Fertilizer: 15 days gas curtailment & impact

With growing gas shortage in Pakistan , Ministry of Petroleum has proposed 15 days monthly gas load shedding for fertilizer plants.

Under this plan Sui Northren Gas Pipe Line (SNGL) will supply gas for 15 days on alternative basis. The worst part is that this will be over and above the gas curtailment plan (20 percent Sui & 12percent Mari) introduced in 1H2010. This will again set a stage for another urea price increase. We expect urea price may go up further by Rs400-450 per bag in next 3-4 months triggered by plants operating at Sui Northern network. And as a result of this fertilizer plants on SSGC and Mari network will get the benefit. According to Engro’s chief, urea price may reach Rs 2000 per bag if this crisis continues.

Currently, the country's urea manufacturing capacity is around 6.5mn tons of which approx 2.3mn tons is installed on Sui Northern Gas network (SNGPL). These plants include Engro Enven (1.3mn tons), Agritech (0.46mn tons), Dawoood Hercules (0.44mn tons) and Pak Arab (0.1mn tons). Adjusting the gas curtailment of 20% agreed last year, the annualized effective capacity on SNGPL network would be around 1.8mn tons. Thus with additional gas shortage of 15 days a month, local urea production would decline by round 0.9mn tons (without adjusting startup delays).

To compensate the production losses, the government will go for additional import of 0.9mn tons of urea. Thus according to our estimates, the total urea shortfall could increase to 2.3-2.5mn tons. However, this may create supply delays which could further force dealers to sell urea at more than the official price.

Given such a scenario, the largest player on Sui Northern network (Engro Enven) will be affected and hence it is expected that urea prices to increase by Rs400-450 per bag to compensate production losses. However, this will be a straight gain to fertilizer plants operating on Mari (specially FFC and Fatima) and on SSGC network (FFBL). In our covered stocks, FFC’s annualized earnings will increase by Rs13-14 per share while that of FFBL’s to increase by Rs2.8-2.9 per share, other things being constant.

As mentioned in our note dated July 20, 2011 titled ‘Fertilizer: Will the party continue?’ there remains a regulatory risk to this anomaly as inefficiency don’t continue for a longer period of time. Sooner or later the slow moving government bureaucracy will eliminate this inequality/inefficiency where the gas curtailment continues to be blessing in disguise for few manufacturers. Moreover, government will eventually intervene as farmers’ cost of production has increased whereas commodity prices like cotton are under pressure.