Levy on gas to fuel rise in urea prices

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Urea prices will need a rise of Rs 22 per bag in order to cope with a 10 percent levy on gas price in the upcoming budget. Price subsidy on feedstock gas for the fertiliser sector (currently priced at Rs102 per mmbtu versus Rs 382 per mmbtu for fuel gas) is likely to be phased out.An increase in feed gas prices will be matched by an offsetting rise in urea prices to maintain margins. Engro Fertiliser and Fatima will be potential winners of this increase, as new plants of the two companies have guaranteed gas at $0.70 per mmbtu for ten years. This price hike will help these companies gain margins, while FFBL will be among the key losers, said a research analyst Muhammad Saqib Sajjad at KASB Securities.Gas price subsidy has prevailed as it is the most simple way for the government to channel a subsidy to farmers (direct subsidy will be an administrative challenge). Fertiliser companies, however, have clarified that they do not favour the feed gas price subsidy. However, agriculture sector lobbies strongly support the subsidy. Figures reflect that Rs 10 per mmbtu rise in the feed gas price requires a corresponding Rs 12 per bag increase in urea price.The government is again considering the reformed General Sales Tax (GST) or value added tax (VAT) in the budget of FY12. Whether the reformed GST will be levied at the previously cited rate of 15 percent or at the current GST i.e. 17 percent remains to be seen.The GST exemption for fertilisers, tractors and pesticides ended in mid-March, 2011 (as per a presidential order), while domestic urea and DAP prices already build in a similar impact. Resultantly, potential imposition of a 17 percent reformed GST would have no impact on domestic fertiliser prices, while 15 percent reformed GST will allow room for Rs 65 per bag and Rs 22 per bag reduction in DAP and urea prices respectively. Meanwhile, potential imposition of the reformed GST or an end of the GST exemption on packaged milk (via a SRO) will be a risk for Engro’s 100 percent-owned subsidiary, Engro Foods, currently Pakistan’s leading UHT milk brand. Under the current GST regime, milk and its products are exempted from sales tax, but the VAT Act of 2010 proposed imposition of a 15 percent VAT on packaged milk and its products.Sales tax levy will result in an equivalent increase in UHT milk prices (margins are likely to be cushioned by the pass-through nature of the tax). However, price hikes could soften demand growth for packaged milk by widening the gap between loose and packaged milk prices.The government is likely to announce some farm support measures as this will be the first budget after the 2010 floods. Among the would be the announcement of higher wheat support price (fixed at below-global Rs950/40kg since FY09). Meanwhile, any measures the government announces to boost agri output (availability of seeds, farm credit etc) would be a latent positive for the sector.