Urea capacity reduction is in progress – but why is it so difficult?

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Urea capacity reduction is in progress – but why is it so difficult? Author/Source: China Fertilizer Network Date: 2016-07-25 Clicks: 11 The term “reducing overcapacity” has been appearing frequently in our news feeds since the beginning of 2015. There is an overcapacity in the steel industry, so it is necessary to reduce its capacity; there is also an overcapacity in the coal industry, and capacity reduction there is essential. **Special funds have been allocated to address the issue of laying off workers that arose during production last year, and efforts to reduce overcapacity in the steel and coal industries have already yielded some results. 　　As for the overcapacity in our urea industry, we have no choice but to reduce production capacity! In the first half of this year, the urea market experienced roughly three periods of price increases, but the magnitude of these increases was small, generally not exceeding 100 yuan per ton. By early July, prices dropped back to levels seen before those increases, falling below the lowest factory prices for winter-stored urea recorded in early February 2016. The root cause of this situation is the severe overcapacity in urea production. According to China Fertilizer Network, by the end of 2015, China’s theoretical annual production capacity for urea was around 89 million tons. The actual production in that year was approximately 74.278 million tons, with exports amounting to 13.748 million tons. Domestic demand for urea in industrial and agricultural purposes was about 50 million tons; thus, it can be estimated that there was a surplus of around 10 million tons of urea. 　　Reducing urea production capacity is now an urgent necessity! From April to June this year, some urea manufacturers halted production for maintenance taking advantage of conditions such as low rainfall and moderate temperatures. By early July, according to incomplete statistics, over 85% or even 90% of urea manufacturers across the country were operating at a loss, with prices both domestically and internationally remaining low. Some manufacturers that had not carried out maintenance earlier began to do so. According to China Fertilizer Network, in Inner Mongolia, where production capacity is concentrated, 6 out of 10 manufacturers have started to suspend production for maintenance, with these interruptions lasting around a month. Hubei Yihua Group will also pause production at its urea manufacturing facilities in Lianghe, Hunan, and Inner Mongolia, deciding to address the issue of excess capacity in August or later. 　　Since so many companies are operating at a loss, why not simply give up the urea industry once and for all and get rid of this excess production capacity? 　　There are roughly four reasons for this. First, although some urea manufacturers operate at a loss in the urea business, they can still make profits from melamine or other related products. When taking into account the profits from all their products, these companies can achieve a break-even point or even earn a certain amount of profit. 　　Secondly: Urea manufacturers established in the past five to six years rely heavily on bank loans to finance their operations; this increases their debt servicing costs due to interest payments. The mutual dependence between banks and these urea manufacturers forces them to sell urea at prices below cost in order to generate cash to repay their bank loans. 　　Thirdly: Some urea-producing enterprises are not privately owned; in the event of bankruptcy, issues related to the employment of their workers extend beyond just wages and re-employment matters, to include compensation for various welfare benefits as well. 　　Fourth: Some urea manufacturers have high expectations regarding how long the capacity reduction process will last; they believe that once a portion of the outdated and excess production capacity is phased out, the urea industry will be able to become profitable again, which is why they are reluctant to withdraw from the market ； Alternatively, some urea manufacturers believe that the suppliers of raw materials such as coal and natural gas exert pressure on them; if some of these urea manufacturers stop production, it may force the raw material suppliers to lower their prices, thereby reducing the production costs of urea and creating opportunities for profit, which is why they are reluctant to withdraw from the market. 　　It is understood that if an old urea production facility stops operating for 4–6 months or more, it will no longer be possible to restart its operations due to equipment aging, issues with the supply of raw materials, and technical limitations. Therefore, as long as urea manufacturers do not stop operating for more than this period in the second half of the year and continue to produce on a intermittent basis to stay afloat, they cannot be considered truly eliminated from the market. Thus, it will not be easy for the urea industry to eliminate outdated production capacity, nor will capacity rationalization take place quickly. 　　In summary, dealing with urea last year required some time; difficulties were inevitable, and the problems that arose during that process need to be addressed and solved by all of us together. (Cheyan Hong)