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Ind-Ra: Higher LNG Prices to Impact Urea Production Beyond Reassessed Capacity

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Ratings and Research (Ind-Ra) opines the recent increase in term-LNG prices due to and spot LNG prices, driven by increased purchases from China, has led to higher pooled prices for the fertiliser sector. This could result in the cost of production beyond reassessed capacity (RAC) exceeding the imported prices. In such a situation, plants which used to make higher contribution margins from sales beyond RAC would see a compression in the contribution margins.

Internationally, prices have fallen to USD200-225/t from USD320/t in October 2014, due to a higher supply than demand. According to the of the (FAO), the supply of primary nutrient nitrogen (N) might exceed the demand. During FY18, FAO estimates the global demand for N for fertiliser usage to increase by 1.2% to 119mmt whereas the supply is likely to be 134mmt, thus leaving a surplus of 15mmt globally. The surplus has been the highest over FY13-FY18. Additionally, the imports by impact global prices, as is the second largest consumer of urea globally.

Given that India is looking to bring down imports of urea to nil over the next few years, driven by a revival of loss-making/idle fertiliser units, the addition of these capacities in the country could further pressure urea prices over the medium to long-term.

Conversely, the price of gas, the key raw material for making urea, has seen an uptrend. This is because in its bid to cut pollution levels in the country has resorted to buying LNG, which has resulted in the increase in the spot LNG prices. This along with the rise in the crude prices has led to increase in the term LNG prices and thus pooled price. believes this would remain, given the structural change seen in the LNG markets. With the urea prices declining and the imported LNG prices rising, there are two alternatives available: i) urea manufacturers stop production above RAC and ii) the government increases the incidental charges/allowances reimbursed on the imported urea, thus increasing the imported urea price above the variable cost of generation plus the additional fixed allowance of INR2,300/t.

The (Gcal <=5.42) would find it viable to produce urea beyond RAC until and unless the government increases the incidental charge on the imported urea to make domestic beyond RAC viable.

Most urea manufacturers have historically derived a higher proportion of their EBITDA by operating their plants at As gas prices rise, these savings are likely to increase in absolute amount. However, this would be offset by an under-recovery at the fixed cost level as the increase in the wages and other expenses have not been completely reimbursed by increasing fixed cost allowed per tonne. Additionally, a lowering of contribution from sales beyond RAC could offset the

Under the New Urea Policy 2015, the production beyond RAC is reimbursed by the government by way of a minimum of 'variable cost of production + INR2,300/t' or 'import parity price + incidental charges'.

Ind-Ra, in a four-part series, will present its analysis on the risks faced by urea manufacturers because of movements in international urea prices and prices. In Ind-Ra's opinion, the risks are broadly classified as (i) impact on production beyond RAC, (ii) structural change in levels, (iii) offtake risk for upcoming urea plants, and (iv) impact of direct benefit transfer on working capital profile of urea manufacturers.

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(This story has not been edited by Business Standard staff and is auto-generated from a syndicated feed.)

First Published: Fri, March 09 2018. 11:41 IST