The Hindu Business Line : Subsidies through sunset years

THE group pricing system for urea producers, which came into vogue in April 2003, aims to gradually tighten the purse strings on subsidy payments to the players and smoothen the path to eventual decontrol of the industry. The group-pricing regime takes players through a three-stage process over four years.

Given the enormity of the transition that some players have to handle during this period, only cost-efficient, gas-based producers may emerge unscathed from the change. Others may have a splash of red ink on their financials and may fall victims to the consolidation process that is likely to gather pace.

Stage I: Leeway to high-cost units

Stage I, which began on April 1, 2003, was relatively easy on the high-cost players. In this stage, units were classified into six groups based on the feedstock they used. For each group, a weighted average retention price was computed. This, then, was used to determine the subsidy per tonne payable to all the players in that group.

In Stage I:

Units get paid only a flat rate of subsidy per tonne of urea produced.

All producers were allowed to pass on all increases in input costs to the subsidy bill.

`Outliers', or units which deviated from the group price by more than 20 per cent, were partly compensated through a higher subsidy.

Units whose retention prices are lower than the `group price' are paid the actual retention price as subsidy.

The initial stages of group pricing are slightly harsh on the low-cost units. The Government mops up any savings reaped by these units through cost-cutting or productivity improvement measures. This meant that low-cost producers such as Tata Chemicals, Indo Gulf Fertilisers and GNFC faced a squeeze on realisations during this period.

Stage II: Tightening the belt

Stage II of the group-pricing regime, which is to begin from April 1, 2004, is expected to tighten the screws on the high-cost units. In this stage:

The `outliers' in each group will get no special treatment. This will mean cutbacks in subsidy paid to units such as RCF (Trombay), FACT (Kochi), Madras Fertiliser (Manali) and GSFC (Vadodara), which are the `outliers' in their groups.

The reimbursement for capital charges is set to be trimmed. This could reduce the annual subsidy receipts of Indo Gulf and Tata Chemicals by about Rs 10 crore and Rs 15 crore respectively, while Chambal Fertilisers could face a cut of about Rs 30 crore. This trimming of capital charges will not impact GNFC, with its fuel-oil-based unit.

Units are also expected to bring down their energy consumption levels, in line with norms already announced by the Government. Units that fail to bring their energy costs in line will have to absorb the additional costs without any subsidy support.

Stage III: The final step

Stage III of the group-pricing regime, originally slated to begin on April 1, 2006, marks the final phase of transition to a decontrolled regime. By this stage:

All units are expected to bring their costs in line with international efficiency norms.

Units using more expensive feedstock, such as fuel oil and naphtha, are expected to switch to such cheaper alternatives as natural gas or imported LNG. This stage may pose a significant challenge to players such as Duncans Industries, Zuari Industries, Madras Fertilisers and GNFC, which use non-gas feedstock to operate their urea units. Once cost structures are in line with the international standards, Indian producers of urea are expected to be able to compete freely with imported urea.

Over this period, the selling prices of urea, too, are expected to be hiked to import parity levels, so that the subsidy paid to producers can be whittled down and finally dispensed with.

Though the Government has announced the dates for Stages I and II of the group-pricing regime, it is yet to notify when producers will be required to make the transition to Stage III. But even if there is a delay in its implementation, the change appears inevitable.

Understanding the progress of the group-pricing regime and how it will impact individual players in the industry is crucial for investors in the stocks of companies producing urea. Stage I of the regime has already left a significant mark on both the revenues and profits of the players.

But high-cost units are likely to face their real test of survival in stage II, which is set to begin from April 2004. Given that it is likely to be the most trying phase of the transition to decontrol, the shape of things to come will be clearly evident when players begin to announce their first financials for the fiscal 2004-05.

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