Fertilizer: a subsidy for dealers?

For a very long time, the government has been supplying gas at a subsidized rate to fertilizer companies (mainly to urea manufacturing plants where natural gas is the chief raw material), to provide fertilizer at a cheaper rate to farmers to ensure food affordability and security in the country. However, the full benefit of low gas prices is not being passed on to the farmer, as fertilizer companies in Pakistan have historically made abnormal profits (relative to similar businesses in other countries).

Experts are raising questions on the mode of the subsidy–some suggest that a better model could be to provide direct subsidy to the farmers. However, given the poor governance in the country, policymakers fear that model could fail – as is the case of providing direct subsidy on DAP fertilizer. The use of technology and other innovative methods can improve governance, and that topic requires some deliberation.

This article highlights the growing delta between the urea market price (at which farmers buy) to the dealer transfer price (at which fertilizer companies sell), and today, local urea prices are almost at par with the international prices, while the major benefit of low gas prices is in essence being accrued by dealers (the middlemen).

The urea dealer transfer price per 50 kg bag ranges from Rs3,300 to Rs3,500 (avg is approx. Rs3,400) and the latest market price ranges between Rs4,900 and Rs5,300. The usual profit of a dealer is Rs150-200, and at the prevailing rates, dealers are making profit of Rs1,500. There is no rational reason for such hike in prices and dealers are not paying any tax on the exuberant income – unlike the fertilizer companies which pay full income tax on their abnormal profits.

That is the worse outcome. Dealers say that the prices are increasing due to shortage, as the urea stock (inventory with fertilizer companies) in November is at the second lowest (120k tons) of the last ten years during high demand wheat sowing season.

The general perception is that shortage is due to smuggling of urea to Afghanistan and beyond to the Central Asia. Thus, part of gas subsidy is enjoyed by importing countries at the expense of Pakistani taxpayers and farmers. And the shortage shall be met by importing Urea or gas (RLNG) to make urea at home. In both cases, the government (taxpayers) is providing subsidies.

Government, farmers, and taxpayers are the losers in this game while dealers are the key beneficiaries. No one knows how much inventory dealers hold – either they are hoarding in or have smuggled out. Without a robust track and trace system, there is no way to track the stocks, and dealers resist its implementation.

That is the stock of the situation. Farmer is paying high price while fertilizer companies and middlemen are accruing profits. With domestic prices converging to the international rates, one simple solution is to increase the gas price for fertilizer companies to bring the dealer transfer price close to the market price.

The point is that farmers are already paying high price, it is optimal to increase the gas price to pass on the benefit to government of Sindh and companies involved in the gas supply value chain. And the federal government must provide lower subsidy on imported Urea or imported RLNG to be provided to marginal fertilizer manufacturers.

Perhaps the market price is set where it is at equilibrium to smuggling price, and with increase in dealer transfer price that incentive to hoard or smuggle shall diminish as well.

There are three big companies in the Urea business which in total have ten manufacturing plants. There is varying pricing for different plants, as they fall under separate policies. The pricing is based on feedstock and fuel. The price varies from Rs580/mmbtu to Rs1,600/mmbtu in these plants (barring one Engro plant where concessional feedstock price is to end in June 2024), and the final product is almost homogeneous and is sold at similar pricing.

According to Optimus Capital calculations, if all the fertilizer feedstock and fuel prices are set at Rs1,600/mmbtu, at last year’s average gross margins and blend, the dealer transfer prices are coming in the range of Rs4,000 to 4,400 per mmbtu while the market price is hovering around Rs5,000.

The government should do apply a track and trace system to track dealers’ inventory and to curb smuggling. The next step is to implement track and trace in letter and spirit. That is to track dealers’ inventory and build in the date of farmers buying it. That would help to build a system of direct subsidies to farmer and normalize profits of fertilizer companies.

Copyright Business Recorder, 2023