India’s Fertilizer Under Pressure

Profitability for P&K players

For the non-urea players, profitability is largely based on the demand-supply balances, competitive raw material procurement and the currency movements, given that all companies have to import raw materials. Profitability for these players remained weak during FY2016 – FY2019 as agro-climatic factors, high international commodity prices, depreciation of the rupee and high build-up of inventory in the domestic market, led to low profitability. Profitability improved marginally in FY2020 due to softer raw material prices.

Overall, high subsidy delays and weak return on capital employed across the industry remain major concerns. The subsidy backlog at the end of FY2020 is expected to have been apptoximately Rs. 470 billion and is expected to increase to approximately Rs. 570 billion by the end of FY2021, given the inadequate subsidy budgeting, depreciation of currency and expected volume growth during the year. As the COVID-19 crisis has squeezed the finances of the GoI, there has been a proposal to reduce the subsidy budget allocated to the fertilizer sector to 80% of its budgetary allocation in the Union Budget for FY2021. In such a scenario, the subsidy backlog would balloon to ~Rs. 800 billion, which may result in the industry-facing severe liquidity stress. Nevertheless, the strategic importance of the sector in ensuring food security of the nation and the certainty of subsidy receipt from the GoI, mitigate the above risks to some extent.

Update on new urea projects

Domestic urea capacity had not witnessed any significant capacity additions over the last couple of decades, apart from debottlenecking of existing capacities. The pause on capacity additions was a result of unattractive policies governing the urea sector. After the Urea Investment Policy of September 2008 failed to encourage any major expansion projects, the GoI approved the New Urea Investment Policy (NIP) in December 2012, under which the realisation of urea from new projects has been benchmarked to import parity prices, subject to a floating floor and ceiling prices, which are, in turn, linked to gas prices, to effectively ensure 12% (floor) and 20% (ceiling) post-tax RoE. Subsequently, the DoF notified certain amendments to the NIP-2012 in October 2014, as per which, the term ‘guaranteed buyback’ was removed. This move increased the marketing risk for the new plants by providing the GoI the flexibility to restrict the offtake from the plant and resort to additional import of urea and lower its subsidy outgo if it was substantially lower than the domestic procurement from the new plants. However, with the focus of the GoI on reducing its reliance on urea imports, the offtake risk is somewhat reduced. Moreover, some of the older urea plants might face closure, which are unable to meet the tightened energy norms.

Post the amendments in the policy among private players only Chambal Fertilizers & Chemicals Ltd had shown interest in setting up a new urea capacity and has successfully commissioned the 1.34 million tpy capacity in January 2019. Four other plants, one of Ramagundam Fertilizers & Chemicals Ltd (RFCL), as a joint venture (JV) of Engineers India Ltd and National Fertilizers Ltd, and three plants of Hindustan Urvarak & Rasayan Ltd (HURL), a JV of Coal India Ltd (CIL), Indian Oil Corp. Ltd (IOC) and NTPC Ltd (NTPC) are being set up. While RFCL’s plant is expected to be commissioned in 2H21 after getting delayed by nearly 1.5 years, HURL’s plants are expected to be commissioned in 1H22. With these capacities coming up India’s reliance on imports for urea is likely to fall drastically. Other notable projects include talcher fertilizers (based on coal gasification), where progress has been slow, and matix fertilizers, which has been stalled over the gas availability issue.

These plants are highly capital intensive and are being funded through a large portion of debt. To achieve debt servicing, these plants will have to work at high capacity utilisation levels, thereby underscoring the offtake risks. As can be seen from Figure 6, as capacity utilisation reduces, the key financial metrics for the new brownfield projects are adversely impacted.

Note: INR/US$ rate has been assumed as Rs. 75 per US$ for FY2022 and thereafter depreciation of 1% anually.

Going ahead, key policy changes which are expected in the urea sector are the nutrient-based subsidy policy and the direct benefit transfer of subsidy to farmers’ bank accounts, both of which are fraught with significant risks for the incumbents.

India’s impact on the world urea market

India is one of the largest players in the urea industry in terms of production, consumption and trade. It is the second largest producer of urea in the world, accounting for 14% of the global urea capacity. However, India’s domestic consumption is much higher than the domestic production and it is a net importer of urea. During the last few years, urea imports to India were reported to be high, at 7 – 9 million t, that is, 18 – 28% of the world urea exports. With such a high import requirement, India is a key market for the global fertilizer producers currently. However, going forward ~6.4 million t of urea capacity is to be added over the next 2 years, leading to a fall in import dependence. As per ICRA estimates, urea imports will decline to around ~0.5 – 1 million t by the end of FY2023, which will lead to an increase in the global surplus of urea.

India’s impact on the world phosphatic market

The global phosphate fertilizer industry is relatively well consolidated, compared to urea, with the top 10 producers accounting for around 65% of the total DAP and MAP capacity. Though India is the third largest producer of phosphatic fertilizers, a large proportion of P&K fertilizer and/or their raw materials are imported. During FY2020, India’s DAP imports stood at 5.3 million t, which forms 35 – 40% of the world trade in DAP. Hence, India enjoys a formidable position in the global phosphatic market as well, wherein any movement in India’s DAP demand impacts the international DAP prices. However, a relatively well consolidated industry structure for phosphates reduces India’s bargaining power to some extent.

India’s impact on world potash market

There are only a few large suppliers of potash fertilizers globally as potash mineral reserves are available only in certain regions. As India does not have potash reserves, it imports its potash requirement of ~2.5 – 3.5 million tpy. Its potash consumption accounts for only approximately 5 – 7% of the global demand for potash, which provides it with moderate bargaining power. The pricing of the contract between the potash suppliers and two of the major consumers is set through negotiations. The pricing of the potash contract with China, which consumes nearly 20% of the total potash market, usually sets the floor on the price at which potash will be available to India. Hence, despite no domestic production, India enjoys a moderately dominant position in potash fertilizers as well, although the extent of the dominance is much lower than in the case of urea and phosphates.

Outlook

Overall, for the year FY2021, the growth in the volumes is expected to be 12 – 14%, driven by healthy progress of the monsoons and the elevated sowing levels being witnessed in the kharif season, which has driven fertilizer sales to unprecedented levels. The various measures taken by the GoI to aid the rural economy through direct cash transfers has helped in improving the purchasing power of the farmers. With a healthy kharif season, the rabi season should also witness healthy fertilizer offtake as farmer’s incomes are expected to improve. With the level of growth expected in FY2021, the reliance on imported urea is expected to increase in the current year materially.

The urea industry is expected to benefit from the softening of spot R-LNG prices and crude oil prices as low energy prices keep the cost of production lower. It also results in lower working capital requirements and associated interest outgo, which is a drain on the profitability. The profitability of the P&K players is also expected to remain stable following the healthy capacity utilisation levels, driven by the healthy demand for both DAP and NPK fertilizers in FY2020.

With regard to the subsidy issue, the industry continues to face liquidity issues due to the high outstanding subsidy, the timeline for which needs to be improved, being a big drain on the players’ profitability. Although, DBT has been implemented for the sector, the subsidy continues to be routed through the industry instead of the farmers. With the subsidy recognition point shifting from the point of despatch to the point of retail sale, the working capital cycle for the industry has been elongated. Inadequate budgetary allocation of fertilizer subsidy continues to remain a thorny issue for the industry, resulting in large unpaid subsidy backlogs resulting in cash flow mismatches. The subsidy backlog at the end of FY2020 is expected to have been approximately Rs. 470 billion and is expected to increase to approximately Rs. 570 billion by the end of FY2021, given the inadequate subsidy budgeting, depreciation of currency and expected volume growth during the year. As the COVID-19 crisis has squeezed the finances of the GoI, there has been a proposal to reduce the subsidy budget allocated to the fertilizer sector to 80% of its budgetary allocation in the Union Budget for FY2021. In such a scenario, the subsidy backlog is likely to balloon to ~Rs. 800 billion, which may result in the industry facing a severe liquidity stress.

To conclude, ICRA believes that the GoI needs to take concrete measures to improve the financial health of the fertilizer industry, which continues to reel under pressure from the subsidy delays and continued CAPEX, owing to the reduction in the energy norms for the urea players, which keeps the profitability under pressure and credit metrics subdued. An increase in the farm gate price of urea to a meaningful level in relation to the import parity price, will also be a key imperative to address nutrient distortions and subsidy concerns.

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