Financial Daily from THE HINDU group of publications
Sunday, Feb 08, 2004
Agri-Biz & Commodities - Fertilisers
Corporate - Interview
`Urea prices are unlikely to fall back to $90 levels'
Mr Prasad Menon, MD, Tata Chemicals
Discipline. This, in one word, explains how Tata Chemicals has managed a healthy growth in sales and net profits despite the transition to a new subsidy regime in 2003-04. Over the past year, Tata Chemicals has ruthlessly driven down its costs, in preparation for the eventual decontrol of the sector. In this interview with Business Line, the company's Managing Director, Mr Prasad Menon, talks of the impact that the unfolding changes in the policy and business environment for urea may have on individual companies and Tata Chemicals' game plan.
Tata Chemicals has performed well in 2003-04 despite the introduction of the group pricing system for urea this year. What are the initiatives that helped you weather the change from the earlier retention pricing system to the present one?
Group pricing has had a negative impact on all the players, but the degree has been varied. What we have done is to accept this as a phased move towards decontrol. So we have seen this as an opportunity to examine our own costs, streamline our processes and understand how a decontrolled market operates.
We have taken it upon ourselves to bring down costs to the maximum extent, so as to be better prepared for decontrol as and when this happens. Under the group pricing system, this does impact our bottomline in the near term. But we have still gone ahead, as it would be in our interests over the long term. For instance, we have driven down our energy usage significantly, through comprehensive audit and improved instrumentation. We have placed much focus on discipline in running our plants. We have also been trying to streamline our distribution and selling costs.
But you have no control over feedstock costs. What is the mechanism for handling escalation in input costs under the new system and are there delays in getting payments?
We can claim escalations under the new regime as and when they happen. The system is much the same as before. There is a short time lag between our raising a claim and actually getting reimbursement. With the Budget delayed and a vote-on-account being proposed, the lag may be slightly longer than usual.
Your cost structure is linked to the type of feedstock you use. But natural gas availability is limited. What are you doing to get over the problem?
Right now we are using naphtha to supplement natural gas. This is pushing up the costs, but currently the Government is reimbursing this. We are in negotiations for the supply of LNG. And if this gets finalised, LNG will be the supplementing feedstock, instead of naphtha. This is expected to bring down the costs. Many issues on the LNG contract have been settled, but the price is yet to be settled. While we are asking for $3.2-$3.3 per million btu, the suppliers are talking of $4-4.4.
There is talk of linking the domestic gas prices to international benchmarks. How will this impact you?
If this happens, natural gas prices will move up closer to LNG prices. But globally, gas is not priced on the basis of its cost of production; it is priced on the basis of demand. So the extent of the increase in India will also be subject to what user industries fertilisers and power can pay.
Right now, global urea prices are on a high, giving domestic players some cushion against imports. But what if urea prices slump back to $90-110 per tonne, as it was a couple of years ago?
I think $90-110 levels are highly unlikely. I think over the long term, global prices could largely fluctuate between $120 and $140 (per tonne), with dips to $120.
But would you be in a position to compete with imports if prices drop to $130 per tonne?
This depends on a couple of factors. Gas and LNG availability is one. It also depends on whether we can get LNG at prices that we are asking for. But the picture on feedstock is looking better now, than it was two years ago. Reliance's gas find is one factor which has helped this happen. While we may not have a huge amount of gas available for fertilisers, it will be significantly more than in the past. Second, globally, LNG prices are beginning to soften from the high levels of the earlier years. As a buyer, you are no longer forced to take very long-term contracts on LNG at fixed prices.
A couple of years ago the absence of demand from China was stated to be the reason for the slump in global urea prices. What has been driving factor behind the recent surge in global urea prices?
I think one of the drivers has been the US. Demand from the US has pushed up natural gas prices and this has triggered a spike in ammonia and urea prices. Last year, the US started importing ammonia and gas, after shutting down its capacities because of high costs. This has set off an imbalance in both availability and price. This development is also important because all along, everybody was talking of India and China, as the influencing factors on global prices. This shows that there could be new sources of demand for natural gas or urea. That is why I think it is unlikely urea prices will fall back to $90 levels.
Is the Government likely to step up imports of urea, if global prices do soften?
I think the Government would continue to place a certain amount of reliance on the domestic industry. Look at what is happening with respect to ammonia the prices have shot up so sharply. The same could happen to urea as well. Over the long term, the Government will try to depend on domestic capacities to the extent of 60-70 per cent, so that there is a good balance between imports and domestic output. Then, there are also the constraints on the infrastructure front to handle large volumes of imports.
Until recently, the Government had imposed a cap on production. Has the Government offered to lift this cap? And will you be taking advantage of this?
There is a policy on excess production. But we are waiting for LNG pricing to be finalised before deciding to ramp up production. This is because we expect LNG to be a much cheaper fuel than naphtha. Once this is clear, we may consider ramping up production, maybe next year.
The industry is also moving towards a decontrolled marketing regime, with ECA allocations being gradually phased out. What are the changes that you have made in your marketing system to take advantage of this change?
With the marketing function being transferred from Rallis to Tata Chemicals, we have been using the Tata Kisan Kendras (TKKs) more extensively to market our products. We believe that the range of offerings under the TKKs offer an attractive package to the farmer. As to our selling strategies, we have largely stayed with our existing markets and there are no plans to move into new ones like, say, Maharashtra, because freight costs would be a factor.
Basically, the ECA allocations were guided by careful planning. They took into account freight costs, location and other factors. So you may not find companies making any drastic shifts in their marketing areas, even after the ECA system is phased out. Yes, you may find them pulling out of some of the extremities, where freight costs make it uneconomical. You may find trends, such as product swaps, taking place to handle deficit areas. But the Government still has the right to ask producers to take care of supply shadows. In that case, it will reimburse the freight costs.
In other industries, producers could use price cuts or rebates to gain market share. Since you have to sell at government-determined prices, what do you do to drive sales?
We believe that the TKKs are a big initiative. The business model of the TKKs rests on giving a complete set of inputs to the farmer. Along with this, we also offer extension services and technology inputs to help farmers plan their crops. Eventually, we also have plans to help farmers with marketing their output, by helping them establish forward linkages.
In the current year, you've said that you have `re-phased' urea sales to coincide with the marketing season. What does this mean?
We are ensuring that we do not put the product in the market much before the marketing season begins. There is usually a tendency to push material into the markets before the season starts, but now we make sure that the inventory does not get built up at the dealer level and we try to move with the monsoon. We think this brings market discipline.
Despite the exceptionally good monsoon, urea sales have grown just by 6-7 per cent in the year. Why?
This is just the average figure. We have had very good sales in some pockets, but this has been evened out by unimpressive sales in other pockets. Sales have been very good in Uttar Pradesh, Punjab, Haryana and West Bengal. The picture has not been as good in the South, especially Karnataka, pockets of Andhra Pradesh and parts of Tamil Nadu. These are big consuming areas and must have pulled the averages down. Again, 6-7 per cent is a good growth rate in our business, considering that sales growth has been a mere 2 per cent over the past four-five years.
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