ICRA's review of new urea investment policy 2012

ICRA Research has come out with its report on new urea investment policy 2012.

• Clarity on gas price pass-through in New Urea Investment Policy to incentivise capacity additions of 8-10 MMTPA over the next 5 years
• New R-LNG projects and anticipated pick up in domestic gas availability over the next 4-5 years should enable gas tie-ups
• Credit profile of urea players undertaking expansion projects will be influenced by the funding mix adopted

• The recently announced New Urea Investment Policy benchmarks realisation of urea for new projects to import parity prices (IPP), subject to floating floor and ceiling prices, which are, in turn, linked to gas prices. As per the policy, the floor-cap prices of urea increase in line with the gas prices till the gas price of US$ 14/mmbtu, beyond which the units shall be paid only the floor price based on the delivered gas prices irrespective of the prevailing IPP and the concept of ceiling price will not be applicable. The pricing structure leads to an implicit pass-through of gas prices while providing reasonable returns to the investors.
• Production of urea in India has been stagnant since FY2001 due to lack of an encouraging policy framework. Consequently, India’s dependence on imports has increased to the extent of 27% in FY2012 from nil imports in FY2001. This has led to increase in the subsidy burden on the Government of India (GoI). The policy should help reduce subsidy outflows as reliance on imports would reduce and international prices may also correct due to lower demand from India.
• The new policy is in line with the demand of the industry to do away with the gas price ceiling of US$ 14/mmbtu in the earlier proposed policy. Further, it provides downside risk protection through a cost-plus mechanism (minimum implicit RoE of 12%) and upside benefit through import parity price (IPP)-linked pricing mechanism (with a maximum implicit RoE of 20%) for new projects.
• Given the clarity on gas price pass-through, ICRA expects at least 5-6 greenfield / brownfield projects to materialise in the near future. The policy may help creation of incremental capacities to the extent of 8-10 million metric tonnes per annum (MMTPA) over the next 5 years.
• As the plants get commissioned over the next 3-4 years, improvement in domestic gas availability and improvement in R-LNG infrastructure leading to R-LNG tie-ups should enable long-term gas tie-ups for these new projects.
• Currently, GoI is paying a significant subsidy (~Rs. 17,435 crore in FY12) for imported urea. While the GoI may have to provide higher subsidy in a scenario of high gas prices and low IPP, ICRA expects that the same would be true only during the interim period while these capacities are being created. Increase in domestic capacities is expected to lead to decline in import dependence of urea, which should lead to moderation of global urea prices. Further, improvement in gas availability should lead to reasonable gas prices, thereby leading to lower urea realisations and correspondingly, lower subsidy. All these factors are expected to lead to decline in subsidy outflow from GoI for urea in the long term.
• Decline in subsidy outflow should also lead to lower subsidy receivables for the urea players, which should lead to an improvement in the working capital cycle of these players and decline in interest costs for the working capital borrowings, which have been high for the industry has faced in the recent past.
• Incumbents going for brownfield / greenfield projects will need to undertake substantial investments, which would affect the capital structure of the companies depending on the funding mix adopted.
• Overall, the new investment policy is favourable for the domestic urea industry, given the importance of attaining self-sufficiency in urea for the country. The policy provides a more transparent mechanism for managing the high gas prices, which are likely to be faced by the domestic industry on account of structurally high R-LNG prices in case of lack of domestic gas availability.

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