1. ICRA COMMENT ON AMENDMENTS TO THE NEW INVESTMENT
POLICY 2012 FOR UREA
Analyst Contacts
K. Ravichandran
ravichandran@icraindia.com
+91-44-4596 4301
Pranav Awasthi
pranav.awasthi@icraindia.com
+91-124-4545 373
Ankit Deora
ankit.deora@icraindia.com
+91-22-30470082
Website
www.icra.in
On January 2, 2013, the Government of India had notified the New
Investment Policy 2012 (NIP-2012) to facilitate fresh investments in the
urea sector. The policy benchmarked the realisation of urea for new
projects to import parity prices (IPP), subject to floating floor and ceiling
prices, which are in turn linked to gas prices. The floor-cap prices of urea
increase in line with the gas prices till the gas price of US$ 14/mmbtu
and the units shall be paid only the floor price based on the delivered
gas prices and the concept of ceiling price will not be applicable in the
event that the delivered gas price crosses US$ 14/mmbtu. The policy
was considered favourable for the industry as it provided downside risk
protection through a cost-plus mechanism (minimum implicit RoE of
12%) and upside benefit through IPP-linked pricing mechanism
(maximum implicit RoE of 20%) for new projects. ICRA had estimated a
post-tax IRR of 12.8%-15.6% (for gas prices of US$ 7-20/mmbtu) for
brownfield projects based on the key assumptions of the policy.†
Subsequent to this policy, the Department of Fertilisers (DoF) had
received 15 applications from various players for brownfield / greenfield
projects – much in excess of requirements, necessitating a mechanism
to approve new projects. Further, international prices of urea witnessed a
substantial decline since Q4 FY13 leading to low urea import prices
(Please refer Exhibit-1 on Page 2). With the outlook on urea prices
globally becoming bearish because of factors such as decline in energy
costs and increased supplies likely to be added, and possibility of
substantial increase in domestic gas prices, the Government had to re-
think on the policy as it would otherwise have led to a sharp increase in
subsidy.
Accordingly, the Government of India (GoI), on October 7, 2014, notified
certain amendments to the NIP-2012. The amendments are aimed at
encouraging only serious players to participate in the application for a
greenfield / brownfield urea project, while moving the GoI away from the
legal obligation to provide subsidy on the entire urea production under
the guaranteed buyback clause as was implied in the original policy.
†
For ICRA’s Special Comments on NIP-2012, released in
January 2013, please refer to the link
http://icra.in/Files/Articles/ICRA%20Special%20Comment_Urea%20NIP_Jan
%202013.pdf
ICRARatingFeatureOctober2014
2. ICRA Special Comment Amendments to New Urea Investment Policy 2012
ICRA Rating Services Page 2
The amendments / developments are briefly discussed below:
Provision of “guaranteed buyback” removed: As per the originally notified policy, the dispensation
of “guaranteed buyback” under NIP-2012 was to be available to the units for a period of eight years
from the date of start of production. However, the term “guaranteed buyback” has been removed and
the amended policy states that subsidy will be given “only upon domestic sale as at present” for a
period of eight years from the date of start of production. ICRA believes that the amendment gives the
GoI flexibility to import urea and lower its subsidy outgo in case the subsidy to be provided on imported
urea is substantially lower than domestic procurement from the new plants. Thus, in a scenario after a
new plant begins production, if international urea prices are substantially lower than the realisation for
a plant due to high cost of gas, the DoF has the flexibility to lower its subsidy outgo by importing urea
instead of procuring urea from the new plant. For instance, under a hypothetical but realistic scenario
that a brownfield project has a delivered cost of gas of USD 11/mmbtu, while international urea prices
are ruling at USD 300/MT, the applicable floor price for the new plant would be USD 375/MT. Under
such a scenario, if the GoI is able to import urea at a total cost which is substantially lower than the
floor price for the plant, the amended policy gives GoI flexibility to import the urea, while the new plant
may have to curtail production.
Time period for the investment policy extended: As per the originally notified policy, it was
proposed that only those units whose production starts within five years from the date of notification of
the policy would be covered under the policy. The time period has been shifted forward as per the
amended policy and it is now proposed that those units, whose production commences within five
years from the date of the amendment notification, that is, the units which commence production by
October 7, 2019, will be given subsidy for a period of eight years from the date of commencement of
production. Hence, theoretically the policy will be applicable for a maximum of thirteen years, i.e. till
October 2027. Thereafter, the units will be governed by the urea policy prevalent at that time.
Bank guarantee for application: To ensure that only serious players participate in the application for
new plants, all the project proponents will be required to furnish a bank guarantee (BG) of Rs. 300
crore for each project. The BG will be linked to milestones in the project cycle: (i) Rs. 100 crore of BG
will be released after finalisation of LSTK / EPCA contractors and release of advance to the
contractor’s account (ii) The next Rs. 100 crore of BG will be released on completion of requirements
ordering and supply to the site or midpoint of the project cycle, whichever is earlier (iii) The balance Rs.
100 crore of BG will be released on completion of the project. However, PSUs are exempted from
furnishing the BG.
The amendment has been notified to ensure that only serious bidders participate in the application and
would likely result in a significant decline in the number of participants with only players, who are
reasonably sure of going ahead with the project, applying for approval to the DoF. Private players will
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Urea Prices Urea - 10-yr Avg
Exhibit 1 – Urea International Price Trends
(Source: indexmundi.com, ICRA Analysis)
3. ICRA Special Comment Amendments to New Urea Investment Policy 2012
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have to face minor additional cost to the extent of financial charges for the bank guarantees, although
not material considering the overall cost of the project.
Committee of Secretaries constituted: A Committee of Secretaries (CoS) comprising Secretary
(Fertilizers) as Chairman of the Committee, Secretary (Department of Expenditure), Secretary (Ministry
of Petroleum & Natural Gas), Secretary (Planning Commission) and Secretary (Agriculture) has been
constituted to take decisions on various issues which will arise during the implementation of the policy.
Presence of stakeholders from all departments should ensure smooth implementation of the policy and
issues, if any, can be ironed out by the CoS.
Impact Analysis
Quantum of domestic gas availability and actual prices of gas to determine project returns
The new units are expected to be competitive in terms of energy consumption as the plants would be
commissioned using modern technology, which should lead to energy consumption levels of sub-5
GCal/MT of urea production (as opposed to 5.5-6 GCal/MT for relatively newer gas-based plants and even
higher for older vintage plants). Thus the cost of production will significantly depend on the gas prices. As
per ICRA’s calculations, in case international urea prices continue to prevail at US$ 300-325/MT, the
subsidy outgo for the GoI will be similar to that on imported urea even at gas prices of ~US$ 10-11/mmbtu.
Hence, the new units cannot be entirely based on R-LNG / spot gas, for which prices may likely to continue
to stay higher compared to these levels. This is the major change following the amendments, as the
original policy had mandated that the entire gas price for the unit would be a pass-through, which meant
that units based on R-LNG could also earn healthy returns, but subsidy outflow for the GoI would have
increased substantially for production from units based on R-LNG.
Nevertheless, ICRA expects that with revision in gas prices likely in the near term, domestic gas production
levels should increase substantially over the next 4-5 years (expected of the order of 40-50 mmscmd), by
which time these plants are expected to begin production. Accordingly, these plants may receive domestic
gas allocation to some extent depending on the quantum of production. Fertiliser sector, and urea in
particular, have historically enjoyed the highest priority for domestic gas allocation. Although the new NDA
government has recently proposed a change in the allocation policy for allocation of domestic APM gas,
giving higher priority to the city gas distribution (CGD) sector and has capped the amount of gas available
to the urea sector, increase in domestic gas production should likely lead to some amount of gas being
allocated to the urea sector, given the importance of the sector in terms of India’s food security.
However, the quantum of domestic gas availability and actual prices of gas remain uncertain at this point of
time. Any upcoming project will have to be undertaken under a great deal of uncertainty with regard to the
actual project realisations and returns from the project, given the lack of clarity on gas availability. The
returns for the project will be meaningful only if the players are able to source domestic gas to a significant
extent, which would depend on increase in domestic gas production. Higher cost of gas for the new plants
would mean higher cost of production and increased subsidy outgo for the DoF, which the latter may try to
curtail by importing more urea at the cost of lower volumes from the new plants. The amendment gives the
DoF flexibility to that extent. The removal of the ‘guaranteed buyback’ provision has, therefore, increased
the marketing risks for the bidders to some extent. However, in case domestic gas availability increases to
the extent that it is available to the new urea plants by the time these plants become operational, the
returns should remain favourable.
Increase in capital costs and weaker currency since the original policy was notified
The policy was notified in January 2013 based on assumptions of capital costs based on currency rate
assumption of Rs. 50/US$. However, due to delay in the implementation of the policy as well as substantial
currency depreciation (~20%), the capital costs for implementation of the project are estimated to have
increased substantially (~10-15%). On the other hand, since the realisations for urea as per the policy were
in US$ terms, the realisations are likely to increase as compared to the assumptions used for the policy
formulation in case the currency continues to remain at similar levels. The depreciation of the currency will
theoretically lead to an increase in the IRR for the project as the cash flows earned by the companies in
rupee terms will increase, although the returns may not actually be achieved as the subsidy outflow at high
gas prices becomes substantially high, in which case the GoI may choose to curtail procurement of urea
from these plants to save on subsidy, thereby leading to an increase in the risk for the project to some
4. ICRA Special Comment Amendments to New Urea Investment Policy 2012
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extent. (Please refer Annexure-1 and 2 for the price benchmarks and IRR analysis under different scenario.
As an illustration, Annexure-3 shows the impact on DSCR under different capacity utilisation levels in case
production were to be curtailed during the 3rd
year from the commencement of production).
Risks in case of decontrol / implementation of nutrient-based subsidy (NBS)
If urea is brought under nutrient-based subsidy (NBS) / decontrolled over the long term, some of the
existing domestic manufacturers may not be able to match the IPP prices due to lower energy efficiency
vis-a-vis newer plants and may have to curtail production, thereby increasing the risks for existing plants as
well to improve their energy efficiencies over the long term, as has been emphasised by the DoF in recent
years. However, these plants are largely depreciated and hence, may have lower capital costs. On the
other hand, while energy efficiency is expected to be healthy, capital costs will be significantly higher for the
new plants. In case of implementation of NBS / decontrol of the urea sector, the differential in the cost of
production of the various players at similar gas prices may pose some commercial risk for the various
players, particularly the older energy inefficient plants.
Conclusion
ICRA believes that the number of urea plants that will be approved following this policy will be limited to 3-4
(not including the revival of old fertiliser units belonging to Fertilizer Corporation of India Ltd. and Hindustan
Fertilizer Corporation Ltd.), and may include the already commissioned plant of Matix Fertilisers &
Chemicals Ltd., provided it is able to declare commercial production upon availability of gas. ICRA believes
that the quantum of domestic gas availability and pricing have become paramount post the notification of
the amended policy and will likely determine the returns and debt servicing ability of the new projects, given
the flexibility to the DoF to import urea post the removal of the “guaranteed buyback” clause. Returns may
also likely decline to some extent compared to previous estimates as urea IPP is expected to continue to
remain at relatively lower levels in the medium-to-long term. Overall, the policy amendments are
moderately negative as compared to the original policy from the point of view of new investments as the
uncertainty associated with the cash generation is higher due to the removal of the ‘guaranteed buyback’
clause.
5. ICRA Special Comment Amendments to New Urea Investment Policy 2012
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Annexure-1: Comparison of Benchmark Prices for Existing and New
Investment Policies for Brownfield Projects
Exhibit 2 – Existing vs. New Investment Policy (Brownfield Projects) – Applicable till the 8th
Year After
Commencement of Operations
Gas Price
(US$/mmbtu)
7 8 9 10 11 12 13 14
Prevailing IPP --------------------------------Benchmark Realisation-----------------------------------
250 295 315 335 355 375 395 415 435
275 295 315 335 355 375 395 415 435
300 300 315 335 355 375 395 415 435
325 320 325 335 355 375 395 415 435
350 320 340 350 355 375 395 415 435
375 320 340 360 375 375 395 415 435
400 320 340 360 380 400 400 415 435
425 320 340 360 380 400 420 425 435
450 320 340 360 380 400 420 440 450
475 320 340 360 380 400 420 440 460
500 320 340 360 380 400 420 440 460
550 320 340 360 380 400 420 440 460
600 320 340 360 380 400 420 440 460
Exhibit 3 – Comparison of benchmark realisations against IPP
Realisation Comparison Remarks
Benchmark Realisation > IPP
Higher benchmark realisations under NIP-2012 compared to
international parity prices
Benchmark Realisation ≤ IPP
Lower or equal benchmark realisations under NIP-2012 compared to
international parity prices
6. ICRA Special Comment Amendments to New Urea Investment Policy 2012
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Annexure-2: Estimated Project Metrics for Brownfield Projects
Exhibit 4 – Post-tax Project IRR Analysis at various urea IPP and gas prices
Gas Price
(USD/mmbtu)
Floor
12% RoE
Ceiling
20% RoE
Applicable Import Parity Price (US$/MT)
300 325 350 375 400 425 450
7 295 320 15.3% 16.9% 16.9% 16.9% 16.9% 16.9% 16.9%
8 315 340 14.8% 15.6% 16.9% 16.9% 16.9% 16.9% 16.9%
9 335 360 14.8% 14.8% 16.0% 16.8% 16.8% 16.8% 16.8%
10 355 380 14.8% 14.8% 14.8% 16.4% 16.8% 16.8% 16.8%
11 375 400 14.7% 14.7% 14.7% 14.7% 16.8% 16.8% 16.8%
12 395 420 14.7% 14.7% 14.7% 14.7% 15.1% 16.8% 16.8%
13 415 440 14.7% 14.7% 14.7% 14.7% 14.7% 15.5% 16.7%
14 435 460 14.7% 14.7% 14.7% 14.7% 14.7% 14.7% 15.9%
Note: The IRR analysis assumes that the applicable realisations beyond the 8
th
year of commencement of
production would be the floor price (i.e. 12% RoE) as is applicable under existing policy. Also, the capacity
utilisation level is assumed at 95% for the first year post the commencement of operations and 100% from the
second year onwards.
Exhibit 5 – Minimum DSCR Analysis at various urea and gas prices
(Assuming term loan repayment in 7 years after 4 years of moratorium – incl. 3 years of construction period)
Gas Price
(USD/mmbtu)
Floor
12% RoE
Ceiling
20% RoE
Applicable Import Parity Price (US$/MT)
300 325 350 375 400 425 450
7 295 320 1.19 1.34 1.34 1.34 1.34 1.34 1.34
8 315 340 1.15 1.22 1.33 1.33 1.33 1.33 1.33
9 335 360 1.15 1.15 1.25 1.33 1.33 1.33 1.33
10 355 380 1.14 1.14 1.14 1.28 1.32 1.32 1.32
11 375 400 1.13 1.13 1.13 1.13 1.31 1.31 1.31
12 395 420 1.13 1.13 1.13 1.13 1.16 1.31 1.31
13 415 440 1.12 1.12 1.12 1.12 1.12 1.19 1.30
14 435 460 1.12 1.12 1.12 1.12 1.12 1.12 1.22
7. ICRA Special Comment Amendments to New Urea Investment Policy 2012
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Annexure-3: Impact On DSCR In Case Of Lower Production
For illustration on the impact on DSCR in case of lower production than 100%, the table below carries the
impact on DSCR in the 3rd
year after the commencement of production under different scenarios of lower
production. The key assumptions are as follows: Gas prices of USD 10/mmbtu, INR/USD = 60. At these
gas prices, the floor of USD 355/MT and ceiling of USD 380/MT is applicable for a brownfield project.
The exhibit below illustrates the DSCR levels at different levels of capacity utilisation during the 3rd
year. It
continues to assume that production levels would continue to remain at 100% levels from the 2nd
year
onwards (except for the change in capacity utilisation during the 3rd
year).
Exhibit 6 – DSCR for brownfield project in the 6th
year (3rd
year after commencement of production)
(Assuming term loan repayment in 7 years after 4 years of moratorium – incl. 3 years of construction period)
Gas Price
(USD/mmbtu)
Floor
12% RoE
Ceiling
20% RoE
Capacity Utilisation
60% 70% 80% 90% 100%
10 355 380 0.00 0.32 0.64 0.93 1.22
