Fertiliser subsidy: X factors that could sway a ballooning bill either way

Two policy tweaks to lower the govt's bill depend on weather, state of the global economy and the trajectory of the Russia-Ukraine war

Tumbling global gas and liquefied natural gas (LNG) prices should please Finance Minister Nirmala Sitharaman as she prepares to present India’s annual Budget for 2023-24 on February 1. If gas rates stay benign, after hitting unaffordable levels last year, Sitharaman can perhaps divert a huge chunk of the fertiliser subsidy to productive uses.

Last year, Narendra Modi’s government proposed two measures to bring down the fertiliser subsidy bill. The first involves asking fertiliser companies to buy up to 20 per cent of their LNG needs directly or via the Indian Gas Exchange (IGX). The second proposal reviews the domestic gas pricing formula, and caps rates.

Can this make a difference? Consider, first, the dimensions of the problem.

The fertiliser subsidy is a big-ticket spend in the Budget, along with food. Fertiliser plants — the subsidy goes to manufacturers, mainly urea makers, to compensate them for selling fertiliser below market rates — are the biggest consumers of imported LNG. And fertiliser subsidies cannot be wished away because Prime Minister Modi, seeking a third term, can ill afford to anger the farm lobby.

With domestic gas production stagnant, India is at the mercy of global gas rates. Last year, spot LNG surged to over $50 per million British thermal units (mBtu), five times more than the rate India paid for LNG purchases in 2021-22. In Feb­ruary 2022, Sitharaman had allotted Rs 1.05 trillion for 2022-23 to compensate fertiliser makers (imported LNG accounts for 77 per cent of gas use by the fertiliser industry).

But the Ukraine conflict upended all calculations. This fiscal may end with fertiliser subsidies exceeding Rs 2.5 trillion, an all-time high, reckons Crisil Research and ICRA, more than double the Budget estimates and 2020-21 levels, and exceeding the Rs 2.07 trillion allocated for food subsidies. “Owing to high international prices of raw materials and finished fertilisers, currency depreciation, and firming up of pooled gas prices, the industry’s subsidy requirement is expected to reach its highest ever level,” said Sabyasachi Majumdar, senior vice president, ICRA.

The Rs 1.5-trillion differential bet­ween budgeted and actual spending could have funded nearly 80 per cent of the combined Rs 1.9 trillion that the government earmarked for education and health for 2022-23.

A large chunk of the subsidy goes to foreign gas suppliers because 80 per cent of the cost of urea is natural gas, a fertiliser industry official said. Fertiliser companies alone consumed 57 per cent of re­gassified imported LNG of the total 19.5 billion cubic metres used in the April-December period, according to oil ministry data.

“At current prices of gas and assuming some growth in fertiliser consumption, ICRA expects the subsidy to remain elevated at around Rs 2 trillion for FY24,” Majumdar said.

Russia’s invasion of Ukraine had sent global gas prices to record levels. But with some luck with the weather and upcoming global recession, gas prices may soften. European gas prices, a bellwether for spot LNG rates, dropped more than six-fold from August to their lowest levels since September 2021, said Greg Molnar, gas analyst at the Paris-based International Energy Agency. US benchmark Henry Hub prices dipped below $3 per mBtu last week from over $7 in November. And spot LNG levels have dropped to a third of last year’s highs, at around $18 per mBtu, according to Argus. Some Indian consumers may still find such levels high, but they are better than the $25-$30/mBtu levels seen recently, said A K Singh, CEO, Petronet LNG, at a briefing.

So how will the government’s diktat to buy up to 20 per cent of their LNG needs change the subsidy dynamics?

“We expect a new gas sourcing policy for fertiliser (urea) plants will allow them to buy in a most cost-effective way and there they will find an exchange most suited for the purpose,” said Rajesh Kumar Mediratta, MD and CEO, IGX. “This has huge potential to save on gas subsidies.”

But for companies to gain from this, the government needs to change regulations, a fertiliser industry official said. Fertiliser units source LNG using a pooling mechanism managed by Gail India. But the way the pool works is that efficient fertiliser plants end up subsidising inefficient ones.

Even if an efficient fertiliser maker gets gas from IGX at, say, $15/mBtu under the new 20 per cent sourcing rules, it would still need to pay the difference between the IGX rate and the average pool price for the month, the official said, reducing the incentive for efficient fertiliser units to seek gas outside the pool. The 20 per cent procurement volumes should have been kept out of the pooling price mechanism, the official suggested. Pool prices have averaged $25-$30/mBtu in the recent past.

This is where a cap on domestic gas prices could help. “The recomm­endations of the Kirit Parikh Committee, if implemented, can lower the domestic gas prices and, thus, the pooled gas prices for fertiliser companies,” Prashant Vasisht, co-group head, ICRA, pointed out. “Overall, a $1 per mBtu reduction in pooled gas prices reduces the subsidy requirements by around Rs 4,500 crore.”

In November, the Parikh Comm­ittee recommended capping domestic gas rates, and changing the peg for domestic gas from global gas benchmarks to crude oil rates. “Given the high LNG prices, industrial customers have switched to crude-linked alternatives as the rise in crude prices was not as steep as gas prices,” said Sudhir Kumar, director, CareEdge Ratings.

But the impact of domestic policy tweaks may be limited. Europe will need more LNG this year after Russian supplies cease, and China’s need for gas will rise after lifting Covid-19 restrictions. But LNG production capacity is limited. “The picture remains tight for 2023, even though the relatively warm winter in Europe seems to be a temporary painkiller for high gas prices,” Molnar said. But to make a dent in subsidies, Sitharaman will need the effects of the painkiller to linger for the whole of 2023-24.