This is part 2 of 3 in a series on rising input costs. Read part 1 on FMCG here and part 2 on Cement here. 

Fuel costs have been surging in 2021, eating into the profits of a recovering sector - cement makers. Cement production, after rising above pre-Covid levels in Q4FY21, fell sharply due to the second wave. But fuel prices continued to rise.

Companies involved in the construction of houses and infrastructure activities use fuel like crude oil, petroleum coke, coal, diesel and petrol to produce and transport cement. Both these categories of fuels - production fuels and freight fuels - have been rising steadily in 2021. This is increasing cost pressures on cement and steel makers in FY22. Fuel accounts for nearly 13% of all costs of cement companies.

To produce cement, cement companies’ kilns use coal and petroleum coke (or petcoke). In Q1FY21, the primary fuel used by the cement sector was petcoke. Due to low demand by domestic cement makers amid the national lockdown, the price of petcoke fell 15% YoY to $70 per tonne. However, petcoke prices grew steadily in FY22. In Q1FY22, petcoke prices almost doubled YoY.

In Q2 and Q3 the demand for cement from the realty and infrastructure sectors (90% of cement demand) recovered. Cement companies required large volumes of petcoke and coal to cater to this demand. But petcoke prices were elevated because petcoke supply from the United States was disrupted due to rising Covid-19 cases. This forced cement companies to switch to coal, an alternate fuel source. Between January to September 2020, Indian cement companies imported 0.4 MT of petcoke, a decline of 21% YoY. 

Cement factories’ kilns can use either petcoke or coal. Hence, the switch did not result in higher costs in Q2FY21. What did result in higher costs was the rising price of coal from Q4FY21. 

The cost pressure of expensive coal affected cement companies in H2FY21. However, they were cushioned by rising demand, and cement production using coal continued. In H2FY21, domestic cement production was 172 MT, a 42% growth against the first half of FY21.

Q4FY21 was the first full quarter in FY21 when cement companies’ primary fuel source was coal. Between January to March 2021, coal prices grew by 4%. Then in Q1FY22, coal prices surged even further on higher global demand and production curtailment. Cement companies use imported coal, primarily from Australia, because it’s priced 20% lower than domestic coal. 

In Q1FY22, coal from Australian mines saw higher demand from South Korea, Taiwan, and Japan due to recovering economic activity in the Asian countries. This kept the price of imported coal from Australia high (24% higher since January 2021), resulting in higher costs for domestic cement makers. Coal, which remains the primary fuel source in the industry, is priced 15% lower per tonne than petcoke, but its price is rapidly rising. However, cement companies have already made the switch to coal from petcoke over the past three quarters. This is evident from the fuel mix of India’s largest cement company UltraTech Cement.

This rising price of production fuels was accompanied by rising freight costs. Freight costs were higher due to the rising price of diesel and petrol. In FY21, diesel and petrol prices grew by 29% and 30%, respectively. In addition to the rising production fuel costs, higher freight costs will weigh on cement companies’ bottomline in H1FY22. In Q4FY21, UltraTech Cement’s freight costs rose by 25% YoY. This is expected to rise further as diesel and petrol prices increased by 10-12% sequentially in Q1FY22.

In response to these rising fuel costs, domestic cement companies hiked prices in two phases in 2021. The first was in March (by 5% MoM) and the next was in June (by 4% MoM). The second price hike was because of an expected slowdown in coal imports. Australia was unable to increase coal production at its main mine in Newcastle because of a train accident in June 2021. 

Higher cement prices are unlikely to pay dividends in Q1FY22 due to low demand from the real estate and infrastructure sectors. Analysts said cement sales volumes in Q1FY22 fell by 20% sequentially. Costs of production and freight fuels remain elevated, as well as in other minor inputs (rubber, packaging materials, etc.). Cement companies have signaled another round of price hikes may be in the offing. 

The sector will have to exercise caution with price hikes given that demand outlook remains muted, and they need all the help they can get from festive season demand. Fuel costs are unlikely to moderate in Q2FY22, making price hikes all the more important. But will this accrue to cement makers’ bottom lines?