War Gainers: Chemical Stocks Outperforming Oil and Defence

The Strait of Hormuz is a vital shipping route for many goods besides petroleum, and oil prices directly affect oil-derived products, potentially leaving certain industries poised to see increased gains amid the war.

The Market-Moving Factors

• Chemical companies are seeing gains as petroleum derivatives rise in price due to the war in the Middle East.
• Around 30% of the world's fertiliser supply is trapped behind the Strait of Hormuz, including up to 50% nitrogen-based fertilisers.
• US companies that produce domestically are seeing stock prices rise as key fertiliser prices soar amid the high-demand season.

Chemical Companies Rising Faster Than Defence

When the war with Iran began, investors were immediately worried about the impact on oil prices, since about 20% of global crude supply transited the Strait of Hormuz. But the Persian Gulf is also a major supplier of other products, either byproducts of crude refining or crude products produced in the region. One of those key products is fertiliser, with approximately a third of the global production shut off behind the Strait of Hormuz. Around 10% of global polyethene plastics also come from the region. Major oil producers saw their stock prices rise in February as investors priced in the risk of a conflict in the Middle East, giving them a higher baseline. Since the war started, traders are now realising which other products could be affected, contributing to gains in fertiliser and chemical companies. Companies such as CF Industries are up 36% since 1st March, along with Dow, up 22%, and Lyondell, up 29%.

One of the main factors driving price differentials could be exposure to the region. Oil majors have seen their share prices reach record highs as crude oil prices stay above triple digits this week. However, many of these companies also have production in the Middle East. For now, inventories in the Atlantic Basin are being used to fill the gap, but if the war persists, many major oil companies could see their production reduced. The situation is different for the chemical industry, especially fertilisers. Typically, the bulk of US fertiliser is imported between March and May for spring sowing. Due to transit time, most of those shipments have already left their ports, meaning that chemical companies will be able to sell them at rising prices in the US and see improving margins.

The Rosy Outlook for Chemicals

While chemicals across the board are benefiting, some stand out in particular. Farmers don't just use any fertiliser, and spring planting often requires replenishing soil nitrogen. Typically, urea is used for that purpose, produced from natural gas reforming. Nearly half of global urea production passes through the Strait of Hormuz, which helps explain the 32% price jump since the war began. China is the world's largest urea producer, but it relies on LNG shipments from the Middle East and is cutting back exports due to high cost and to protect its domestic market. Meanwhile, CF Industries has the world's largest nitrogen facility in Louisiana, which uses natural gas sourced in the US and has long-term, fixed-price contracts with its suppliers. An increase in fertiliser prices, particularly those of urea, would directly boost the company's bottom line. Despite its strong gains, the company is still trading at a PE ratio of just under 14x, making it relatively undervalued and within its usual defensive-stock range.