A steep fall in gas prices in sync with crude oil will reduce the urea subsidy bill of the Government of India by a fourth, or over Rs 12,000 crore, this fiscal. That will keep a leash on the working capital requirement of urea makers.

Earlier, in March 2020, the government had agreed to the long-pending demand of reimbursement of ‘additional fixed cost¹’. This will lead to a one-time relief of about Rs 5,000 crore and, going forward, an annual inflow of ~Rs 850 crore for all urea makers.

Both cheaper gas and additional cost recovery will support the credit profiles of urea makers. In addition, demand for urea would be stable even as most other sectors reel under the severe demand shock wrought by the Covid-19 pandemic.

CRISIL expects the prices of natural gas, which is feedstock for urea plants and accounts for 75-80% of their total cost, to be 25-30% lower on-year this fiscal.

Urea is a regulated commodity with its retail selling price (RSP) fixed by the government. To incentivise farmers to use fertilisers for better crop yield, the government keeps the RSP significantly lower than the market rate and reimburses the deficit to urea makers through subsidy payments.

While lower cost of gas is a pass-through for urea makers and won’t impact their profitability, it will reduce the government’s subsidy bill. That, in turn, will cull both revenue and receivables of urea makers.

Says Sachin Gupta, Senior Director, CRISIL Ratings, “Lower gas prices will certainly ease the working capital pressure on urea makers. Despite implementation of the direct benefit transfer scheme, large subsidy arrears² continue to be a structural issue, which has elongated the working capital cycle of urea makers, as reflected in an increase in receivable days to 180-200 days (as on March 31, 2020) from 140-160 days (March 31, 2018).”

Another positive for urea makers is the clarity the government has finally provided in March 2020 on reimbursement of additional fixed cost. Earlier, this was done based on cost estimates as on March 31, 2003, which did not reflect any increase in cost thereafter, and led to lower operating profits for urea makers. Now, the government has allowed the calculation to be based on March 31, 2013, estimates, which will lead to obvious benefits.

Says Nipun Anand, Associate Director, CRISIL Ratings, “The reimbursement of additional fixed cost of Rs 850 crore will be tantamount to 10-12% of the current operating profits of urea makers. That, along with the Rs 5,000 crore arrears from fiscal 2015 can potentially cut down the industry’s total working capital debt by 8-10%.”

The lockdown has not impacted the offtake of urea for the kharif season much. Urea makers have reported steady production and sales numbers³ for April and May. The recent proposals under the Aatma Nirbhar Bharat package for the agriculture sector also augur well for urea demand.

Besides steps such as attracting investments in the farm sector and amendments in the agricultural produce marketing committee or APMC legislations are aimed at better price realisation for the farmers. These measures can increase the income levels for farmers and should be positive for agriculture-linked sectors such as fertilisers.

That said, timely disbursement of subsidy and additional fixed cost will be the key monitorables given the pandemic-triggered fiscal strain on the exchequer.

¹ This decision was taken way back in April 2014 but could not be implemented because of some ambiguity. The government put out a notification on March 13, 2020, clarifying this. Now, an additional fixed-cost reimbursement of Rs 350 per metric tonne will be paid to all urea manufacturing units and another Rs 150 per metric tonne to plants that have completed 30 years of operations.
² Fertiliser subsidy arrears were estimated to be over Rs 45,000 crore (indigenous and imported urea, and complex fertilisers) as on March 31, 2020.
³ As per data available in Fertiliser Monitoring System.