Hike in gas tariffs: an analysis

As their parting gift, before they left, Caretakers have increased gas prices again to comply with the IMF (International Monetary Fund). Rationalizing gas prices is the right move to end the growth of the gas circular debt, as the last round of hike price was not enough. There is a socioeconomic limit to the increase in the residential segment where the increase is ranging from 5 to 67 percent in various slabs with a higher impact to be felt on the lower income groups.

The prices for the commercial segment were already high and there is no change there while the prices of bulk consumers are raised again. However, the above-mentioned increases in prices have not been enough to end the circular debt growth; hence the prices for industries and fertilizer manufacturers had to be increased as well.

However, the industry is losing competitiveness and cannot take any further burden of cross subsidy. Hence, the increase is mainly for captive users, and the discrimination of exporting and non-exporting sector has ended. That is a good move.

To balance the equation, the principal decision is to have uniform pricing for fertilizer manufacturers where the price variation was huge for production of an almost homogenous product (Urea). Here the price increase is massive. However, there is no check on the price and margin control of fertilizer companies who have historically not passed on the full benefit of low prices to farmers. In fact, in the case of increase in prices, some companies may see windfall profits.

These companies are enjoying over 30 percent gross margins, which are much higher than those in other countries. The point to raise here is that profits and margins of these companies should be regulated as the sector is protected and the chief raw material (gas) is provided at a cheaper rate to ensure fertilizer prices are lower.

These are big companies and have entry barriers. Thus, suppliers are big while buying power of individuals (the farmer) is low, and there is no substitute of the product available in the market. These are key ingredients for companies to form cartels and extract the benefit from buyers (farmers).

It appears that the increase in fertilizer prices is likely to have undue increase in the profitability of two companies – Engro fertilizer and Fatima fertilizers. Partial gas supply of these companies is already on the Power Policy 2012 and are already paying top price. With recent increase, their weighted average cost increase would be less than others’ (such as Fauji Fertilizer) and they may increase the prices as much as Fauji Fertilizer, which will swell the gross margins of these companies further. That should not happen.

The above-mentioned argument assumes that Mari gas prices which supplies mainly to Fauji Fertilizer will increase in line with the increase in pipeline gas supply to others. The notification is awaited. If the Mari gas price increase does not happen soon, then the beneficiary would rather be Fauji Fertilizer, as the company could increase the price in line with the increase by others whereas there is no increase in the cost.

Clarity is warranted, as one or the other fertilizer manufacturer would make extra profits based on the revised gas prices where the objective is to end the circular debt. Apart from this, there is another issue. If the gas prices are lower than the cost of Sui companies, the circular debt is formed and that has to be covered by the federal government. However, if the gas prices are higher than the cost, the extra profit goes to the provinces in the form of Gas Development Surcharge (GDS).

There are two issues. One is that fertilizer companies may benefit from higher cost as the overall price increase in Urea is higher, which is to be borne by farmers and eventually to be translated into food inflation. The other is that gas subsidies are a liability of the federal government while the surplus is enjoyed by provinces.

These lopsided incentives should be corrected. The next step is to regulate the margins of the fertilizer companies. They should move to the tolling model by having gross margins capped on per ton urea basis – similar to the Indian model. There must be a fixed gross margin regime to ensure the benefit of gas prices to be fully passed on to the farmers.

As of now, the concern is inflationary impact of gas prices where the direct impact of increase in domestic consumers is not much. But the fertilizer price increase could have a secondary round. This creates doubt about stock brokers’ forecast of inflation coming down significantly in the next few months.

Copyright Business Recorder, 2024