India revises gas procurement rules for fertilizer firms

India has revised the gas procurement policy for fertilizer companies, allowing them to buy about a fifth of their monthly needs through the domestic spot market to help the government cut its subsidy bill, reports Reuters.

The federal government provides financial support for domestic fertilizer sales at rates below the market to insulate farmers from high prices and to contain inflation.

The government expects to cut its fertilizer subsidy bill by up to 240 billion rupees if the fifth of companies' supplies is bought through bilateral contracts or gas exchange, said one of the government officials, who declined to be identified.

India, which imports up to 40% of the 50 million tons of fertilizer annually, has been hit hard by rising prices after Russia's invasion of Ukraine disrupted supplies. Russia is a major fertilizer producer.

Early last month, Fertilizers Minister Mansukh Mandaviya said that due to higher global prices, India's fertilizer subsidy bill for the fiscal year would rise to a record 2.25 trillion rupees from about 1.5 trillion rupees the previous year.

"To help rein in the fertilizer subsidy bill for next fiscal, the fertilizer ministry is trying to rework the mechanism of how gas is procured by fertilizer plants," said a second government official, who also declined to be identified.

Both of the officials are directly involved in the issue but are not authorized to speak to media.

The government has amended 2015 gas procurement guidelines under which fertilizer plants had to procure 80% of their gas through long-term contracts, and the balance through three-month tenders, they said.

"Three-month prices are high as there is lot of padding and hedging by suppliers, more so since there is so much volatility in global gas prices," the first official said.

Under the revision, fertilizer companies will have to buy 40% of their supplies under a "take or pay" rule, in contrast to no minimum purchase required under the guidelines previously, the official added.

The "take and pay" rule led to shares of state-run fertilizer companies, National Fertilizers Ltd, Rashtriya Chemicals and Fertilizers Ltd, falling by 4% to 5% after the news, under performing the broader index.

Fertilizer plants can source gas through the Indian Gas Exchange and inter-company contracts. The new rule also allows fertilizer companies to withdraw tenders if they feel the bidding has led to higher-than-expected prices.

Fertilizer plants bought gas at US$38 per million British thermal units (mmBtu) for supply in the October-December quarter through a tender. The maximum price quoted in the tender was US$55 while gas was available at the Indian Gas Exchange and bilateral markets for US$15 to US$20 per mmBtu.

Asia's third-largest economy needs crop nutrients to feed its huge agriculture sector, which employs about 60% of the workforce and accounts for 15% of nearly US$3 trillion economy.

Mari Petroleum offers enormous upside potential

Mari Petroleum (MARI), a leading exploration and production company of Pakistan offers an upside potential on the expectation of dividend payout after the removal of cap by the government. 

Other contributing factors are: 1) stable and growing volumetric sales from Mari Habib Rahi Limestone (HRL) field, 2) likely entry into other possible energy/gas chain projects, 3) healthy cash generation as it is least affected by circular debt and 4) favorable shift in gas pricing.

Stable and growing volumetric sales: 

Gas production from Mari field has grown at a 5-Y CAGR (FY16-FY21) of 3% compared to annual natural decline rate of 5-6% of a gas field. This growth is attributed to continuous efforts to keep production above the threshold of 577.5 mmcfd (+10% of 525 mmcfd) by drilling more development wells and adapting various production enhancement techniques like acid simulation, debottlenecking activities, compression installation amongst others.

Removal of cap on dividends: 

The government has removed cap on dividend payout of the company in wake of likely divestment to attract a better price. Analysts consider this as a positive development as high cash generation capability (12% of market cap every year) of the company can attract more strategic investors. The Company is expected to maintain payout ratio of 60%, translating into decent D/Y of 8-11% in next four years.

Likely entry into other energy chain projects: 

The company is taking service of renowned consultancy firm Mckinesy and other energy sector consultants to evaluate and consider projects like offshore blocks, acquisition of international blocks, setting up LNG terminal, gas power plant, expanding into fertilizer business, renewable power plants and petrochemical plant. It is believed that capital will not be a constraint for the company for projects like petrochemical and fertilizer due to healthy existing cash balance and recurring cash generation.

Healthy cash generation: 

Over the last two years (FY19 and FY20), the Company has accumulated a cash balance of Rs35 billion due to healthy operating cash flows thanks to rising profits and lower link with circular debt. This has increased book value of the company to Rs822/share as of December 2020, from Rs302 as of June 2018), translating into net cash of Rs446/share.

Favorable shift in gas pricing:

In FY20, the Company had recorded 35% of its revenue from fields (including incentive) based on PP2012 policy. Pricing based on PP2012 policy is 3x higher than the prevailing 2001 pricing policy (50% of 2001) of the Company. In FY17, revenue based on PP2012 used to be 5-10% of total revenue.

CAGR: 

Analysts expect MARI to post 3-Year earnings CAGR of 10% on the back of 2.2% per annum growth in gas sales, PKR depreciation of 5-6% per year, and 1.9% per annum growth in oil prices assumption.

Valuation: 

Analysts have used reserves based discounted cash flow methodology to arrive at December 2021 Target Price of Rs2,103, providing a total return of 41% (including D/Y of 9%). The Company is currently trading at FY22E PE, EV/Reserve (boe) and EV/EBITDA of 5.5x, US$1.4 and 2.9x, respectively.

Key risks:

The key risks include: 1) The Company’s inability to complete debottlenecking and other production enhancement projects on time, 2) lower than expected oil prices, 3) change in pricing regulations and 4) PKR appreciation.