May 21 - 27, 20

To begin with, the government is not meeting its contractual obligations towards fertilizer industry, which is a victim of wrong priorities. Due to curtailment of gas supply, the industry's capacity utilization has declined to disappointingly low level. This could be gauged from the fact that the country capable of producing exportable 1.2 million tons urea is forced to import around the same quantity. On one hand, import of urea is eroding foreign exchange reserves, and the government is forced to pay billions of rupees subsidy to keep prices of urea at affordable level on the other.

In the upcoming federal budget, the government intends to increase the gas infrastructure and development surcharge (GIDS) to self-finance Iran-Pakistan gas pipeline. The government has already been charging fertilizer industry Rs197/mmbtu under GIDS that was introduced at the beginning of CY12. Its impact has not yet been totally passed on to farmers since GIDS implementation since evidently retail prices have remained almost stagnant at Rs1,800/bag over past four months.

The stiff competition with the imported urea available in the local market at relatively lower (subsidized) price has created very unlikely situation for local manufacturers to completely pass on the impact to farmers. Although any exact figure of increase in GIDS has not yet been estimated, analysts expect raising GIDS will impact fertilizer sector negatively and sector wide reduction in key margins may be witnessed.

Fauji Fertilizer has decreased urea prices by Rs145/bag and other producers are also likely to follow the suit. This is an indication that huge import of urea has created a glut in the local market. The oversupply has emerged despite intermittent closure of fertilizer plants due to curtailment of gas supply.

It seems that urea was imported with an objective to 'bless the favorites'. There was a whisper that some of the employees of the state-owned fertilizer distribution company were asking Rs150/bag as 'speed money'. If this allegation is true, they must have made a fortune on 1.2 million tons imported urea.

According to a report, fertilizer companies had no option but to reduce the price. The huge urea inventory pileup in the market is estimated around 800,000 tons inclusive of 264,000 tons of imported urea.

The local producers are of the view that the demand of both urea and DAP will pick up by middle of this month with the commencement of sowing of Kharif season. However, likely import of another 300,000 tons of urea and prospects of barter trade with Iran (fertilizer in exchange of wheat) can further increase the inventory.

Fauji Fertilizer Bin Qasim (FFBL) has posted net loss of Rs0.41 per share in Jan-Mar 2012 (1QCY12). The management was of the view that decline in earnings was due to low production as DAP plant remained closed for 20 days while urea plant was shut down for 50 days for annual maintenance. As a result urea production dropped 69 per cent year on year (YoY) to 26,000 tons and DAP production was also lower by 28 per cent YoY to 87,000 tons. Urea off-takes of the company slid 90 per cent YoY to 7,600 tons while DAP off-takes decreased 76 per cent YoY to 25,000 tons.

The delay in purchase by dealers was in line with the expectations of further reduction in urea prices. Aggregate industry sales of urea declined by 16 per cent YoY at 1.034 million tons and DAP off-takes decreased by 46 per cent YoY to 86,000 tons.

In the first three months, the company generated the revenue of Rs1.9 billion compared to Rs8 billion for the corresponding period last year. The company recorded gross loss of Rs265 million compared to the gross profit of Rs2.7 billion. The repairs and maintenance cost rose 21 per cent YoY due to annual turnaround activity conducted during the period. As a result, FFBL posted loss after tax of Rs387 million (loss per share: Rs0.41) compared to profit of Rs1.5 billion (earning per share: Rs1.67) in the corresponding period last year.

As per the media reports, barter deal with Iran of one million tons of wheat in exchange for urea will be finalized by May 12, 2012. Industry experts' estimates suggest that this would result in import of hefty 600,000 tons of urea from Iran, starting from end May12.

Keeping in view that already 300,000 tons of urea import has been finalized by the economic coordination committee (ECC), the additional supply from Iran will result in total urea imports of staggering 900,000 tons. The country has already imported estimated 800,000 tons of urea in Jan-April 2012 (4MCY12). This leads to imported urea availability of 1.8 million tons for CY12 (including opening inventory), compared to 1.1 million tons in CY11 (up 64 per cent YoY).

Keeping industry urea demand constant at 6.2 million tons, the substantial availability of imported urea will result in 10 per cent YoY decline for local fertilizer players' off-takes to 4.4 million tons. Thus, to reduce the said impact, local manufacturers may have to further slash urea prices to boost the sales. One potential benefit of reducing urea prices right now could be to ease inventory pileup as well as make room for raising prices following an expected increase in gas prices effective July 01, 2012.

Next winter is likely to be worse. Therefore, it is recommended that the government comes up with the precautionary policies. While power plants can be operated on alternate fuels, suspension of gas supply to fertilizer plants results in reduced production of urea.

Options: 1) operating plants at optimum capacity utilization and produce exportable 1.2 million tons surplus urea, 2) meeting gas requirement of fertilizer units through import of LNG, 3) operating power plants on furnace oil to be financed from export of urea and 4) subsidy to be paid on imported urea to be used for paying the difference in the cost of furnace oil and gas.