BackUncertainty over gas prices can weigh on plans of fertilizer firms
Lack of clarity on gas prices and the subsidy-sharing mechanism can force fertilizer firms to go slow on investment plans
Premium(Pradeep Gaur/Mint)
The rally in fertilizer stocks after the gas price hike is perplexing. Perhaps it has to do with the finance minister indicating the fertilizer sector would be cushioned from a price increase. The expectation is that the government may adopt differential pricing or assume more subsidy burden.
Now, that can hardly be good news for the industry that sells urea way below production cost. By not laying out the contours of the new gas-pricing mechanism for the fertilizer industry, the government has only increased regulatory risks for urea makers.
Sure, the government has a good nine months to decide on how it wants to cushion the industry. However, the intermediate period can create uncertainty for the sector. Post the release of the new urea investment policy guidelines, several companies had begun firming up plans to increase their capacities. A lack of clarity on gas prices and the subsidy-sharing mechanism can force them to go slow on investment plans.
In any case, differential pricing can hardly be a solution to the problems in the fertilizer industry. The lack of sufficient gas in the domestic market is a major headwind for prospective investors. The new urea policy allows pass-through of gas prices, but it also caps investor returns (on equity) at 12% if rates cross $14 per million metric british thermal units.
Even if the government agrees to foot a heavier subsidy bill, there is no relief for the working capital problems of fertilizer makers. The thrust to contain the fiscal deficit has resulted in delayed payments. To ease liquidity pressures, firms are taking short-term loans, which are driving up interest costs.
With the hike in natural gas prices estimated to result in an additional annual subsidy burden of ₹ 8,000-9,000 crore, analysts fear the finances of fertilizer firms may be adversely affected if the trend of delayed payments continues. According to Crisil Research estimates, higher interest costs can affect net profit margins of urea manufacturers by 30-40 basis points. One basis point is one-hundredth of percentage point. Overall, the decision to hike gas prices without laying a road map for its implementation can increase uncertainty among the prospective investors in the fertilizer sector. Urea manufacturers have been hankering for a price hike for some time now. An increase in prices would have improved their realizations and reduced the price gap with complex fertilizers. A decision on that front would have helped revive investor interest in the sector.
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