It is a little disputed fact that agriculture is the socio-economic backbone of our economy; although cropping activity contributes only 10 per cent to the GDP, the sector accounts for 45 per cent of the total work force. Moreover, agro-based products are the largest earners of foreign exchange. Given such economic positioning, it is needless to stress the development of this sector any further.
So what is important for the agriculture sector itself? Amongst other things, the need for fertilisation ranks right up there. The supply of cultivable area is fixed and land is considered deficient in requisite nutrients, resulting in low yields. Therefore, the foremost means to enhance agricultural productivity is via the application of fertilisers; demand of which has outpaced supply historically.
Lately, major fertiliser players have been in expansion mode (1.8mln tonnes of urea added to the system) which bodes well for the sector and economy in terms of reducing the demand/supply deficit. However, even at expanded levels, shortages are most likely to continue. The major culprit being low utilisation levels, hinging around limited natural gas availability – the principal raw material to produce urea, which is the dominant type produced.
Insignificant development with respect to gas extraction and an absurdly large oil import bill has caused supply to fall and demand to rise for the resource. Out of a production capacity of 4,000mmcfd of gas, the power sector eats up around 50 per cent while the fertiliser sector is the second largest, consuming almost 17 per cent. Input from industry players reveals that to produce 1KWh of electricity, 3,000btu of gas are required.
This is of course an estimate assuming a 100 per cent efficiency level of power generation given a host of other factors relevant to gas fired IPPs and thus varies across companies. Running at 50 per cent efficiency is a more realistic assumption which would entail a requirement of twice that amount, 6,000btu. This roughly translates to a cost of Rs3100/MWh produced. A similar kind of analysis yields a unit cost close to Rs15,000/MWh of electricity when gas is substituted by High Speed Diesel (HSD).
Profitability
The fertiliser sector just cannot produce if not supplied with gas. So what do manufacturers do to preserve profitability? They simply increase the final price to compensate for lower volumes – interestingly they have ability to do so owing to the large differential between international and local prices of the commodity. This ability is there for all to see, testified by three price hikes during the past 12 months, followed by the recent price increase of Rs125/ bag by Engro.
Increasing prices is surely not a preferred manner for producers but an action they are forced to take due to reducing volumes. These price increases have been generally initiated by players who have faced the brunt of gas curtailment the most. In such regard, players such as Dawood Hercules, Pak Arab, and Engro with its new 1.3mln MT urea capacity, who are situated in the northern regions or more specifically on the SNGPL network, have been the frontrunners.
In lieu of the structure of the fertiliser industry, a price hike initiated by one player is generally registered across the board; hence with lower gas curtailment players like Fauji Fertiliser, Fatima, and Fauji Fertiliser Bin Qasim emerge as windfall gainers. This is exactly what explains the baffling growth in share price of the major player – Fauji Fertiliser Company Limited. The stock has posted an outstanding return of 28 per cent since the start of the year as investors seem to attribute Engro’s high debt levels and increasing urea prices as a bonus for the company.
Although trading below its intrinsic value, given the steep growth incline, doubts do creep up as to the continuity of such a pattern. Lately, a proposition moved by fertiliser representatives to directly pay IPPs for a quantum of diverted gas was tabled. Under this proposal, fertiliser manufacturers, in return for 80mmcfd, would compensate 75 per cent of the differential in cost bourn by power producers by using HSD rather than gas for the diverted amount. This would have amounted to a hefty Rs6.2b in payments made by manufacturers according to news estimates; however, it is a cost they were ready to bear illustrating how dear volumes are to them.
The quantum produced is also important owing to technical reasons as plants have set levels of utilisation for efficient manufacturing. Nevertheless, regardless of how short-term this compensation arrangement was, it was at the minimum an effort to continue production supply and lessen the price burden on farmers. The recently announced additional gas curtailment for the annual turnaround of gas fields is an added blow at a crucial time.
The Kharif season is upon us, entailing the sowing of vital crops such as cotton, rice and maize. Fertilisation for the soil is a must and if our local produce deficit exceeds expectations, a greater amount would have to be spent on costlier imports which further strain an already constrained fiscal environment. In this regard, it is of utmost importance that an equitable distribution of gas needs to be arrived at. Even if gas curtailment is maintained at current levels of 20 per cent, it is vital that consistency is observed at the least.
These are likely to be testing times for industry players and policy makers alike, with both being required to demonstrate their mettle hereon.