The recent implementation of stricter energy efficiency norms on domestic urea manufacturers would partly reduce the quantum of subsidy reimbursement. Increase in pooled gas prices: Ind-Ra believes the price increase of term-liquefied natural gas (LNG), driven by an increase in crude oil and spot LNG prices attributed to higher purchases from China, has resulted in an overall increase in the average LNG prices in India.
India Ratings and Research (Ind-Ra) opines urea subsidy burden could increase to INR590 billion by FY21 from INR390 billion estimated in FY18 driven by i) an increase in pooled gas prices for domestic urea manufacturers, ii) higher subsidy pay-outs for upcoming urea plants, and iii) increasing rupee depreciation.
This, coupled with the rise in domestic gas prices due to an increase in prices of reference indices is likely to lead to an increase in the overall pooled gas prices for domestic urea manufacturers as stated in Ind-Ra's wire Pooled Natural Gas Prices for Urea Manufacturers to Continue to Increase in Short to Medium Term. For every USD1/million British thermal units (mmbtu) increase in the pooled gas prices, the subsidy burden increases INR1,600/tonne (t), assuming a weighted average energy consumption of 6.198 Gcal/t. Ind-Ra estimates the pooled natural gas price could inch up to USD11/mmbtu-12/mmbtu over FY19-FY20 from the present USD9/mmbtu-10/mmbtu.
New urea plants: Five new gas-based urea manufacturing plants of a combined urea capacity of 6.42 million metric tonnes (mmt) with a combined natural gas requirement of 10 million metric standard cubic metres per day (mmscmd) and a new coal gasification-based urea manufacturing plant of urea capacity of 1.27 mmt are likely to commence operations during FY20-FY21. The cost of urea production from these plants would be significantly higher than the imported urea prices, as the reimbursement allowed under the policy has a floor price of USD285/t to USD305/t and increases by USD20/t for every USD1/mmbtu increase in gas prices above USD6.5/mmbtu. At a delivered gas price of USD10/mmbtu, the price to be paid to urea manufacturers would be USD355/t-375/t compared with imported urea price of USD250/t.
This is likely to result in higher subsidy outgo for the government. Once all the plants are operational, the total subsidy burden from these plants is likely to be INR145 billion.
Rupee depreciation: The fertilizer sector consumes average 42 mmscmd of natural gas; thus any depreciation of rupee leads to an increase in the gas price, which is USD-denominated. Since the subsidy reimbursement quantum is directly proportional to the pooled gas price, rupee depreciation will lead to higher subsidy reimbursement. Ind-Ra believes that INR1 depreciation leads to INR250/t increase in subsidy burden.
Stricter energy efficiency norms: The government implemented stricter energy efficiency norms for the gas-based urea plants effective 1 April 2018, resulting in the movement of current weighted average energy efficiency norm to 6.118GCal/t from 6.198Gcal/t. This is likely to result in lower gas consumption, and hence reduction in the overall subsidy burden on the government.
Given the above factors, Ind-Ra estimates the total urea subsidy outlay to increase to INR590 billion by FY21 from INR390 billion estimated by Ind-Ra in FY18.
Where subsidy burden is likely to increase INR200 billion by FY21, the government would be required to increase its fertilizer subsidy budget to prevent an increase in subsidy backlogs.
Over the last two years, there has been an increase in subsidy pay-outs by the government. In a sample of six urea manufacturing companies analyzed by Ind-Ra, the average subsidy pay-outs by the government have been higher than the subsidy booked during the year by the manufacturers, indicating partial liquidation of the subsidy arrears, resulting in an overall decline in the subsidy receivables as a percentage of sales.
In case the subsidy budget/allocation is not increased proportionately, the urea manufacturers are likely to face additional burden on their working capital cycle owing to increased receivables. This would lead to higher borrowing and higher interest costs, thus reducing their already low profitability. The sector would require either timely subsidy payments from the government or other means such as special banking arrangement to provide liquidity support to the urea manufacturers.
