Fertiliser sector is a major consumer of natural gas and is a part of the larger problem of gas crisis. Lately, it has been in the news for having been fined by CCP for overcharging, profiteering and unethical and even illegal practices of price collusion. Suspecting a lot more, CCP has asked SECP to undertake a forensic audit of the companies involved. In any case, it is being widely believed that the fruits of low priced gas are not being transformed into fair prices for fertilisers.
In this background, the rationale for low prices and preferential approaches sought by the fertiliser industry seems to be disappearing. We will seek to investigate the gas crisis and the gas pricing issue of fertiliser sector and examine the options available to the stakeholders on the intertwined issues in this respect. For this, let us have some background first.
The gas crisis is real and serious and often goes unappreciated by all the stakeholders. There is a shortage of 2 BCFPD against a production of 4 BCFPD. Gas reserves are falling alarmingly with gas production projected to dwindle down to only 2 BCFPD in 2020, not very far. Even with the implementation of all the gas import projects LNG, IP and TAPI, there is going to be a gas shortage. The general feeling is that IP is a panacea and will solve all the gas problems, while the fact is that it will be significantly contributing to bridging supply-demand gap. Apart from shortages, all imported gas would be oil-linked (76-85% of Oil price),the current valuation being 17-18 USD per MMBtu, almost four times of the current prices. And no body is willing to pay the increased prices but expects enhanced supplies. Without demand control measures, the gas crisis cannot be eliminated through supply measures. Presently every sector is making the case for itself as being the most important for the economy.
CCP FINES FFC AND ENGRO CCP (Competition Commission of Pakistan) has levied a fine of several billion rupees on FFC and Engro Fertiliser for an anti-competitive price-setting behaviour in the light of 102% ROE of FFC and 24% ROE (Return on Equity after tax) of Engro. Farmers had complained of doubling of the Urea prices in a matter of 12 months. Ironically, fertiliser industry as a whole argued that they are the high cost producers but not the profiteers to invite the penalty of CCP. International cost and price data reveal that there is not much of an advantage in local production with a low priced gas carrying a subsidy of 3 USD per MMBtu or 78 USD per Ton of Urea, may be even more. Including GIDC (Gas development charge), the Fertiliser industry composite gas tariff is only 2.5 USD per MMBtu. At such a low gas price, the cost advantage in locally produced Fertiliser is not much and the benefit of cheap gas is being devoured by excessive profiteering of the sector. European Fertiliser prices are 360-385 USD per ton with a gas price of 8-10 USD per MMBtu, while Urea prices in Pakistan are 330 USD per ton with gas prices of 2.5 USD per MMBtu. In India, the regulated producer price of Urea is 245 USD per ton at gas prices of 7.5 USD per MMBtu for revamp projects and 305 USD per ton at gas prices of 6.5 USD per MMBtu for Greenfield projects (There is a sliding scale specifying prices up to a gas price of 14 USD per MMBtu and even more). The DAP is sold locally at 720 USD per ton vs international price (Black Sea fob) of 500 USD per ton. So whatever price advantage is offered by Urea producers is taken away by high producer prices of DAP. Table 2 shows that it is literally true. Urea industry has itself argued that non-Urea fertiliser industry is not passing on the low gas price advantage to the farmers, although, Urea producers live in glass houses themselves.
At present, the net price advantage of local production with subsidised gas prices is negative. Farmers lose an average of 24 Million USD per year. Actual gas subsidy to the sector stands at 600 Million USD (USD 100 per Ton). If European gas prices (10 USD per MMBtu) are taken as a reference, as we are taking European fertiliser prices (Black Sea f.o.b) as reference, the implicit subsidy reaches a level of 1600 Million USD(267 USD/ton). When LNG/IP gas would be inducted as, the subsidy would go up to 2.8 Billion USD 467 USD/ton). The Fertiliser Advisory Council has been accused of publishing misleading and incomparable data on Gas prices. Middle Eastern gas prices cannot be taken as a reference. Petrol is sold there at a price less than that of mineral water. Can we or any other country do that?
Balance Sheet analysis of Fertiliser companies We select the two major companies of the sector, FFC and Engro, having market shares respectively of %. An analysis of FFC and Engro Balance sheets indicate some understandable and some confusing aspect. FFC’s ROE consistently went higher and higher from 44 % to 97 %, amid a hue and cry of gas supplies and increase in gas prices, while prices tripled in the same period. Did input prices increase in the same fashion? FFC’s feedstock (and some other raw material like P which has a negligible component) was Rs 7702 per ton vs Rs 9472/- per ton,23% lower, while apparently gas tariff is the same. If at all, Engro’s agreement is older. Annual Reports should explain these variations. We find the annual reports quite cryptic on other account as well. Similarly, Fuel and Energy costs of FFC are lower by 25%; Rs 2692 per ton vs Rs 3568 per ton of Engro, a difference of 876 Rs per ton. Put together, there is a difference of Rs 2646 per ton(Rs 132 per bag) in raw material and energy cost only. Had there been a regulatory body, it would have asked such questions before allowing such prices. No wonder, CCP has requested a forensic audit; more on Auditors at some other opportunity. Still the RM costs are around 25 % of the sales price, while internationally, RM costs (plus energy) are more than 50-70%.This is due to atrociously low prices of local gas.
The reader would note from Table 3(Urea Price history compared: International (FOB) vs local retail), that there is a negligible price advantage in local production, despite lower gas prices. If there are efficient fertiliser trading companies in the private sector importing and distributing fertilisers (on free list) in place of TCP and NFML, this little margin of difference may not be there at all. In fact latest TCP tenders indicate the lowest landed price at 374.3 USD per ton which is lower than spot prices. Black markets and over-pricing can only be eliminated through active competition from imports. If gas prices are rationalised upwards and imports set free, GOP may not have to beg the fertiliser companies to reduce prices, but alternatively, these companies may publish ‘SOS’ advertisements in newspapers crying for help. Why should government leave itself to the arbitrariness and profiteering of companies?
Engro’s non-cash costs jumped from 10.9 to 16 Bn. Rs (almost 50% of sales price), in the year 2012 which is perhaps a major cause of loss in that year apart from a lack of full capacity utilisation due to low gas supply. By comparison FFC had a non-cash cost of Rs 999 per ton only; reason, Engro’s new plant investment has higher loading of interest and depreciation (non-cash costs) than older investments of FFC.FFC exploited this cost structure peculiarities to enhance its profitability to quite unreasonable level.
Our estimates indicate that if profiteering is cut down to a fair and reasonable ROE of 20-25 % after tax, a price reduction of Rs 300/- per bag is possible. Engro has also offered similar reductions, provided gas is supplied to its new plant. A Ministry of Industries report has developed a package of recommendations that is based on withdrawal of GIDC and GST reductions resulting in a price reduction of Rs 159 per bag. If the two approaches are combined, a price reduction of Rs 459/- per bag (27%) of the current retail) are possible. We would, however, not advise to extend these concessions to the sectors on the grounds explained elsewhere in this paper.
NO MORE CHEAP GAS OR GAS AT ALL Local production and self-sufficiency of fertiliser was largely premised on the availability of cheap gas locally. One may have to revisit the idea of self sufficiency under the changed circumstances of non-availability of gas. It takes, 0.75 kg of gas to produce one kg of Urea, and gas costs internationally are 90% of the cash production costs. To understand the complexity of the case, let us examine some international data. China is the largest producer of fertilisers (Urea and Ammonia), with an output of 50 MTPA, which is almost one-third of the global capacity. Three-fourth of China’s Urea production is on coal. All other major producers are energy surplus countries like Trinidad, Russia and Oil/gas -rich Middle Eastern countries like Oman, Qatar, Algeria, Morocco and Saudi Arabia. India is perhaps the only exception, but has major issues of food security. US is the largest importer of Fertilisers (Urea, Ammonia) importing 70 MTPA and producing less than 10 MTPA, having the largest agricultural sector and generally quite sensitive about self-sufficiency. Largely due to gas scarcity, the US did not take much interest in local fertiliser production and preferred imports. It is only recently, that new capacity has been added to its resources in the light of a cheap shale gas.
POLICY REFORMS There are a number of options that ought to be examined for the fertiliser sector including the fertiliser industry to deal with the evolving situation;
— Policy reforms of the sector; either freeing the sector totally, or bring the fertiliser industry under a firm regulatory control.
— Shunning the self sufficiency argument in favour of a more realistic policy in this respect.
— Locate and relocate some of the fertiliser capacity to the energy rich countries of the region in the form of JVs.
— Gas price and supply reforms rationalising gas prices to the sector without any preference or subsidy
— Look for other viable options for raw material and energy supplies
Keeping in view the CCP decision determining anti-competitive pricing collusion, rising prices of fertilisers and complaints of farmers, and the economic consequences of providing cheap gas, there appears to be a strong case of bringing some rationalisation of the sector. Benefiting from cheap gas but being free to set their own prices and that under collusion is not acceptable. The sector should either be regulated (price control) or should be totally free. Gas prices for the sector to be set keeping in view the European gas prices and local gas prices for the cement sector. Simply speaking, the policy regime should be; get gas at international (European Gashub price of 10 USD per MMBtu) and give fertiliser at international fertiliser prices (Europe Black sea Fob). Imports may be put on Free List with or without TCP imports. The gas price differential is to be channeled to government account in the form of a Fertiliser development surcharge. The Fertiliser subsidy may be kept for price stability only. The price advantage of local production is only marginal, at best of 15%. The additional farm sector expense may be compensated through alternative means and financed through the enhanced gas prices and the surcharge. This should create incentives to the fertiliser sector to switch to other sources of feedstock such as coal. Cement industry has done it under gas price pressure, so will the fertiliser sector.
GOING ABROAD AND RELOCATION? The international fertiliser environment is poised to a shake-up as the new Shale gas takes effect on international market and capacities are relocated to the US Consequently, the prices are to go down further deteriorating the comparative disadvantage. It is easier to import fertiliser than to import gas, pipeline or LNG, as we are trying to do so for the last five years. Pakistan is certainly not a choice location for gas intensive fertiliser plants due to gas shortage and certainly not in the recent years when this problem finally struck. In this very period our industry wizards decided to make 2 billion USD worth of investments. We should have looked for JVs in the gas rich countries such as Iran (preferably), Oman and Qatar. A JV on Pak-Iran border would have been an ideal choice. If gas crisis does not end, it appears that some of the plants may have to be relocated on Pak-Iran border.
SWITCHING TO COAL? The recent investments in fertiliser capacity should have been based on coal-feedstock of Thar. Such decision should have been delayed, while Thar uncertainties were being resolved. In fact Engro is involved both in Thar Coal and as well as in Urea. There is no self-sufficiency based on imported and expensive gas. There is therefore a strong case for converting the existing fertiliser plants to Thar coal. It is difficult and expensive, but much less expensive than the projected subsidy of 2000 million USD that may have to be provided to the fertiliser sector with the advent of the imported gas.
As we have mentioned earlier that China’s bulk of Ammonia/Urea capacity is based on coal, a serious consideration has to be given to coal. Chinese plants, however, are based on the up ground gasification of Anthracite coal. Gasification of Brown coal has been done successfully HZ2 in North Dakota, in the wake of oil crisis of 1973.There are projects in Australia and Newzealand considering Brown coal gasification. We could also consider UCG (underground coal gasification) for the same. Fertiliser industry has the financial and organisational muscle to induct such projects. A LLNL-Lawrence Livermore National Laboratory (2007) study projects the cost of production of UCG-Syngas at USD 1.66 per MMBtu. If the estimate is escalated several times, the proposition would remain feasible in our circumstances. If coal option is not found feasible, although we do not see why it would not be feasible, the other option is LNG. Instead of expecting GOP or Gas companies, fertiliser sector could take initiative and launch its own LNG project. Under a regulated regime, similar to the power sector, their profitability would be guaranteed. This would, however, enhance the subsidy requirements. It is really a question of, as they say, how you hold your ears.
Actually, it is a bad policy to subsidise producer prices and should be replaced by consumer/farmer subsidy directly or in an equivalent forms. Producer prices can and are invariably manipulated, even under regulation and not to talk of free pricing regime pursued by the current fertiliser policy. Protection and subsidies almost always breed corruption and rear inefficiency and inefficient or profiteer producers. Free pricing is all right when both input and output prices are free. In the present case, fertiliser producers are getting subsidy and are free to set their prices at will. What they have done has been determined and demonstrated by CCP to be illegal and immoral.
CONCLUSION Unfortunately, under the garb of agricultural self sufficiency and farmer’s support, policy apparatus has been manipulated by the vested interest and the intended benefits could not have been passed on to the farmer. And ironically, at the top of these pricing scandals are the companies one thought of as model companies.
Buying cheap gas and selling expensive fertiliser has been pursued by the fertiliser industry rather relentlessly. There are serious charges of price collusion as finally determined and adjudged by CCP. It has created problems for power sector and has harmed farmer’s interest. Their lobbying for supplies of cheap gas to protect national interest should not be taken at its face value. The gas supplied to fertiliser sector takes gas away from the power sector and the industry increasing the oil import bill and cost of production of electricity .The new government should examine the whole question, rationalise fertiliser policy on a fair and balanced footing.
