Tata Chem beats raw material, policy risks with African foray

Aarati Krishnan | Updated on April 11, 2011

Tata Chemicals' move on Monday to acquire a strategic 25.1 per cent stake for $290 million in a greenfield ammonia-urea facility at Africa, makes strategic sense for three reasons. One, it may enable it to participate more actively in the global fertiliser market at a time of rising prices and realisations. Two, it allows the company to manufacture fertilisers at a low-cost location, without the pricing controls that characterise the sector in India. Three, it may also open up a trading opportunity to ship the output to India, if eventually allowed by policy-makers.

Free play

To start with, despite being very competitive on conversion costs, manufacturers such as Tata Chemicals are still hamstrung in scaling up their Indian urea output to a significant extent owing to a few factors. One, India is short of critical fertiliser raw materials such as natural gas and naphtha and a lion's share of the raw material requirements have to be imported.

Then, with urea makers required by government policy to sell at a fixed price, manufacturers need to rely on a group-based subsidy system for compensation of their production costs. The lack of pricing power, combined with the wild swings in prices of natural gas and ammonia- critical feedstock for urea, thus make for a difficult situation for purely Indian producers of the fertiliser. Seen in this backdrop, owning a strategic stake in facilities located overseas may give players such as Tata Chemicals more room for manoeuvre on both costs and pricing. The company may get to enjoy the full benefits of competitive manufacture while selling a good part of the output in global markets, at prevailing prices.

Locked in for inputs

The point to note is that the greenfield urea facility now being set up with Tata Chemicals' participation at the Republic of Gabon in Africa is locked into a 25-year fixed price supply contract for natural gas. Moreover, it is free of land acquisition troubles (the government would provide the land) and enjoys a 10-year tax holiday once it commences commercial production. These are factors that are likely to substantially trim the cost structure for urea produced out of this facility and lead to lucrative margins. More so, as the company is entering into this venture at a time when global urea prices are soaring once again, linked to the crude oil price table.

Finally, there is the fact that the facility may also be able to ship urea to India, if policy allows, to meet the substantial domestic shortfall in the fertiliser. The shortage of fertiliser feedstock in India and the policy uncertainties regarding urea, have led to very limited investments in fresh manufacturing capacity in recent years. Though the gap between domestic demand (about 260 lakh tonnes in 2010-11) and Indian production (215 lakh tonnes) of urea has stayed put, it has been met mainly by imports. Upto 25 per cent of the output from the African project is to be earmarked for exports to India for sale by Tata Chemicals' distribution network.

Published on April 11, 2011

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