notice on the Policies on Resuming the VAT Levy on Fertilizers (关于对化肥恢复征收增值税政策的通知) jointly issued by the MOF, the General Administration of Customs and the State Administration of Taxation on 10 August 2015, which cancelled the VAT exemption enjoyed by fertilizer producers, and the Notice on Reduction of the On-Grid Tariff and Industrial and Commercial Electricity Tariff of Coal-Fired Power Generation (关于降低燃煤发电上网电价和工商业用电价格的通知) issued by PRC National Development and Reform Commission on 13 April 2015, which came into effect from 20 April 2015 and achieved a nation-wide call-off of preferential electricity tariff for fertilizer producers by 20 April 2016. Furthermore, on 23 July 2016, the General Office of the State Council issued Guiding Opinions on Promoting the Transformation and Benefit of Petrochemical Industry (关于石化产业调结构促转型增效益的指导意见) which aims to resolve the excess production capacity and strictly control new capacity to better regulate the development of several industries including urea industry. The 13th Five-Year Development Plan for Nitrogen Fertilizer Industry put forward by the China Nitrogen Fertilizer Industry Association also laid out objectives for a limited nitrogen fertilizer production capacity at around 61.0 million tons and a higher capacity utilization rate of more than 80% by 2020. Such support in industry upgrade and transformation is likely to be a key market driver for China’s urea industry. Urea has vast industrial applications. Industrial application of urea requires urea of various purity grades. Based on the purity grades of urea, the price of urea can generally range from CNY 3,000 per ton to CNY 8,000 per ton. The use of urea in China for industrial application lags behind those of developed countries. Hence, increasing and broadening of industrial application of urea in China will increase China’s urea production and consumption which will in turn drive China’s urea market.