Go for course correction in urea pricing

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Published: June 13, 2015 12:09:10 AM

The real reason for diversion of urea to industrial use, smuggling, black marketing and its excessive use is its ridiculously low selling price.

On May 13, the government approved the Comprehensive New Urea Policy, which seeks to promote energy-efficiency, maximise indigenous urea production, and reduce subsidy burden on the budget.

At present, under the New Pricing Scheme (NPS), in use since 2003, each of the 30 urea manufacturing units gets a retention price (or ex-factory price) based on the production cost specific to it. Since all of them are required to sell urea at ‘uniform’ controlled price which is lower, the difference is reimbursed as subsidy.

NPS was designed as a group-based uniform pricing scheme, whereby each unit in a given group—six groups were carved out depending on feedstock and vintage based on the recommendation of the Expenditure Reforms Commission (ERC) in 2000—was to get the same subsidy/concession amount. This was mooted as a bridge, leading to eventual decontrol of urea and poor farmers getting direct subsidy support from the government.

ERC proposed a five-year roadmap for this to happen; it even recommended that selling price of urea be increased 7% per annum so that farmers get acclimatised to a realistic (cost-based) price level.

But the grouping concept remained on paper. NPS relapsed into a unit-wise dispensation. The system continues till date despite there being no compelling reason as, unlike in the past when plants were based on a variety of feedstock—gas, naphtha, fuel oil/LSHS, etc—leading to widely different cost structures, at present all plants run on gas except three (Madras Fertilizers, Southern Petrochemicals & Industries Corporation, and Mangalore Chemicals & Fertilizers) which are on naphtha. The new policy extends this by four years—2015-16 to 2018-19.

The government refrained from touching urea selling price; it was increased only once (in 2010) during the last one-and-a-half decade. However, there is a mark up of R14 per bag—on the current price of R268 per bag—to allow producers recover from farmers the cost of ‘neem coating’ which is mandatory for 75% of production and can go up to 100%.

What is so comprehensive about the fertiliser policy approved now? The government has revised specific energy consumption norms for units based on “a combination of norms under previous NPS and average energy consumed in the last three years.” What are the implications?

The fuel cost allowed under retention price is energy norm, say, X million Btu needed for a tonne of urea multiplied by delivered cost at factory-gate, say, Y in rupees per million Btu. Both X and Y are unit-specific. When X is revised based on performance in the last three years, a unit which did not do well will continue to get a higher price tag, whereas a unit which improved over its previous norm would have its efficiency improvement mopped up.

Thus, instead of incentivising reduction in energy consumption, the methodology for fixing new norms penalises units that have reduced and puts no pressure on others that made no efforts to improve. The policy would have served the intended purpose if only all units had been benchmarked to common energy norm, which was the intent of ERC but never practised.

As regards incentivising domestic production, the policy provides for giving to a unit—producing in excess of a cut-off level at 110% of its reassessed capacity—an amount equal to ‘variable cost plus part of the fixed cost’ or import parity price (IPP), whichever is lower. How does this compare with extant policy under which it is reimbursed at 85% of IPP?

Due to shortfall in availability of domestic gas, units are forced to use imported LNG which, until last year, was very expensive, much in excess of $10 per mBtu (against the price of domestic gas at $4.2 per mBtu prior to November 1, 2014, and $5.6 per mBtu thereafter). This led to fuel cost alone exceeding 85% of IPP and no incentive to produce in excess of the cut-off level. Since then, two favourable developments have taken place. One, the price of imported LNG has declined in tandem with decreasing global crude price. Two, from April 2015, the government has put in place a uniform gas pricing policy to ensure supply of gas from a pool (of domestic and imported LNG) at ‘uniform’ delivered price to all urea manufacturers.

Under existing policy (at 85% of IPP) units would have got good incentive to produce more. But by mooting ‘variable cost plus part of fixed cost’ or IPP whichever is ‘lower’, a clever bureaucrat has quietly taken away extra cushion. How much of the incentive would get killed as a result will depend on precise numbers to be allowed towards fixed cost for each unit.

What about saving in subsidy? Over a four-year period—2015-16 to 2018-19—the government expects savings of R2,600 crore due to changes in energy consumption norms and R2,200 crore due to increase in domestic output (about 2 million tonnes), substituting higher cost imported urea. Even if these materialise (unlikely), an annual saving of a little over R1,000 crore will be pittance in the overall subsidy bill of R73,000 crore (2015-16).

While winds of reforms are sweeping all other sectors, it is ironical that fertilisers remain untouched. This is despite the government knowing well that maladies afflicting this sector—serious imbalance in fertiliser use, worsening soil health, rampant misuse of subsidised urea, ballooning subsidy, a big slice of subsidy accruing to rich farmers and a stagnant industry—owe their origin to the existing convoluted regime of controls.

The controls are so deep-rooted that how much profit a company will make or its viability depends solely on the bureaucrat who sets norms and determines retention price. It is a case of micro-management by the fertiliser ministry. No wonder, in the last 15 years, not a single new grass-root or brown-field urea project has been set up and none of the big names in Indian industry, leave aside FDI, are keen to invest in fertilisers.

It is argued that once urea is coated with neem, it cannot be diverted for industrial use. Technically, the reasoning may look convincing, but who will do the policing? Who will check each bag (a colossal 600 million bags of 50 kg each)? Even so, mandatory requirement is 75%; so dubious persons would still have 150 million bags to play around with.

The real reason for diversion of urea to industrial use, smuggling to neighbouring countries, black marketing and its excessive use is its ridiculously low selling price. It is a paradox that Modi, who is known for his tough stance on reforms, is unable (or unwilling) to allow even modest increase in the price which, if suitably calibrated, will solve all these problems. He wants every farmer to have a soil health card so that the latter knows how much nutrient he will need to apply for getting good crop yield and keep soil healthy and robust. Yet he is keeping intact disjointed policies for urea vis-a-vis non-urea fertilisers—the prime cause of imbalance in fertiliser use. Why does he not implement nutrient-based scheme (NBS) for urea to bring parity with policy dispensation for non-urea fertilisers?

In the past, staying with unit-wise pricing was justified on the grounds that plants were based on different feedstock, and even within the same feedstock category, there were differences in delivered cost. Now, the industry is homogeneous with almost all plants on gas and even its delivered price is uniform. Then what is preventing the government from putting in place uniform pricing for urea?

The government has declared its intent to bring fertilisers under DBT. This is necessary for better targeting and curbing leakages. The government should first stop giving subsidy to manufacturers. Yet, by announcing continuation of extant fertiliser policy for four years, it has correspondingly deferred DBT.

It is evident that Modi’s intent is not getting translated into action. There is a big disconnect between the PMO and the fertiliser department.

The government should go for a course correction. The way forward is to implement NBS for urea and allow free float of its selling price. The uniform subsidy may be so fixed to prevent steep increase in price in one shot. After keeping NBS in vogue for two years, it may switch to DBT and at that stage also free up urea imports for increased supply at competitive prices.

The author is a policy analyst


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