Sensitivities about sugar

Price revision mechanism will have to be swift to tackle the difference between ethanol and crude oil

The livelihoods of many voters, as well as the financial wherewithal of politicians, are tied to the fortunes of the sugar industry. Cane, sugar and alcohol are all politically sensitive commodities. Vast numbers are employed in sugar cultivation and in downstream industries across six states. There is far too much policy interference. There is a physical constraint in that cane must be crushed quickly for high yields. But mills are forced by policy to source only from within a given a catchment area, and a minimum distance is mandated between any two mills. So, each farmer can only sell to a given mill, which in turn cannot buy from any farmer outside its prescribed catchment area. This creates a dangerous co-dependency.

The Centre sets a so-called fair and remunerative price (FRP) for cane procurement. States can set a state administered price (SAP), higher than FRP. If the local mill cannot afford to pay the procurement prices, the farmer has no other buyer. He gets paid late or only part-paid.

Every mill must sell 10 per cent of its sugar to the government at a set procurement price. The mill can sell the remaining 90 per cent in the free market. However, the government also sets a quantitative quota for free sales. That is, the mill cannot sell more than a certain amount in any given quarter. This is supposedly to even out sugar availability, since it is a discontinuously produced good. In practice, it means supply distortions and artificial scarcity. Mills can't sell more when open market prices rule high.

India is, by far, the world's biggest sugar consumer. So, deficient Indian production usually leads to higher global prices. India is also one of the two largest sugar producers in the world (along with Brazil). But it doesn't participate too much in global trade due to export/import controls. India produces an average of 17 per cent of global sugar. But it only holds about five per cent share of the global sugar trade.

Apart from sugar, the industry produces valuable products like alcohol, molasses and bagasse. Bagasse is a waste product (from crushed cane). It's used in power generation, and in the paper industry as a raw material. Molasses and alcohol are also subject to many controls.

Sugar price variation ultimately depends on supply-demand. But farmers take price signals from the previous year's experience when they decide how much acreage to plant. Over-planting leads to low prices. Low prices trigger under-planting, which leads to high prices. This cycle alternates. This is a surplus cane season and prices are low. Some time in the next two years, prices might swing sharply, going by history.

About 50 years ago, Brazil embarked on a fuel-substitution experiment, replacing petrol with ethanol. A similar move could smooth out cash flows for the Indian sugar industry and it is attractive, due to import substitution. Ethanol is renewable but it isn't "green", since cane is water-intensive and leaches soil nutrients. In Brazil, large swathes of rainforest have been ruined by sugar plantations.

By policy, Indian oil marketing companies (OMCs) are supposed to blend five per cent of ethanol into every litre of retailed petrol. The aim is to increase the blend over time. However, only about 1.3 per cent of ethanol is blended at present.

The procurement price of ethanol has been raised. The new scheme fixes prices, as well as imposing obligations on OMCs to buy ethanol, and on mills to supply. There is talk of supply or pay agreements. That is, mills must supply agreed amounts of ethanol or compensate the OMC. Right now, mills and farmers are happy since sugar prices are low. Ethanol is cheaper than petrol (after hikes raised prices to Rs 47-49 per litre). So, OMCs are also happy.

Crude oil prices are expected to stay low in 2015 and about 90 per cent of petrol's cost of production is dependent on crude prices. Sugar prices shouldn't rise either until September 2015, when the next crop comes in.

The OMCs will not buy ethanol in quantity if petrol production costs drop below ethanol prices. This might happen if crude gets cheaper. Conversely, if crude rises, the OMCs might want to buy more ethanol. If crude and sugar prices rise together, things get tricky. The price review mechanism would have to be fast, robust and flexible to cope with all possible scenarios. We actually have little idea of how these reviews are performed. There lies a possible danger. It is only one of the many dangers caused by over-regulation.