In the CCEA (cabinet committee on economic affairs) meeting on March 31, 2015, the government decided on a uniform gas pricing policy and pooling of domestic and imported liquefied natural gas (LNG) for urea plants. Under it, gas will be supplied at ‘uniform’ delivered price to all urea plants on gas grid through a pooling mechanism.
What do these announcements have in store for the industry? Does it mean Modi – dispensation has finally got cracking on big bang reforms in fertilizers after a 10 month wait and 2 full-fledged budgets?
Currently, there are a total of 30 urea producing units in India. Of these, 27 are based on gas which is considered to be the most energy efficient and environment-friendly feedstock. The remaining three plants viz., Mangalore Chemicals & Fertilizers (MCF), Madras Fertilizers Limited (MFL) and Southern Petrochemicals & Industries Corporation (SPIC) – are based on naphtha.
Under a government directive for switch over of existing naphtha based plants to gas, promoters of MCF had done necessary revamp which was completed early last year. However, due to non-availability of gas – courtesy delay in laying pipeline infrastructure – it continues to work on naphtha.
Together, these 30 plants produce around 23 million tons annually (mta) vis-a-vis total consumption of 30 mta. The deficit of 7 mta is plugged by imports viz., 2 mta from OMIFCO (Oman India Fertilizer Company) in which IFFCO and KRIBHCO are equal equity partners with Oman Oil Company (OOC) under a long-term off-take agreement, in place till 2020 and 5 mta from other sources.
The plants are covered by new pricing scheme (NPS) under which each is paid subsidy equal to excess of its production cost over net realization from selling urea at controlled MRP (maximum retail price) currently at Rs 5360 per ton. The cost ranges from about Rs 11,000 per ton for efficient gas based plants, Rs 15,000 per ton for other high cost gas based units and over Rs 20,000 per ton for naphtha-based plants.
While, 50% of production of a unit is subject to distribution controls [under a scheme of ECA (Essential Commodities Act) allocation, central government in consultation with states decides who will sell where and how much], it is free to sell the other 50%. A unit producing in excess of a cut-off level at 110% of its re-assessed capacity, is paid subsidy on incremental output benchmarked to 85% of import parity price (IMPP) of urea.
The inter-plant variations in cost are due to differences in feedstock, location (it affects delivered cost vide transport charges and local taxes), energy consumption and conversion cost. Within gas group, variations arise on account of some plants being forced to use LNG – due to shortage of domestic gas and not getting adequate allocation from this quota – which is much more expensive.
In this backdrop, pooling of domestic gas and imported LNG is intended to meet requirements of all urea plants consistent with full utilization of their available capacity at a uniform price (total value of domestic gas and LNG at their respective prices divided by total quantity). This will eliminate a major source of variations in production cost.
However, government will have to carefully navigate through implementation as this will involve re-working of existing gas supply agreements to incorporate changes in price and quantity, overcoming resistance from units who are currently getting bulk of their requirements from domestic gas at low price and galvanizing GAIL to charge uniform transport tariff from all units.
Yet, it will still not be able to ensure uniform price of gas on ‘delivered’ basis as VAT varies substantially from a low of 5% in Rajasthan to a high of 21% in Uttar Pradesh and states like Maharashtra and Gujarat occupying middle slot of 12.5% and 15% respectively. For this, we have to wait till GST (Goods and Services Tax) is introduced from April, 2016 as per time line given by government.
Under extant dispensation, shortfall in domestic gas has affected ability of efficient gas based units to deliver additional output beyond the cut-off level. For getting this, they have to depend entirely on imported LNG and cost thereof is not fully covered due to admissible reimbursement restricted to 85% of IMPP.
With gas pooling and uniform pricing in place, cost of incremental production will decrease enabling higher domestic output. According to Department of Fertilizers (DOF), we can get additional urea production of about 3.71 million tons over next four years (2015-16 to 2018-19). This in turn, will reduce high cost imports leading to saving of about Rs 1550 crores in subsidy.
A compelling reason often advanced in the past to stay with unit-wise retention pricing for producers [NPS that replaced erstwhile retention price scheme (RPS) in 2003 continues to be unit-wise] was that there are differences in delivered cost of feedstock. Now, that government has addressed this upfront, it should also announce switch-over to a scheme of uniform retention price for all units.
Indeed, it should go a step forward to replace NPS by nutrient-based scheme (NBS) under which subsidy is paid to all manufacturers at a uniform rate say Rs X per unit of nitrogen. All non-urea fertilizers such as DAP, other complex fertilizers, MOP, SSP etc are already covered under NBS since April 2010 and extending this to urea will ensure uniformity of policy dispensation.
Apart from correcting imbalance in fertilizers use, improve fertilizer use efficiency, crop yield and soil health, this will unleash competitive forces and drive industry to reduce cost and provide better solution to farmers based on their needs. Above all, it will create a predictable and conducive policy environment for investors to take a favourable look at fertilizer industry.
NBS may be kept in vogue for say 2-3 years to acclimatize manufacturers to rigours of uniform pricing. At the end of it, the government may stop routing subsidy through industry and put in place direct transfer to farmers using JAM [Jan Dhan Yojna (JDY), Aadhaar and mobile numbers] platform.
Having taken the first bold step, Modi should get cracking on other logical steps to consummate reforms in fertilizers.