Urea subsidy – price for populism and greed

With pressure building on union budget, it is time to take a re-look at fertilizer subsidy which was allocated Rs 70,000 crores during 2017-18 and is a major factor contributing to high fiscal deficit. Here, we focus on urea – a major source of nitrogen – which accounts for over 70% of total subsidy.

Subsidy on each ton of urea produced/imported and sold to farmers is the excess of cost of production/import and distribution over maximum retail price [MRP] controlled by government at a low level. Of the nearly 24 million tons of urea produced in India, over 80% is based on use of natural gas as feedstock/fuel. Of the total gas requirement, 2/3rd comes from domestic production and 1/3rd from import as liquefied natural gas [LNG] which is re-gasified at the import terminal and transported to fertilizer plants via a network of pipelines.

The two overarching factors which influence subsidy payments are the MRP and cost of gas. Ironically, successive political dispensations have done little to calibrate these in a manner as to rein in subsidy. A cursory look at the movement in urea MRP during the last four decades or so, would show that every government kept the price unchanged and increased only when forced by external circumstances which was invariably followed by reduction.

Thus, the increase from Rs 1050 per ton to Rs 2000 per ton w.e.f. June 1, 1974 was propelled by ‘oil crisis’ of early 70s which led to steep increase in international price of urea and feedstock viz., naphtha [then] used in its production. This was followed by series of reductions in subsequent years bringing it down to Rs 1450 per ton as on March 10, 1979. The next hike increase to Rs 2000 per ton [June 8, 1980] and further to Rs 2350 per ton [July 11, 1981] was compelled by second bout of oil crisis in 1979-80.

A third time around, increase in MRP by 40% [July 25, 1991] but truncated to 30% [August 14, 1991] with exemption for small and marginal farmers was forced by the International Monetary Fund [IMF] who insisted on stiff conditions – one of these being to eliminate fertilizer subsidy in three years – for bailing us out of an unprecedented balance of payments [BoP] crisis.

W.e.f Feb 29, 2000, the price was increased from Rs 4000 per ton to Rs 4600 per ton and further to Rs 4830 per ton from Feb 28, 2002. It remained stuck at this level for 8 years. From April 1, 2010, price was raised to Rs 5310 per ton a mere 10%. The current MRP is Rs 5360 per ton consequent to a ‘negligible’ Rs 50 per ton – less than 1% – increase in October, 2012!

Modi – government excelled all previous dispensations by announcing -under a comprehensive new urea policy – in 2015 that the price would remain frozen at existing level for 4 years.

As regards gas, during the last three decades or so, there was steep increase in the price of domestic gas even while remaining under administered price control. In 2007, it was fixed at US$ 4.2 per million British thermal units [mBtu]. The UPA – regime [second term] decided to double it to US$ 8.4 per mBtu to be effective from January, 2014. However, its implementation was withheld by Modi – government.  Instead, it adopted a formula [since November 1, 2014] that uses prices at 4 international hubs as the benchmark. On this basis, the current price works out to US$ 2.75 per mBtu.

In March, 2016, it had given an ‘incentive’ price for gas from deep water & ultra-deep water and high pressure–high temperature [HPHT] areas [e.g. KG-DWN-98/2 of ONGC] using a formula based on price of alternate fuels viz. fuel oil, naphtha and imported LNG. That price was almost double of the normal price or US$ 5.5 per mBtu.

In respect of imported LNG, various long-term contracts [signed in 2000s] led to India getting gas at highest possible price. Petronet – a private company in which GAIL, IOCL, BPCL and ONGC hold 12.5 per cent each – had entered in to a long-term 25 year contract with RasGas of Qatar for import of 7.5 million tonnes a year or around 30 million standard cubic metre per day [mmscmd].

Initially, in an open tender floated by Petronet, RasGas had won a firm bid that would have translated to a floor or minimum price of $3 per mBtu and a cap or maximum price of $4 per mBtu for supply of 30 mmscmd over 25-year period.  Yet, the bid was re-negotiated exclusively with RasGas without approaching competing bidder [Petronas, Malaysia].

The price was fixed at mid-point of quoted floor and cap for first five years; followed by an annual increase equal to 33 per cent of originally bid cap, for each of next five years. For balance 15 years, it was linked directly to average price of crude in immediately preceding five years without any floor or cap. On this formula, in 2015, Petronet LNG would have to pay US$ 13 per mBtu almost double the price in spot market US$ 6.5-7 per mBtu.

In a number of other long-term deals also viz. Petronet LNG with Exxon in Gorgon in Australia [2009]; GAIL with Cheniere Energy for US gas [2011] and GAIL with Gazprom [Russia] [2012], the price would have come to US$ 10 per mBtu plus.

Modi – dispensation is renegotiating above contracts to lower the price.  In 2015, it persuaded Qatar government to modify the pricing formula to link it with immediately preceding 3-month average price of Brent crude oil thereby bringing down the price closer to its spot rate. Yet, currently, the cost comes to over $8 per mBtu. Supplies from Gazprom too have been linked to Brent crude. Likewise, the re-negotiated price for Gorgon project comes to US$8.5 per mBtu.

In short, the current price of domestic gas US$ 2.75 per mBtu or Rs 7.2 per cubic meter is 22 times the price Rs 0.32 per cubic meter in 1981. The price of gas from difficult HP/HT areas US$ 5.5 per mBtu or Rs 14.4 per cubic meter is 44 times the 1981 level. The price of LNG US$ 8 per mBtu or Rs 20.8 per cubic meter is 65 times the 1981 level. In sharp contrast, current urea MRP at Rs 5360 per ton is a mere 2.2 times the level of Rs 2350 per ton in 1981.

The widening gap between cost and MRP is the root cause behind ever increasing subsidy. The government should take urgent steps to bridge the gap more so, by increasing MRP or else, the budget will have to eternally live with destabilizing effect of fertilizer subsidy.

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