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FERTILIZER INDUSTRY
MORE DEMAND LESS SUPPLY

The country will become a net importer of urea if new plants are not established at the earliest possible

By SHABBIR H. KAZMI
June 03 - 09, 2002

It is a fact that Pakistan's economy is agro-based and its GDP growth is driven by agriculture. It is also a fact that large scale manufacturing sector's performance is dependent on the two agro-based industries, i.e. textile and sugar. In order to achieve sustained and higher GDP growth rate, production of food as well as cash crops have to be boosted. However, the key issue is that cultivable land in the country is deficient in nutrient contents. This deficiency can only be overcome through balanced use of fertilizer.

The Fertilizer Policy announced in 1989 has helped in mobilizing significant investment of over US$ 1.2 billion, mostly in urea production. Since a number of incentives provided in the Policy were to expire in/around year 2003, there was a need for the new Policy. The GoP announced the revised policy in the middle of last year. It continued duty exemption on plant and machinery but supply of gas (feedstock), at lower rate as compared to gas used as fuel, was withdrawn.

The fertilizer industry was anxiously waiting for the new policy to initiate BMR and expansion of urea production capacity. However, due to refusal of the GoP to continue supply of feedstock at the prevailing price, addition of grass-root plants will not be possible. At the best, there will be some increase in capacity through de-bottlenecking of the existing plants. As a result, it is feared that Pakistan will once again become a net importer of urea. The country is entirely dependent on imported DAP fertilizer.

The immediate fallout will be: 1) spending of millions of dollars on the import of urea and 2) exposing the local farmers to volatility of urea price in the international market. It must be remembered that prices of locally produced urea has always been lower as compared to its international prices, except for a couple of years. It is also feared that with the hike in urea prices, its consumption may go down and adversely affect the already low yield of various crops. The reduction in the production of wheat, sugarcane and cotton may necessitate their import and export of rice and textiles and clothing may also go down.

The key issue to be understood is, why the GoP is not willing to continue supply of feedstock at lower price? According to some experts the decision of the GoP was due to internal as well as external pressures. Therefore, it is necessary to first of all discuss the external pressure. It is believed that the lenders are pressurizing the GoP to discontinue all types of subsidies being offered presently. The main objection is that under the new economic world order all the countries must follow market based policies and should not offer any subsidy to local manufacturers. Another objection on continuation of subsidy, in the past, was the huge budget deficit faced by the GoP.

However, it is a paradox because most of the developed countries provide huge subsidies to their agriculture sector or farmers. If providing subsidy is legitimate for them, why are the restriction on developing countries? Providing subsidy to agriculture sector is all the more necessary for developing countries to achieve self sufficiency in food. Continuation of subsidy on agriculture is very important for Pakistan for two reasons: 1) its economy is largely dependent on agriculture and 2) import of food items is a huge burden in its limited foreign exchange reserves.

To further dilate this point it is necessary to look at the use of fertilizer for various crops. Wheat is the most important food crop and 45 per cent of the total fertilizer is for this crop. It is followed by Cotton (21%), rice (10%), sugarcane (8%) and balance by other crops. Any decline in the usage will adversely affect the yield of these important crops, which is simply not acceptable.

The resistance within Pakistan against the subsidy on feedstock was based on the assumptions that the benefit was not being passed on to farmers and sponsors of urea plants are making huge profit. It was also argued that local manufacturers were selling urea above its international prices. However, the critics ignored some basic facts. These are: 1) during the last decade a huge investment of over US$ 1.2 billion was made by the industry, 2) for a number of years the local manufacturers had supplied urea below its international prices and 3) the ROE of fertilizer units is even lower than the earnings of many other industries.

Some sector experts say, "It is completely incorrect to say that feedstock is supplied at a subsidized price. The only reference point is price of gas used as fuel. As a principal one should compare an apple with an apple only. Comparing feedstock price with fuel gas price is incorrect because the two products are not identical. The gas extracted from Mari field is far inferior in quality and cannot be termed 'pipeline' quality gas. The inferior quality gas cannot be sold at a price being charged for the superior quality gas. Therefore, the question of subsidy does not arise. It is simply sale of inferior quality gas at a discounted price."

The next question to be addressed is, can the gas from Mari field be used for any other purpose, particularly as fuel? Analysts say, "It was evident, as back as in mid sixties when the field was discovered that this gas could not be used as fuel due to higher content of carbon dioxide and low heating value. Therefore, Exxon which discovered this field, decided to use it for the production of urea only. Later on two other urea units, i.e. Pak Saudi Fertilizer and Fauji Fertilizer were established in close proximity to make the best use of available gas reserves. Since it was established long ago that the gas from Mari field was suitable for urea production only, initiating the debate about its alternate uses was simply waste of time and energies."

"After reaching the conclusion that the gas from Mari field is inferior and cannot be used as fuel gas, the next point to discuss is its price. It is clear that since this gas does not fall under pipeline quality, its price has to be lower as compared to pipeline quality gas. Therefore, sale of this gas at discounted price does not mean providing a subsidy. It is simply selling the inferior quality gas at discounted price," is the unanimous decision of sector experts.

The point for discussion is, what should be the price of feedstock for those plants which are supplied gas from the networks of Sui twins. Dawood Hercules, FFC-Jordan and Engro's NPK plant are supplied feedstock from the networks of Sui Northern Pipeline Company Limited (SNGPL) and Sui Southern Gas Company Limited (SSGC). Theoretically, it is misuse of pipeline quality gas to use it as feedstock and the logical decision should be to discontinue supply of feedstock to these plants from SNGPL and SSGC networks.

This cannot be done without making alternate arrangements. Ideally these plants should be supplied feedstock from any nearby gasfield producing low heating value gas. However, this means laying down separate pipeline which is an expensive proposal. The other alternate is to continue supply of feedstock as per prevailing arrangement but at a discounted price, which is also logical. The difference between the two prices should be borne by the GoP.

Therefore, the GoP must announce the revised price of feedstock for the existing as well as future plants immediately. The GoP must also convince the lenders that no subsidy is being offered on feedstock, it is simply sale of inferior quality gas at a discounted price. The lenders must also accept this and should also stop putting pressure on the GoP to charge price of feedstock equivalent to the price for gas used as fuel.

INDUSTRY PROFILE

Currently local manufacturing companies meet about 80 per cent of Pakistan's fertilizer requirement. The total installed capacity is over 5.124 million tonnes/annum. It mainly comprise of 4.180 million tonnes for urea and remaining for NP, CAN and SSP. It does not include DAP facility of FFC-Jordan which has been closed down recently. The total urea market is shared among Fauji Fertilizer (48%), NFML (22%), Engro Chemical (20%) and Dawood Hercules (10%).

Currently urea production capacity is around 4 million tonnes/annum and there seems to be a temporary over-supply in the country. It is mainly due to two factors: 1) most of the plants are working above designed capacity and 2) lower offtake of urea. Traditionally, urea demand has been growing above 5 per cent per annum. Keeping in view the lower offtake registered in last couple of years, even if a growth rate of 4 per cent is assumed the estimated demand would exceed 4.7 million tonnes in year 2005 and 5.7 million tonnes by the year 2010. Therefore, if the additional capacity is not created in due course by establishing grass-root projects, Pakistan will be forced to spend millions of dollars annually on the import of urea to meet its demand.

Therefore, the work for expanding the capacity must begin without any delay to maintain self sufficiency in urea production. Pakistan will have to add at least three new grass-root plants over the ten years. A typical world-scale grass-root new 1000 MTPD Ammonia and 1800 MTPD urea complex needs an investment of around US$ 450 million. Since the fertilizer industry is extremely capital intensive the investors are demanding a comprehensive and clear cut policy for the next ten years, particularly feedstock pricing.

A question may arise, why should Pakistan invest so heavily in urea manufacturing? The investment in urea plants is necessary because of two reasons: 1) to meet the high deficiency of nitrogenous content in the land and 2) to finance the import bill of DAP. Fauji Fertilizer made a very bad investment for producing DAP locally. The plant had to be closed ultimately due to very high cost of production, the reason being that basic raw material for DAP production is not available locally. Therefore, the better option is to produce surplus urea and export it to finance import of DAP. Pakistan has the potential to export urea to Afghanistan and some other neighbouring countries.

In the recent past Pakistan experienced dumping of urea from the Middle East. Therefore, the future feedstock price for local urea plants should be comparable with gas price in the Middle East. The gas price US$/MBTU in Saudi Arabia are the lowest (US$ 0.75). In Qatar at present it ranges from US$ 0.5 to US$ 0.6 and new contracts being signed at US$ 0.8. Qatar has signed an agreement to supply gas to Indian fertilizer industry at US$ 0.77. Compared to this fertilizer plants are supplied gas from Rs 1.30 to Rs 1.80 per MBTU.

It is often alleged that fertilizer industry is not passing the benefit of lower feedstock price to farmers, is it a fact or fiction? To find the details let us refer to Engro's performance. During 1991-2001 period the company has earned Rs 9,440 million profit out of which Rs 5,399 million was distributed among the shareholders. Besides, the company undertook capital expenditure of Rs 9,304 million and also made long-term investment worth Rs 1,346 million. Alongwith this, a total of Rs 13,166 million was contributed to national exchequer in the form of duties, taxes and development surcharge. Is this not a credible evidence of sharing the benefit with all the stakeholders?

To get the overall picture one must also look at the investment and contribution of the industry. An investment of over US$ 1.2 billion was made in response to the GoP's Fertilizer Policy of 1989. For the year 2001 the subsidy on feedstock amounted to Rs 12,409 million. The net benefit accrued to the industry was only Rs 2,783 million and Rs 7,720 million was passed on to farmers in the form of differential between domestic urea price and imported urea cost.

A question is often raised, why should fertilizer industry be the sole beneficiary of supply of gas at lower price? As stated above the supply of gas at a lower price, compared to fuel gas, was aimed at achieving self sufficiency in fertilizer and boosting agriculture out put. The cost of gas is the largest component of total cost of production of urea. Therefore, it should be the top priority of the GoP to ensure availability of feedstock at the best possible price.

It may also be said that electricity is essential for the manufacturing sector and power plants should get gas at lower price. The demand is legitimate but based on an incorrect premise. The high electricity tariff for industry is due to two factors: 1) supply of electricity to domestic consumers at subsidized rates and 2) exceptionally high T&D losses, mostly comprising of theft. Even if the power plants are allowed to use gas as fuel, there would be hardly any benefit to industrial consumers. On top of everything, power plant use gas as fuel and fertilizer plant use gas as basic raw material. Since the purpose is different, pricing policy has to be distinct also.

OUTLOOK

There cannot be two opinions regarding establishment of additional urea production capacity. This can only be achieved by ensuring future feedstock supply at a rate which is comparable with gas price in the Middle East and not making it equal to fuel gas price. This is not demanding too much but asking for a level playing field only.

After reaching the conclusion that feedstock is not being sold at subsidized price, the lenders must also stop putting pressure on the GoP to withdraw subsidy on feedstock. As regards feedstock price for fertilizer units linked with SNGPL and SSGC, the GoP must come up with a mechanism to supply feedstock to these plants at a price being charged from plants getting the supply from Mari field.

It is also suggested that Mari gasfield should be solely dedicated to fertilizer industry. Three of the major urea plants are getting feedstock supply from this field. All the units have the resources to add further capacity and the gasfield also has the potential to meet additional demand for gas.

A lot of time has been wasted on unnecessary debate. The GoP must make necessary amendments in the Fertilizer Policy which can pave way for the investment in fertilizer industry. The expansion in capacity is a must for achieving self sufficiency in food and accelerating GDP growth rate.

IMPORTED VS DOMESTIC UREA PRICE
(US$/Tonne)

Year

Imported

Local

1990

175

144

1991

192

160

1992

173

160

1993

164

152

1994

170

149

1995

250

157

1996

233

172

1997

163

171

1998

140

157

1999

110

131

2000

170

128

2001

175

128

 


 

CONTRIBUTION TO EXCHEQU
(Rupees in million)
(upto year 2000)

Company

Income
Tax

Surcharges
plus Duties

Workers
Fund

Duty
plus taxes

Total

FFC

12,676

11,070

2,045

1,349

27,140

NFC

12,123

1,121

1,309

6,073

20,626

Engro

2,551

7,635

718

1,665

12,569

DHCL

3,130

2,424

468

620

6,642

FJFC

42

368

-

106

516

Grand Total

30,522

22,618

4,540

9,813

67,493

 


 

PROFITABILITY
(Year 2001 results)

Company

EPS
(Rs)

DPS
(Rs)

Dividend
yield (%)

ROE
(%)

Lever

92.01

96.50

10

75

Pak Oilfield

28.90

23.00

17

56

Al-Ghazi

15.38

7.50

12

44

PSO

15.75

10.00

6

24

Shell

30.11

12.50

6

21

Engro

7.65

7.50

12

20