In January 2013, government had notified a urea investment policy (UIP) for new green field projects; expansion of existing units; additional urea from revamp of existing units and revival projects of sick public sector units of Fertilizer Corporation of India (FCIL) & Hindustan Fertilizer Corporation (HFCL).
Early this year, it made two amendments in UIP. The first amendment dispensed with the “dispensation of guaranteed buy-back ” outlined earlier. A second amendment requires interested private companies to give a bank guarantee (BG) of Rs 300 crore for every project, while PSUs firms are exempted from it.
(In view of general elections and model code of conduct coming in to force, its notification was kept in abeyance. The amended policy has now been notified).
UIP (2013) had led to a flood of proposals for setting up urea capacity totaling around 20 million tonnes or 12 million tonnes more than the current deficit of 8 million tonnes (30 mt demand minus 22 mt domestic supply). If all proposed projects materialize, India would be staring at an unprecedented urea surplus 4-5 years from now.
This sounds bizarre! A country that has not seen any new urea plant being set up during last one-and-a-half decade or so, what sort of a wonder a new policy could do to turn it in to a huge surplus in just 1/3rd of that period? This is all the more glaring when seen in backdrop of a similar UIP in 2008 failing to enthuse investors (only 2 mt was added through revamp of existing units).
How did UIP (2013) compare with UIP (2008)? And, where does amended UIP (2014) take us?
UIP (2013) assures investors in new green field projects – besides revival projects of FCIL & HFCL – a price linked to import parity price (IPP) with a floor (F) US$ 305 per ton and ceiling (C) US$ 335 per ton (for revamp & expansion projects, benchmarks are lower). These basics are similar to UIP (2008). However, an “add-on” under UIP (2013) relates to adjustment for variation in price of gas.
The prices correspond to gas price of up to US$ 6.5 per mbtu (million British thermal unit). Beyond this level, for each dollar increase in gas price up to US$14 per mbtu, ‘F’ and ‘C’ would increase by US $ 20 per ton each. For increases beyond US$14 per mBtu, only ‘F’ price would apply albeit with full protection for gas cost.
Since, gas cost accounts for about 75% of urea production cost and gets fully compensated irrespective of gas price level [e.g., at US$14 per mbtu, project will get a price of US$ 485 per ton (335+(14-6.5)x20)], attraction was palpable. A second add-on was guaranteed buy-back (GBB) or a commitment by government to buy entire urea production from unit. This requires closer scrutiny.
For long, urea has been under pricing and distribution controls. While, maximum retail price (MRP) is controlled at a low level (currently Rs 5360 per ton), excess of this over production cost is reimbursed to producer as subsidy. Some 30 operating units get retention price/ subsidy specific to each under new pricing scheme (NPS).
Projects that come up under UIP will also be covered under the above dispensation. Thus, a new green field project paying for gas @ US$14 per mbtu will get a price of US$ 485 per ton or Rs 29,100 per ton or subsidy of Rs 23,740 per ton (29,100-5360).
Until 2003, 100% of urea production was subject to movement & distribution control. Since 2003, this is down to 50% even as manufacturers are free to sell the other 50% in a manner they deem fit. However, free urea is entitled to freight cost Rs 100 per ton less than the rate applicable to controlled urea.
What happens if a unit is unable to sell its entire production to farmers? The balance can either be exported or sold to manufacturers of complex fertilizers at IPP but will not qualify for subsidy. However, due to domestic gas being un-available and imported LNG coming at prohibitive price (US$ 16 per mBtu plus), such sale will be at a loss! GBB was meant to nip this problem in the bud.
Clearly, the 2 features in UIP (2013) viz., full compensation for gas cost and GBB had almost put promoters of new projects in safe heaven. That would also explain initial tumultuous response from industry. Now, under amended UIP (2014) with GBB gone, uncertainties have come to haunt them. But, the bigger problem relates to uncertainties of subsidy payments.
Due to urea MRP being controlled at a fraction of production cost, all units depend heavily on subsidy support for survival. New projects will be no exception. But, government wants to rein in subsidy. So, it axes fertilizer subsidy payments by reducing entitlement, under-provision, delayed payments etc. During current year, net funds available (after paying arrears from 2013-14) barely meet requirements of first quarter.
The trend will continue affecting viability of even existing units not to talk of fresh investment which will not come despite assurance of covering full gas cost under UIP (2014).
There are three core reasons as to why investment in urea industry is not considered safe (forget yielding good return) viz., (i) shortage of domestic gas and high price of imported LNG; (ii) political expediency of keeping MRP artificially low and (iii) compulsion to rein subsidy. Ironically, the three work at cross-purpose.
Thus, for increasing domestic production of gas, exploration and production companies want higher gas price which will increase fertilizer subsidy. On the other hand, control on urea MRP at low level forestalls efforts to rein in subsidy. Yet, fiscal discipline requires subsidy cuts. Industry is made to bear brunt of these pulls.
Government needs to take holistic look and put an end to these conflicts forever. If it feels that MRP cannot be raised or higher gas price has to be allowed to E&P companies, it must accept inevitability of higher subsidy and make adequate budget provision. On the other hand, if, it wants to rein in subsidy, there is no escape from increase in MRP and keeping gas price within reasonable bound.
Such a coherent policy framework is need of hour instead of piecemeal changes here and there pandering to individual segments in isolation. Alternatively, government may allow market forces in both gas and fertilizers and take care of poor farmers by giving direct subsidy support.