New urea policy 2015: Positive for urea industry

New urea policy 2015: Positive for urea industry The Government of India (GoI) notified the New Urea Policy 2015 (NUP) on May 25, 2015 post Ratings approval by Cabinet Committee on Economic Affairs (CCEA) on May 13, 2015 which has principal objectives of maximizing domestic urea production and promoting energy efficiency in urea units to rationalize subsidy burden. The policy aims at reducing the pre-set energy consumption norms and it also incentivizes urea units to maximize their production at the same time. The NUP is effective from June 1, 2015 to March 31, 2019. The provisions of new pricing scheme (NPS) - III and modified NPS-III were applicable till May 31, 2015. The key parameters of NUP for existing gas based urea units are as under: August 10, 2015 Tightening of energy consumption norms to encourage energy efficiency The variation in the variable cost in urea manufacturing is the result of two factors: 1) gas cost which depends on the composition of domestic gas and re-gasified liquefied natural gas (RLNG) in overall gas usage and 2) conversion efficiency or energy consumption level measured in Gcal/MT of urea production. The gas cost was made uniform for all units with gas pooling mechanism approved by CCEA on March 31, 2015. Hence, the cost of production varies largely with the variation in energy consumption level. At present, the energy consumption level varies from 5.3 Gcal/MT to more than 8 Gcal/MT, based on different vintage and technology of the plant. For computation of subsidy, up to May 31, 2015 under NPS-III, the gas cost was entirely pass-through and the energy consumption level for the same was pre-set based on energy consumption of units during the year 2003 or norms of NPS II (2004-06) whichever was lower and did not factor in the actual energy consumption level in the recent past which had reduced for majority of urea units. The NUP has however, taken into account the actual energy consumption level for setting up the new norms. Further, the existing gas based urea units are classified into three groups based on the pre-set energy consumption norms of NPS-III. The energy consumption norms under the new policy have been revised as follows. Energy consumption norms Exhibit 1: Energy consumption norms under NUP From Jun 1, 2015 to Mar 31, 2018 From April 1, 2018 to Mar 31, 2019 Minimum of; 1. Average of pre-set energy norms of NPS-III and actual energy consumption of FY12 to FY14 2. norms of NPS III Group I 5.5 Gcal/MT Group II 6.2 Gcal/MT Group III 6.5 Gcal/MT Source: Notification no.12012/1/2015-fpp, GoI, Ministry of Chemicals & Fertilizers (MoCF) dated May 25, 2015, NUP 1

The details of the energy consumption norms under NPS-III and indicative figure for NUP are given below: Group I norms between 5 Gcal/MT to 6 Gcal/MT Group II norms between 6 Gcal/MT to 7 Gcal/MT Group III norms more than 7 Gcal/MT Exhibit 2: Details of energy consumption norms for existing urea units Units Earlier preset energy norm as per NPS - III Energy consumption achieved during 2011-12 2012-13 (Gcal/MT) Revised energy consumption norm under NUP for the period *June 1, 2015 to April 1, 2018 to March 31, 2018 March 31, 2019 NFL - Vijapur I 5.952 5.840 5.863 5.902 5.500 NFL - Vijapur II 5.712 5.449 5.472 5.586 5.500 KRIBHCO Hazira 5.952 6.342 6.048 5.952 5.500 Indo-gulf Jagdishpur 5.874 5.372 5.488 5.652 5.500 IFFCO - Aonla I 5.938 5.666 5.635 5.794 5.500 IFFCO - Aonla II 5.660 5.571 5.369 5.565 5.500 KSFL - Shahjahanpur 5.712 5.564 5.575 5.641 5.500 CFCL - Gadepan I 5.712 5.510 5.595 5.632 5.500 CFCL - Gadepan - II 5.678 5.365 5.398 5.530 5.500 TCL Babrala 5.417 5.309 5.218 5.340 5.417 NFCL - Kakinada I 5.712 5.646 5.585 5.664 5.500 NFCL - Kakinada - II 5.712 5.591 5.613 5.657 5.500 IFFCO - Phulpur II 5.883 5.545 5.713 5.756 5.500 IFFCO Kalol 6.836 5.906 5.787 6.341 6.200 GSFC Baroda 6.935 6.623 6.510 6.751 6.200 RCF Thal 7.004 6.356 6.728 6.773 6.200 GNVFC Bharuch 7.989 7.905 7.571 7.989 7.989 / 6.200 NFL Nangal 9.517 9.433 9.524 9.517 9.517 /6.500 NFL Panipat 9.654 9.995 10.698 9.654 6.500 NFL Bhatinda 10.221 9.825 10.039 10.221 6.500 ZACL Goa 7.585 6.835 6.948 7.585 6.500 SFC Kota 7.847 7.333 7.338 7.591 6.500 RCF - Trombay V 9.589 7.423 7.437 8.510 6.500 IFFCO - Phulpur I 7.847 6.632 6.682 7.252 6.500 KFCL Kanpur NA Source: Indian Fertilizer Scenario 2013, Department of Fertilizer (DoF), NA not available NFL National Fertilizer Ltd, KRIBHCO Krishak Bharti Cooperative Ltd, Indo-gulf Indo Gulf Fertilizers Ltd, IFFCO Indian Farmers Fertilizers Cooperative Ltd, KSFL KHRIBHCO Shyam Fertilizers Ltd, CFCL Chambal Fertilizers & Chemicals Ltd, TCL Tata Chemicals Ltd, NFCL Nagarjuna Fertilizers & Chemicals Ltd, GSFC Gujarat State Fertilizers & Chemicals Ltd, RCF Rashtriya Chemicals & Fertilizers Ltd, GNVFC Gujarat Narmada Valley Fertilizers & Chemicals Ltd, ZACL Zuari Agro Chemicals Ltd, SFC Shriram Fertilizers & Chemicals Ltd, KFCL Kanpur Fertilizers & Chemicals Ltd *indicative only as average of FY12 and FY13 was considered as actual energy consumption for FY14 for all units were not available in public domain. For units, which have implemented feedstock conversion projects or have undertaken energy savings/debottlenecking projects, the actual energy consumption level was lower in FY14 and FY15. Some units which have already implemented such projects, the actual consumption level was also much lower in FY12 and FY13 as compared to pre-set norms. The units which are not connected to gas grid and use naphtha as feedstock such as Madras Fertilizers Ltd (MFL) Manali, Manglore Chemicals & Fertilizers Ltd (MCFL) Bangalore, Southern Petrochemicals Industries Corporations Ltd (SPIC) Tuticorin are not covered in NUP. Further, Brahmaputra Valley Fertilizers Corporation Ltd (BVFCL) Namrup II and III units are also not covered under NUP. New urea policy 2015: Positive for urea industry 2

The units which have converted their feedstock base from fuel oil/low sulphur heavy Stock (FO/LSHS) to gas, i.e. NFL Bathinda, Nangal & Panipat and GNVFC Bharuch and units have which have converted their feedstock base from naphtha to gas, i.e. ZACL Goa and KFCL Kanpur, will have the energy consumption norms of NPS - III till they recover the project cost subject to a cap of five year from date of conversion, to recover the project cost from energy savings and capital subsidy (where applicable), which is likely to be completed by 2018-19. Impact on units from June 1, 2015 to March 31, 2018 The energy consumption norms for group III and group II units are expected to be tightened by a higher degree than group I units, except for units which have undertaken feedstock conversion projects. Hence, the extent of profit on energy savings in future would be driven by their ability to reduce energy consumption level. However, actual energy consumption for many units is still lower than the revised norms under NUP and hence, would continue to earn reasonable profits through energy savings. The energy consumption norms for group I units are likely to be tightened marginally for almost all units. Further, the actual energy consumption level is already lower for majority of units than the revised norms and would continue to earn reasonable profit through energy savings. Impact on the units from April 1, 2018 to March 31, 2019 During this period all units will be subjected to a common group benchmark level. For group III, the benchmark level is expected to be substantially lower than the likely norms of previous period (Jun 1, 2015 to Mar 31, 2018). For group II, the benchmark level is expected to be reduced by lesser degree as compared to group III. The units which have undertaken feedstock conversion project under group II and group III would also be subjected to the same norms as their five year period for the reimbursement of project cost would be completed by early part of FY19. Hence, the actual consumption level achieved by the same time period would be crucial for any energy savings. For majority of units under group II and group III, energy saving projects need to be undertaken to achieve the target group benchmark energy consumption level. For majority of units under group I, the norms are likely to be tightened marginally from previous level and few units at present also have actual consumption lower than the applicable norms. The policy decision is likely to result in lower subsidy outgo by Rs.2,618 crore as estimated by Department of Fertilizers (DoF), and also incentivize units to reduce their energy consumption. Further, with common New urea policy 2015: Positive for urea industry 3

group benchmark level from April 1, 2018, the energy efficient units would benefit to a greater extent and will lead to improvement in overall energy efficiency of all units. All urea units likely to benefit for the production beyond reassessed capacity The NUP has modified the subsidy applicable for production beyond the reassessed capacity (RA) which is shown below: Exhibit 3: Modification in subsidy for production beyond reassessed capacity Subsidy for production beyond its reassessed capacity (RA) NPS III Beyond 100% RA and up to 110% of RA Gain sharing between Government and unit in the ratio of 65:35 with respect to IPP subject to concession rate Beyond 110% RA and up to cut-off level At concession rate subject to cap of IPP Beyond cut off level At 85% of IPP NUP Minimum of: 1. Variable cost + uniform per MT incentive equal to lowest of the per MT fixed cost of all the indigenous urea units 2. IPP+ weighted average of other incidental charges which government incurs on imported urea Source: Notification no.12012/3/2010-fpp (II), GoI, Ministry of Chemicals & Fertilizers dated April 3, 2014, modified NPS-III, Notification no.12012/1/2015-fpp, GoI, Ministry of Chemicals & Fertilizers dated May 25, 2015, NUP Note - The RA and cut off-level for all domestic manufacturing units under NPS III are given in Exhibit 4. The RA capacity under NUP remained the same as per Urea investment policy (UIP) 2008. Concession rate is reimbursement over and above farm gate price based on the retention price, which is equal to variable cost (feedstock cost, power, water, etc.) and fixed cost (includes return on net worth, interest, salaries, repair and maintenance, etc.) Under NUP, the provision of sharing of gain with GoI in ratio of 65:35 for production from 100% RA to 110% of RA is removed which is expected to improve profitability of all units which produce more than the RA. The production beyond 100% RA had become less profitable for many units under NPS-III in FY14 due to decline in international prices of urea (realization linked to 85% of IPP) and inadequate availability of domestic gas leading to use of R-LNG which increased the cost of production. Some units with higher energy consumption level or with higher average cost of gas also stopped production beyond cut off level which could be seen below (Exhibit 4) and which led to increase in import to that extent. New urea policy 2015: Positive for urea industry 4

Exhibit 4: Reassessed capacities and actual production ( 000 MT) Units Reassessed capacities Capacity post revamp projects Target production for receiving IPP based price beyond cut-off quantity under NPS-III Actual production in FY12 FY13 FY14 Group I norms between 5 Gcal/MT to 6 Gcal/MT Group II norms between 6 Gcal/MT to 7 Gcal/MT Group III norms more than 7 Gcal/MT NFL - Vijapur I 864 1,000 951 902 966 1,007 NFL - Vijapur II 864 1,066 951 1,012 965 1,162 KRIBHCO Hazira 1,729 2,195 1,902 1,432 2,132 2,210 Indo-gulf Jagdishpur 865 1,073 1,040 1,163 1,085 1,033 IFFCO - Aonla I 865 1,000 964 1,066 1,092 1,103 IFFCO - Aonla II 865 1,000 962 987 1,153 1,075 KSFL Shahjahanpur 864 864 955 1,016 1,008 1,036 CFCL - Gadepan I 864 1,023 992 1,107 1,036 991 CFCL - Gadepan - II 864 990 951 1,016 1,056 951 TCL Babrala 864 1,155 1,005 1,165 1,120 1,138 NFCL - Kakinada - I 597 767 753 793 788 648 NFCL - Kakinada - II 597 753 722 769 778 780 IFFCO - Phulpur - II 865 1,000 992 1,133 992 951 IFFCO Kalol 545 545 599 600 600 601 GSFC Baroda 371 371 408 287 348 323 RCF Thal 1,707 2,001 1,877 1,773 1,952 1,994 GNVFC Bharuch 636 636 710 702 709 696 NFL Nangal 479 479 536 503 471 395 NFL Panipat 512 512 564 500 414 512 NFL Bhatinda 512 512 563 483 394 561 ZACL Goa 399 399 461 365 386 377 SFC Kota 379 379 417 386 385 404 RCF - Trombay V 330 330 363 336 384 353 IFFCO - Phulpur I 551 698 611 701 673 652 KFCL Kanpur NA Source: DoF, Fertilizer Association of India, UIP-2008, NA Not available Note - As per the UIP-2008 for units which undertook revamp projects, the urea produced from existing units beyond their RA under NPS or maximum achieved capacity by a unit for 330 days during 2003-2007 whichever is higher (cut-off quantity) is recognized as the production under revamp of the existing unit. The realization for this urea is at a rate of 85% of IPP of urea subject to a floor of USD 250/MT and a ceiling of USD425/MT as opposed to that on a retention price basis for urea below cut-off quantity. The urea produce under revamp quantity is only eligible for these realizations once the total production crosses 105% of the cut-off quantity or 110% of RA, whichever is higher. However, there are some positive developments on this front. With approval of gas pooling, the input gas cost has been made equal for all units. The spot R-LNG price has reduced in recent past. And under NUP, GoI has modified the reimbursement mechanism for production beyond RA with introduction of a fixed component and increase in cap to 100% of IPP plus other charges on imports incurred by GoI. New urea policy 2015: Positive for urea industry 5

The lowest fixed cost component could be taken as Rs.2,300 per MT (as per NPS-III) which units would receive apart from variable cost subject to a cap of IPP and other charges on imports. The IPP of urea is expected to be around USD 300/MT in near term due to reduced cost of gas and increase in capacity in recent times which lead to surplus availability in international market. The other incidental charges which GoI incurs on imported urea (which includes transportation and port charges) could be taken at around USD 25 per MT. The pooled price of gas is also critical as it would determine the benefit available to urea units, for production beyond RA, assuming that pooled gas price is allowed for the same. In NPS-III, APM gas was not allowed for production beyond RA, however other categories of gas (Pre- NELP, NELP, contracted gas) were allowed for the same. The impact for the production above the 100% RA/cut-off level could be shown with different level of energy consumption and gas cost as below: Exhibit 5: Impact on contribution margin - Scenario I Energy consumption (Gcal/MT) 5.50 Gas cost (USD/mmbtu) 9 10 11 Variable cost 13,200 14,600 15,900 Urea IPP (USD/MT) 275 300 325 275 300 325 275 300 325 NUP (above 100% RA) 100% IPP+ 25 USD /MT (import charges) (USD/MT) 300 325 350 300 325 350 300 325 350 Urea realization 18,000 19,500 21,000 18,000 19,500 21,000 18,000 19,500 21,000 4,800 6,300 7,800 3,400 4,900 6,400 2,100 3,600 5,100 Allowable contribution margin 2,300 2,300 2,300 2,300 2,300 2,300 2,100 2,300 2,300 NPS - III (above cut off level) 85% IPP 234 255 276 234 255 276 234 255 276 Urea realization 14,025 15,300 16,575 14,025 15,300 16,575 14,025 15,300 16,575 825 2,100 3,375 (575) 700 1,975 (1,875) (600) 675 New urea policy 2015: Positive for urea industry 6

Exhibit 6: Impact on contribution margin - Scenario II Energy consumption (Gcal/MT) 6.50 Gas cost (USD/mmbtu) 9 10 11 Variable cost 15,500 17,100 18,700 Urea IPP (USD/MT) 275 300 325 275 300 325 275 300 325 NUP (above 100% RA) 100% IPP+ 25 USD /MT (import charges) (USD/MT) 300 325 350 300 325 350 300 325 350 Urea realization 18,000 19,500 21,000 18,000 19,500 21,000 18,000 19,500 21,000 2,500 4,000 5,500 900 2,400 3,900 (700) 800 2,300 Allowable contribution margin 2,300 2,300 2,300 900 2,300 2,300 (700) 800 2,300 NPS - III (above cut off level) 85% IPP 234 255 276 234 255 276 234 255 276 Urea realization 14,025 15,300 16,575 14,025 15,300 16,575 14,025 15,300 16,575 (1,475) (200) 1,075 (3,075) (1,800) (525) (4,675) (3,400) (2,125) Exhibit 7: Impact on contribution margin - Scenario III Energy consumption (Gcal/MT) 7.00 Gas cost (USD/mmbtu) 9 10 11 Variable cost 16,600 18,400 20,100 Urea IPP (USD/MT) 275 300 325 275 300 325 275 300 325 NUP (above 100% RA) 100% IPP+ 25 USD /MT (import charges) (USD/MT) 300 325 350 300 325 350 300 325 350 Urea realization 18,000 19,500 21,000 18,000 19,500 21,000 18,000 19,500 21,000 1,400 2,900 4,400 (400) 1,100 2,600 (2,100) (600) 900 Allowable contribution margin 1,400 2,300 2,300 (400) 1,100 2,300 (2,100) (600) 900 NPS - III (above cut off level) 85% IPP 234 255 276 234 255 276 234 255 276 Urea realization 14,025 15,300 16,575 14,025 15,300 16,575 14,025 15,300 16,575 (2,575) (1,300) (25) (4,375) (3,100) (1,825) (6,075) (4,800) (3,525) Thus under NUP, all units are likely to largely benefit for the production above 100% RA as compared to NPS-III, especially the less energy efficient units. However, GoI has also limited the upside benefit upto fixed contribution (~Rs.2,300 per MT). The contribution would be lower than what some urea units earned for production above 100% RA over the past few years due to high international prices with no cap to upside gain and access to low cost gas. However, units are still expected to earn reasonable profit in scenario of reduced international prices. New urea policy 2015: Positive for urea industry 7

Units which have revamped their capacities tend to gain more under this policy Under Urea Investment Policy (UIP) - 2008, 14 units had undertaken revamp projects with total capacity of 2.75 million metric tonne per annum (MMTPA) which represent around 10% of domestic urea manufacturing capacity. The revamped capacity is entitled for IPP linked realization and hence, such units have earned healthy profit till FY13 due to high international prices of urea. The extent of benefit from production above RA thus would be more under NUP for units which have undertaken revamp projects as entire revamped capacity would be entitled for fixed contribution. The details of the units which have undertaken revamp projects are given in Exhibit 4. The policy is thus beneficial to both GoI and industry. The energy efficient units with pooled gas price now would be able to compete against imports, produce more and earn reasonable fixed contribution. Further, the subsidy outflow for the GoI would not exceed opportunity cost of imports. Conclusion CARE believes that overall impact of NUP would be positive on the fertilizer industry. For GoI, the NUP is expected to bring benefits of subsidy rationalization and maximization of domestic production, thus reducing reliance on imports. Further, the policy is also expected to reduce complexity in implementation of previous policies. With tightening of energy consumption norms for urea units, the profit on energy savings would be driven by their ability to reduce energy consumption level. Many units would still earn reasonable profit on energy saving even with tightening of norms. The policy for production above RA is also likely to be positive for all urea units as it entitles units for a fixed contribution, subject to a cap of IPP of urea plus other incidental charges. Thus, energy efficient units would be able to compete against imports and produce more which would improve their cash flows. Contact: Naresh M. Golani Kaushal Vaidya Sr. Manager Dy. Manager Naresh.golani@careratings.com Kaushal.vaidya@careratings.com 91-079-4026 5618 91-079-4026 5668 Disclaimer This report is prepared by Credit Analysis & Research Limited (CARE Ratings). CARE Ratings has taken utmost care to ensure accuracy and objectivity while developing this report based on information available in public domain. However, neither the accuracy nor completeness of information contained in this report is guaranteed. CARE Ratings is not responsible for any errors or omissions in analysis/inferences/views or for results obtained from the use of information contained in this report and especially states that CARE Ratings has no financial liability whatsoever to the user of this report. New urea policy 2015: Positive for urea industry 8