Fertiliser costs are soaring amid war in the Middle East. Will your grocery bill follow?

Conflict between the United States, Israel and Iran has now led to the effective closure of the Strait of Hormuz, a key shipping route through which a fifth of the world’s oil passes.

But oil is not the only important commodity that has been disrupted. The Middle East is a key supplier of fertiliser, exporting some 45% of global supply.

Since the beginning of the conflict, the price of urea, a key source of nitrogen used in agriculture, has surged by about 25%, similarly dramatic to the spike in crude oil prices.

This is unwelcome news for Australia, which is a large importer of urea. With effectively no domestic urea production, Australia is fully exposed to global supply shocks.

For farmers, the crisis is not just of affordability, but potentially availability as well. And the timing is far from perfect, with winter crop planting starting soon.

Consumers almost always feel a major oil shock shortly afterwards at the fuel pump.

But if there’s a major shock for fertiliser to grow wheat, do consumers soon see rising prices of bread, flour and beer?

Usually not – and here’s why.

A key ingredient for crops

Urea is a key fertiliser used for agricultural production globally. It’s a concentrated source of nitrogen, widely used by farmers to boost crop and pasture growth.

Australia used to produce some of its own urea. But after fertiliser giant Incitec Pivot shut down its Gibson Island manufacturing facility (near Brisbane) in 2022, the country was left with virtually no domestic production.

A major new fertiliser plant, Perdaman’s Project Ceres (in Western Australia), isn’t expected to come online until 2027.

Right now, more than half of Australia’s urea imports come from United Arab Emirates, Qatar and Saudi Arabia. These countries are all impacted by the conflict and shipping disruption.

How will farmers respond?

Economic theory makes a straightforward prediction: when the price of an input (such as fertiliser) rises, holding everything else constant, it becomes optimal to produce less.

In the present scenario, without close substitutes, one might expect a sustained fertiliser shock would reduce agricultural production and lead to higher prices for consumers.

This is unlikely to happen, however, and there are several reasons for it.

We have been here before

To begin, we have been here before. In this century alone, urea prices have surged substantially on two occasions: first in the late 2000s, then again in the early 2020s.

Focusing on wheat – one of Australia’s key exports, which relies on fertiliser for its production – in both instances, the price spikes were followed by an increase in production.

This may sound perplexing. But this price relationship isn’t like that of crude oil and petrol, where the former input is the main ingredient of the latter final output. While crucial, urea and other fertilisers are just some of many inputs used to grow food.

Indeed, the key input in agricultural production is weather. Much of the variability we see in agricultural yields is driven by climatic shocks rather than costs of fertilisers or other inputs.

Other cogs in the machinery

A recent study found in high-income countries such as Australia, commercial agricultural producers are both able and willing to absorb increased input costs.

It also found, perhaps surprisingly, neither fertiliser demand nor farm profitability were substantially affected by the 2021–2022 fertiliser price surge. An important part of the reason why was high agricultural commodity prices, especially cereal crops (such as wheat).

This neatly aligns with the theory we referred to earlier. Even though fertiliser prices spiked, other factors (such as grain prices) did not remain constant. This somewhat balanced out the effect rising fertiliser costs may have had on production.

Your grocery bills

So, what does all of this mean for the price of bread, meat, rice and other staples in your shopping trolley?