Ind-Ra: Pooled Natural Gas Prices for Urea Manufacturers to Continue to Increase in Short to Medium Term

India Ratings and Research (Ind-Ra) opines that the upward bias in the prices of pooled natural gas available to fertiliser companies would continue in the short to medium term.

The increase in the pooled gas prices would be driven by a combination of the following events: i) a continued increase in long-term LNG prices because of the continuously rising crude oil prices ii) continued higher levels of spot natural gas prices due to a strong demand from China and the more balanced LNG demand-supply dynamics iii) an increase in demand for imported gas, coming from the five upcoming gas-based urea plants iv) continued higher growth rates in the CNG and the domestic PNG segments, leading to a greater share of domestic gas being allocated to the city gas segment than the fertiliser segment, v) further rupee depreciation, leading to higher gas cost and vi) continued lower growth in domestic gas production, leading to increased reliance on imported LNG.

Increase in Long-Term LNG and Spot LNG Prices: Ind-Ra in its wire Increase in Chinese Demand for Natural Gas Leads to Structural Change in Spot Prices dated 2 April 2018 had highlighted that the price of term LNG is likely to increase owing to rising crude oil prices while the spot LNG prices would increase on account of higher purchases from China. The agency believes the rise in the spot LNG prices is not a temporary phenomenon, but more structural in nature.

This increase in gas prices could result in a compression in the contribution margins for urea plants which make higher contribution margins from sales beyond reassessed capacity. Ind-Ra had highlighted this in its wire Higher LNG Prices to Impact Urea Production Beyond Reassessed Capacity dated 8 March 2018. Increased Demand from New Urea Plants: Five new gas-based urea manufacturing plants with combined urea capacity of 6.42 million metric ton (mmt) and an estimated gas requirement of 10 million metric standard cubic metres per day (mmscmd) are likely to commence operations beginning FY20 and FY21. Since, the majority of this gas requirement would be met from imported LNG, the share of RLNG in the fertiliser mix is further likely to increase, resulting in an overall increase pooled gas price. The fertiliser sector has 43% domestic gas usage and 57% imported gas usage, which Ind-Ra believes, after the commissioning of the five plants, could increase to 67% by FY21.

The share of cheaper domestic gas has been gradually coming down while that of costlier imported LNG has been increasing in the mix.

However, higher gas prices would increase the price payable to these new urea manufacturing units to about 50% compared to imported urea prices. This would further increase the subsidy burden of the government and off-take from these plants could come under pressure.

Higher Growth in City Gas Business: The government in the Gas Allocation Policy has accorded the highest preference to city gas distribution. Thus, the share of fertiliser sector has come down gradually to around 25% in March 2018 from around 37% in November 2015 while that of city gas distributors has increased to around 19% from around 11%, which has impacted the pooled gas price since domestic gas cost less than imported LNG.

Additionally, the city gas distribution sector will grow with the government focusing on expanding the city gas distribution network and higher number of cities being bid for. This would result in a lower allocation of domestic gas to the fertiliser sector, thus further increasing the share of imported LNG in the overall pooled gas mix.

Nominal Growth in Domestic Gas Production: The domestic gas production declined continuously during FY13-FY17 and grew only 2.2% to 89.7mmscmd in FY18 (FY13: 111.4mmscmd). This has further led to increased reliance on import of RLNG as the domestic consumption has been gradually increasing.

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