Fertile matters: Urea, DAP

Fertiliser industry has played a key role in the development of agriculture in the country. Demand for fertilisers is derived from the need to improve crop yields in order to feed an ever growing population and help attaining the all-important food security.
Total nutrient consumption in the country has grown at an average annual rate of 5 percent over the last two decades to 4.4 million tons. In terms of global consumption, Pakistan seems pretty advanced as application per hectare of arable land at 184kg/ha is 28 percent higher than the global average and at par with consumption in high income countries.
Fertiliser consumption in Pakistan is highly skewed towards Nitrogen (N), owing to high usage of urea. Of the total fertiliser consumed, urea accounts for a sizable 72 percent, easily making it the apex fertiliser in the country. The high alkalinity of Pakistans soil and cheaper availability of urea compared to other fertilisers, particularly phosphates (P), has aided the demand tilt towards N. The N:P ratio in FY10 was at 4.0x while the ten year average has been 3.7x, far greater than the desirable ratio of 2.5-3.0x.
Urea demand in the country has grown at 5 percent per annum over the last decade, reaching 6.1 million tons in 2010, while production has increased by just 3 percent per annum over the corresponding period to 5.1 millionn tons, making the country a net importer of urea. Pakistan is expected to remain a net urea importer in the foreseeable future as despite the two new expansions of Fatima (0.5mn tpa) and Engro (1.3mn tpa), gas curtailment coupled with growing demand for urea will keep indigenous production in deficit to demand.
Gas price plays the most important role in determining pricing of urea in Pakistan, which are de-linked from the international urea prices with domestic urea trading at a historical discount of 20 percent to international prices.
Factors contributing to this discount are i) lower gas prices, particularly feed stock (raw material for urea) and ii) PKR depreciation, making imported urea dearer. Feedstock gas has historically been priced at 65 percent discount to fuel stock or heating gas, which has drawn considerable ire from other manufacturing industries.
DAP: PLAYING SECOND FIDDLE TO UREA Di Ammonium Phosphate or DAP is the second most popular fertiliser in Pakistan accounting for 15 percent of total fertiliser off-take. However, the demand dynamics of DAP are much more volatile when compared to urea largely due to the fact that DAP prices follow international price as domestic production caters to just 40 percent of total consumption.
Additionally, DAP is a more expensive fertiliser (~2.5x times of urea), making demand much more price elastic. Fauji Fertilizer Bin Qasim (FFBL) is the sole manufacturer of DAP in the country, located in the port city of Karachi as the major raw material of DAP, phosacid, has to be imported, as opposed to urea where natural gas is the major raw material.
Demand drivers for DAP are, i) differential between DAP and urea prices, ii) GoP direct subsidy and iii) wheat support price. Greater the differential, more likely is the farmer to substitute DAP with urea. In order to promote balanced fertiliser application, the GoP provided direct subsidy on DAP during CY06-08 period. The subsidy was removed following the crash in DAP prices post the financial crisis of 2008, while a tight fiscal situation these days has curtailed GoPs ability to subsidise DAP.
Wheat support price is also an important determinant of DAP application as wheat is the only major Rabi crop, and a higher support price would encourage greater cultivation of wheat. DAP demand is at its peak during October-December, accounting for 52 percent of annual off-take as it is during this period where most of the wheat sowing takes place.
ENVIABLE PRICING POWER Fertiliser has been one of the most profitable sectors in Pakistan, with overall profitability growing at a 10-year CAGR of 37 percent, while in terms of Return on Equity (ROE), the sector has consistently outscored KSE ex-financials. Thanks to strong urea pricing power, fertiliser sector net margins have been considerably higher than KSE ex-financials.
Despite the low asset turnover (fertiliser plants are capital intensive) and leverage, it is the superior net margins that have helped fertilisers ROE to continually outpace that of KSE ex-financials. Factors that have continued to augment fertiliser manufacturers pricing power have been i) net importer of fertilisers, ii) domestic urea being sold at considerable discount to international price, and iii) oligopolistic situation in the urea industry whereby two major groups, Fauji and Dawood together operate 83 percent of industry capacity, making it easy or concerted price increases, as was witnessed recently when all the manufacturers unanimously raised urea prices by PKR190/bag in response to the gas curtailment.
GAS CURTAILMENT The gas crisis in Pakistan has been getting graver by the year. Gas production in the country is not enough to meet increasing demand for a nation that has been hooked on to cheap supply of gas for decades. The gas crisis is threatening to turn into a gas famine as two of the countrys major fields Sui and Qadirpur are already on their decline stage. The situation is further compounded by the fact that exploration and development activities of the countrys biggest E&P company; OGDC has been curtailed by the circular debt.
Fertiliser sector is no longer an exception to the gas crisis. Plants on the Sui network are scheduled to face 20 percent gas curtailment, effectively translating into a loss of 20 percent of production. The gas curtailment on Sui network is significant given the fact that Engros new urea plant will be supplied gas via the Sui grid, effectively killing the prospects of urea overcapacity in the country.
Urea manufacturers on the Mari network accounts for 54 percent of industry capacity are still relatively better off as they will face curtailment of up to 10 percent. Unlike the Sui network, which transports gas to all the three major consumer segment i.e. households, industries, and power generation plants, Mari network supplies gas almost exclusively to the fertiliser industry with the Guddu power plant being the only non-fertiliser consumer of Mari, thus leaving little room to channel supplies elsewhere.
Fertile matters: Urea, DAP

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Gas curtailment impact on Urea demand deficit:

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(000 tons)              CY11     CY12     CY13     CY14     CY15

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a.) Urea demand        6,338    6,559    6,789    7,027    7,273

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With out Gas curtailment

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b.) Production         6,822    6,822    6,822    6,822    6,822

Deficit (b - a)          484      263       33     (205)   (451)

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With Gas Curtailment

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c.) Production         5,782    5,933    5,933    5,933    5,933

Deficit (c - a)         (556)    (627)    (856)  (1,094) (1,340)

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