Demand and supply equation
By SHABBIR H. KAZMI
Apr 05 - 11, 2004
Pakistan has attained temporary surplus in urea production but continues to meet DAP demand through import, to a large extent. However, urea demand is expected to surpass supply this year. The situation seems real alarming because current international prices of urea are hovering around US$ 160/tonne. Import of urea will further increase the deficit of balance of trade. The policy planners have realized the gravity of situation but it is too late to mend.
Lately, the GoP has constituted a 12-member committee to submit a plan for attracting fresh investment and suggest the remedies to resolve the problems facing the fertilizer sector. The formation of this committee can only be termed a futile effort. The GoP must accept the fact that the Fertilizer Policy 2001 has failed to attract investment in grass root plants and further deliberation cannot yield any result without addressing the key issue. The fresh investment in the sector is directly linked with the cost of gas (feedstock) but the GoP does not seem to be ready to guarantee its price for next ten years, as demanded by the sector.
At the time of announcement of the Policy in 2001, international prices of urea were around US$ 80/tonne. In last six months urea prices have gone up to as high as US$ 160/tonne. The hike in prices is attributed to closure of a number of plants, particularly in North America. Though, the locally produced urea is 40% cheaper than imported, some quarters in Pakistan are still demanding further reduction in its prices. They believe that local producers are minting money. However, they tend to forget that for a considerably long period local manufacturers have been selling expensive imported urea at the prices much below its landed cost. Urea prices should have been adjusted upwards with every increase in feedstock cost but the critics of fertilizer industry have been demanding further reduction in its retail price.
While the Policy was being prepared there was extensive and intensive consultation between the policy planner and existing producers of urea. Most of the discussion was regarding future price of feedstock. The policy planners were bent upon increasing feedstock price as they believed that GoP was supplying gas at subsidized rate to fertilizer industry. The producers even went one step further by suggesting to the government that feedstock price in Pakistan should be linked with the gas price in the Middle East for the existing plants. However, they made it clear to the GoP that feedstock price has to be guaranteed for new plants.
At that juncture it was also made very clear that at least three new plants, with an aggregate capacity of about 2 million tonnes/per annum, have to be established in the country up to year 2010. Since it involved huge investment, the industry insisted on guarantees regarding feedstock price. It was also made clear that to achieve sustained growth of GDP specific attention has to be given to agriculture sector. This sustained growth can only be achieved by keeping the prices of different types of fertilizers at affordable level. This argument was based on the fact that cultivable land in the country is highly deficient in nutrients, which in turn keeps yield low. Since increasing cultivable land is not possible in the short run, production of a various crops can only be improved by overcoming soil nutrients deficiency.
However, policy planners bowed down before the pressure of international financial institutions (IFIs), which were insisting on withdrawal of subsidy on feedstock. It was surprising that the GoP failed in convincing the IFIs that the feedstock was not being supplied at subsidized rate in the country. The key argument, which the GoP should have followed is, 'the feedstock has low calorific value as compared to pipeline quality gas'. Therefore, selling low calorific value gas at lower price is not a subsidy. It is sale of low quality gas at discounted price.
According to industry sources, later on the IFIs agreed to this rationalization and stopped pressing on implementation of price escalation formula and time frame and left it at the sole discretion of the GoP. It is also understood that the GoP once again called the local producers for consultation. Some of the players suggested that an increase of around 5% per annum in feedstock price for the existing plants could be absorbed as normal inflation. However, they reiterated that providing guarantee on feedstock for new plants was a must.
Around the same time market realities also changed. Engro Chemical Pakistan came up with its new investment strategy. It started working on diversification policy and also exploring option for setting up a urea plant in the Middle East. Fauji Fertilizer acquired Pak Saudi Fertilizer and preferred to concentrate on improving efficiency of newly acquired plant. It was also bogged down with FFC-Jordan, temporary closure of DAP plant. And the third key player, Dawood Hercules, did not seem interested in adding new capacity. It was eyeing getting control of Engro.
The situation seems to be entirely changed in year 2004. It is understood that Engro has abandoned the idea of setting up urea plant in the Middle East and it is once again evaluating the option of enhancing capacity of its Dharki plant. Fauji has also overcome problems pertaining to Pak Saudi unit as well as its Bin Qasim Plant. However, the sector analysts strongly believe that both the giants have missed the boat. According to these analysts, the only new plant which may become a reality is being set up by a group which has no prior experience of operating a fertilizer plant.
The constitution of Committee at this juncture raises the question, is this the preamble for incorporating drastic changes in Fertilizer Policy 2001? According to an analyst, "The policy planners wanted the existing manufacturers to decide against investing in fertilizer plants. In the mean time they were preparing this group to complete the home work. They wanted to wait till the crisis starts appearing. Once crisis starts appearing than the entry of this group can be termed a remarkable achievement of policy planners. It is also believed that this group will be given far more incentives than those being demanded by the existing players".
The other point of view is, "While the GoP must accept the responsibility of failure of the Policy, the existing players are also to be blamed. If they were engrossed with their own problems why should they accuse the government for not responding to their demands? They knew that the surplus was a short lived phenomenon. If a group having no past experience of operating a fertilizer plant was willing to invest in locating second-hand plants, why were they not ready? They have lost the opportunity only because of their own lack of interest".
However, another analysts said, "Realistically speaking Engro and Fauji have not missed the opportunity. Pakistan needs three new plants. Even if a new entrant sets up a plant, both Engro and Fauji can still establish one unit each. Engro and Fauji enjoy proximity to Mari gasfield and the GoP has dedicated this gasfield for fertilizer plants. Keeping in view the financial strength and expertise of these companies, if required guarantees are provided by the GoP, Pakistan can once again attain self-sufficiency in urea.
In early 2003, the National Fertilizer Corporation (NFC), a public sector entity, stated its intends to set up one plant each of urea and Single Super Phosphate at a cost of US$ 500 million. The combined capacity of these two plants was indicated at 861,000 tonnes/annum. If this becomes a reality, NFC will emerge as the second largest producer of urea in the country. However, many analysts strongly feel that through such an announcement the GoP only wanted to magnify its bargaining strength to the private sector players.
Some of the sector analysts rejected the very concept of establishment of such a mega facility in the public sector. The announcement was termed 'departure from the basic policy of the GoP'. Since the GoP has declared to follow deregulation, liberalization and privatization policy, allowing NFC to incur capital expenditure of half a billion dollars does not seem prudent. According to a large number of analysts, "The GoP should not try once again to manage the business. It should only facilitate the private sector in managing the business effectively and efficiently".
FERTILIZER VS POWER SECTOR
Lately, the GoP has decided to switch over thermal power plants from use of furnace oil to gas. This policy shift is said to be aimed at achieving reduction in electricity tariff by curtailing cost of electricity generation. The policy has received a lot of appreciation. However, some of the analysts have an entirely opposite point of view. They say, "The real cause of higher electricity tariff in Pakistan is not the cost of generation but the transmission and distribution (T&D) losses. The T&D losses of both WAPDA and KESC are around 40%. Unless these entities bring down their T&D losses, switching over from furnace oil to gas is a futile and fruitless effort. Use of gas as fuel for power plants can only be termed 'burning the dollars'. Therefore, the GoP should not follow this policy. Instead, efforts should be made to take maximum advantage of the available gas by using it, as basic raw material, for producing urea".
These analysts also say, "To ensure supply of gas to thermal power plants, scattered through out the country, it will be necessary to pump in additional gas into the existing gas supply infrastructure. This is not possible without incurring huge capital expenditure for expanding and revamping the existing transmission and distribution networks of Sui Southern Gas Company and Sui Northern Gas Pipeline. Ideally Pakistan should base its entire thermal power generation on coal, as the best fuel. Since conversion of thermal plants from furnace oil to coal is a long drawn process also requiring additional capital expenditure, the second best alternative is to continue the furnace oil use".
At present the supply of furnace oil in Pakistan is far higher than the domestic consumption. At present thermal power plants are the largest consumers of furnace oil. The other major consumer of furnace oil, cement sector, has almost switched over to coal. The storage tanks of local refineries are overflowing with furnace oil. If power plants also switch over to gas there will be hardly any buyer for furnace oil in the country. Pakistan cannot compete in the global market of furnace oil. Therefore, the best option is to keep on burning it as fuel at the thermal power plants till the country finds a better use.
According to an oil sector analyst, "Ideally Pakistan should now make concerted efforts for setting up a hydrocracker plant. Establishment of this plant in the country will yield two benefits: consumption of a product that cannot be exported and production of those higher value-added POL products which are currently being imported. This project could not be established in Pakistan in the past because mobilizing funds for such a mega project was not possible. Keeping in view Pakistan's improved financial stature and willingness of foreign investors to invest large sums in the country, concerted efforts can make this dream come true".
DEMAND VS SUPPLY
At present there are five producers of urea in Pakistan namely Fauji Fertilizer Company, Engro Chemical Pakistan, Fauji Fertilizer Bin Qasim, Dawood Hercules and National Fertilizer Corporation (NFC). Out of the total installed capacity of around 4.2 million tonnes/per annum Fauji controls nearly 2.5 million tonnes. The second largest producer is Engro with 850,000 tonnes capacity and the balance is shared almost equally by Dawood and NFC. Fauji's Bin Qasim plant also produces DAP and Engro's Bin Qasim plant produces NPK type fertilizer.
UREA PRODUCTION CAPACITY(Thousand tonnes per annum)
A review of demand and supply from 1999 to 2003, shows that during two years, out of five, Pakistan had to import small quantity of urea. Otherwise indigenous production was not only sufficient to meet the local demand but small quantities of urea were also exported. A major achievement in 2003 was the restart of DAP plant of Fauji Bin Qasim after a gap of exactly two years. This plant is capable of meeting approximately 35% of DAP demand of the country. Yet another achievement was the demonstrated ability of Engro's NPK plant to produce up to 140,000/annum as against its designed capacity of 100,000 tonnes/annum. However, production at this plant was contained at 72,000 tonnes to liquidate carryover stock. The company achieved a record sale of 84,000 tonnes of NPK during the year, a growth of 34% as compared to year 2002.
Overall, urea demand in the country remained robust during 2003 and grew by 3% to 4.5 million tonnes. Better crop prices, improved availability of water and higher disbursement of credit by commercial banks to agriculture sector resulted in strong product demand. All the urea manufacturing plants operated above designed capacity. The indigenous production of urea during the year increased by 6% to 4.5 million tonnes and matched the demand volume.
The domestic prices of urea remained stable for most of the year and the industry absorbed the gas price increase as desired by the government. The price of locally produced urea remained 25 to 40 per cent lower than the landed cost of imported urea. As against this, the DAP market remained sluggish during most of 2003 due to the high cost of imported product because C&F price of DAP soared in the international market from US$ 190 to US$ 270 per tonne. Sales stood at 1.2 million tonnes, which was at the level of 2002.
According to fertilizer sector analysts, "Higher prices of DAP forced the farmers to use its inadequate quantity and they applied extra urea in the hope of meeting soil nutrients deficiency. This was improper as the land requires input of proper combination of various nutrients. The imbalance use of fertilizer affects the yield negatively". Though, fertilizer manufacturers regularly undertake farmer education programmes, financial constraints often force the farmers to deviate from the basic teachings.
Having the faith that the GoP is serious in accelerating the GDP growth rate by following transparent and pro business policies, it is still necessary to reiterate that policy planners must abstain from coming up with policies aimed at achieving short-term objectives. Agriculture and agro-based industries are the driving engine of Pakistan's economy. Therefore, focused attention should be given to these two sectors. Ensuring adequate availability of all types of fertilizers at affordable cost has the potential to accelerate the GDP growth rate.
Dedicating Mari gasfield for fertilizer industry is not enough. The GoP must create conducive environment whereby new fertilizer plants can be established in the country to utilize gas from this field. This can be made possible by guaranteeing the feedstock price for next ten years. This guarantee can only be given once the policy planners accept the fact that gas is not being supplied to fertilizer industry at a subsidized rate. It is sale of low quality gas at a discounted price.
The GoP should follow the strategy of producing surplus urea in the country to earn extra foreign exchange for financing the import bill of DAP and other types of fertilizers. The local production of DAP can hardly meet 35% of total requirement of the country.
Last but not the least, please do not burn dollars by running thermal power plants on gas. The country produces surplus furnace oil which cannot be exported. Therefore, the GoP must ensure establishment of hydrocraker plant at the earliest for producing higher value-added POL products. The country has already achieved self-sufficiency in furnace oil now it is time to strive for achieving self-sufficiency in POL products.