Increase in feedstock price

Profitability of urea manufacturers expected to come under pressure as any increase in sale price of urea may not be possible

By SHABBIR H. KAZMI
August 02 - 08, 1999

After enjoying an extended run of stable feedstock (gas for urea manufacturing) prices, it was inevitable that prices would rise at some point in time. The government has increased the price of old feedstock but there has been no increase in new feedstock. It is appropriate to assess the likely impact of this increase on the earnings of fertilizer sector.

Generally it is said that the price hike was fair and timed well by the government, the manufacturers term this a bad move at a wrong time as the industry faces over supply and dumping of urea in Pakistan. While the local manufacturers have the capacity to meet the demand, precious foreign exchange has being wasted. Till recently the cost of imported urea was higher and the decline in its global prices is a temporary phenomena.

The first group says that the last increase was in January 1997 and the recent increase cannot be termed as a steep rise considering the discount still available on feedstock rates. However, industry refutes this as it strongly believes that urea manufacturers do not get the feedstock at a subsidized rate when compared with the gas rate in countries dumping their products in Pakistan. In those countries urea manufacturers get gas at 50 to 70 per cent lesser cost.

It is being said that the local urea manufacturers should not be allowed to pass on the price increase to the farmers. It may be true that urea is an important input and if inputs for the agriculture sector have to be kept low, urea manufacturers should not be allowed to increase prices. If the government wishes to ensure availability of these inputs at affordable and stable prices the increase in gas price is not justified. Since 1997 price of urea has not increased in the same proportion as the support prices of various crops have been increased. Industry strongly believes that the government should have followed a policy of gradual increase in feedstock price rather than a sudden and substantial increase.

In the prevailing circumstances it is very unlikely that any urea manufacturer will be able to increase price significantly in the near term. Not only that urea is being dumped in the countries but the local production is also more than the demand. In fact, even if urea producers do decide to pass on the entire impact, it will range from Rs 15 to Rs 30 per bag of 50 kg but no manufacturer would like to forego its market share.

According to a sector analyst, it is believed that the current cost increase cannot be immediately passed on to consumers, unless some protection is provided to the local manufacturers who are already concerned about the excess supply and availability of low cost imported urea.

Imported urea is available at 15 to 20 per cent discount as compared to the price of locally produced one.

However, the immediate protection can be made available to the local manufacturers with the promulgation of Anti-Dumping Law and imposing 15 to 20 per cent regulatory duty on imported urea. It is still a long way to go. Urea manufacturers are expected to meet the relevant quarters regarding imposition of regulatory duty in the first week of August. However, one cannot say with certainty that their point of view will be accepted.

According to sector experts, the year 1999 after tax profit forecast for Fauji and Engro are likely to fall to Rs 2,922 million and Rs 1,063 million respectively. However, the effect of increased feedstock price will take a toll on the year 2000 earnings. In line with the eventual elimination of subsidy on feedstock by the year 2003, gas prices to fertilizer manufacturing companies will again be increased next year. Many analysts estimate this increase to be around 30 per cent in the uncovered commitment of feedstock for the year 2000. Hence profit after tax for Fauji and Engro for the year 2000 are estimated around Rs 3,155 million and Rs 1,225 million respectively, the increase will be of a much higher magnitude in the following years.

According to some sector experts, it is clear that the fertilizer manufacturers will continue to see an erosion of earnings as the subsidy on feedstock is gradually removed by year 2003. In the short term (12-18 months), the ability of these companies to limit decline in profitability will hinge primarily on import prices of urea and wheat support price.

It is often said that fertilizer manufacturers in Pakistan have been making substantial profit. Is there any thing wrong? If fertilizer manufacturers have earned profit there has also been an investment of over US$ 2 billion in this sector. Pakistan has become self sufficient in urea production after remaining an importer and spending millions of dollars annually on the import of the commodity. The process of expansion of capacity in the sector should continue. The government must keep the long-term perspective in mind rather than trying to achieve political mileage.