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| Sugar continues to be a bitter pill |
| Devangshu Datta / New Delhi Jan 31, 2010, 00:22 IST |
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Distortions in the market place will lead to high prices for sugar in the next few seasons
The demand-supply dynamics of the sugar industry is deceptively simple at first glance. India is the largest global consumer with domestic demand hovering at around 23 million tonnes. India is also among the largest global producers. Domestic demand has grown sharply due to rising incomes. Global sugar prices are, to a very large extent, influenced by India's demand-supply equations. In years, when Indian sugar production matches domestic demand, all is fine.
However, Indian production fluctuates alarmingly between 14.5 million tonnes and 22 million tonnes, due to several factors. Apart from the vagaries of monsoons, acreage under cane fluctuates. This is where the explanation starts getting complicated.
Sugar is a “necessary good” and production is discontinuous. Basic demand remains stable through a large range of price-variation and demand-supply gaps persist until the next season. This means that, when there's a glut, prices drop. And small shortfalls can cause large price rises. From the farmers' angle, record production means low cane-procurement prices. Hence, if there's a good harvest, farmers plant less cane acreage in the next season. If it's a deficit season, procurement prices climb and farmer plant more acreage.
In practice, we've seen a cycle of two good seasons followed by two bad seasons but that may change. The definition of “good” and “bad” depends on whether you're looking at production or price. A “good” production season is a “bad” season in terms of price.
From the mills' perspective, surplus sugar can be stored until higher prices can be realised. Value-addition is also possible. Sugar processed into sweets and confectionery offers better margins. Sugar can also be processed into alcohol for industrial and consumption purposes.
Here's where political interference starts playing a role. State governments set cane-procurement prices. The mill cannot pay less than the procurement price though it may pay more in deficit seasons. Hence, if there's a glut, mills don't pick up the full harvest.
There's various restrictions placed on mills. Cane must be crushed within 24 hours of harvesting for the best yields. Mills therefore, have natural catchment areas determined by transport logistics.. But state governments determine the catchment area – mills are not allowed to buy cane outside a certain radii, regardless of their ability to do so. In addition, states often arbitrarily ban movement of cane, molasses, etc., across state borders.
There's more restrictions on price, sale quotas and value-additions. A great deal of “interaction” with various authorities is required to get an alcohol production license for value-add. A certain amount of sugar must be sold at the controlled “levy” price. The rest can be sold at free market prices. However, the amount of sugar sold at free-pricing in a given month is also controlled. So mills cannot make bumper profits by releasing large surpluses when prices are high.
The distortions make the marketplace even more complicated. The government of India also arbitrarily allows and bans imports. Even trading sugar on the commodity exchange is often banned, further interfering with price-discovery. There will probably be a trend of rising prices over several seasons to come. There is growing demand and a global gap between demand-supply. This year, Indian consumption will be around 23 million tonnes while domestic production will be between 15-16 million tonnes. Globally, consumption is likely to hit 167 million tonnes while production will be 160 million tonnes. Sugar is also an important feedstock in the renewable energy chain. Brazil for example, uses sugar-based alcohol to power internal combustion engines. This is a further cause of rising demand.
The political distortions won't be removed. Around 70 per cent of cane comes from UP and Maharashtra but Karnataka and Tamil Nadu are also major producers with contributions from several other states. Sugar is the only major industry in most cane-growing areas, and therefore, a key employer of both farm labour and semi-skilled mill workers. Voting patterns are linked to the industry's fortune. So is substantial funding for several political parties. Hence, there's consensus on political control.
There are many listed players in the industry as well as various cooperatives in Maharashtra. In the last quarter, profits rose by around 80 per cent for listed players. A 35 per cent shortfall in supply has led to 100 per cent price appreciation.
That trend of high prices could continue into late 2010 and even further. More acreage will be planted but who knows about the monsoons? Sugar was among the few sectors that delivered capital appreciation in 2008 (a deficit year) and among the best performers of 2009.
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