Anil Ambani / RIL: Fertilizer Sector & Government Policy | NowPublic News Coverage

by someshahuja on Aug 12, 2009      Category: Economics & Business Tags: ril rnrl anil ambani mukesh ambani



§        Gas based fertilizer units in the country share about 38% of the total subsidy bill but account for 66% of total urea production

§        New Pricing Scheme (NPS) 2007, necessitates for complete switchover to natural gas as feedstock from substitute fuels, within three years, to rationalize the rising subsidy bill

§        Savings in subsidy due to conversion to natural gas from other substitute feedstock to the extent of Rs 50.15 billion

§        Natural gas demand for fertilizer sector is currently estimated at 43.9 mmscmd, which is expected to grow to around 75 in by 2014

§        Government policy affirms that no APM gas would be allocated to future Greenfield plants and brown-field expansion projects

§        Worldwide natural gas is used as feedstock for 83% of urea production as compared to 53% in India

§        KG D-6 gas vital for Indian fertilizer sector to reach the global benchmark

§        With augmentation of domestic capacity, spot urea market to ease

§        With development of National Gas Grid gas distribution would improve

§        Natural gas even at $6 per mmbtu competitive for urea production, hence, availability not the price key issue




The Fertilizer Ministry was quick to voice it concerns over the implication of the judgment over the private arrangement on fertilizer sector. Fertiliser Secretary Atul Chaturvedi wrote on June 24 to his counterpart in Petroleum Ministry, R S Pandey stating that the private Ambani family agreement that split gas output from the Krishna Godavari basin D6 field between brothers cannot over-ride Government's right to formulate gas utilization policies aimed at larger public interest.


The fertilizer industry is regulated by government policies administering the price of fertilizer and the production. There are around 31 plants in the country engaged in the manufacturing of urea. The government has categorized these plants on the basis of usage of various feedstocks. Major feedstock presently being used in urea production is natural gas, naphtha and fuel oil / LSHS .  Some plants also operate on mixed fuels.


Feedstock cost for urea production varies from 65% to 87% of total production costs. Since Natural gas is one of the most cost effective fuels for fertilizer plants, gas based fertilizer (urea) production accounts for more than 66% of the total fertilizer production.


The letter goes on to state that if such a private arrangement has implications on previously signed Gas Sales and Purchase Agreements for the allocated gas and if the existing rights of fertiliser companies are distorted, the Fertiliser Ministry will purport to seek available legal remedies independently.


A) Implication on Fertilizer PSU


U S Awasthi, MD, Indian Farmers Fertiliser Co-operative Ltd (IFFCO) had recently stated that the gas supply from D6 block in the KG basin will help reduce the subsidy bill by a substantial amount. He further says that the cost of production is expected for IFFCO it will come down by Rs 800 crore.


B) Implication on Fertilizer Sector


Government of India has noticeably favored natural gas for fertilizer production as per New Pricing Scheme (NPS)

Natural gas constitutes about 60% of the cost for production of fertilizers in gas-based units vis-à-vis 75% in naphtha-/fuel oil-based units. With the Government of India regulating prices of most fertilizers, it doles out concessions/subsidies to the manufacturers regularly. Currently, gas-based units share about 38% of the total subsidy bill, but account for about 66% of the total fertilizer production in India.


The Government, therefore, clearly favors the usage of natural gas over naphtha for the fertilizer sector as it is cheaper and helps save on the subsidy bill. Lower feedstock cost may also allow the eventual decontrol of fertilizer pricing, which has been the long standing demand of the fertilizer manufacturing companies.


Prices of urea is government regulated and currently fixed at Rs 4,830 per tonne. Differential between production cost including margin and consumer prices are borne by the government historically in the form of subsidy. To bring the efficiency in urea manufacturig and counter the rising subsidy bill, the government came up with New Pricing Scheme (NPS) in 2007. NPS divided all the urea manufacturing units into different groups based on their feedstocks and allowed the weighted average cost for each group as the benchmark for differential payment with flexibility of + 20%.


If the cost of production of any urea manufacturer is more than 20% below of the weighted average cost, the manufacturer will receive only the weighted average cost and will have to bear the differential. Furthermore, NPS emphasized the need for complete switchover to natural gas as feedstock from other substitute fuels, within three years, to rationalize the rising subsidy bill.


Major jolt to government’s effort to contain subsidy

The court verdict is a major jolt to government’s efforts in containing rising fertilizer subsidy bill by switching over to cheaper gas. Government is estimated to save Rs 50 billion annually by converting all the fuel oil and naphtha based plants to gas. With court decision contradicting the government’s plan, it can also affect government’s present policy.


As per Department of Fertilizers estimates, India would require about 33 mn tons of urea by FY2012E to be self sufficient in food grain production. Thus the twin objectives of increase in fertilizer production and managing the subsidy burden could be met only by ensuring availability of gas for the existing and proposed requirements of the fertilizer sector. Hence the supply of KG D6 Gas to Fertilizer Sector is of paramount importance to the implement the Government objective. 


Gas demand from fertilizer sector:

Natural gas demand of 43.9 million standard cubic metre (mmscmd) from existing gas-based urea plant far exceeds the supply of almost 30.2 mmscmd. Additional gas demand of 13 mmscmd is likely to come from expansion and de-bottlenecking of these projects by next year. Switching over to substitute feedstocks based plants to natural gas is estimated to generate another 7.2 mmscmd of gas demand. Additionally, revival of closed urea units will require 10 mmscmd going forward. In total, gas demand urea manufacturing is expected to be around 75 mmscmd in next few years.


Impact of court verdict on fertilizer industry in RIL-RNRL case

Uncertainty, however, looms large over future gas supply to fertilizer sector, as the Bombay High Court ruled in favour of RNRL for gas supply from D-6 field without considering present allocations. If the MoU is made effectual, first 40 mmscmd (28mmscmd + 12 mmscmd of NTPC) can go to RNRL. Next 25 mmscmd will be supplied to RIL for its captive consumption. This leaves only 15 mmscmd in spare which will further be divided in 40:60 ratio to RNRL and RIL. This leaves no space for supply of gas from the source to urea plants. Furthermore, the decision would leave little room for future gas supplies to switching over urea units.


C) Gas availability also drives policy decision

India has not focused on building urea capacity since past decade as cheap feedstock was not available. However, since sufficient key feedstock in the form of natural gas in urea production will be available post KG basin gas supplies, the Government was likely to encourage domestic urea capacity. Availability of natural gas would improve post supply from KG basin and as a result, India may become natural-gas sufficient by FY11.


New government policy affirms that no APM gas would be allocated to future Greenfield and brownfield expansions projects. The policy also underlined the necessity for early conversion of existing LSHS-/fuel oil-based units to gas-based units so as to bring about operating efficiencies in the fertilizer sector to international standards.


D) Saving due to conversion to natural gas

As per the government’s policy related to third stage of Urea Pricing Scheme (announced in January 2007), all urea producing units need to convert to natural gas as a feedstock by March 2010. While calculating savings, Crisil Research assumed that a certain portion of the capital cost for conversion of FO/LSHS to natural gas would be paid as capital subsidy by the government. Hence, the annual amortized amount over a decade has also been taken into account. Crisil Research expects net savings Rs 50 billion.


Saving in Subsidy                                                                                Rs billion

Savings from FO/LSHS based urea moving to gas                                             11.87 

Savings from naptha based urea moving to gas                                                38.79 

Net advantage based on Feedback conversion                                                 50.66

Amortization of capital subsidy payable for FO/LSHS on conversion              0.51

Net saving in subsidy due to swtiches                                                                 50.15

Source: Crisil Research


It also needs to be noted that With increasing availability of natural gas (fertiliser sector allocation set to improve 3x by FY11), which is the key feedstock in urea, promoting domestic capacity is cheaper as against buying from the international market, which would escalate current account deficit.


Impact of gas supply from KG D-6

In supply side, gas production from KG D-6 came as a godsend gift for urea industry, which otherwise was forced to use costlier feedstock like RLNG and naphtha (price ranges between $5.45 to $12.00.). Whilst using RLNG, cost of production of a particular manufacturer goes significantly higher compared to weighted average cost for the group. Hence, the burden affects the bottom-line of the company. Current gas demand-supply gap for urea production is bridged as fertilizer sector has been allocated 15 mmscmd of gas from the first 40 mmcmd gas production from KG D-6. Future gas demand from fertilizer industry could be met with allocation from second lot of 40 mmscmd gas production.


Near term investment under serious threat

Court decision has come as a shock to urea manufacturers, particularly ones who are converting their units from naphtha or fuel oil to natural gas based plants, as per government policy. Future gas supply uncertainty has raised doubts over the investment of these units, who were switching over to gas in hope of easing out working capital crunch. Unavailability of gas from D-6 will force these plants to use costlier RLNG, which in turn would result in higher urea production cost. Consequently these plants will have to bear the difference of weighted average production cost of all the units (which would obviously be lower for plants receiving domestic gas supply) and their actual cost. This will lead to a disadvantageous situation for these urea manufacturers for no obvious reason.


E) Shifting to KG D6 gas would have decreased liquidity crunch; but new dynamics can create challenging situation for the industry


Rising subsidy bill leads to delay in disbursement

It’s a well known fact that escalating subsidy pressure is causing hindrance in disbursement of subsidy as the budgetary provisions are falling short of actual requirement. In FY08, the actual subsidy was Rs460bn vis-à-vis Rs225bn provided in the budget. Even the secondary budget provided only respite of Rs150bn, resulting in total under provisioning of Rs85bn in FY08. Notably, half of the secondary budget at Rs75bn was paid in form of fertiliser bonds.


Fertiliser bonds creating liquidity crunch

Fertiliser companies were paid Rs75bn subsidy in FY08 in the form of fertiliser bonds. This led to working-capital crunch for fertiliser companies as such bonds were quoting discount to par value owing to lower coupon, high duration and non-SLR status. These bonds have been trading at 6-10% discount to their face value as per the Clearing Corporation of India (CCIL). Thus due to bonds trading at below par value, most fertiliser companies posted losses on account of mark-to-market (MTM) and/or realised losses on such bonds in FY08.


Shifting to cheaper feedstock to ease working-capital crunch

Currently, fertiliser companies in India use multiple feedstock such as natural gas, naphtha, fuel oil (FO) and LSHS (Low Sulphur Heavy Stock). Notably, the effective energy cost of fertilisers produced through expensive naphtha and LSHS is 3-4x that of urea produced via natural gas. Thus the usage natural gas becomes more important in the context of the current economic


F ) Natural gas is convenient Feed stock globally; should India lag behind?

Energy cost is most vital for urea production. Worldwide natural gas is used as feedstock for 83% of urea production as compared to 53% in India. If the allocated gas will not be available to the fertilizers manufacturers, they have to resort back on naphtha and expensive spot gas for urea production, thus affecting their financial viability and the growth of agriculture sector.

China, the US and India are the three largest producers of ammonia and urea, accounting for over 40% production of world. China and India have substantial fertiliser capacity, utilising feedstock other than natural gas. Thus availability of KG D6 gas is important for the Indian Fertilizer Sector to reach the global benchmark.


Share of Natural Gas as feedstock


Source IFA, I-Sec Research


Currently, the fuel cost is a pass-through cost and gets reimbursed through the subsidy bill; hence costs do not have any considerable affect on profitability. In the NPS proposed policy, gas cost would not be a pass-through, thereby impacting profitability. If KG basin gas is not available, gas costs would be significantly higher; thus, fertiliser companies would not be able to reap the complete benefit of the new policy.


India’s influence on global urea prices

Indian urea imports have significant influence on fertiliser Spot prices internationally as the country contributes ~30% of world trade in urea. Rise in Indian imports in FY08 was also an important factor for increase in international urea prices. With augmentation of domestic capacity, Spot market would ease. With development of the National Gas Grid (NGG), gas distribution would also improve.


Availability not the price key issue

As per Goldman Sachs report, it is estimated that natural gas even at $6 per mmbtu is competitive for urea production. Thus it can be safely concluded that the question is not the price but availability of gas.



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