We need a coherent urea investment policy

In January 2013, the Government had notified a urea investment policy (UIP) for new greenfield projects; expansion of existing units; additional urea from revamp of existing units and revival of projects of sick public sector units of the Fertilizer Corporation of India (FCIL) and Hindustan Fertilizer Corporation (HFCL).

Early this year, it made two amendments in the UIP. The first dispensed with the “dispensation of guaranteed buy-back”, while the second requires interested private companies to give a bank guarantee of ₹300 crore for every project, while PSUs firms are exempted from it. The amended UIP (2014) has now been notified.

The 2013 policy had led to a flood of proposals for setting up urea capacity totalling around 20 million tonnes or 12 million tonnes more than the current deficit of 8 million tonnes. If all proposed projects materialise, India would be staring at an unprecedented urea surplus 4-5 years from now.

This sounds bizarre! India has not seen any new urea plant being set up during last 15 years or so. How could the new policy turn it into a surplus in just a third of that period? This is all the more glaring when seen in the backdrop of a similar UIP in 2008 failing to enthuse investors.

How did UIP (2013) compare with UIP (2008)? And, where does amended UIP (2014) take us to? The UIP 2013 assures investors in new green field projects — besides revival projects of FCIL and HFCL — a price linked to import parity price (IPP) with a floor (F) of $305 per tonne and ceiling (C) of $335 per tonne. These basics are similar to UIP (2008). However, an “add-on” relates to adjustment for variation in price of gas.

The prices correspond to gas prices of up to $6.5 per mbtu (million British thermal unit). Beyond this level, for each dollar increase in gas prices up to $14 per mbtu, ‘F’ and ‘C’ increase by $20 per tonne each. For increases beyond $14 per mbtu, only ‘F’ price would apply albeit with full protection for gas cost.

Since gas cost accounts for about 75 per cent of urea production cost and gets fully compensated irrespective of gas price level, the attraction was palpable. A second add-on was guaranteed buy-back (GBB) or a commitment by government to buy entire urea production from the unit. This requires closer scrutiny.

For long, urea has been under pricing and distribution controls. While, maximum retail price (MRP) is controlled at a low level (currently ₹5,360 per tonne), excess of this over production cost is reimbursed to producer as subsidy. Some 30 operating units get retention price/subsidy specific to each under the new pricing scheme (NPS). Projects that come up under UIP will also be covered under the above dispensation.

Until 2003, urea production was subject to movement and distribution control. Since 2003, this is down to 50 per cent of production, leaving manufacturers free to sell the rest. Urea remaining un-sold to farmers can either be exported or sold to manufacturers of complex fertilisers at IPP but will not qualify for subsidy. Due to shortage of domestic gas and imported LNG coming at high price ($10 per mbtu plus), such sale would be at a loss!

The GBB was meant to take care of such eventuality. Full compensation for gas cost and GBB under UIP (2013) had thus put new projects in safe heaven, leading to tumultuous response from industry. Under amended UIP (2014) with GBB gone, uncertainties have come to haunt them. But the bigger problem relates to uncertainties of subsidy payments.

Due to continued control on MRP at a fraction of production cost, urea manufacturers depend heavily on subsidy support. But, government wants to rein in subsidy. So, it axes subsidy payments by reducing entitlement, under-provision, delayed payments, etc. New projects, too, will be hamstrung affecting their viability despite assurance of covering full gas cost.

There are three core reasons as to why investment in urea industry is not considered attractive: shortage of domestic gas and high price of imported LNG; political expediency of keeping MRP artificially low and compulsion to rein subsidy. Ironically, the three work at cross-purpose.

Thus, exploration and production (E&P) companies want higher gas price which increases fertiliser subsidy. On the other hand, control on urea MRP at low level forestalls efforts to rein in subsidy. Yet, fiscal discipline requires subsidy cuts. Industry is made to bear the brunt of these pulls.

The Government needs to put an end to these conflicts forever. If it feels that MRP cannot be raised or higher gas price has to be allowed, it must accept the inevitability of higher subsidy and make adequate budget provision.

If, it wants to rein in subsidy, there is no escape from increase in MRP and keeping gas price within reasonable bounds.

Such a coherent policy framework is need of the hour instead of piecemeal changes pandering to individual segments in isolation. Alternatively, government may allow market forces in both gas and fertilisers and take care of poor farmers by giving direct subsidy support.

The writer is a policy analyst

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