Analysis of Pakistani Cement Industry – History, Capacity, Costs and Outlook
Analysis of Pakistani Cement Industry – History, Capacity, Costs and Outlook
Cement industry is one of the few industries that existed in Pakistan before the partition of the sub-continent. The major reason for the existence of this industry is the availability of the raw materials. Pakistan has inexhaustible reserves of limestone and clay, which can support the industry for another 50-60 years. The annual production of the cement at the time of the creation of Pakistan was only 300000 tones per year. By 1954 the production increased to 660000 tonnes per annum against a demand of 1000000 tonnes per annum. At this time PIDC took initiative and established two cement factories Zealpak (240,000 tonnes) and Maple Leaf (100,000 tonnes) having a capacity of 340000 tones, thereby increasing the production to 1000000 tonnes per annum. Since then besides expansion of the existing plants, new plants have also established. Besides producing OPC, the Pakistani cement industry also started producing SRC, Slag cement and white cement.
In 1921 the first cement plant was established at WAH. At the time of independence in 1947 there were four cement factories with an installed capacity of 470,000 tonnes per annum. These units were located at Karachi, Rohri, Dandot and WAH. In 1956 PIDC established two plants at Daudkel and Hyderabad and subsequently more plants were established in the private sector.
The industry was nationalized in 1972 and the State Cement Corporation of Pakistan (SCCP) was established following the Economic Reforms Order, 1972. As a result of nationalization, a total of 10 cement units with an installed capacity of 2.8 million tonnes per annum were transferred to the SCCP. Effective price control was also vested with the SCCP and for a long time the industry operated under a regime of strict regulation and price control. While the cement industry was working under the state control, the SCCP established five new units with an installed capacity of 1.8 million tonnes per annum. For the next fifteen years no new cement plant was established under the private sector, which resulted in acute shortage of cement in late 70s and early 80s. This gap was filled by the import of cement. Severe shortage of cement and price deregulation prompted the private sector to establish more plants. Seven units were established in the private sector before commencement of the process of privatization in 1991.
During the regime of Nawaz Sharif the industry went through major transformation. As a part of its privatization policy, the Government of Pakistan, has privatized 8 cement plants since 1992. Due to privatization the SCCP lost its control over the prices of the cement and as a result new cement plants were established under private sector. The units working under the SCCP control are old and inefficient using “wet process” whereas the units established in the private sector are new, efficient and use “dry process”. At present there are more than 28 cement plants in Pakistan with installed capacity of over 19.5 million tonnes per annum. The present demand for cement in Pakistan is around 9.5 million tonnes per annum.
COMPOSITION OF CEMENT
Pakistan is a country rich in deposits of limestone, shale and gypsum, which are the main ingredients for the production of cement. The mining costs for these deposits come to only about Rs. 100 per tonne or approximately 6% of total manufacturing cost. Thus cement is an extremely “value-added” product and must be given its due importance. The chemical composition of cement is as under:
- CaO 70%
- SiO2 23%
- Al2O3 04%
- FE2O4 03%
Gray cement manufacture consists of about 73% limestone and 25% clay. The amount of gypsum that is added to the clinker may be taken at 4%. About 1.23 tones of limestone, 0.31 tones of clay and 0.04 tones of gypsum are required for producing one tone of cement. In case of gas fired kiln about 50000 to 60000 cubic feet of gas is required for a tonne of cement. For the production of slag cement, blast furnace slag is also used and for the production of sulphate resistant cement sand and iron ore are also used.
TYPES OF CEMENT
The five types of cement manufactured in Pakistan are
- Ordinary Portland Cement (OPC)
- Slag Cement.
- Sulphate Resistant Cement (SRC)
- Super Sulphate Resistant Cement (SSRC)
- White Cement.
The manufacturing process can be of any of the 3 types:
- Wet Process; an obsolete method of manufacturing due to poor kiln heating and large water requirements.
- Semi-Wet Process; not popular due to high levels of fuel and energy consumption and suited for materials with extreme elasticity. Quite obsolete.
- Dry Process; suitable for materials with low moisture content. Low fuel usage as compared to the wet process, less maintenance requirements, higher kiln efficiency due to pre- heating facility and low kiln setup and maintenance costs.
Two main methods of cement manufacturing are prominent, the dry process and the wet process. Dry process now has almost replaced the wet process since wet process consumes high thermal energy for drying the moisture. In dry process the rock is the principal raw material, the first step after quarrying is the primary crushing. Mountains of rock are fed through crushers capable of handling pieces as large as an oil drum. The first crushing reduces the rock to a maximum size of about 6 inches. The rock then goes to secondary crushers or hammer mills for reduction to about 3 inches or smaller. It is then ground in ball mill to fine powder with other ingredients like clay/iron ore/bauxite to create a combination of values for silica/alumina/lime etc in the mixture. The ground powder is then sent to blending silos for uniform mixing of components added during the grinding stage. This blended material is feed to the preheater / calciner. The preheater is a group of cyclones placed over one another where in material comes down and hot gases goes up heating the material and calcining it in the process.
The only difference between dry process and the wet process is that in the later on the crushed raw material is ground with water to form the slurry. This slurry is then filtered and pumped to the kiln and the rest of the process is exactly the same as that of the dry process.
British standard Specification # 12 are followed in Pakistan. For a good quality cement initial setting time should not be less than 45 minutes and the final setting time should not be more than 10 hours, all existing cement plants in Pakistan meet these quality criteria.
IMPACT OF PROCESS ON COST
The process used has a major impact on the cost structure of the company. Using old and out-dated forms of technology not only effect the overall quality of the final product but result in higher maintenance costs, more replacement of parts etc. and the result is less competitive prices in both the domestic and foreign markets. We can see that Indian cement is sold at lesser prices since they have been able to cut back on their costs of production. This has been done by lowering energy costs via reliance on coal rather than furnace oil for running and operating their processes.
The key players in the industry, which attained billion rupees mark (in sales) in 1998, are listed below:
Name of the Company Sales (in billions of Rupees)
Fauji cement 1.401
D.G. Khan Cement 1.045
Cherat Cement 1.302
Fecto Cement 1.098
Dadabhoy Cement 1.000
The cement market in Pakistan is divided into two zones: the North zone and the South zone. The North zone includes Punjab, Azad Kashmir, N.W.F.P. and the upper region of Baluchistan. The remaining area of the Baluchistan and entire Sindh constitute the Southern zone.
Historically the Northern zone has faced an under-supply situation while the Southern zone has experienced over-supply situation. The demand of the Northern zone was used to be met by the production of the Southern zone. After the establishment of new plants especially D.G. Cement (with a capacity of over 1 million tonnes per annum) the Northern region has also become almost self sufficient in the cement the province–wise distribution of cement plants is given below
The cement industry is very unevenly distributed in the country with a vast difference in capacity and production as can be seen in the following tables. The number of plants is less than double in the south zone as compared to those in the north but total production in the latter region is nearly 3 times that in the former area. Even then all units charge the same price when in reality their technology, layout, product range and efficiency differs. This implies a misuse of cartel power exerted by the APCMA.
# of Units
SOUTH ZONE PLANTS
|LOCATION||CAPACITY (million tonnes/annum)||EFFECTIVE CAPACITY (million tonnes/annum)||
|Zeal Pak||Hyderabad||1.058||0.567||Partially closed|
|ACC Rohri||Rohri||0.241||–||Wet plant closed|
|LOCATION||CAPACITY (million tonnes/annum)||EFFECTIVE CAPACITY (million tonnes/annum)||
|D.G. Khan||D.G. Khan||1.732||1.732||–|
|Maple Leaf||Daud Khel||1.03||1.039||Wet lines closed|
At present KSE has 21 companies in the cement sector on its list. Total paid up capital of these companies stood at Rs. 15.584 billion and the net worth at Rs. 24.947 billion. Total sales of these companies stood at Rs. 14.589 billion. At present all companies are showing losses. According to APCMA the industry as a whole incurred a loss of Rs. 2.786 billion during six months period of 1998-99 as compared to Rs. 2.836 billion of 12 months period of last year.
An adverse development in the sector is the deterioration in the EPS. The total sales of all cement companies have decreased from Rs. 15379 million in 95-96 to Rs. 13118 million in 96-97. The accumulated loss incurred by the cement plants increased from Rs 1026 billion in 96-97 to Rs. 2.836 billion in 97-98. The poor performance of the sector is mainly due to the excess supply situation. All this resulted in deterioration in the General index of share prices of cement as shown below
General Index of Share Prices
(1990-91 as base year)
Year Share prices
The profitability of the sector was further affected by the increase in the prices of fuel power and packaging material that consists 70-80 % of the total production cost. In the last budget the sales tax was lifted and the excise duty was increased from 35-40% of the retail price. In order to provide support to the industry the government allowed the export of cement via sea allowed draw back of 12.5%. The permission to export 3 million tones of cement has given some breathing to the crisis stricken cement industry.
The demand and supply situation in the cement industry has tilted sides during the last few years. Until 1996 there had been a shortage of supply as compared to the demand, but then there has been a consistent demand shortage due to new units being set up, converting the sellers market into a buyers market. The demand for cement has grown at a steady rate of 8% in the northern region while 4% in the southern region. The way the new plants are being set up and the existing plants are undertaking expansion. The demand and supply situation is bound to create surpluses.
Over the last ten years, cement consumption has grown unequally in the two marketing segments. The pace of industrialization, infrastructure development and urbanization in the North has prompted a higher growth rate of 7-10 % in the North as compared with 4% in the South.
50% demand comes from the private housing and real estate activity, while 40% comes from government infrastructure projects. The industrial sector generates the remaining 10%. Private housing and real estate activity have slowed due to a high inflation rate that has led to lower savings. This coupled with fraudulent practices of the builders and real estate brokers has shattered the public’s confidence. In view of the lack of government funds and regional disparities surrounding large infrastructure projects such as Ghazi Barotha project, the cement demand is expected to remain low. Especially the government expenditure in the construction sector has decreased by about 29%.
The present crisis in the cement sector first emerged in 1995. Until 1992, the government’s active control over the cement sector through State Cement Corporation had dept private investment in the sector to a minimum. This sale of state-owned units to private sector in 1992 led to price deregulation. The rising margins attracted fresh private investment, which resulted in an exorbitant increase in capacity from 8.2 million tonnes in 1992 to 17 million tonnes in 1998. The huge addition in the capacity of the cement industry is heavily responsible for the current strife in the cement sector of Pakistan. This increase in capacity increased the competition between the producers, but with the rising cost of production they couldn’t keep themselves competitive. The rising overheads could no longer be afforded in a tight industry and eventually an industry with redundant capacity and heavy losses found its way into the already troubled Pakistani economy.
The situation has further aggravated as demand failed to grow at the same pace at which it was growing at the time of starting of the new cement projects. The slowdown in the economy has led to a decline in growth for the housing sector, which accounts for a major part of total consumption. The problem has compounded by the decline in government development expenditure. As a result of all this the demand has declined over the past few years.
The supply of the cement became out of the control of the government with the privatization of the government owned units in the early nineties. The demand for the cement was particularly high in the eighties from the housing sector as the remittance form the Gulf was used to build homes by the expatriate Pakistanis. Now with the changing scenario from the Gulf and a decrease in the trend of the Pakistanis to heavily invest in real estate is changing the trend, resulting in serious decrease in demand of cement. The serious mistake on the part of the cement manufactures to accurately estimate the demand of the cement has hit hard on the cement manufactures. The result is the present scenario with excess capacity and lack of demand.
The demand of the cement is now increasing at a much slower pace then it was before, now the supply of the cement in the market is being controlled by the cartel of the cement makers association (APCMA). Since its inception APCMA is deciding upon the price of the cement to be offered to the public. A comparison of the demand and supply of the cement over the years is shown below:
The supply of the cement doesn’t exceed the demand of the cement by a big margin, but the capacity that has been installed by the cement industry far exceeds the demand of the cement. Rather the cement capacity is approximately double then the demand. Over and above that, the profitability of the industry has been hit hard by the increase in the cost of inputs, which include furnace oil, power and packaging material. These constitute about 60% of the total cost of production, which the producers have been unable to pass to the consumers. Demand of the cement has a high correlation with a GDP, coefficient of correlation found to be 93%.
Factors, which can possibly change the surplus position into a near equilibrium between demand and supply, are:
- APCMA actions to avoid price decline
- Delay in implementation of planned additions and expansions
- Efforts to export cement
- Increase in demand if construction of huge mega-size projects starts.
The cement industry is very unevenly distributed in the country with a vast difference in capacity and production as can be seen in the following tables. The number of plants in the North Zone is double in number to those in the South Zone. The following two tables will give the zonal effective capacity, percentage capacity utilization, consumption and the prevailing gaps between demand and supply in the two production zones. It shows both the actual present scenario and future estimates. These tables give the effective capacity of the operating unit in the cement sector.
NORTH ZONE (million tonnes)
|Year||Effective Capacity||Capacity Utilization||Local Consumption||Surplus/(Deficit)|
SOUTH ZONE (million tonnes)
|Year||Effective Capacity||Capacity Utilization||Local Consumption||Surplus/(Deficit)|
As we can see from the above tables in the South Zone the surplus supply situation is expected to continue for as long as the next 5 years. Also capacity utilization is not estimated to reach even 90% much less full capacity utilization of the plants. The question that then arises is what then is the reason for the extensive expansion projects and the setting up of new plants when existing plant capacities create an over supply situation before attaining full capacity levels of production. The reason lies in the growing export potential for cement manufacturers and all of them want to capture a sizeable share before their competitors do.
As per the figures available the total production of cement during the year 97-98 was about 9.8 million tonnes as compared to production of 9.5 million tonnes production the preceding year. The total installed capacity of all the 28 cement units in Pakistan comes to about 17.312 million tonnes. The actual production of these units during 98-99 was about 10.3 million tonnes.
New projects are being undertaken in the cement sector. The capacity of these projects is estimated somewhere between eight and nine million tonnes. The existing plants are also increasing their capacity, which comes to about 4.030 million tonnes. Thus the total capacity of the existing and upcoming projects would be as follows:
CAPACITY OF CEMENT PLANTS
Status No. Capacity (M. Tonnes)
Existing Plants 28 19.143
Expansion – 4.030
New Projects 9 9.670
INPUT COST STRUCTURE
The cement price has seen a very unrealistic trend over the past two years, where the price per kg of cement has increased by about Rs. 2. Price of 50-kg bag rose from Rs. 140 in October 1998 to Rs. 240 in January 1999. The APCMA (All Pakistan Cement Manufacturers Association) was directed by the Monopoly Control Authority (MCA) to cut back on this unreasonable increase in prices and a show-cause notice was issued. This increase in price by the APCMA was viewed as a monopoly practice. APCMA had a standpoint that the previous price set at Rs. 140 was not justified by any means as the costs associated have increased drastically leaving the operations almost impossible at the old prices.
The debate went on for a while and the APCMA failed to produce any valid explanations thereby earning a penalty imposed on them by MCA. Government of Pakistan, however, considered APCMA’s point valid and assured them some relaxation in this concern.
Due to this drastic increase in prices, the construction sector was badly affected and turned down most of its operations. The Association of Builders and Developers (ABAD) protested and demanded from the government to cut the prices back to Rs. 140 per bag. They warned of Rs. 1 billion investment in housing-sector going to waste if the issue was not resolved soon. As an immediate affect of the slowdown in construction sector some 3000 to 4000 civilians went out of job.
MCA finally gave out its word on the issue and ordered a cut back to original price of Rs. 140 immediately. The order, however, was challenged by APCMA in the court of law, and thus not observed.
The government has offered several incentives to the cement manufactures considering their demands to be valid. MCA on the other hand is of the view that the prices of the inputs for cement manufacturing have not increased after 1997, and thus there is no point to increase the prices. The present price is around Rs. 228/bag.
A relationship of price to the cost is given in the figure.
The cement manufacturing involves several raw materials used in different proportions. The main raw material consists of limestone, gypsum, silica etc. Each tonne of cement requires about 1.7 tonnes of limestone (80 % by volume), gypsum, and silica. All these components of raw material are easily available in Pakistan, therefore are cheap. Raw material has a very trivial share in the total cost structure and therefore doesn’t affect it much either.
The other inputs include fuel (furnace oil), packaging, power (electricity), and other expenses. The major part of the cost is claimed by fuel, power, and packaging, i.e. about more than 46 % of the total cost. Any fluctuation in the prices of these three inputs has a very significant effect on the over all cost. A breakup of different input cost in the overall cost structure of a 50-kg bag of cement is given below.
|Items||Rs. (per bag)|
|Salaries and Wages||7.25|
|Mfg. & Selling Overhead||7.61|
|Total Cash Cost||118.67|
|Total cost per bag||138.72|
Another important cost consideration is the process employed by the unit to produce cement. The manufacturing process can be of any of the 3 types:
- Wet Process
- Semi-Wet Process
- Dry Process
The cement manufacturers advocate their point based on the increase in the prices of inputs. According to APCMA, the increase in cement prices is attributed to the following events:
- A 90 % increase in prices furnace oil over February 96 to February 97;
- 85 % increase in electricity charges over July 94 to July 97,
- 79 % increase in prices of paper bags during November, 1994 to December 1997
- A 128 % increase in excise duties over July 1992 to June 1997.
FURNACE OIL PRICES IN THE RECENT YEARS:
Furnace oil prices rose by 112% in 1997 as the government decided to annex furnace oil prices to international oil prices such that they came to about Rs.6297 in 1997 from Rs.3900 in 1995. But when the price of furnace oil in the international markets fell to $12 from $20 the local prices were not adjusted to accommodate this change. At present furnace oil prices should fall in the range of Rs.3000 per ton in Pakistan. Thus, furnace oil is available locally at double the prices in the foreign markets. In turn, the average impact of the rise in furnace oil prices works out to be around Rs.17 per bag.
|Input||1998(In Rupees)||1999(In Rupees)||2000(In Rupees)||%age change|
|Furnace oil (MT.)||6070.5||7285.00||8800.00 *||20.06||20.79|
*This is the current price as per figures of March 21, 2000. The prices before this 11 % increase were Rs. 8,377.
ELECTRICITY PRICES IN THE RECENT YEARS:
Electricity charges were escalating due to the additional surcharges levied on them. These were about Rs. 1.82 per kWh in 1992-93 and rose by 107% to Rs. 3.76 in 1997-98. The prices have, however gone down in the year 1998-99.
|Input||1998 (In Rupees)||1999(In Rupees)||%age change|
RELATIONSHIP OF INPUT COSTS WITH THE OVERALL COST
Sensitivity analysis shows that a five- percent increase in furnace oil prices results in one percent decline in gross margins. The fuel and power claim the major part of the total cost of cement manufacturing. The major standpoint of APCMA for their price increase is an increase in the prices of furnace oil.
The following is and evaluation showing how the price changes of these inputs impact the total cost and price of cement.
|Input||Total cost 50 kg of Cement(In Rupees)||%age of Total Cost||10 % Increase in Price Adds to Cost(In Rupees)||Total Cost after Price Change(Rs.)|
One proposition as a cost cutting measure given by APCMA is that if the government allows direct imports of furnace oil by the manufacturer and index government’s supply of furnace oil with international prices. The excise duty on ex-factory rate instead of retail, the prices of cement could be cut back. If this proposition is considered the prices of furnace oil could be reduced from Rs. 45 per liter to almost half the price.
When the hasty privatization in the 1991-92 was initiated, it was stated that the privatization would benefit the common man as it was thought to be the panacea for all economic ills in the public sector.
The cliché-ridden privatization policy was based on the principle of competition, deregulation and liberalization. Consumers were amazed when the results started surfacing. Prices of all commodities went up, the massive layoff of employees in the name of “Golden Handshake” and bad business practices emerged as the governing principle of the newly privatized units.
The cement industry is also a victim of the newly enacted privatization strategy. The prices of the cement went up from Rs. 85 per bag to Rs. 235 per bag, without an plausible justification of cost and benefit. The social cost was far more than the economic cost. The rhetoric of the broad based ownership has proved abortive as the ex-production minister Mr. Islam Nabi, at some point disclosed that the government had handed over six to a particular group. The Association of Builders and Developers (ABAD) and Monopoly Control Authority (MCA) has also joined the popular criticism about concentration of ownership and misuse of cartel power.
There are in all 28 cement units in the country with an installed capacity of approximately 17.3 million tonnes production. Out of these units only four units with merely 1.8 million tonnes are now in the public sector while a majority of the installed capacity is concentrated in the 20 privately owned cement plants. The installed capacity is far more than the current national demand. The oligopolistic behavior of the cartel has contributed a lot in falling national demand along with some other factors like decline in public works program activities in the country.
The depressed trend in the construction sector is evident from its falling sectorial share in the national output (GDP) which has decreased from 4.2 percent in 1992-93 to 3.6 percent in 1998-99. The growth in the construction sector has also declined from in the vicinity of 6 percent during 1990-91 to one and two percent during the period of 1993-94 to 1998-99 with an exception of 1995-96 when it recorded 3.25 percent growth. The poor growth of the construction sector is attributed mainly to two important factors, first the upward adjustment of cement prices and curtailment in the public sector development expenditure in recent times. The development expenditure of the federal government has fallen from 7.5 percent of the GDP in 1991-92 to 3.6 percent of the GDP in 1998-99. The public sector was a major consumer of cement.
The cement industry attributes the high prices of cement to the government’s imprudent policy regarding taxation and upward adjustment of furnace oil prices and electricity tariffs. The combined impact of electricity and furnace oil on cost of production is 47 percent. However, the MCA and ABAD have different views on the issue. According to the government the MCA has reduced the total tax incidence from 47.5 percent (35 percent CED + 12.5 percent ST) to 40 percent excise duty in the Federal Budget 1997-98. There was a marginal increase in electrical charges in late 1997, which was far below than lowering of tax incidence. The furnace oil prices were also depressed in the market.
The cement was being sold in the market at around Rs. 165 per bag until February 1998 but prices escalated to Rs. 240 – Rs. 245 per bag in July 1988. The cartel, APCMA, in a report submitted to the Ministry of Commerce in May 1998, mentioned the total cost of production was Rs. 184.32, when adjusted with profit and transportation the prices rose to Rs. 228.50 per bag. On the other hand in an earlier report in June 1997, the APCMA had estimated the cost of production at Rs. 136 per bag and adjusted it with profit and transportation at Rs. 170 per bag. The MCA and ABAD have also worked out different cost structures. A comparison of cost of production from different sources are given in the table:
|Maintenance & Store||4.44||4.15||2.92||2.92|
|Overhead & Labor||7.65||15.81||7.75||7.75|
|Cost of Production||68.00||92.92||63.49||63.49|
|Total Cost of Production||136.00||184.32||131.49||122.49|
The fluctuation of the cost in visible inputs hardly supported the logic for price hike. The furnace oil prices fell sharply during 1998, which moved up to attain prices of 1996 and 1997. If we include recent rise (of December 10, 1999) in the furnace oil prices, the total rise hardly exceeds 10 percent over peak prices prevalent during 1996 and 1997. The same is the case with electricity, whose prices remained stagnant during the period February 1997 and March 1998. A ten percent rise in March 1998 could hardly justify the case for 35 percent upward adjustment in cement prices. The arbitrary increase Rs. 40 to Rs. 50 per bag by cement manufacturers in February 1998 had laid the foundation for the slowdown of the construction activity in Pakistan. A close look at the table would reveal that the cost structure data is manipulated by the APCMA, otherwise, the on ground realities depict a different picture of upward adjustment of input cost. The cost data provided by the ABAD and MCA may be termed as biased by the cement cartel, even then, the prices of cement could not be justified beyond Rs. 200 per bag.
Another very disappointing aspect of exorbitant profiteering in the industry is that the cement industry is unevenly distributed in various regions of the country. Different units use different technologies and different units have different plants of different ages with different efficiencies. But irony is that all units charge almost similar prices across the country, which implies misuse of cartel power. Another valid principle of the market economy based on competition is when market is depressed, prices move downwards, but in the case of cement the reverse has happened. The cement industry is working under capacity and there is scope for full capacity utilization at affordable prices. But the thrust for extraction of exorbitant profits dominates the principle of fair play.
The forces of exploitation and greed determine prices in Pakistani markets rather than market forces. The government must check the in-ordinate price hike. The shelter is a basic need of the common man and to ease the provision of shelter cement prices have to be brought down.
CHARACTERISTICS OF THE INDUSTRY
The cement produced in Pakistan by different manufacturers is virtually of the same quality and standard, that is why consumers do not perceive any quality difference in the cement produced by different manufacturers; therefore, the market for cement is oligopolistic. In oligopolistic competition the market consists of few sellers who are highly sensitive to each other’s pricing and marketing strategies. Each seller is alert to the competitors’ strategies and moves. If one company slashes its price by say 10% buyers will quickly switch to this manufacturer and the other manufacturers will respond by lowering their prices. In contrast if one oligopolist raises its price, the competitors might not follow this lead and the oligopolist then would have to retract its price increase or risk losing customers to the competitors. But the cement manufacturers have formed a cartel APCMA and have set monopolistic prices. This is evident from the fact that all manufacturers sell at almost the same price even though they use different processes, have different technologies and different transportation cost.
ROLE OF ADVERTISING & PROMOTION
In Pakistan all cement manufacturing companies adhere to the British Specification # 12. The product of each company is virtually same in terms of quality and price. The only role that advertising play in this situation is that, it reminds the customers of the presence of the company in the market.
The cement industry is characterized by the need of an elaborate distribution system. The role of distribution becomes more important when one area of a country is deficient in the production of a product while the other is producing the same product in excess of the demand. The presence of the product in the market is what makes or breaks a company. This is true for both export market and the local market
NATURE OF THE INDUSTRY:
Before privatization the cement industry was highly regulated. Under the control of SCCP the prices were kept to an artificially low level. However after privatization, the SCCP lost control over the prices of the cement, however the industry is subject to the policies of the MCA and ECC.
SENSITIVITY OF THE INDUSTRY
- Technological Change
The industry is capital intensive and is defined as one that makes use of the latest technology to deliver quality product to the customer. Consideration needs to be given to this factor when making capital budgeting decisions to arrive at the appropriate amount of capital that needs to be invested in acquiring plant and equipment. This has a direct correlation with the type of the technology that the firm wishes to use.
To remain competitive in the market, the players need to follow the highest standards of the technology, but acquiring new technology and replacing the older one with the newer is very expensive and most of the time unfeasible. Any major technological change can cause the entire plant to become obsolete. As such there is no major technological changes affecting the cement industry in the near future.
- Change in Energy Prices
The industry is highly exposed to the change in energy prices because energy (fuel & power) comprises around 40-45% of the total cost of production. Sensitivity analysis shows that a 5% increase in furnace oil prices results in a 1% decrease in the gross profit margin. Some companies that use wet process are highly exposed to change in the energy prices as the wet process consumes 50% more energy than the dry process.
- Dumping Effect
In the international market Pakistani cement industry is exposed to the dumping by the Chinese manufacturers.
- Effects of Exchange Rates
The effect of exchange rate on the cement industry is quite complex. On one hand, weakening of Pakistani Rupee makes the Pakistani exporters more competitive in the international market and on the other hand the cost of manufacturing increases because the cement has a high forex component in the form of energy, capital and transportation.
- Size & Growth Rate of Population
The size of population and the population growth rate besides the consumption habits of the customers have a great impact on any industry. The per capita consumption of cement in Pakistan is around 71 kg against the international standard of 100 kg. It means that there is a potential of increase in the consumption of cement in future. Pakistan has one of the highest population growth rates in the world, which is around 3%. It means that in future the increase in the housing needs will increase the demand for cement.
PROBLEMS AND ISSUES
The cement sector contributes Rs. 15-20 billion per annum to the National Exchequer. The taxation policy should have ensured lower prices since cement is an essential commodity for the development of an economy. The industry in Pakistan is paying Rs. 90 per bag as excise duty as compared to Indian producers who pay only Rs. 17.50 per bag. If the excise duty rates are revised to Rs. 300 per tonne then the price owf domestic cement can be reduced to as low as Rs. 160 per bag. Inordinate and frequent increases in taxes create a dilemma for local cement manufacturers since they have to appreciate their prices every now and then, adding to the lack of stability in the form of fluctuating prices. This has led to a reduction in the demand for cement. The rates of excise duty have been escalating at the tremendous rate of 350% in the last 10 years and 200% in the previous 5 years. This is the reason per capita consumption of cement in Pakistan is as low as 71 kg. Import of machinery for expansion was exempt from duties until 1995 after which 10% regulatory duty was imposed on all imported goods. This led to arise in the capital cost of new plants and on-going projects. Apart from excise duty the sector adds to the state revenue in the form of:
- Provincial royalties on limestone, gypsum etc.
- Import duties on spares and parts
- Octroi on all items purchased
- Excise duty on all raw materials
The rapid escalation in excise duties has transformed the sector to a loss making industry from one that was earning around 35% profit margin previously. The proposal now is to charge the levy as a combination of excise, sales tax with adjustment margins for the same taxes paid on oil, power and materials. In lieu of this recommendation the government has reduced the excise duty to Rs. 1400 per tonne as compared to the past trend of a fixed 40% of retail price.
Exports too are being affected by fickle state policies. Low duty drawback of only Rs. 600 per tonne reduces the level of exports. The reduction in excise duties should help local producers lower and maintain their prices at around Rs. 200 per bag.
Under the principles of taxation only those commodities should be subjected to high rates, the consumption of which is intended to be restricted and discouraged such as cigarettes and alcoholic drinks. On the contrary cement is a basic commodity which has the potential to promote development efforts and therefore its availability in the market at a reasonable price should be ensured.
DECLINING PROFITABILITY AND MARKET CAPITALIZATION
Since 1995 the cement sector has been in trouble. In 1993-94 the sector’s profits were well above Rs. 2 billion but they reduced to half the amount in the following year. Companies in this industry, from 1995-96, were incurring losses onwards. On top of this the overall market capitalization witnessed a severe decline from Rs. 62 billion in 1994 to Rs. 3.486 billion in 1998. The following table shows the actual and forecasted profits in the 2 regional divisions of the cement sector
Most cement companies are incurring heavy losses due to the fact that the retail price after excise and other taxes leaves an amount not even able to cover their production costs much less give them space for profit margins. 4 public limited companies were forced to close down since their losses had reached a level they were unable to account for. The losses suffered by some of the companies in the 6 months ended December 1998 are as follows:
|Company||Operating Losses(in millions) for 6 months December 1998|
|D.G. Khan Cement||371|
The financial crisis in the industry has led to a severe liquidity crunch in this sector. The debt burden comprises of $300 million owed to international agencies and around Rs. 20 billion debt is outstanding in relation to the local banks and DFI’s. Financial charges have been on the rise ever since 1992 when they amounted to only Rs. 428 million, while in 1998 the same amount had risen to Rs. 1595 million. Cement manufacturers are in a fix as to what to do to remedy the situation. One option available to them is liquidation and 4 of the companies had to eventually resort to this. Fauji Cement, D.G.Khan Cement, Pioneer and AC Wah are nearing a default situation on their debt servicing on loans obtained from foreign institutions such as International Finance Corp. and Commonwealth Development Corp. total credit liabilities of the sector towards local banks is to the tune of Rs. 23.881 billion. Details are as follows:
Companies have been unable to pay interest due on loans, owe payment to utility companies like WAPDA and KESC. Depletion of stocks of furnace oil and paper bags for packaging and defaults in payments to suppliers adds to their burden bringing them nearer to the edge. Late payment of bills will lead to an additional loss in the form of 10% surcharge. Suppliers on the other hand will demand immediate payment with the due penalties to avoid a complete default by the manufacturers. Low stocks of paper bags will delay dispatches of orders and tarnish the goodwill developed with the consumers.
INCREASING CAPITAL COST OF PLANTS
The cement industry is a capital-intensive industry with heavy reliance on the engineering sector of the economy. In addition to this, the manufacturers depend on technology, which is usually imported when setting up a new plant or considering expansion. So far European and American plants are being set up in the country. The cost of a 2000-tonnes per day plant lies within the range of Rs. 3.5-4 billion and for a 3000-tonnes per day plant the capital cost is approximately Rs. 5.5-6 billion. This large capital outlay is increasing financial charges.
70% of the plants in Pakistan have been supplied by a Danish firm named FL Smidth. Japan and Germany have sold only 2 plants here. The situation now is such that FLS is now a price- making monopolist who is causing a steady upward trend in the price of its plants. All the new 15 plants being set up have been sold to us by FLS except those of Saadi Cement and Kaiser Cement. Due to persistent devaluation plants which cost Rs.35-80 million in 1993 are now in the range of Rs. 3-6 billion. This hinders expansion plans and adoption of latest technology by the new and existing plants.
CAPITAL COST COMPARISON OF NEW PROJECTS
|Nature of Project||Expansion||Green Field||Expansion||Expansion||Green Field||Green Field|
|Origin of Plant||Europe||Europe||Europe||Europe.||Europe.||Europe|
|Rs./ton of ann.capacity||3733||4000||6643||6275||6048||6556|
With the costs of FLS plants on the rise, a few plants have been bought from the Chinese who have adopted this technology via franchise but are offering lower prices as compared to their Western competitors. The drawback is that they are offering only very small capacity plants such as those producing 300-2000 tonnes per day.
The cement industry continues to operate under pressure of inconsistent Government policies announced from time to time.
These briefly are:
- Capacity taxation was abolished from August 1993 which took away special incentives for increased production which, in turn could have revived the industry in the larger national interest.
- The taxes and duties on inputs have consistently been increased. The system of charging excise duty is extremely unfair as cement being voluminous product, freight and allied charges vary widely from place to place.
- The price of furnace oil, a major cost component of cement manufacture, has increased sharply. Just now it has increased to Rs. 8800 per tonne.
Import of machinery for expansion project was a exempt from import duties and sales tax which expired on June 30, 1995 and additional duties have been imposed on imported goods. This has increased the capital cost of the on-going projects in addition to the effect of devaluation of the Pak Rupee.
Since consumption of cement in southern region has gone down and northern region has attained self-sufficiency, units located in southern region are forced to cut down their capacity utilization. The possibility of cement export is the proverbial silver lining for the recession-torn industry. While there are cement deficient countries like Sri Lanka and Bangladesh importing approximately 2 million tonnes per annum each, there is tough competition from India and Chinese suppliers.
In fact, apart from the prices offered by Pakistani manufacturers, lack of facilities for handling bulk export of cement has become a major impediment. Where bulk handling is cheaper than handling bagged cement. Export of cement is necessary for the existence and survival of the industry rather than a source of profit.
Dumping by Chinese manufacturers, lack of incentives, high costs of production and freight charges have made the cement export unviable. In the recent development, there has been a radical change in the political scenario of Afghanistan. The war-ravaged country is a prime target for the northern producers to sell their cement. This possibility is still remote until the situation settles. According to an IRS all countries except Bangladesh and Philippines are in a position to export cement and hence pose competition for Pakistan. Yemen is another potential destination but there too government subsidized cement from Gulf countries will pose serious competitive threat.
The export potential available to the Pakistani cement sector can be summarized in the following table:
|Current Demand 1998||Demand Growth %||Local Production (metric tonnes)||Current Gap||Est. Gap in 2003||Remarks|
|Sri Lanka||2000||1||500||1500||1600||Fast depletion of limestone reserves|
|Myanmar||2400||8||500||1900||3000||No major capital|
|Yemen||2800||10||1200||1600||1000||High growth rate|
Demand though in the above countries is on the rise, potential is highly jeopardized by the high prices at which local clinker/cement is available to these importers. Further more clinker/cement is available in these countries at extremely low prices due to the South Asian crisis and the crash of currencies. On average the C&F prices in these countries have fallen by US $15 per tonne. Pakistan on the other hand is unable to export these products even at variable cost. The price offered by local producers is $80 per tonne, which is much higher than those quoted by other players in the international market.
Pakistan though has an excellent opportunity to capture these markets since they offer benefits in the form of geographic proximity, and perceived high quality of Pakistani cement. Presently India and China are reaping the benefits since they are able to offer competitive prices as their costs of production is lower and state subsidies for exports are given to cement producers of these countries.
Import requirements of the countries mentioned in the above table are approximated at 17.7 million metric tonnes. Pakistani producers were of the view that they could capture around 30% of this market in 1998-99 and increase their share to 50% in the following year, that is, 1999-2000. By the year 2000 the forex earnings were estimated at US$ 697 million.
DEMAND FOR IMPORT OF CEMENT (000 metric tonnes)
In relation to the above scenario the targets set by our local producers are as follows:
EXPORT TARGETS OF CEMENT PRODUCERS
|Import Demand(000 tonnes)||17700||18914||20205|
|Target % mkt.share||30||40||50|
|Total Export (millionUS$)||345||507||697|
Apart from non-competitive prices domestic cement manufacturers face problems in the form:
- Inadequate port facilities
- Present export rebate of 12.5% of FOB i.e., Rs. 300 and Rs. 270 per tonne for cement and clinker respectively is very high
- Clinker/cement are not Non-Traditional Exports and therefore denied extra 50% rebate
- Export of cement allowed only via sea which eliminates cheaper road transport through Afghanistan and into Central Asia
- Lack of sufficient duty and surcharge drawbacks. Reimbursement of these duties to the exporter should be made.
Chinese dumping and high freight charges also act as a disincentive for local exporters. For instance freight charges from Pakistan to Dhaka are around $17 per tonne, whereas it costs the Chinese only $12 per tonne to the same destination. Rupee devaluation poses another problem for exporters in the form of changing fuel and furnace oil prices and thus increasing costs. A 5% increase in furnace oil prices leads to a 1-% fall in gross margins for exporting companies.
The country’s cement manufacturers can gain a strong foothold in the foreign market by competing on prices because brand image and value are not of prime consideration for cement in the international arena. Proposals offered to remedy this situation are duty drawbacks, refunding of development surcharge and freight subsidies to the tune of $180 million. Pakistani cement can attract buyers only if it offers a combination of superior quality with competitive prices. Also fast action is needed to tap the vast potential available for foreign market development for the cement sector to regain its balance and revert to its former status as a well performing industry.
At the current point cement manufacturers and the government have to take concrete steps even to keep units in production. On the input side, necessary steps are required to contain the energy cost. The following are the general recommendations that would help to improve the situation of the cement industry
- The liberalization policy Pakistan is so eager to adopt will work both for and against the local industries. Unrestricted trade will allow free entry of low priced cement into the country and reduce existing market shares of all domestic players.
- Growing emphasis on low prices may reduce the qualitative aspect of production and give way to inferior products. Companies have to maintain quality standards and at the same time try and reduce costs via economies of scale.
- Too much expansion by a few players will lead to the development of a monopolistic environment in the sector. At present the industry is oligopolistic in market structure with a few sellers in the market who compete on the basis of price and technology and resort to means to increase their relative shares in the market.
- The wet process technology is outdated and all manufacturers using this method will stay far behind if they do not take measures to improve and update their production facilities.
- Focus in the future will be on cost competitiveness and product differentiation so that producers of cement can enhance margins and increase earnings by capturing a wider market base. Players specializing in different varieties can develop to various market segments and increase customer base.
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