Chambal Ferts, Zuari Agro to benefit more from gas pooling

While move positive for entire industry, companies currently having higher cost of sourcing will gain more than others

The Cabinet Committee on Economic Affairs gave a nod on Tuesday to pool or average out the prices of domestic natural gas and imported liquefied natural gas (LNG) used by fertiliser manufacturers. The move will make the cost of fuel uniform for fertiliser companies and is seen as largely positive.

Though the actual margin gains might not be significant for the sector, as companies pass on the gains/higher costs to the government, the move will lead to a lower working capital requirement and encourage higher output in the coming years.

Not surprisingly, stocks of Chambal Fertilisers, National Fertilizers, Rashtriya Chemicals and Fertilizers and Zuari Agro Chemicals rallied by six to 10 per cent on Wednesday versus a mere one per cent rise in the benchmark S&P BSE Sensex (see table). Effective Wednesday, the government also lowered the price of domestic gas by eight per cent to $4.66 an mBtu (million British thermal units).

Sudip Sural, senior director, CRISIL Ratings, says: “Both moves, of cutting the domestic price and pooling, are positive. Natural gas prices are a pass-through for production up to cutoff capacity (20 million tonnes or 90 per cent of domestic capacity). Therefore, both gas price reduction and pooling will not impact profitability up to cutoff capacity. However, since gas and energy costs are a significant driver of working capital, for 75 per cent of the domestic production up to cutoff, where the pooled gas price of around $8.5/mBtu is lower than their current price (current cost to company), working capital requirements and, therefore, subsidy receivables will be lowered. For the balance 25 per cent of the capacity, working capital requirements will go up.”

The pooling move has other long-term ramifications for the industry. The pricing mechanism is positive for the fertiliser sector and is a precursor to urea decontrol, believes Manish Mahawar of Edelweiss Securities. Decontrol of urea will encourage companies to become more efficient, which will rub-off positively on their profitability in the long run, believe experts.

For now, the actual benefits are likely to vary from company to company. So far, though the domestic gas price is the same for all, that of imported LNG varied for each company. This is due to factors such as landed cost and type of contract for importing LNG. While some companies buy LNG from the spot market, others have long-term contracts to source it. The proportion of domestic gas and LNG also varies for each. The pooling mechanism will now provide a uniform price for all companies.

Under the pool mechanism, companies with higher domestic gas content will have to increase their imports, as the proportion of LNG imports will have to be the same for all or they'll will have to pay the difference to GAIL, the pool operator. As a result, for such companies, it will lead to a higher average price and, hence, increase in working capital.

“Companies not using LNG at all, such as Nagarjuna, will be affected, as they are replacing domestic gas with higher-priced LNG,” says K Ravichandran, senior vice-president, corporate sector ratings, ICRA.

On the other hand, “Pooling will help reduce cost of production for players which were reliant on regasified LNG to a great extent. This will make production beyond the cutoff capacity viable and help improve the player’s profitability,” says Sural.

Companies having a higher gas sourcing price, such as Chambal and Zuari, will benefit more from pooling, in the form of reduced working capital needs, say analysts.

The bigger positive is that the pool mechanism will benefit companies with higher capacity utilisation and boost their turnover. K Ravichandran says, “Companies having increased capacity will pay at import parity prices, which means their realisation will be linked to import prices. Thus, companies which have gone for expansion such as Tata Chemicals, Chambal Fertilizers, National Fertilizers, Aditya Birla Chemicals and Iffco will benefit.

“Operationally, fertiliser companies are expected to do well in FY16, provided India has a normal monsoon,” say experts.