It is widely argued that historically cement cartel existed in Pakistan. It appears that the 'cartel' is back. Last week, reportedly, there was a meeting of cement companies to jack up prices in North. Some say that how can a cartel persist with around two dozen companies in operation. Well, it can as long as, entry barriers exist. Like many other industries, it is hard for even big groups to enter into cement manufacturing business, and the domestic production is being protected from imports. Whenever there is excess demand, the cement cartel becomes active and it breaks in days of excess supply.

In the last few years (2012-2018) EBITDA (Earnings before interest, taxes, depreciation and amortization) margins of 16 cement companies ranged from 30 percent to 44 percent. Such kind of returns are unheard of in a competitive environment. In 2016, EBITDA per ton in dollar terms for Pakistan cement industry was 2.5 times of that in India. China was even more competitive. Interestingly, throughout he period of exuberant returns, local producers were protected by 20 percent regulatory duty on imports, while capacity utilization was over 80 percent (2016-19).

Since cement manufacturing was (and will be) a lucrative business, the domestic big groups (not in this business) were trying to enter. But there were barriers. They could not get licence from provincial government(s) to extract limestone (basic raw material to manufacture cement). Limestone is in abundance in Pakistan as proven reserves are enough to cater domestic demand for two centuries. Yet, it is next to impossible to get a new license, especially for those who do not have an existing stake in the industry.

Competition Commission of Pakistan (CCP) conducted an inquiry in 2008 on the price increase in 2007, and later in 2012 the CPP did another inspection - on both counts the Commission did not rule out the possibility of cartel. The CCP in its early days under Khalid Mirza was against the cartelization practices and monopolistic structures, but the big money has big influences. These were enough for CPP to not develop teeth.

The 'cement cartel' is like any other cartel. The players are protected from competition; but are free to fight each other. When they all are being able to sell at a level to maximize profits, they collude. In days of excess supply, some companies may undercut prices to boost sales. Someone makes a first move and the rest follow. They all make losses (or less margins in the process). And when the demand picks up, the cartel gets back to life again.

It is all cyclical. There was active cartel prior to expansion in 2007. Seeing high profits, most of the companies expanded. The cartel broke and EBITDA margins were down from 47 percent in 2006 to 15 percent in 2010. With all the expansions online whilst companies' margins were squeezed, the cartel was back with pick in demand and 2012-2018 was bonanza for cement companies.

Now another cycle of expansion took place. Almost all the new expansions are online. The demand growth is slow. That is why cartel was not really working. In July 2019, cement prices in North went up by over Rs100 per bag. There was a case of higher excise duty on cement. But price hike was more than the increased taxes. But that could not sustain and prices came down. The situation is different in South. Prices in South are sticky and at a premium to North. Since South can export, and expansions are less, higher prices can be sustained. There is a transportation cost of moving cement, this explains the differential in prices to an extent.

In the last few quarters, the cement companies in North are under immense financial pressure. They are highly leveraged and have recently expanded. The higher interest cost and depreciation of plant has resulted in many companies posting losses in the last quarter. The lockdown has suppressed the demand further to lower prices.

At the current prices, one can say that the prices in Pakistan (north) are competitive to those in India and Bangladesh, if not lower. The companies' net margins are in red too. Seeing this, recent price increase cannot be described as exploitation. But the international coal prices (most cement plants use coal as energy source) are falling, and domestic interest rates are down too. Seeing this, the government is raising eyebrows on cement price hike. Reportedly, the PM has taken a stern notice of last week's cement price increase.

Cement companies might have justification of recent price increase; but this could bring more bad than good for them. The first point is that this price increase might not be sustainable as when demand picks up (after lockdown is end or relaxed), the companies will undercut each other. The capacity utilization is low and every company would look for higher market share.

The other point is that government is on fire against cartels and abnormal practices in various sectors. Cement could be another casualty after sugar (and wheat) and power (mainly IPPs). The PM has recently announced a construction package and the aim is to arrest further slide in the economy (creating jobs) through boosting construction activities.

Rising cement prices is not good for construction. If an inquiry committee is formed against cement companies, many issues of past can be highlighted today. One aspect not touched yet, is the environmental consequences of cement manufacturing. There are loose ends. It is likely that rise in cement prices may not sustain.