THE FERTILIZER INDUSTRY
The delay in the fertilizer policy the increase in gas prices and the duty on plants and machinery are the main issues
By SHABBIR H. KAZMI
Apr 02 - 08, 2001
The delay in announcing Fertilizer Policy is not allowing fertilizer manufacturers to undertake capacity expansion to keep the country self-sufficient in urea production. However, industry experts fail to understand reasons which are keeping various ministries entangled in any debate. It is simply a two-point agenda: gas (feedstock) price and duty on plant and machinery. The increase in feedstock price and imposition of duty on plant and machinery can only bleak the potential for future investment in fertilizer industry.
It is often said and believed that fertilizer manufacturers in Pakistan get feedstock at subsidized rate. It may look so when one compares feedstock price with furnace oil price. But the belief is totally incorrect when one looks at feedstock price prevailing in the Middle East and the fact that feedstock is an important raw material. Whereas furnace oil is a fuel.
In the recent past, Pakistan has witnessed large scale dumping of urea from the Middle East. The only reason for lower cost of urea in the Middle East is around one third price of feedstock in the region as compared to the price being charged in Pakistan — despite the claim that local urea manufacturers get feedstock at a subsidized rate.
According to sector experts the feedstock price in the Middle East range from US$ 0.5 to US$ 0.75 per MBTU, whereas fertilizer plants in Pakistan pay US$ 1.4 to US$ 1.7 per MBTU. While there was dumping from the Middle East, the GoP imposed regulatory duty on imported urea to protect the indigenous manufacturers. Imposition of regulatory duty can be termed a temporary remedy only. The permanent solution is to make the industry strong enough to compete in the global market without the crutches of regulatory duty. Therefore, the price of feedstock in Pakistan should be comparable with its price in the Middle East.
The other fact that feedstock constitute nearly 70 per cent of total cost of urea should not be ignored by the opponents of low cost gas supply to fertilizer plants. The reasons being that urea is an important agriculture input and the largest percentage of total population is involved in the sector. While any hike in the prices of agricultural inputs can influence less than 5 to 10 per cent of total population in developed countries, the similar surges in Pakistan not only affects over 65 per cent of total population of the country, it also affects earnings of textile and sugar industries — the engine of GDP growth. Therefore, the logical conclusion is continued supply of feedstock at competitive price to urea manufacturers.
The argument put forward for the removal of subsidy is that the World Trade Organization and multilateral lenders do not approve this. This statement is not only incorrect but in conflict with national interest. Pakistan should not bowdown before this pressure. This is not a political statement. It is a fact that no country can deny the fact that it offers subsidy to agriculture sector. The only debate could be on the mechanism of disbursement of subsidy. Even if one accepts that fertilizer plants in Pakistan get feedstock at subsidized rate, it is the most transparent system. Therefore, why to look for any other system which may not be so transparent?
According to the sector experts, the slogan for withdrawal of subsidy has been raised only because urea manufacturers make profit. Had they were making losses the resistance would have not been there. Therefore, it is necessary to understand the quantum of investment made in the industry and the profit being made by the local players. In the recent years a fresh investment of over US$ 1.5 billion was made and the profit posted by these companies during the year 2000 was around US$ 100 million. Another fact is that manufacturers have not been distributing total profit to their shareholders but ploughing back substantial percentage. Can this be termed profiteering?
Another argument put forward in the opposition of subsidy is that the price of urea is higher in Pakistan as compared to its international prices. The basis of comparison is FOB prices. Generally such comparison is based on recent prices which is not correct. If one compares the prices over the last decade, it is clear that urea prices in Pakistan were lower as compared to its international prices. Besides, when the GoP decided to deregulate urea trade, it also asked the manufacturers to bear higher cost if cost of imported urea was higher. It is evident that local manufacturers have sold expensive imported urea at lower price in the past. Therefore, why a noise if they make higher profit when international price of urea is low?
An important factor which these ardent opponents of subsidy forget is that the basis of price comparison should be the cost of urea delivered at farms and not the FOB prices. It should also be kept in mind that now manufacturers are required to import, in case of any shortfall in supply, according to their market share. Therefore, the best efforts of these companies is to minimize the landed cost of imported urea. The price issue was an outcome of entry of commercial importers in the fertilizer trade.
It is understood that CBR is resisting continuity of duty free import of plant and machinery for fertilizer industry. Its only objective is to raise revenue collection and probably it is not willing to understand the logic being put forward by the industries in general. The prudent approach is to collect taxes from industrial units which are in operation and not the front loading. Imposition of import duty is outright front loading. Besides, there is no logic in taxing an industrial unit which has not commenced operations. As such the manufacturing companies enjoying bulk of the market share pay corporate and other taxes in millions of rupees. Is it not enough for the CBR?
Bulk of the market share is being controlled by companies who get supply of feedstock from a dedicated gas field — Mari. The companies drawing gas from this field are Fauji, Engro and Saudi Pak. Therefore, any additional allocation of gas, if these companies undertake expansion, could be ensured with least expenditure on infrastructure for gas supply. As such the cost of pipeline from gas field to fertilizer units was born by fertilizer companies and they would do the so without any hesitation if they are allocated additional quota. Engro is located within a radius of 6 miles and Saudi Pak are located at a distance of 10 miles and 30 miles respectively. This is as good as being located at the gas field. As opposed to this, FFC-Jordan and Dawood are linked with a grid supplying gas to millions of consumers.
Most important factor also ignored by the opponents of subsidy on feedstock is that the GoP had dedicated Mari field for fertilizer plants. The reason being that the specification of this gas is most suitable for use in urea manufacturing plant. Besides, this gas has low BTU value and it is not suitable for use for power plants. Therefore, the best option is to increase the output of this field to achieve higher production of urea.
Another argument in support of enhancing output of Mari field is that the field is owned by the GoP and Mari Gas Company Limited has been given operating rights only. According to sector experts, gas purchased from any other operator of gas field is atleast 20 times more expensive than the gas drawn from Mari field.
Supplying low cost but having required specification, to fertilizer plants is need of the day. Since bringing more area under cultivation is difficult, at least for the time being, a prudent option is increasing yield by using balanced nutrient contents. The land under cultivation are mostly deficient in nitrogenous content which is met by urea. As much urea use in the country is below the required dosage. This consumption has to be increased and the most appropriate option is increasing its indigenous supply.
The country also needs to enhance local production of urea to create exportable surplus. Pakistan has to earn extra dollars to finance import of DAP type fertilizer. The current DAP production is not capable of meeting the demand. On top of this DAP production in Pakistan is not economically viable as one of the basic ingredient, quality phosphate rock, is not available. The industry experts also say that surges in price of urea are more intense as compared to DAP. Therefore, the top priority for the country is to remain self sufficient in urea production and continue import of DAP fertilizer.
An analysis of current demand and supply situation of urea indicates a marginal over supply. This has been there only because offtake has been low due to shortage of water. Had there been normal supply of water Pakistan would have been forced to import urea. Therefore, Pakistan has to add capacity according to a time frame. The country has to add 2.5 million tonnes production capacity during the next ten years. According to sector experts fresh investment decision are dependent on two important components of new fertilizer policy — price of feedstock for next ten years and rate of duty on plant and machinery.
In other words, fresh investment is linked with return on equity (ROE). To arrive at a desired ROE the above mentioned two factors are very important. At present ROE plays a key role in selecting a particular project or industry for future investment. Some sector experts say that the ROE has to be based on dollars and not on Pak rupee. This formula has been accepted in case of independent power plants. In gas distribution and oil refining sectors minimum rate of return on operating is allowed. Therefore, a mutually acceptable formula has to be drawn at the earliest to ensure self-sufficiency in urea.
According to sector experts urea production capacity in the country can be increased through debottlenecking of the existing units and establishing three grass-root plants of 600,000 tonnes/per annum each. Both Engro and Fauji can increase their capacity through debottlenecking and BMR. They are capable of adding 200,000 tonnes per annum capacity by the year 2003. However, they have been forced to defer their plans due to lack of clear cut policy.
However, for the establishment of three units of 600,000 tonnes per annum each no decision can be made by any investor in the absence of guarantee on feedstock price and duty on plant and machinery. It must be kept in mind that urea plants are capital intensive and even lenders insist on a certain levels of cashflow and ROE.
The policy planners must also realize that delay in announcing fertilizer policy has become the major reason for the delay in privatization of Saudi Pak Fertilizer. It must also be kept in mind that another plant, preferably of 600,000 tonnes per annum, can be established at this site with the least investment. A substantial part of project cost consist of infrastructure cost. The existing plant is located within a radius of less than 15 miles from Mari gas field. This decision can only be made once the two key issues are resolved.
It is understood that Engro, Fauji, Dawood and a consortium with foreign investors have been prequalified for the bidding of Saudi Pak Fertilizer. All the three local companies would be more than keen to takeover Saudi Pak due to proximity of its location to Mari field and potential for expansion at least cost.
As it is evident that payment of subsidy is fairly common, no efforts should be made to sell feedstock to local urea plants at inflated price. As such the industry is not demanding any subsidy, its requirement is availability of gas at Middle East price. This is a very legitimate demand which should be accepted by the government without any delay.
Availability of gas at a lower price alone cannot ensure profitability of a fertilizer company and FFC-Jordan is one such example. FFC-Jordan has not been able to overcome its operational problems and the advantage of low cost feedstock is being wasted. The key factors determining the profitability of a fertilizer plant are efficient operation and cost optimization.
Since fresh investment in the industry is dependent on feedstock price and duty structure on plant and machinery, the announcement must come at the earliest. With each passing day the country is inching towards import of urea — a threat to limited forex reserves of the country.
The GoP is trying to boost GDP growth rate and depending a lot on textile industry — the major foreign exchange earner for the country. Alongwith this sugar industry suffers due to poor capacity utilization. If production of cotton and sugarcane is increased, by achieving higher yield, performance of two key industries will improve substantially.
The GoP should also encourage relocation of fertilizer plants. If Engro can do this once, they should be asked to emulate themselves once again and others should be encouraged to follow the footsteps of Engro. Buying a new plant is an expensive proposal.
On top of this, the economic managers of Pakistan should not bowdown before the pressure of multilateral lenders. They should convince the lenders about their own programme which include higher GDP growth by boosting agricultural output. As such, the GoP does not give any subsidy on feedstock. The price being charged is still three times higher than the price at which gas is sold to fertilizer plants located in the Middle East.
Pakistan has to add facilities capable of producing additional 2.5 million tonne urea per annum. As the industry is capital intensive, investment decision are dependent on ROE. Investors look forward for an ROE not in rupee terms but in dollar terms.
Dawood and FFC-Jordan draw gas from the grid mainly used for supply of gas to domestic, commercial and industrial users. This is pipeline quality gas. Analysts suggest that no other plant should be allowed to draw gas from this grid and all future sanctions should be from Mari field. The gas from Mari field is not only better suited for urea plants but far cheaper than the gas bought from other gas field operators.
Supply of gas to fertilizer plants at competitive price is more important than using it at power plants because wheat and rice provide basic food. Textile and sugar industries provide not only direct employment to millions of people, but textile industry is the major foreign exchange earner for the country.