One can be bullish on the sugar industry because of its scope as a sustainable alternate energy source.
Over the past year, many corporate offices have become quieter places. Ambient noise has been reduced by the induction of cooler, greener, new generation IT equipment. The whine of fans working overtime to cool hot motherboards has eased.
New generation IT hardware is more energy-efficient. By some estimates, data-intensive businesses can reduce overall energy needs by a third or more through modern hardware and smart power management tools.
This is a “win-win” situation - it’s environmentally better and cheaper. The rise in energy costs in the past two years has sparked interest in developing such energy-efficient solutions. In that sense, the crude spike has been fortuitous. Businesses have become more environmentally conscious because of the cost-benefits.
Rising crude prices have sparked off inflation and near-recession in the US and elsewhere. But this has happened 10-20 years before Peak Oil. That gives the world extra time to develop alternate energy solutions. This could lead to a softer landing when Peak Oil does dawn.
The Indian sugar industry could be a major beneficiary of the quest for sustainable alternate energy. It has always been subject to absurd controls because prices and offtake of this key commodity directly affects the political stances of 60 million farmers and many more industry workers across six states.
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States set cane procurement prices; mills must sell a proportion of their produce at controlled prices; mills are restricted to small catchment areas for cane procurement; distillation is controlled; molasses sales are controlled; open market sales quotas are capped month-by-month, etc. As a result of these inefficient controls, around 12 per cent of India’s labour force is stuck in an industry that generates 1 per cent of GDP.
Sugar also suffers massive cyclicality over 5-7 years. Demand is around 20 million tonnes per annum while production has swung between 28 MTPA (2007-08) and 14 MTPA (2003-04). In surplus years, farmers and mills suffer since sugar prices drop. Scarcity then follows as less cane is planted.
Apart from value-addition through the distillation of potable alcohol, sugar can produce other useful by-products. One potential revenue stream is the co-generation of power through the incineration of bagasse (waste left after crushing). Another potential stream is cellulose ethanol production from bagasse and from excess cane.
Co-generated power can be traded and wheeled onto commercial grids. The ethanol can go into petrol-ethanol mixes. The rise in crude prices has prompted a new look at both these revenue streams.
The excess of supply over demand (for sugar) can be profitably employed and quite possibly, generate higher revenues than sugar itself in glut years. In that case, the harsher aspects of agricultural cyclicality will be mitigated.
The industry is currently in the glut stage of the cycle. Cane procurement prices are a political hot potato that makes it impossible to lower them. Decontrol of sugar including removal of free market monthly quotas and the lowering of export barriers, is also politically “dangerous”. The price of ethanol is fixed rather than (ideally) free or tied to the price of crude.
If say, roughly 15 per cent of sugar production goes into ethanol however, that would automatically lead to stability in sugar prices. The demand for ethanol from the energy industry is ample enough to absorb any excess supply that may arise.
So the basic drivers are now in place for the sugar industry to try and improve production. This is one reason why the share prices of listed sugar companies has remained high despite the industry being at a low point on the cycle.
Right now, ethanol prices are controlled at roughly 30-35 per cent below crude price-equivalent. If the sugar industry has profit margins at these prices, there is a good chance that it could stay profitable, even if crude prices dropped. The co-generation power comes from waste, so power-trading is liable to stay profitable as well.
Can one make a case for the comprehensive revaluation of the sugar industry? The linkages and controls will hinder the maximisation of profits but the downside has also been “stop-lossed” by rising crude prices. That could also mean better PE multiples as alternate revenue streams grow. It’s difficult to evaluate these prospects in terms of hard numbers but the long-term scenario seems bullish.