Business Recorder (BR) Research
Farmers in the country are facing some tough times. Agriculture commodities’ prices are headed south while input prices continue to escalate. Margins are shrinking and farmers’ livelihoods are at stake. The latest hit is the revision in fertilizer prices by FFC which has been matched by Engro. The price hikes are reportedly, in response to government’s hike in input gas prices.
The government appears blind to the ground realities under the immense pressure of IMF while the fertilizer producers appear fixated with profitability, even at the expense of farmers. Earlier this week, the government increased feed-stock gas prices of fertilizer by 18 percent (62% on base excluding GIDC). In response, FFC increased urea prices by nine percent. Engro followed with a similar hike and it’s only a matter of time until Fatima fertilizer, also announces a similar move.
FFC simply passed on the entire impact of the price hike in gas, to farmers. The actual pass on would have been Rs138 per bag; but the company has raised prices Rs22 per bag in excess of this hike. The increase for Engro and Fatima should have been much lower as feed stock price of major production for the former; and entirely of the latter, is highly subsidized.
This situation raises serious concerns over the continuation of a deregulated regime for fertilizer producers because their major input (gas); is regulated and heavily subsidized. There are question marks over the exuberant profits pocketed by big producers without any check by the government.
In the fertilizer business, demand is hedged and raw materials are subsidized while prices are deregulated. The result is that these companies make high profits; due to the benefits they derive from policies which are supposedly to support farmers.
The EBITDA margins of FFC averaged 33 percent in CY06-10, while they increased to 43 percent in the CY11-14 period. Engro had similar margins in CY11-14 while Fatima’s average EBITDA margins were as high as 59 percent. Which fertilizer business in the world makes such hefty profits? Why are the returns on this business not regulated similar to the gas marketing companies and independent power producers (IPPs)?
Let’s peek into the history for details. Urea’s chief raw material is gas and that has been historically available at a steep discount to international prices because the government wants to ensure affordable urea in the country. Every country has its own way of subsidizing inputs for farmer. Low gas prices for fertilizer producers, has remained the prevalent option in this country.
Urea prices in the country were at an average discount of 47 percent during CY00-11, compared to imported fertilizer in equivalent landed prices in PKR. Farmers were the beneficiaries however the cash-strapped government had to halt its subsidy.
In January 2012, the government imposed GIDC of Rs300 per unit on feed stock prices which increased the effective input prices (combination of feed stock and fuel stock) by 2.1 times. As a result, local urea prices started to rise. Today, gas input prices are 3.2x times higher than they were in December 2011. The discount in urea prices in the country compared to international equivalent price; fell to an average of 29 percent, in CY12-14.
In 2011, the gas shortage worsened and fertilizer plants did not have enough gas to run at or near full capacity. The problem was especially severe for Engro’s new plant. Meanwhile the rest of the manufacturers enjoyed a bonanza as their prices were at par with each other. Engro had to increase its urea price due to its high financial and operational costs from the new plant which was running at sub-optimal capacity. FFC and Fatima increased prices simultaneously to similar levels.
Both companies raked in abnormal profits during this period. Yet the government did nothing to rectify the situation. FFC and Fatima’s EBITDA margins were 56 percent and 68 percent, respectively in CY11. The farmers were the losers. The government could have cross subsidized by transferring rent from FFC and Fatima to Engro. But it did nothing to improve the situation for agriculturists.
Today after the latest increase in gas prices, the urea produced in Pakistan is priced just eight percent lower than international prices. While the gas input price is at $5.5 per unit (weighted average of feed stock and fuel stock based on their usage). The imported LNG is coming into the system at $10-11 per unit. This implies that the input prices are still at half of what they are in the world. Yet urea prices are almost at par.
This poses a question that should the government keep on supplying gas to the fertilizer companies? There are other sectors which are suffering and the benefit of producing urea locally has virtually eroded. There are other benefits of producing urea locally; if all the urea is imported, there would be significant strain on import bill which could swell by $2-2.5 billion per year. The direct and indirect employment loss is apart from that.
Hence, there is no rationale for halting domestic production. But there is a strong case for not letting fertilizer companies continue their rent seeking ways. The need is to have a close look at the margins of these companies and come with a regulatory formula whereby the government can fix fertilizer prices and let the producers earn normal profits. Precedents are available in gas marketing and IPP sectors.
Do not leave the farmers high and dry to take the full impact. Back of the envelope calculations for FFC reveal that the company makes Rs317 per ton of urea, in excess of passing on the gas price hike in the last five years (and even adjusting for inflation the rent is almost Rs150-200 per ton). This is also evident from the surge in its EBITDA margins. Someone in the government should take a note of this exception and come up with a formula to rectify it.
Apart from that, the government should abolish General Sales Tax on fertilizer as its prices are already too high for farmers to compete in days of falling commodity prices. India gives $15 billion subsidy on fertilizer while in Pakistan, the subsidy is around $200 million. This is simply peanuts. It compels farmers to use lesser fertilizer and thus harvest lower yields. The situation is not helping the country’s agricultural backbone; it is breaking it.
