Fertile Changes?

For an industry which has a lopsided consumption pattern and is a casualty of fickle-minded policy makers, the Hanumantha Rao Committee Report has come as a relief. The deregulation of the industry looks closer now

Till now, the fertiliser industry was partially deregulated when the phosphatic fertilisers were decontrolled in August 1992. But as prices skyrocketed, Di-ammonium phosphate (DAP) and Single Super Phosphate (SSP) prices were brought down by the government through ad-hoc concessions. In spite of this, there is a wide price differential between urea and phosphatic fertilisers. While urea is priced at Rs 3660 per tonne, the DAP farm gate price is at an average of Rs 8000 per tonne.

 

The complex retention price scheme (RPS) ensured complete insulation from international price fluctuations and an assured return of 12 per cent on the net worth for all urea producers. This was protecting the inefficient units. And the cross subsidising, which meant a lower retention price for the older units offsetting the higher prices of the newer units was, ultimately, benefitting the new high cost units. Yet another aberration, has been the fixing of the retention price at 12 per cent on the net worth and at 90 per cent capacity utilisation. This has led to players understating their nameplate capacity and inflating capital cost, so the 12 per cent return effectively works out to be higher.

The Committee correction

The Hanumantha Rao Committee Report seems to have done away with these imbalances to ensure a level playing field. Firstly, it recommends a ceiling farm gate price below which the producers can sell at any price. Then, it has arrived at a normative referral price (NRP) that is, the ex-factory price. The subsidy will then be the difference between the farm gate price and the NRP plus the distribution and selling expenses which include the dealer margins and the average freight.

The NRP has been arrived at by taking into consideration all the existing fertiliser units which include both DAP and urea producers. For determining this, the long-range marginal cost method (LRMC) has been proposed.(See box)

Impact

Apparent benefit to DAP producers

A possible 10 per cent increase in the urea farm gate prices would mean a cut in the subsidy. If the saving from this goes into the decontrolled fertilisers special concession , subsidies for phosphatic and potassic fertilisers will go up. Although the impact will be marginal, the logical fallout would be a more balanced nitrogen-phosphorous-potassium (NPK) ratio which is currently 8.5:2.5:1. That would imply a better consumption of DAP, SSP and other phosphatic fertilisers. The difference between urea and DAP prices will be narrowed down, at least to the extent of the subsidy cut.

The average domestic company price for DAP is currently Rs 11,500, a price fixation of Rs 12,800 will take care of the high input cost incurred in acquiring phosphoric acid. DV Ramakrishna, analyst with Birla Marlin Securities, opines, The hitch lies in the rise in naphtha prices by Rs 2000 per tonne. While the complex fertilser producers are reimbursed for the P-content, they are not compensated for the N-content. However, if the recent correction in international naphtha prices continues, domestic prices might follow suit.

Older urea units at an advantage

Since the capital-related costs for newer units are currently higher than what they will incur in the next 15 years, the price arrived by discounting the future cost would mean a lower realisation compared to the actual cost incurred today. However, the variable cost, which is largely ruled by raw material costs incurred today, will be less for the newer and more efficient plants. To what extent this will offset the fixed cost remains to be seen. As of now, the fully depreciated older units stand to gain due to lower capital service charges.

GSFC

Gujarat State Fertilisers Corporation (GSFC). Around 44 per cent of the business is coming from urea and DAP. Since its price per tonne of urea works out to around Rs 5300 and 64 per cent of the feedstock consumption comprises gas, the company stands to gain if the recommendations are implemented.

DAP contributes 35 per cent to the turnover, 31 per cent being produced by the Sikka unit. Phosphoric acid which accounts for 46 per cent of raw material consumption in value terms, is not produced in-house. In fact, 77 per cent of the raw material is imported. This could partly explain the rise in expenditure by 21.45 per cent in the first half over that of the previous corresponding period. The Sikka unit realises around Rs 11,300 per tonne of DAP, a drop in urea subsidy and the proposed NRP may help improve its margins.

GNFC

Urea is the single largest contributor to the Gujarat Narmada Valley Fertilisers sales at 25 per cent. With a retention price of Rs 4900, the plant being based on fuel oil, the NRP takes ample care of the feedstock used. In addition, it is also into marketing of imported urea which is more lucrative. This is because the international prices are down to $95-$100 a tonne and the landed cost is Rs 5000 per tonne. At the recommended prices, this will give a fairly good return to the company.

Rashtriya Chemicals and Fertilizers (RCF)

One of the largest producers of urea, with 58 per cent of the turnover, it will be one of the main players to benefit from the committee recommendations. The retention price is around Rs 4000 per tonne which is by far the lowest amongst all urea producers. In spite of such low realisations, it has been able to operate at 8 per cent margins. As the NRP for gas based plants is Rs 6500, the company will be much better off than its counterparts who are operating at higher costs. Says Ramakrishna, RCF is will be the major beneficiary since its retention price is the lowest.

SPIC

It sources 63 per cent of its phosphoric acid requirement in-house. The phosphoric acid consumption is 46 per cent in DAP and its landed cost is Rs 14,000 per tonne, implying a consumption cost of Rs 6400 per tonne of DAP. It is currently realising Rs 11000 per tonne on DAP and it has been able to offer this price because of its cost competitiveness.

For urea, SPICs retention price is currently Rs 4800, lower than the NRP. Being a comparatively older unit, a change in the policy will positively impact its urea business.

Tata Chemicals

The plant, having become operational in 1994-95, is one of the newest additions in the industry capacity. Operationally, it is quite efficient with a dual feedstock facility. It currently realises a price of Rs 7300 a tonne of urea which is much higher than the NRP for a gas-based unit. Its capital related costs like depreciation and interest are almost 27 per cent of the total expenditure incurred compared to a unit like RCF where this element constitutes just three per cent. Market sources pegged the companys expectation for a final retention price of Rs 8500 a tonne. If the provisional price of Rs 7300 a tonne is not sufficient, then the NRP is much below its expectations.

Nagarjuna Fertilisers

With the highest retention price in the industry at Rs 8200 a tonne, this company is in for tough times. Being a gas-based plant it will obviously be very unhappy with the NRP.

The plant having started in 1992 has a high depreciation and interest cost component at 28.65 per cent of the total expenditure. It has been operating at a very high capacity utilisation of 127 per cent to improve its profitability. Moreover, apart from manufacturing, it also trades urea which accounts for 38 per cent of the total urea sales and the cost of urea purchased during 1996-97 works out to Rs 2400 a tonne only.

Already, it has been hit by the governments decision to limit its offtake to 115 per cent from manufacturers with retention price of over Rs 7000 a tonne. The company has been expanding its urea capacity at Kakinada. Although this would help in achieving economies of scale in the long run but in the short run would be high cost and low returns.

Indo Gulf Fertilisers

Having started in late eighties, it is better off than the newer units with a lower fixed cost component. The retention price works out to Rs 5300 which is much lower than the NRP for both naphtha and gas based units considering its dual feedstock capabilities. It has been operating at 24 per cent margins, so if Rs 5300 is taken as an indicator, it stands to benefit.