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Should Gas Prices be Pooled for the Fertiliser Sector?, Shri V S Laghate, Vice President (Strategic Planning), Deepak Fertilisers and Petrochemicals Corporation Limited

There are several issues that need to be considered before taking any action on pooling of prices of various gas forms for the gas-based fertiliser units.

Cross subsidy and its side effects

  1. In the gas baskets of the gas-based fertiliser units, there are large variations in the share of LNG, a high cost gas. Once pooling is introduced, the average gas cost will rise for the units having small LNG share in their gas basket and it will decline for the units that use large quantities of LNG.
  2. Thus, pooling of gas prices will introduce a cross subsidy across gas consumers also, as the units whose cost of gas is lower than the pooled cost will end up subsidising the higher-cost units.
  3. These gas consuming units are corporate bodies, and many of these are listed on the stock exchanges and are responsible to their shareholders for profitability. The units that see an increase in their cost of gas are likely to resist the pooling proposal.
  4. Further, each gas buyer signs independent contracts with the gas suppliers. The buyer who is put at a disadvantage will resist revision in his contract.

Impact on Fertiliser Industry

  1. The idea of providing a subsidy is contrary to the overall trend in government policy of minimizing subsidies. The fertiliser industry has operated on the basis of subsidies for long, because the selling prices are determined by the government and they are not related to the cost of production. However, now, the government is trying to reduce fertiliser subsidy. The new Nutrient Based Subsidy Scheme (NBS) has been made applicable to all fertilisers, except urea, which is expected to be covered by this scheme from 1 April 2011.
  2. Fertiliser units will respond to pooling depending on how it impacts their profitability. For example:
    1. Under the current subsidy policy, the urea units will not be affected by pooling of gas prices, as their subsidy amount will be proportionately adjusted. However, when NBS is made applicable to urea units, their response will be similar to that of complex manufacturers discussed next.
    2. The manufacturers of complex fertilisers are covered by NBS, wherein they are given a fixed subsidy which is not related to their cost of production. They are allowed to fix their selling price within some guidelines. So, their cost of production will decrease or increase depending on how pooling affects their cost of gas. Thus, pooling could distort the competitive position of some of the complex fertiliser manufacturers. The aggrieved companies will resist the pooling scheme, and, if necessary, may seek legal intervention. In absence of suitable relief, they could curtail or even stop production.
  3. Such a move will have wide-ranging implications. It is not merely an issue of financial burden on either the government or the fertiliser industry. It is a question of sustainability of the farm economy. The old subsidy policy has led to stagnation in fertiliser output and skewed usage of fertilisers. It has resulted in excessive Nitrogen content in the soil and reduction of P, K, S and micro-nutrients. Thus, agricultural yields have suffered and the food grain production has fallen way behind the trajectory required to meet the future demand in the country. The new subsidy policy has tried to correct this situation by providing financial incentives to encourage the manufacture of non-urea fertilisers.
  4. If the pooling of gas prices results in reduced output of complex fertilisers, then it will undo the correction provided by NBS to improve agricultural production through balanced use of fertilisers. It may be noted that the NBS is a joint effort by the Ministries of Agriculture, Finance Fertilisers and Planning.
  5. The proponents of the pooling scheme may suggest that complex manufacturers be taken out of the sectoral pool for fertilisers, but this may not be easy. Many manufacturers of complex fertiliser also have urea units at the same location, with both types of units using gas. Hence, bifurcation of pooling within fertiliser sector may be complicated.

Non-economic units should not be encouraged

  1. The pricing formulae in India's long term LNG contracts are expected to set the fob price for LNG in 2014 between $ 12 & $ 14 per mmbtu, assuming JCC crude price at $ 95 / mmbtu; the ex-terminal sale prices would be at least $ 2 higher. At these high prices of LNG, new units in either the power or the fertiliser sectors can hardly be planned based wholly or predominantly on LNG. Pooling will, however, facilitate setting up such new units because the pooling mechanism will camouflage the high input costs. Other economic units will subsidise these congenitally un-economic units. In effect, pooling will drag the country back into the "high-cost economy" zone that prevailed prior to liberalization. This will not help reduce subsidies.
  2. The alternative for the power sector is to use coal, which is available in abundance in India and can also be imported economically. If they want to use LNG, then they will have to find innovative means of becoming competitive (other than pooling !).
  3. Similarly, the alternative for the fertiliser sector is to follow the global trend of setting up new units at overseas locations where gas is available cheap and in abundance. The government should provide enabling mechanisms to support such a move. An excellent example from the past is OMIFCO, which is a global scale export-oriented Urea plant set up in Oman by IFFCO and KRIBHCO, with buy back arrangement. More such units should be encouraged. This will ensure the desired fertiliser security at globally competitive prices.
  4. Pooling reduces transparency, and will prevent the consumers from recognizing the true cost of gas. They will indiscriminately consume the end products since they would not have to pay the full cost. Any policy that shields consumers from the real prices leads to distortions that keep increasing over time and finally become unbearable, as is the case with petroleum products today. In order to reduce the losses of oil marketing companies, the government has been compelled to free the prices of petrol so that the customers curtail their usage as crude oil prices rise. The reduction in demand will force the crude suppliers to hold the price line. The pooling of gas prices will prevent the market forces from operating and will encourage LNG suppliers to push up prices. This is clearly not desirable.

Regulatory Issues

  1. Government has enacted the PNGRB Act, which has the following purpose:
    "An Act to provide for the establishment of Petroleum and Natural Gas Regulatory Board to regulate the refining, processing, storage, transportation, distribution, marketing and sale of petroleum, petroleum products and natural gas excluding production of crude oil and natural gas so as to protect the interests of consumers and entities engaged in specified activities relating to petroleum, petroleum products and natural gas and to ensure uninterrupted and adequate supply of petroleum, petroleum products and natural gas in all parts of the country and to promote competitive markets and for matters connected therewith or incidental thereto."

  1. The pooling scheme has to comply with the provisions of the PNGRB Act, since it will be covered by the term "distribution, marketing and sale of petroleum, petroleum products and natural gas".
  2. The above purpose also states that the Board has "to promote competitive markets", and the "matters connected therewith or incidental thereto". This is amplified in Section 11, which describes the functions of the Board. Its very first responsibility is defined as: "The Board shall (a) protect the interest of consumers by fostering fair trade and competition amongst the entities;"
    Prima facie, the price pooling mechanism eliminates competition amongst the gas suppliers. It is not clear how this aspect will be dealt with.
  1. Section 11 (f) (iii) requires the Board to "monitor prices and take corrective measures to prevent restrictive trade practice by the entities". A "restrictive trade practice" has been defined in Section 2 (zi) as "a trade practice which has, or may have, the effect of preventing, distorting or restricting competition in any manner and in particular, (i) which tends to obstruct the flow of capital or resources into the stream of production, or (ii) which tends to bring about manipulation of prices, or conditions of delivery or to affect the flow of supplies in the market relating to petroleum, petroleum products or natural gas or services in such manner as to impose on the consumers unjustified costs or restrictions;"
    Those consumers who find that pooling leads to an increase in their average gas price may appeal to the Board on the grounds that the price pooling mechanism "tends to bring about manipulation of prices" and "impose(s) on the consumers unjustified costs". It is not clear how this aspect will be dealt with.

  1. An attempt to overcome these issues through a policy directive under section 42 may turn out to be contentious.

Market-determined approach is the best way forward

  1. The government's current policy thrusts and its commitments in the NELP contracts both are clearly in the direction of market-determined prices. A market-determined approach alone will, in the long run, allow the right balance between demand-supply and appropriate pricing, which in turn will ensure cost-effective usage of a resource and survival of India's fertilizer sector amid global competition. It will also ensure an appropriate return to the oil and gas sector to achieve further growth.
  2. Pooling of gas prices will mean taking two steps backwards from a market-determined approach to pricing. First, it will skew the use of gas through an artificially higher gas price due to high LNG pricing and, thus, discourage additional domestic fertilizer production. This could also raise the fertilizer subsidy burden for the government, and in effect lead to outflow of subsidy to the foreign suppliers of high cost LNG! Second, it will give a false sense of security to the domestic gas suppliers over pricing, which would encourage them to incur higher capital expenditure keeping in view higher gas prices. Such dichotomies will require ever more interventions which could spiral into an unmanageable situation.