CASE STUDY

Urea Fertilizer: Import or Produce?

What is Urea?

Urea is a fertilizer widely used in rice and other crop production. It is 46% nitrogen, and
produced in urea plants. The capital cost of these plants is about $700 per annual ton of
fertilizer produced. Low cost plants now use natural gas or naphtha feedstocks and have a
large capacity of at least 500,000 to over one million tons a year. It takes 24 million BTU
of gas to produce one ton of urea.1 Earlier generation plants used coal, but this process is
being phased out in most places, as the costs of production are much higher.

Rice Farmers are Major Urea Users

Rice farmers are major users of urea fertilizer. The prices they receive for their paddy are
normally (at best) the world price of rice; although if trading is monopolized or taxed,
their paddy prices are then even lower. Most governments of poorer nations do not have
the resources to pay farmers more than the world price for their production. They can
influence the costs of production. Charges for fertilizer, electricity for pumping, and taxes
are among the input costs over which governments have some control. Because the
incomes of rice farmers are often lower than incomes of urban workers, there usually is a
desire to avoid policies that would reduce the income of rice farmers. On the other hand,
there is also a desire to charge enough to cover the cost of production of electricity and
other inputs, though some nations subsidize the price of urea to help farmers.

Large Consuming Nations Face a Make or Import Decision

Assume that urea consumption has been growing rapidly in a hypothetical country and is
currently about two million tons a year. Almost all (95%+) of this urea is imported, with
recent local production coming from one old high-cost plant using coal as an input. The
plant is losing money and asking for protection.

The world price for urea has trended downwards in real terms since 1975, although it can
be volatile. In real terms (1990$), the price per ton was $438 in 1975; $309 in 1980; $199
in 1985, and $131 in 1990. These prices are on a bulk FOB basis, and freight and bagging
charges of about $20 to $25 per ton must be added to arrive at bagged CIF/import costs.
From 1991 to 2000, the current FOB prices of urea ($/ton) are shown in the table below:

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Mean
Urea ($/ton) $151 $123 $ 94 $131 $194 $187 $128 $103 $ 78 $112 $130

Source: IMF, International Financial Statistics, Yearbook and July, 2001 issues.

1
One million BTU is a common unit of measurement for natural gas. The price of gas has varied, but is
normally between $2 and $4 per million BTU or, equivalently, per 1000 cubic feet. However, if natural gas
is liquefied and imported or in especially short supply, the price can be double its normal level. A barrel of
crude oil has a heat value of 5.8 million BTU.

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The longer-term urea price is predicted to be around $100 (its current price) to $130 per
ton, but this will crucially depend on fertilizer policy in India and China, the two largest
users of urea. It is possible to buy urea on longer term contracts to reduce price
fluctuations and improve the security of imported supplies.

The Cost of Urea Crucially Depends on the Cost of Gas and Interest Rates

If the government in question has large domestic supplies of gas and were to charge $3
per million BTU for its gas (equivalent to crude oil of only $17.40 per barrel in terms of
heating capacity), then the raw material for one ton of urea will cost $72. If the
opportunity cost of capital or interest rate is 10%, the capital cost per ton is $70. Bagging
and other production costs will come to $20 per ton. Thus, the minimum profitable price
for urea fertilizer under these conditions would be around $160-$165 per ton. It appears
that this would be competitive with the world price about one-third of the time. For the
remaining 2/3, the government could impose restrictions on urea imports (tariffs or
quotas) and make farmers pay more than the world market price. This would be a
decision to tax farmers so that there could be local production. Or it could pay subsidies
to the urea producers out of tax revenues. Or it could charge the producers less for gas,
but then subsidies would have to be paid to the companies that have contracts to sell the
gas at a fixed price. (Natural gas replaces kerosene and diesel fuel in electric generators.
These fuels would otherwise have to be imported at a price of about $35-40 a barrel.)

Different Interest Groups or Ministries Have Different Views on Producing Urea

It is usually the Ministry of Industry that is a strong supporter of building a urea plant. A
typical argument would be:

We have large supplies of natural gas and are large importers of urea. The world price
fluctuates, sometimes reaching high levels that make it unaffordable for our farmers. It is
obvious that we should make our own urea and not have to rely on unstable markets. If
our costs of production are sometimes higher than those in unstable world markets, then
we should restrict imports or reduce gas prices so the producer can break even.

A view from the Ministry of Agriculture would be as follows:

Rice farmers are large users of urea, and it is true that sometimes world prices are so
high that they have to apply less to their fields. In such cases – which don’t happen very
often – we should consider subsidizing the cost of urea to the farmers. After all,
sometimes the price of rice is also high when the urea price is high! We do not want the
normal price of urea to be higher than the world price, because we export rice and other
exporters charge only the world price for urea. If we kept the local urea price high
enough for our producers, we should be sure not to put our farmers at a disadvantage
compared to other rice exporters.

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The Ministry of Trade might say:

When you suggest using protection to keep out urea imports, remember our commitments
under various trade treaties, such as AFTA. We are committed to having very low tariffs
and no quotas on most goods, and could face retaliation if we broke that promise. I
would oppose any solution that required us to break our existing treaty commitments.

The Minister of Energy might observe:

It is costly to drill for gas and develop a producing field and pipeline. We have
negotiated a fair price for the gas coming from that field with the foreign producers. If
you want to charge less to urea producers than that price, you will need to use profits
from our oil production to make the gas price equal to that in our contracts. That would
mean fewer funds for us to drill in promising areas, with very high rates of return. I
would oppose that, and would prefer that tax revenues be used to make up the difference
between the low gas price the urea producers need and the contract price of gas.

Finally, the Ministry of Finance would argue:

It appears that we cannot easily raise tariffs or use quotas to protect the urea producers.
Even if the state Oil Company charged less for the gas to the urea producers, it would
still reduce their profits and thus their taxes. This would not be an occasional expense,
but appears likely to occur two-thirds or more of the time. I would rather use tax
revenues to subsidize urea imports, as the costs would be less to the Treasury.

The Minister of Construction is sometimes involved, and would offer this opinion:

Building a fertilizer plant is a complicated undertaking that would raise the skills of our
companies and workers. We would learn how to put together a high-tech project, and this
knowledge would help us in other projects as well. Of course, there is also the direct
employment of thousands of workers for several years. If we don’t undertake big projects
like this, we will remain stuck in small and simple construction. I believe that our own
national development demands we be daring and push ourselves.

Evaluate the desirability of building urea plants vs. the desirability of importing urea
from the point of view of

a. Farmers
b. Food security (Assume rice is exported.)
c. Migration
d. Industrialization
e. Employment
f. Education

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g. The urea producers

Other Questions for Discussion:

1. What interest rate should be used to arrive at costs for the plant? A subsidized rate
from aid lending? The cost of borrowing by the company? The rate of return on other
investments that might be financed if the urea plant is not?
2. What is a reasonable price to charge for gas to the urea plant, and why?
3. How might the price of urea to farmers be made more stable? How important is this?