After a policy limbo for several years, there could be some light at the end of the tunnel for urea producers. Three major policy announcements are expected to be finalised in the coming weeks. They are: A modified policy for deciding subsidy on existing urea production (New Pricing Scheme-III), a regime to encourage new investments and retail price increases, that have been held off for many years.

Why a new investment policy?

But first, some background on the urea sector. Both pricing and distribution of urea, the key fertiliser accounting for 58 per cent of consumption, are regulated by the government.

Prices of phosphatic and complex fertilisers, the other key segment, were partially de-regulated way back in February 2010, through the nutrient-based subsidy policy unveiled in February 2010. This has endowed producers with a modicum of pricing power and better margins.

However, with a cap on selling prices and restraints on profitability, the urea segment has been in the doldrums. There have been no major capacity additions in this space for over a decade. With the demand for urea growing at 3 per cent annually and the supply having remained stagnant, India has been importing close to 30 per cent of the urea requirement. This coupled with swift up move (41 per cent) in the international urea prices has led to a sharp spike in the subsidy bill over the last 4 years.

What it means

A new regime for encouraging capacity expansion in urea (new urea investment policy) is expected to be taken up soon. The framework being discussed is on the following lines.

Under the new urea investment policy, producers will receive realisation linked to international urea prices on their expanded capacity.

On Greenfield expansion, they will receive 95 per cent of international price subject to a floor of $305/tonne and ceiling of $335/tonne. For new brown field projects, realisations will be linked to 90 per cent of the international price, subject to a floor of $285/tonne and ceiling of $315/tonne. For revamp projects, the benchmark has been fixed at 85 per cent of the international price with a floor and ceiling of $250/tonne and $ 260/tonne respectively. This has been calculated on a gas cost of $6.5/mmbtu (million metric british thermal unit).

While these floor and ceiling prices are lower than the existing regime, the positive aspect of this policy is the facility to pass on higher gas costs to government. Cost of gas up to $14/mmbtu is expected to be reimbursed by the government, with the industry bargaining hard to increase this ceiling to $20-22/mmbtu.

NPS stage III amendment

This regime promises a certain assured return for existing players who put up new capacity. A calculation shows that, at a gas cost of $6.5/mmbtu, players will in fact make a Return on Equity (RoE) of 12 to 17 per cent at the floor and ceiling price respectively. However, if gas costs increase beyond $20/mmbtu, for every 50 cent increase in the gas price the Return on Equity (RoE) will decline by 190 basis points.

The second big change is expected in the calculation of costs. Under the current pricing scheme, the fixed costs of urea producers were benchmarked to a ‘normative cost' determined in 2006-07. This resulted in under-recovery of fixed cost by urea units.

Now, additional costs of upto Rs 350/tonne are expected to be reimbursed for all units on a retrospective basis. Urea units with fixed cost lower than Rs 2300/tonne can claim additional reimbursement to make up for the shortfall.

Chambal fertilisers, Rashtriya Chemicals and Fertilisers (RCF) and Tata Chemicals are likely to be the key beneficiaries in the listed space. Chambal's earnings are expected to see an increase of 10 per cent; RCF 15 per cent and Tata Chemicals 3 per cent.

The retrospective changes may result in a one-time boost to the earnings of Chambal by 26 per cent; Rashtriya Chemicals and Fertilisers by 31 per cent and Tata Chemicals by 7 per cent.

Hike in urea retail price

The proposal to increase urea retail price by 10 per cent from the current levels of Rs 5313/tonne is said to be under consideration too. Urea price was last revised in April 2010, after having remained unchanged for almost a decade (2000-2010).

Chambal Fertilisers, Tata Chemicals, Zuari Industries, RCF and IFFCO have expressed interest in setting up brownfield urea plants, subject to favourable policy changes.

Assuming that the brownfield expansion plan materialises, urea capacity of Tata Chemicals will almost double from the current levels while Chambal Fertilisers' capacity will go up by 55 per cent and Rashtriya Chemicals and Fertilisers' by 47 per cent.

While the policy, prima-facie, seems encouraging, the bigger challenge will be to ensure availability of natural gas, the key raw material.

In the current scenario of waning supplies from RIL's KG D6 the policy will have to address the issue of feedstock availability to ensure meaningful investment by the players.

nalinakanthi.venkataraman@thehindu.co.in

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