Opinion

Sections
Executive summary Domestic demand-supply outlook Demand-supply overview Supply Demand Exports Global demand-supply outlook Prices Profitability Business model analysis Ethanol-blending programme

September 2008

1.0 2.0 3.0 4.0 5.0 6.0

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Boxes
1.0 01 02 03 Domestic demand-supply outlook Domestic sugar consumption forecast Methodology Alternate methodologies Raw sugar

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6.0 Ethanol-blending programme 01 Background

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Figures
1.0 01 02 03 04 05 06 2.0 01 02 03 04 Domestic demand-supply outlook Sugar Demand-supply State wise sugar production, inventory and prices Indexed MSPs of alternative crops Historical zone wise sugar production in Maharashtra Domestic and export realisations for white sugar Domestic and export realisations for raw sugar Global demand-supply outlook Global demand-supply and inventory Global inventory levels and prices Per cent age diversion of sugarcane to sugar and ethanol in Brazil Indexed domestic prices of sugar and ethanol in Brazil

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Continued

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Figures
3.0 01 02 03 04 05 06 Prices Domestic and international sugar prices Open interest and net non commercial long positions in sugar Net non commercial long positions and sugar prices Indexed raw sugar prices in USD and BRL Raw sugar prices in USD and BRL Appreciation of BRL against the USD

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4.0 Profitability 01 Profitability of sugar companies in North India (UP, Bihar) 02 Profitability of sugar companies in South India (TN, Kar, Maha)

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Tables
1.0 Domestic demand-supply outlook 01 Sugar - Domestic consumption 3.0 Prices 01 Domestic demand-supply situation to tighten 4.0 01 02 03 04 05 Profitability North India Key financial ratios South India Key financial ratios Profitability of North Indian companies in 9M SS 2007-08 Profitability of South Indian companies in 9M SS 2007-08 Comparative sugar prices Mumbai S-30

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5.0 Business model analysis 01 Integrated model has higher returns over the complete cycle 6.0 Ethanol-blending programme 01 Alcohol surplus/(deficit) situation 02 Comparison of profitability of ethanol production under C vs. B' molasses route 03 Surplus/ (deficit) under B' Molasses route 04 Ethanol prices at which C' molasses route and B' molasses route are equally profitable 05 Comparison of ethanol production via C' molasses vs direct route (cane to ethanol) 06 Ethanol prices at which C' molasses route and direct route are equally profitable

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Executive summary

CRISIL Research expects profitability of sugar companies to improve over the next 2 sugar seasons (SS 2008-09 and SS 2009-10) on account of higher sugar prices. Lower sugar production and increasing consumption will lead to a fall in inventory levels causing prices to rise. CRISIL Research forecasts sugar prices (Mumbai S-30) in SS 2008-09 to be between Rs 17,000 18,500 per tonne, a rise of 13 23 per cent over the average levels of SS 2007-08. Prices are expected to rise further in SS 2008-09 and be in the range of Rs 18,500 20,000 per tonne. Sugar production, in SS 2008-09, is expected to fall by 18 per cent from its levels of SS 2007-08 and be at 21.4 million tonnes. Sugar production in SS 2009-10 is expected to fall by a further 6 per cent and be at 20.2 million tonnes. Production is expected to decline on account of a decline in area under sugar cane as sugarcane farmers, whose earnings have fallen on account of lower sugar prices, switch to alternate crops. Maharashtra will see the largest decline in production, with production declining by 30 per cent to 6.3 million tonnes in SS 2008-09. Uttar Pradesh will emerge as the top sugar producing state in the country due to the dramatic fall in Maharashtras sugar production. In this report, we have revised upwards our consumption numbers (please refer Chapter 1 Domestic demandsupply outlook for further details); we expect consumption, over the period 2007-08 to 2012-13, to grow at a CAGR of 4.3 per cent and be at 26 million tonnes in 2012-13. Sugar exports from India are forecast to fall sharply to 0.5 million tonnes in SS 2008-09, down from 4.3 million tonnes in SS 2007-08. The withdrawal of sugar export subsidies coupled with the rise in domestic prices will make sugar sales in the domestic market more attractive as compared to sugar sales in the international market. The global demand supply situation is expected to tighten on account of steady consumption growth coupled with low production in India, the EU and Thailand. Also, Brazil is diverting a higher portion (60 per cent in 2008-09 as compared to 56 per cent in 2007-08) of its 2008-09 sugar cane crop to the manufacture of ethanol. These facts are expected to support international sugar prices which are likely to remain firm in the medium term. Appreciation of the Brazilian Real, against the US Dollar, has pushed up sugar prices in US Dollar terms; the strength of the Brazilian currency will be a key monitorable. Mandatory ethanol blending is to come into effect from 1st October 2008. However, we expect that the target of 10 per cent ethanol blending will not be met on account of lower sugarcane production in the next 2 sugar seasons translating into lower ethanol production. Even 5 per cent blending will not be possible given the lower ethanol production. Blending would only be possible through the use of alternative feedstocks such as B heavy molasses and cane juice. On the other hand, we do not expect ethanol to be manufactured from these feedstocks as it is unprofitable at current levels of sugar and ethanol prices. We conclude that the ethanol-blending programme cannot succeed in its present form.

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1.0

Domestic demand-supply outlook

Demand-supply overview
After 2 years of surplus production in SS 2006-07 and SS 2007-08, CRISIL Research expects sugar consumption to exceed production in the next 2 years, leading to a fall in inventories and support to sugar prices. Inventory levels are forecast to fall to 3.7 months of off take (consumption + exports) at the end of the SS 2009-10, from levels of 5.9 months at the end of SS 2007-08. Sugar production, in the SS 2008-09, is expected to fall by 18 per cent from its levels of SS 2007-08 and be at 21.4 million tonnes. Production is expected to fall by a further 6 per cent in SS 2009-10 and be at 20.2 million tonnes. We expect consumption to grow steadily at 4.3-4.4 per cent and be at 22.9 million tonnes in SS 2009-10. Exports are expected to fall dramatically from 4.3 million tonnes in SS 2007-08 to 0.5 million tonnes in SS 200809 on account of the expiry of exports subsidies (Central government subsidy of Rs 1,350 per tonne and Maharashtra and Karnataka state government additional subsidy of Rs 1,000 per tonne) at the end of the SS 200708.
Figure 1: Sugar Demand-supply
(million tonnes)
30 25 20 15 10 5 0 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 E 2008-09 F 2009-10 F

(Rs / quintal)
2,000 1,900 1,800 1,700 1,600 1,500 1,400 1,300 1,200

Consumption

Production

Prices (RHS)

Inventory

E: Estimate; F: Forecast Note Figures are for the sugar season (October to September)
Source: Indian Sugar Mills Association (ISMA) and CRISIL Research

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Supply
Sugar production, in India, is forecast to decline by 18 per cent in SS 2008-09 and be at 21.4 million tonnes. Historically, Maharashtra has been the most volatile state in sugar production and we expect this trend to continue. 55 per cent of the drop in sugar production in SS 2008-09 is expected to come from Maharashtra. The drop in sugar prices, witnessed in the SS 2006-07 and SS 2007-08, led to arrears building up and caused farmers to switch to alternative crops such as wheat, rice, maize, soybean, etc. Minimum support prices (MSPs) of alternative crops, especially those of wheat and rice, have been hiked substantially further increasing their attractiveness vis--vis sugarcane.
Figure 2: State wise sugar production, inventory and prices
(million tonnes)
30 25 20 15 10 5 0 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10

(Rs / quintal)
2,000 1,900 1,800 1,700 1,600 1,500 1,400 1,300 1,200

Maharashtra Others

UP Prices (RHS)

Tamil Nadu Inventory

Karnataka

Source: Ministry of Agriculture and CRISIL Research

Figure 3: Indexed MSPs of alternative crops

160 150 140 130 120 110 100 90 2004-05 Wheat Cane - UP - SAP 2005-06 2006-07 Rice Maize 2007-08 2008-09 Cane - SMP

Note Figures are the UP SAP for 2007-08 is based on a price of Rs 110 per quintal.
Source: Ministry of Agriculture and CRISIL Research

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Sugar prices (Mumbai S-30) rose sharply by about 20 per cent in August 2008 and are at average levels of Rs 1,900 per quintal. While in the short term, sugar prices are expected to decline from current levels, the long term trend is upwards. However, the supply response (that is, higher production) to the high prices will manifest itself only in the SS 2010-11 and not in SS 2009-10. This is because of sugarcane being a 12-18 month crop and most of the plantings for SS 2009-10 have been completed. The above factors combined with poor rains in the crucial months of June and July in Maharashtra (the key producing state) will see production in SS 2009-10 falling by a further 5 per cent to 20.2 million tonnes.

Maharashtra
We forecast sugar production in Maharashtra, in SS 2008-09, to decline by 30 per cent from its levels of SS 200708 and be at 6.3 million tonnes. Production in SS 2009-10 is expected to fall by a further 12 per cent to 5.5 million tonnes. Historically, sugar production in Maharashtra has been extremely volatile moving from 2.2 million tonnes in SS 2004-05 to 9.1 million tonnes in SS 2006-07. Maharashtra can broadly be divided into three main sugar producing zones South zone (core sugar producing region), the Central zone and the North Zone. The Central and North zone are the areas in Maharashtra witnessing the largest swing in terms of sugar production.

South zone (core region) Comprises districts of Satara, Sangli and Kolhapur
Central Zone (swing region) Comprises districts of Nashik, Ahmadnagar, Pune and Solapur North zone (swing region) Comprises districts of Dhule, Nandurbar, Jalgaon, Aurangabad, Jalna, Beed, Parbhani, Latur, Dharashi, Nanded, Hingoli, Washim, Buldhana, Akola, Amravati, Yavatmal, Wardha, Nagpur and Bhandara.
Figure 4: Historical zone wise sugar production in Maharashtra
(Million tonnes)
10 9 8 7 6 5 4 3 2 1 0 2000-01 2001-02 2002-03 2.4 1.9 2.2 2.9 1.5 1.4 2.3 1.4 2.4

(Rs per tonne)

20,000 19,000 18,000 17,000 16,000 0.8 2.4 0.4 0.7 1.2 2004-05 2.8 3.9 15,000 14,000 0.8 1.3 1.1 2003-04 13,000 12,000 11,000 10,000 2005-06 2006-07

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2.1

South zone

Central zone

North zone

Sugar prices (RHS)

Source: Maharashtra Federation of Cooperative Sugar Factories and CRISIL Research

As can clearly be witnessed from the above graph, sugar production is most stable in Maharashtras South zone, while being extremely volatile in the North and Central zones. Our interactions with industry sources lead us to believe that the bulk of the fall in Maharashtras sugar production, in SS 2008-09 and SS 2009-10, will come from the Central and North zones of the state.

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Lack of sufficient rainfall in the third and fourth week of June and July has severely affected the planting of the 15-month cane crop, due to be harvested in SS 2009-10. The planting of the 12-month cane crop will take place towards the end of 2009; with sugar prices expected to remain firm, it is our expectation that plantings will not decline drastically. Keeping in mind the above facts, we expect sugar production in SS 2009-10 to fall by a further 12 per cent from its levels of SS 2008-09 and be at 5.5 million tonnes.

Uttar Pradesh
We expect sugar production, in Uttar Pradesh (UP) in SS 2008-09, to decline by 8 per cent to 6.7 million tonnes and by a further 2 per cent in SS 2009-10 to 6.6 million tonnes. Sugar production, in UP in SS 2007-08, was down by 14 per cent to 7.3 million tonnes despite only a 3.4 per cent drop in cane production in UP. This was on account of the late starting of the crushing season in UP (due to disputes over cane pricing) leading farmers to sell more cane to manufacturers of gur and khandsari. As sugarcane crushing, in SS 2008-09, is expected to start as per normal towards the end of October 2008, diversion of cane to alternative sweeteners is expected to be lower and thus while sugar cane production in SS 2008-09 is expected to be down by 12.9 per cent, sugar production is expected to be down only 8 per cent.

Demand
In this report, we have revised upwards our estimates on sugar consumption. Our earlier estimate put sugar consumption, for the SS 2007-08, at 20.2 million tonnes which we have now revised upwards to 21.1 million tonnes. We are also revising upwards our estimate for consumption for SS 2009-10 from 20.8 million tonnes to 22 million tonnes. We have made this upward revision in our consumption estimate by revising upwards our estimates for the growth rate of per capita sugar consumption based on the growth of end use sectors (our methodology for forecasting sugar consumption looks at population growth and per capita consumption growth). Based on our interactions with industry sources, we estimate that about 70 per cent of sugar consumption is in the indirect form (that is in sweetmeats, processed foods, soft drinks, chocolates, etc). We have revised upwards on per capita sugar consumption, based on the growth rates of the end use sectors. Lack of availability of comprehensive and reliable data, for all end use sectors, due their highly fragmented nature, is a constraint in this approach. Though, intuitively, a large part of sugar consumption will be in the form of sweetmeats. However, there is no data available on this large segment due to its unorganised and fragmented nature.

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Box 1: Domestic sugar consumption forecast Methodology

Population growth and rise in per capita consumption primarily drive sugar consumption. We have assumed that population will increase at a CAGR of 1.52 per cent between 2007-08 and 2012-13. As incomes rise and awareness increases, the population growth rate is expected to slow down. Between 1986-87 and 1995-96, population growth in India was at 2.0-2.2 per cent. Thereafter, during the subsequent 5 years, growth slowed down to 1.6-1.8 per cent.

Per capita consumption of sugar in India, at around 18.4 kgs, is one of the lowest in the world. From 18.4 kgs during the 2007-08 SS, the per capita sugar consumption is expected to increase and reach 21 kgs by 2012-13.
We believe that rising income levels and the increasing penetration of processed food and other retail products such as soft drinks and chocolates, would be the drivers for the increasing per capita consumption of sugar.
Table 1: Sugar - Domestic consumption
Sugar consumption (million tonnes) 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 Source: CRISIL Research 17.4 17.7 18.5 19.3 20.2 21.1 22.0 22.9 23.9 25.0 26.0 Population (millions) 1,058 1,075 1,094 1,112 1,130 1,148 1,166 1,184 1,202 1,220 1,238 Per capita consumption (Kg) 16.5 16.5 16.9 17.4 17.9 18.4 18.9 19.4 19.9 20.5 21.0

Box 2: Alternate methodologies

As a part of our review of sugar consumption, we attempted to forecast consumption using alternate methodologies such as basing our estimates on data from the NSSO and the relatively simple method of looking at consumption as the difference between opening and closing inventory after considering production, imports and exports. However, neither of these approaches produced satisfactory results. While data from the National sample survey organisation (NSSO) on per capita sugar consumption is available, this data point would only capture direct sugar consumption which would be about 30 per cent of sugar consumption; hence, this method is not feasible. Disappearance of stocks (Opening stock + Production + Imports Exports Closing stock) would be a reliable method of estimating consumption; however, this method fails as the official data on inventories in inconsistent due to stock adjustments made as per excise certificates. These adjustments will only capture sugar inventory with sugar factories and will not capture inventory with the trade. Thus, in this report, we have forecasted consumption using a method of growth in population and per capita consumption.

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Exports
We forecast sugar exports, in the SS 2008-09, to fall to 0.5 million tonnes from levels of about 4.3 million tonnes in SS 2007-08, on account of the withdrawal of sugar export subsidies by the government and the rise in domestic prices. The Central government, in April 2007, in an effort to lend support to falling sugar prices, had announced a sugar export subsidy of Rs 1,350 per tonne for mills in coastal India and Rs 1,450 per tonne for mills in the interiors. Additionally, the state governments of Maharashtra and Karnataka had announced an additional export subsidy of Rs 1,000 per tonne for sugar exported from those two states. The subsidy extended to exports of both raw sugar and white sugar. As per our analysis, exports have only been viable on account of the subsidies and without the subsidies only a small quantum of exports would have taken place. In the graphs below, we have plotted the domestic and export realisations for both white and raw sugar, clearly depicting that export realisations without subsidies have been consistently lower than domestic realisations by an average of Rs 1.8 per Kg in SS 2007-08.
Figure 5: Domestic and export realisations for white sugar
(Rs / Kg) 22 20 18 16 14 12 10 Aug-06 Aug-07 Aug-08
J un-08

Oct-05

Jun-06

Oct-06

Jun-07

Oct-07

Dec-05

Dec-06

Dec-07

Feb-06

Feb-07

Domestic realisation Export realisation (both subsidies)

Export realisation (no subsidies) Export realisation (only central subsidy)

Source: CRISIL Research and Bloomberg

Figure 6: Domestic and export realisations for raw sugar

(Rs / Kg) 20 18 16 14 12 10 8

Oc t-05

Dec-05

Jun-07

F eb-08

Feb-08

Dec -06

Aug-07

Feb-06

Aug-06

Feb-07

Domes tic real isat ion Ex port realis ation (bot h s ubsi dies)

E xport realis ati on (no s ubsi di es) E xport realis ati on (only central subsidy)

Source: CRISIL Research and Bloomberg

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A pr-08

Oct -07

Apr-06

Jun-06

Oc t-06

Apr-07

Jun-08

Apr-06

Apr-07

Apr-08

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Of the 4.3 million tonnes of sugar exported in SS 2007-08, about 2.5 million tonnes has been raw sugar with the balance being plantation white sugar. Most of the raw sugar exported by the country has been to the Al Khaelej refinery in Dubai. India has a competitive advantage in sugar exports to the Middle East on account of freight advantages enjoyed by Indian raw sugar as compared to raw sugar from alternative suppliers such as Brazil and Thailand. Sugar prices have risen by about 20 per cent in August 2008 from their levels of July 2008. Selling sugar at current prices, in the domestic market, is more attractive for mills as compared to exporting, even after considering the subsidies. Both the Central and state government subsidies will be withdrawn at the end of the current (2007-08) sugar season. Thus, with rising domestic sugar prices and the withdrawal of the export subsidies, we expect sugar exports to fall to 0.5 million tonnes in SS 2008-09. We expect no sugar to be exported in the SS 2009-10.
Box 3: Raw sugar

Raw sugar is an intermediate in the production of sugar. It is a moist, coarsely crystalline mass with sucrose content of 95-97 per cent. The solid cores of the raw sugar crystals are still covered with a layer of syrup. These accompanying substances make raw sugar moist and tacky and give it its typical yellowish-brown colour and malty and burnt flavour. As raw sugar is an intermediate product in the sugar manufacturing process all existing plants can make raw sugar without additional capital expenditure. Raw sugar is about 92 per cent processed. India has emerged as a raw sugar exporter for the first time in SS 2007-08. Most of the global trade in sugar, of about 50 million tonnes, is in the form of raw sugar; 33 million tonnes is in the form of raw sugar with the balance being in the form of white sugar. India has generally exported white sugar but the market for Indian white sugar is limited due to its inferior quality. The sugar produced in India is known as plantation white sugar (150 International Commission for Uniform Methods of Sugar analysis -ICUMSA), while the global trade is mainly in the form of refined white sugar (45 ICUMSA). The export market for plantation white sugar, which India produces, is limited to about 4 million tonnes. There is intense competition from Brazil and Thailand in this market. Thus, if India is to be a large exporter of sugar it needs to produce either refined white sugar (45 ICUMSA) or export raw sugar. Mills would need to incur additional capital expenditure for producing refined white sugar. Raw sugar is an intermediate step in the sugar production process and thus no additional capital expenditure is required for producing raw sugar. Therefore, mills are better placed to export raw sugar.

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2.0

Global demand-supply outlook

After 2 years of large surpluses, CRISIL Research expects global demand to exceed global production in 2008-09, leading to a fall in global inventory levels. Sugar consumption is expected to exceed production by about 4 million tonnes leading to inventory declining from about 5 months of consumption at the end of 2007-08 to about 4.7 months of consumption at the end of 2008-09.
Figure 1: Global demand-supply and inventory
(m ill io n to nnes) 175 170 165 160 155 150 145 140 135 130 125 2002-03 2003-04 Product ion 2004-05 2005-06 Consum ption 2006-07 2007-08E 2008-09F (m i ll ion tonn es) 68 66 64 62 60 58 56 54 52 50

Closing st ock (RHS)

Source: ISO & CRISIL Research

Figure 2: Global inventory levels and prices

(months consumption) 6.0 ($ / tonne) 450 400 5.5 350 300 250 200 150 4.0 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08E 2008-09F 100

5.0

4.5

Inventory (months consumption)

White prices (RHS)

Raw prices (RHS)

Source: ISO, CRISIL Research & Bloomberg

Global consumption is expected to exceed production on account of the following:

Lower production in India (for details refer Chapter 1 Domestic demand-supply outlook) Higher diversion of cane to ethanol in Brazil Lower production in the EU (European Union) and Thailand

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High diversion of cane to ethanol in Brazil

In 2008-09, Brazil is expected to divert 60 per cent of its sugarcane crop for ethanol manufacture as compared to 56 per cent in 2007-08. The high diversion, to ethanol, is due to the fact that manufacturing ethanol is more attractive as compared to manufacturing sugar. Brazils ethanol demand has been growing strongly on the back of strong sales of flex fuel vehicles (vehicles which can run on any combination of petrol and ethanol). In the first 6 months of 2008, flex fuel vehicles accounted for 83 per cent of vehicle sales. Flex fuel vehicles account for 23 per cent of Brazils total vehicle fleet. Strong ethanol exports to US support Brazils demand for ethanol. Surging corn prices in USA have pushed up feedstock costs for US-based corn ethanol manufacturers, making Brazilian ethanol competitive in USA even after the import duty of 54 cents per gallon.
Figure 3: Per cent age diversion of sugarcane to sugar and ethanol in Brazil
100 90 80 70 60 50 40 30 20 10 1996-97 1997-98 1999-00 2000-01 2001-02 2003-04 2004-05 2005-06 2007-08 Mar-08 M ay-08 2008-09 Jul-08 0 2002-03 2006-07 Jan-08 1998-99

P er c ent of cane f or s ugar

Per c ent of cane for et hanol

Source: IBGE, USDA & CRISIL Research

Figure 4: Indexed domestic prices of sugar and ethanol in Brazil

215 195 175 155 135 115 95 75

May -05

M ay -07

May -06

S ugar

Et hanol

Source: CEPEA & CRISIL Research

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Jul-05

Sep-05

Nov -05

Jan-06

Mar-06

Jul-06

Sep-06

Nov -06

Mar-07

Jul-07

Sep-07

Jan-07

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Lower production in the EU and Thailand

Sugar production in Thailand, in 2008-09, is expected to decline by 6 per cent to 7.2 million tonnes. The decline is on account of a 5.1 per cent decline in area under sugarcane production. As Thailand exports about 67 per cent of its sugar production, it is vulnerable to swings in global prices. The low sugar prices, witnessed globally in 200607 and the first half of 2007-08, have caused farmers to plant alternative crops resulting in a decline in area under cane cultivation. EU member states are cutting sugar production as per reforms agreed by the EU commission (please refer to Chapter 8 International Scenario in Part B of this report for background information on EU sugar policy) As a part of the ongoing reform process, sugar production, in the EU in 2008-09, is expected to decline by 5.2 per cent to 16.8 million tonnes.

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3.0

Prices

Domestic sugar prices have been consistently moving upwards since November 2007 on account of an improving demand-supply situation. In August 2008, prices shot up by 20 per cent from their levels of July 2008 and were at Rs 1,900 per quintal. Tightness of sugar supply, in the physical market despite a high level of inventory, caused this dramatic price rise. The government had created a buffer stock of 5 million tonnes for supporting the industry when sugar prices were low. Out of the total buffer stock of 5 million tonnes, 2.75 million tonnes were to be sold in SS 2007-08 with the balance being sold in SS 2008-09. Considering that sugar from the buffer stock would be available in the market, the government declared a lower release order for August 2008. The free sale quota for August 2008 was initially set at 0.9 million tonnes as against 1.3 million tonnes in August 2007. Prices spiked on the news of the lower quota and in an effort to contain the price rise the government hiked the free sale quota from 0.9 million tonnes to 1.1 million tonnes. It has been discerned that mills have been selling less sugar from the buffer stock on expectations of better prices going forward. Thus, the lower release order and fewer sales from the buffer stock caused tightness in the physical market. We expect prices to fall from current levels in the short term. In the long term, however, prices are expected to continue their upward move. We expect domestic sugar prices in SS 2008-09 to remain between Rs 1,700 and Rs 1,850 per quintal. Prices in SS 2009-10 are expected to remain between Rs 1,850 Rs 2,000 per quintal. International prices too have moved up in the past 3 months on expectation of a global deficit in SS 2008-09.
Figure 1: Domestic and international sugar prices
(INR / tonne)
2,200 2,000 1,800 1,600 1,400 1,200 1,000

(USD / tonne)
550 500 450 400 350 300 250 200 150

Oct-03

Oct-04

Oct-05

Oct-06

Jan-04

Jan-05

Jan-06

Jan-07

Oct-07

Jan-08

Apr-04

Apr-05

Apr-06

Apr-07

Apr-08

100 Jul-08

Jul-04

Jul-05

Jul-06

Mumbai S-30

Raw (RHS)

Jul-07

White (RHS)

Source: Bloomberg and CRISIL Research

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Table 1: Domestic demand-supply situation to tighten

(million tonnes) Opening stock Production Imports Consumption (CRISIL) Exports Closing stock Closing stock as months offtake Closing stock as months consumption Sugar prices - Mumbai S-30 (Rs / tonne) 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 E 2008-09 F 2009-10 F 10.6 18.5 16.8 1.1 11.2 7.1 7.7 11.2 20.1 0.0 17.4 1.5 12.5 8.4 8.5 12,474 12.5 13.5 0.4 17.7 0.2 8.5 5.5 5.5 14,642 8.5 12.7 2.1 18.5 0.0 4.9 2.8 3.0 17,651 4.9 19.3 19.3 1.1 3.7 2.0 2.2 18,696 3.7 28.3 20.2 1.7 10.1 4.8 5.7 14,879 10.1 26.3 21.1 4.3 11.0 5.9 6.0 14,890 11.0 21.4 22.0 0.5 9.9 5.2 5.2 9.9 20.2 22.9 7.2 3.7 3.7

Note: Prices for 2007-08 are average prices from Oct 07 - Aug 07 Source: CRISIL Research, ISMA, NFCSF & Bloomberg

Speculative activity
Speculative activity, in sugar, witnessed peak levels in March 2008 with net non commercial long positions accounting for 23.4 per cent of world trade and raw sugar prices being about $318 / tonne. However, speculative activity, in sugar, has declined presently. As of 26th August 2008, prices were at $323 per tonne but net non commercial long positions had declined to 16.9 per cent of world trade. Thus, higher prices, despite lower speculative involvement, leads to the conclusion that fundamentals support present levels of international prices.
Figure 2: Open interest and net non commercial long positions in sugar
(million contracts) 1.7 1.5 1.3 1.1 0.9 0.7 0.5 (thousand contracts) 250 200 150 100 50 0 -50

Sep-06

Sep-07

Jul-06

Jul-07

Jan-06

Jan-07

Nov-06

May-06

May-07

Nov-07

Jan-08

Open interest

Net non commercial long position (RHS)

Source: CFTC and CRISIL Research

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Mar-06

Mar-07

Mar-08

Jul-08

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Figure 3: Net non commercial long positions and sugar prices

(USD/ ton ne) 425 375 325 275 225 175 (tho usand con tracts) 250 200 150 100 50 0 -50

M ar-06

M ay-07

Mar-08

Jul-06

Mar-07

S ep-07

May -06

Sep-06

J an-07

J an-06

Nov-07

Raw sugar prices

Net non com merc ial l ong pos itions (RHS)

Source: CFTC, Bloomberg and CRISIL Research

Currency movements
The appreciation of the Brazilian Real against the US Dollar has caused earnings for Brazilian firms in Real terms to decline. Despite the increase in dollar prices since June 2008, prices in Real terms have actually remained flat. The appreciation of the Real against the dollar has pushed up prices in dollar terms.
Figure 4: Indexed raw sugar prices in USD and BRL
130 120 110 100 90 80 70 60 J an-06 M ar-06 M ay-06 Nov -06 Mar-07 May -07 Jul-07 M ar-08 M ay -08 50

Jul-06

S ep-06

Jan-07

Sep-07

Nov-07

J an-08

May -08

Nov -06

Jan-08

Jul-08 Jul -08

I ndexed raw sugar pric es in BRL

Jul-07

Index ed raw sugar pric es in US D

Source: Bloomberg and CRISIL Research

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Figure 5: Raw sugar prices in USD and BRL

(USD / tonne) 450 400 350 300 250 200 150 (BRL / ton ne) 950 850 750 650 550 450 350

M ar-06

M ay-07

Mar-08

Jul-06

Mar-07

S ep-07

May -06

Sep-06

J an-07

J an-06

Nov-07

Raw sugar pric es in USD

Raw sugar prices in BRL (RHS)

Source: Bloomberg and CRISIL Research

Figure 6: Appreciation of BRL against the USD

2.4 2.3 2.2 2.1 2.0 1.9 1.8 1.7 1.6 Mar-06 M ay-06 Mar-07 M ay -07 Mar-08 M ay-08 Nov -06 Nov -07 S ep-06 Jul-07 1.5 Jan-06 S ep-07 Jul-06 Jan-07 Jan-08 Jul-08

BRLvi s-a-vi s the US D

Source: Bloomberg and CRISIL Research

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May -08

Nov -06

Jan-08

Jul-08

Jul-07

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4.0

Profitability

CRISIL Research expects profitability of sugar companies to improve over the next 2 sugar seasons on account of the expected rise in sugar prices. The fall in sugar prices, witnessed in SS 2007-08, significantly eroded the profitability of Indian sugar companies (especially in Uttar Pradesh). Sugar prices, in SS 2006-07, fell by about 20 per cent to Rs 1,488 per quintal. The situation was even worse for sugar companies in Uttar Pradesh where in addition to the 20 per cent decline in prices, the SAP (State Advised Price) for sugar cane was hiked by 9 per cent to Rs 125 per quintal.
Figure 1: Profitability of sugar companies in North India (UP, Bihar)
(Per cent)
30 25 20 15 3.0 10 5 0 Sep-00 -5 Sep-01 Sep-02 Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 0.0 2.0 1.0

(Rs)
6.0 5.0 4.0

OPM

NPM

ROCE

Sugar - cane price gap (RHS)

Source: Prowess and CRISIL Research

Figure 2: Profitability of sugar companies in South India (TN, Kar, Maha)

(Per cent) 25
20 15 10 3.0 5 0 Sep-00 -5 Sep-01 Sep-02 Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 2.0 1.0 0.0

(Rs)

7.0 6.0 5.0 4.0

OPM

NPM

ROCE

Sugar - cane price gap (RHS)

Source: Prowess and CRISIL Research

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Table 1: North India Key financial ratios

Parameter OPM NPM ROCE Sugar & cane price gap Source: Prowess and CRISIL Research Unit Per cent Per cent Per cent Rs Max 23.9 11.7 20.6 5.5 Min 4.4 -3.6 0.3 2.3 Range 19.5 15.2 20.3 3.2 Average 15.0 3.9 10.8 4.3

Table 2: South India Key financial ratios

Parameter OPM NPM ROCE Sugar & cane price gap Source: Prowess and CRISIL Research Unit Per cent Per cent Per cent Rs Max 19.7 8.9 20.4 5.9 Min 12.1 -1.0 6.6 3.8 Range 7.6 9.9 13.8 2.1 Average 16.9 4.6 12.6 4.9

As can be seen from the above tables, the volatility in operating margins, net margins and RoCE, is lower for companies in South India. This is on account of the differing regulatory regimes in North and South India. North India (predominantly UP) has a fixed cane pricing regime which is not linked to the sugar price. Companies in South India have limited flexibility with regards to cane prices. When sugar prices rise, they pay higher prices to cane growers and, subsequently, when sugar prices come down, they are able to pay less to cane growers. Profitability, of sugar companies, in the first 3 quarters of SS 2007-08, has improved, for both companies in North and South India; companies have benefited from higher sugar prices. Companies in North India (UP) have profited to a large extent on account of lower cane prices.
Table 3: Profitability of North Indian companies in 9M SS 2007-08
Parameter Net sales Change in stock Raw materials, stores & spares Salaries and wages Other expenses Total operating expenses OPBDIT Source: Prowess and CRISIL Research 2006-07 9M 100 -44.4 122.0 6.4 11.7 95.8 4.2 2007-08 9M 100 -53.3 111.7 8.4 14.0 80.9 19.1

Table 4: Profitability of South Indian companies in 9M SS 2007-08

Parameter Net sales Change in stock Raw materials, stores & spares Salaries and wages Other expenses Total operating expenses OPBDIT Source: Prowess and CRISIL Research 2006-07 9M 100 -9.8 71.0 4.6 25.1 91.0 9.0 2007-08 9M 100 -9.2 72.1 4.3 21.6 88.8 11.2

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Table 5: Comparative sugar prices Mumbai S-30

Month October November December January February March April May June July August September Source: Bloomberg and CRISIL Research SS 2006-07 1,780 1,747 1,644 1,538 1,471 1,496 1,451 1,329 1,331 1,374 1,335 1,360 SS 2007-08 1,377 1,362 1,357 1,420 1,407 1,508 1,499 1,481 1,484 1,585 1,900 NA Difference -403 -385 -287 -118 -64 12 47 152 154 211 565

Low sugarcane prices in Uttar Pradesh are one of the key reasons for higher profitability of North Indian sugar companies. The Uttar Pradesh state government had announced the SAP for sugar cane at Rs 125 per quintal for SS 2007-08 (unchanged from its levels of SS 2006-07). Mills in Uttar Pradesh have contested, in the Supreme Court, for the state governments methodology in fixing sugar cane prices.. The matter is presently sub judice. The quarterly results, announced by sugar companies, are based on a sugar cane price of Rs 110 per quintal. Profitability will decline from stated levels if the matter in the courts goes against the UP-based sugar companies and they are ordered to pay higher than Rs 110 per quintal.. The outcome of court cases relating to withdrawal of the UP Sugar Industry Promotion Policy, 2004 is another concern for UP-based sugar companies. On June 1, 2007, the new state government in Uttar Pradesh withdrew the states Sugar Industry Promotion Policy, 2004 with immediate effect. The following are the main features of the Sugar Industry Promotion Policy, 2004:

Fixed concessions: A 10 per cent subsidy on capital invested and a remission in stamp duty and registration charges on land purchase. Variable concessions: Exemption of 1) cane purchase tax 2) entry tax on sugar 3) administrative charge on molasses and 4) trade tax on molasses. There would also be re-imbursement of the following expenses: 1) Cane transport expenses 2) sugar transport expenses 3) cane society commission. According to industry sources, the benefit of the variable component of the subsidy worked out to Rs 1 per kg of sugar produced.

It is clear that removing the scheme will negatively impact the profitability of sugar companies in the state. However, the outlook for sugar companies in Uttar Pradesh is uncertain and will be clear only when the outcome of the court cases, relating to the withdrawal of the Sugar Industry Promotion Policy, is known.

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5.0

Business model analysis

Four possible business models for a sugar company

Sugar companies are increasingly diversifying and de-risking their revenue streams by manufacturing ethanol from molasses and co-generating power from bagasse. At present, there are four possible business models for a sugar company. These are as follows:

A company can be a plain vanilla sugar manufacturer, that is, manufacture sugar and sell the by-products (molasses and bagasse) obtained in the course of manufacture without any value addition. This is the sugarmolasses-bagasse model.

A company can convert molasses into alcohol and further process the same into ethanol. It may opt not to forward integrate into the manufacture of power. This is called the sugar-ethanol-bagasse model. A company can go in for bagasse-based cogeneration of power, but decide not to convert molasses into alcohol/ethanol. This could be referred to as the sugar-molasses-power model. A company may opt to forward integrate into complete value addition of by-products, that is, produce sugar, alcohol/ethanol and power. It may continue to sell a certain quantum of molasses and bagasse in the open market, but it will also have the facilities for processing molasses into alcohol/ethanol and bagasse into power. This could be termed the sugar-ethanol-power model.

Returns from alternative business models Sugar companies have been diversifying their business models and derisking their revenue streams by setting up facilities for producing alcohol/ethanol (from molasses) and for co-generating power (utilising bagasse). After conducting a detailed analysis of the four possible business models a sugar company can follow, CRISIL Research concludes that forward integration into power and ethanol enables mills to generate higher average profits over the length of the sugar cycle.
We have analysed the incremental profitability and returns from alternative business models in three possible scenarios an upward cycle in the industry, that is, sugar supply is low and prices are high; a normal scenario of moderate supply and prices; and a cyclical downturn in the industry, that is, supply is high and prices are low. We have made product pricing and cost assumptions for each of these three scenarios. We have assumed that realisations earned on the sale of sugar would be at Rs 13,500-18,500 per tonne, molasses prices would vary between Rs 500-3,500 per tonne, alcohol/ethanol sales realisations would be at Rs 18,500-24,000 per kilo litre, while bagasse prices would be Rs 100-800 per tonne. In a normal scenario, we have assumed sugar sales realisation of Rs 16,000 per tonne, molasses prices of Rs 1,500 per tonne, average alcohol prices of Rs 21,500 per tonne, and bagasse prices of Rs 400 per tonne. The realisation per unit of power sold has been taken as Rs 3.2 per unit, and the price of sugarcane has been assumed at Rs 1,200 per tonne. It is to be noted that the prices and costs we have assumed are indicative in nature. Actual figures would vary from region to region and from company to company.

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In addition, sugar mills are entitled to receive tradable carbon credits (certified emission reductions (CERs)) under the clean development mechanism of the Kyoto Protocol, since power cogeneration plants produce renewable energy through the non-carbon route. We have not considered this in our calculations, as mills have to obtain several approvals before they are eligible to receive CERs. In the normal scenario, we have assumed that a plant with a capacity to crush 5,000 tonnes of sugarcane per day (5,000 tcd), will operate for 156 days at 90 per cent capacity utilisation, crushing a total of 702,000 tonnes of sugarcane. Further, we have assumed that the upcycle mills will crush 8 per cent more as compared to the normal scenario; the downcycle mills will crush 8 per cent more cane as compared to the normal scenario. Recovery and other input-output ratios have been considered at standard industry norms. Further, we have assumed that a mill forward integrating into the manufacture of alcohol/ethanol and/or power will process 100 per cent of its molasses production into alcohol/ethanol and 100 per cent of its bagasse output into power.
Table 1: Integrated model has higher returns over the complete cycle
SMB PBIT Margins Upcycle Normal Downcycle Average margin (weighted) Return on capital employed Upcycle Normal Downcycle Average RoCE (weighted) SEP: Sugar-ethanol-power Note: This is a hypothetical example. Actuals may vary. Weights for calculating average: Upcycle (2 years), Normal (1 year), Downcycle (2 years) Source: Industry and CRISIL Research 15% 5% -6% 5% 15% 8% 0% 7% 13% 8% 2% 7% 13% 10% 5% 9% 18% 7% -9% 5% 20% 12% -1% 10% 20% 14% 4% 12% 22% 18% 10% 16% SEB SMP SEP

SMB: Sugar-molasses-bagasse;SEB: Sugar-ethanol-bagasse;SMP: Sugar-molasses-power;

We can conclude the following from the above table:

It makes sound business sense to opt for an integrated business model, where a mill produces not only sugar but also alcohol, ethanol and power; average profits are higher (over a complete cycle) and variation in profits is also lower than that of a plain vanilla sugar mill producing sugar, molasses and bagasse. This is because earnings from the sale of alcohol/ethanol and power are relatively stable and are non-cyclical compared to the core sugar business (power prices are not volatile since they are decided on the basis of long-term agreements. The price of ethanol sold to oil-marketing companies, for the ethanol-blending programme, is fixed on the basis of quantity-based tenders).

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Processing molasses into alcohol/ethanol and undertaking bagasse-based co-generation of power helps, to some extent, in protecting revenues and improving profitability during periods of downturn in the core sugar business. For example, in 2006-07, sugar prices fell sharply due to oversupply in the market, but alcohol and power prices were relatively stable. During this period, when the sugar business was doing badly, these products contributed heavily to profitability.

However, opting for value addition of bagasse and molasses, could generate lower returns on incremental capital employed (compared to a standalone sugar mill) when the industry is in an upturn. For instance, during a period sugar shortage in 2004-05, several sugar mills were finding the sale of molasses and bagasse more profitable than the sale of alcohol or power.

Opting for a sugar-molasses-power or sugar-alcohol-power model would generate higher profits for sugar companies over a cycle. The business risk in opting for these models is also lower, given the lesser variation in profits. However, sugar mills could prefer to set up a distillery unit first rather than a co-generation plant, due to the lower capital expenditure requirement for establishing a distillery unit.

Our conclusions must, however, be viewed in the light of the following:

The decision of a sugar mill to opt for an integrated business model or to remain a standalone plain vanilla sugar mill is often a function of its long-term strategy and vision. Prices and costs at particular point of time do not necessarily influence business decisions, which are taken with a long-term view.

Past experiences or future expectations also govern decisions. For example, several mills are hesitant to opt for power co-generation in view of the unpleasant experiences that some of them had in the form of delay in receiving payments from state electricity boards against supply of power. There is also a fear among some mills that realisations on power sales may drop in the coming years.

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6.0

Ethanol-blending programme

Blending programme not to succeed in the present form

Mandatory 10 per cent ethanol blending is scheduled to come into effect from 1st October 2008. Presently, 5 per cent ethanol blending is mandatory. However, as per our understanding, the actual level of blending is between 2 3 per cent. It is our opinion that the ethanol-blending programme, in its present form, cannot succeed on account of the following factors:

Attractiveness of ethanol vis--vis other alcohols Cyclical feedstock availability Alternative feedstocks unprofitable Pricing and tendering system

Box 1: Background

The ethanol-blending programme started in October 2003. Under this, the Central government had made the sale of petrol, blended with 5 per cent ethanol, mandatory in nine states (Andhra Pradesh, Goa, Gujarat, Haryana, Karnataka, Maharashtra, Punjab, Tamil Nadu, Uttar Pradesh) and four union territories (Daman & Diu, Dadra & Nagar Haveli, Pondicherry and Chandigarh). The programme had come to an abrupt halt in October 2004, due to the decline in molasses and alcohol availability (following the steep fall in sugarcane output) and the inability of sugar mills and oil marketing companies to arrive at a consensus on economic pricing for ethanol. However, the programme was revived and a national programme to blend 5 per cent ethanol with petrol had been implemented from November 1, 2006. The programme was extended to the entire country except states in the Northeast, Jammu & Kashmir, Lakshadweep and Andaman and Nicobar Islands. However, the government had not made the programme mandatory, and oil companies had been given the freedom to protect their commercial interests for arriving at a viable pricing for ethanol. In October 2007, 5 per cent blending was made mandatory with immediate effect.

Attractiveness of ethanol vis--vis other alcohols

At present, mills have contracted tenders from the OMCs for supplying ethanol for a 3-year period, at a fixed price of Rs 21.5 per litre. The price was acceptable to sugar companies when the tenders were made. Currently, the price of Rs 21.5 is unacceptable to sugar companies. This is because prices of lower grades of alcohol such as rectified spirit, costing less to produce, are selling at Rs 26 27 per litre. Thus, in the current environment, mills would rather sell rectified spirit as compared to ethanol. However, as they are locked into tenders, they are selling ethanol at Rs 21.5 per litre when they could sell rectified spirit in the open market at Rs 26 27 per litre.

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Cyclical feedstock availability

Table 1: Alcohol surplus/(deficit) situation
Year (mn litres) 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08E 2008-09F 2009-10F Cane crushed (mn tonnes) 194 133 125 189 279 255 211 202 Unblended petrol demand A 10,682 11,143 11,642 12,201 14,020 15,056 16,093 17,224 Potable alcohol B 747 775 832 868 911 972 1,037 1,100 Industrial and other uses C 722 764 802 824 846 863 880 898 Ethanol demand at 5% D = A*0.05 534 557 582 610 701 753 805 861

Year (mn litres) 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08E 2008-09F 2009-10F

Ethanol demand at 10% E = A*0.1 1,068 1,114 1,164 1,220 1,402 1,506 1,609 1,722

Total demand F=B+C+D 2,002 2,096 2,216 2,302 2,458 2,588 2,722 2,859

Alcohol production from molasses G 1,968 1,342 1,263 1,910 2,824 2,584 2,137 2,043

Excess/Deficit @ 5 per cent blending H=G-F -35 -754 -952 -392 365 -3 -584 -817

Excess/Deficit @ 10 per cent blending I = G - A - B -E -569 -1311 -1534 -1002 -336 -756 -1389 -1678

Source: CRISIL Research

As can be observed from the table above, in 2007-08, around 753 million litres of ethanol are needed to blend petrol with 5 per cent ethanol. By 2008-09, the quantum of ethanol, required for blending purposes, will shoot up to 861 million litres. At 10 per cent blending level, the demand for ethanol for blending will double. Industrial alcohol-based chemical manufacturers and potable alcohol manufacturers also use the alcohol/ethanol made by sugar mills as a raw material. We estimate that the total demand for alcohol, for other than blending purposes, is expected to increase from 1.8 billion litres during 2007-08 to about 2.0 billion by 2008-09. Thus, by 2008-09, around 2,900 million litres of alcohol/ethanol will be required for meeting the demand for 5 per cent blending and for industrial, potable and other purposes. In the event of 10 per cent ethanol blending, around 3,700 million litres of alcohol/ethanol will be required to meet the demand. As can be seen from the table, post 2007-08, the estimated alcohol production will not be enough to meet total alcohol demand even at 5 per cent blending. This is on account of the fact that sugar cane and consequently sugar and molasses production is expected to decline in the 2008-09 and 2009-10 SSs. Thus, if the blending programme is to be successful, alternative feedstocks will need to be used to meet ethanol demand.

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Alternative feedstocks unprofitable

As discussed above, the ethanol-blending programme cannot be successful unless alternative feedstocks are used for ethanol production. The alternative feedstocks that can be used for ethanol production are as folows:

B heavy molasses Sugar cane juice

However, it is our opinion that ethanol will not be manufactured from these alternative feedstocks, as it will be unprofitable at the current ethanol price of Rs 21.5 per litre.

B heavy molasses route

In sugar factories, sugar is crystallised from a concentrated juice in three separate crystallisation stages wherein each stage results in the production of a crystallised sugar fraction (called the A sugar, B sugar and C sugar, respectively) and a non-crystalline fraction or molasses fraction called A molasses, B molasses and C molasses. The A molasses which is the non-crystalline portion resulting from the first stage, is fed into the second crystallisation stage and further crystallisation occurs to form B sugar. The non-crystalline portion of this stage (the B molasses) is fed into the third crystallisation stage and further crystallisation takes place to give a C sugar fraction and a C molasses. The C sugar fraction is of relatively low quality and is used as seed crystals to facilitate crystallisation in the first and second crystallisation stages. The C molasses (also called final molasses) is not refined further and instead used as a stock feed in the fermentation industry. In case of B molasses, sugar recovery rate would drop by about 150 basis points to about 8.5 per cent while the B molasses recovery goes up by similar amount to about 6 per cent. Further, as against 225 litres of alcohol produced from one tonne of C molasses, one tonne of B molasses would recover as much as about 350 litres of alcohol due to higher sucrose content remaining in B molasses.
Table 2: Comparison of profitability of ethanol production under 'C' vs. 'B' molasses route
Particulars Sugarcane available Cost per tonne Cost of sugarcane Sugar production Cost of conversion of sugarcane into sugar Selling price of sugar Molasses production Ethanol production Cost of processing molasses into ethanol Realisation from sale of ethanol Total cost Total revenue Profit 350 litres of alcohol Note: 1) The above figures are indicative. Actual figures will vary from company to company Source: CRISIL Research and Industry Calculations A B C= A x B D E F G H= G x 350* I J L M=K-L Units tonnes Rs Rs tonnes Rs per tonne Rs per tonne tonnes litres Rs per litre Rs per litre Rs Rs 'C' Molasses Current position 100 1,350 135,000 10.0 3,500 15,000 4.50 1,013 6.0 21.5 176,075 171,769 (4,306) 'B' Molasses Incremental Potential 100 1,350 135,000 8.5 3,800 15,000 6.00 2,100 6.0 21.5 179,900 172,650 (7,250) 3,825 881 (2,944) profit

K=C+(DxE)+ (H x I) Rs

Assumption: We have assumed one tonne of cane yields 6 % 'B' molasses and 8.5 % sugar.One tonne of B molasses yields

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Table 3: Surplus/ (deficit) under 'B' Molasses route

Year (mn litres) 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08E 2008-09F 2009-10F Cane crushed (mn tonnes) 194 133 125 189 279 255 211 202 Unblended petrol demand A 10,682 11,143 11,642 12,201 14,020 15,056 16,093 17,224 Potable alcohol B 747 775 832 868 911 972 1,037 1,100 Industrial and other uses C 722 764 802 824 846 863 880 898

Year (mn litres) 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08E 2008-09F 2009-10F Source: CRISIL Research

Ethanol demand at 10% D = A*0.1 1,068 1,114 1,164 1,220 1,402 1,506 1,609 1,722

Total demand E=B+C+D 2,537 2,653 2,798 2,912 3,159 3,341 3,526 3,721

Alcohol production from molasses G 4,082 2,783 2,620 3,962 5,856 5,360 4,433 4,237

Excess/Deficit @ 10 per cent blending H=G-F 1545 130 -178 1050 2697 2020 906 516

As can be seen from the above table, B molasses will be able to meet requirements of alcohol towards potable and industrial purposes and ethanol requirement for even 10 per cent blending. However, new capacities would be required for producing these volumes of alcohol. It is our estimate that total alcohol manufacturing capacity in the country is about 3.2 billion litres with ethanol capacity being 1.5 billion litres.
Table 4: Ethanol prices at which 'C' molasses route and 'B' molasses route are equally profitable
Sugar price 15,000 16,000 17,000 18,000 19,000 Source: CRISIL Research Ethanol price 24.2 25.6 27.0 28.3 29.7

However, we do not expect any ethanol to be manufactured from B molasses in the next two sugar seasons as it is unprofitable. For ethanol production, from B heavy molasses, to be profitable at sugar realisation of Rs 15,000 per tonne, the ethanol price would need to be Rs 24.2 per litre. As sugar prices rise, ethanol price will also have to rise for ethanol manufacture, from B heavy molasses, to remain profitable.

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Sugar cane juice route (Direct route)

The sugarcane juice route yields seven to eight times the alcohol that can be produced from C molasses. However, our study on ethanol production cost comparison between molasses route and sugarcane juice route indicates that the production of ethanol directly from sugarcane juice is not viable at the current realisations.
Table 5: Comparison of ethanol production via 'C' molasses vs direct route (cane to ethanol)
Calculations Sugarcane available Cost per tonne of cane Total cane cost Sugar production Molasses production Ethanol production Cost of conversion of sugarcane into sugar Cost of processing for ethanol Realisation from sale of sugar Realisation from sale of ethanol Total Revenue Total cost Profit /(Loss) Note: 1) The above figures are indicative. Actual figures will vary from company to company Source: CRISIL Research and Industry A B C=A x B D E F G H. I J K=(D x I) +( F x J) M= K-L Unit tonnes Rs Rs tonnes tonnes litres Rs per tonne Rs per litre Rs per tonne Rs per litre Rs Rs Sugar and C Molasses 100 1,350 135,000 10 4.5 1,013 3,500 6 15,000 21.5 171,769 176,075 (4,306) Cane to Ethanol 100 1,350 135,000 0 14.5 7,600 0 8 0 21.5 163,400 195,800 (32,400) (8,369) 19,725 (28,094) Incremental profit/(loss)

L= C+ (D x G) +( F x J) Rs

Table 6: Ethanol prices at which 'C' molasses route and direct route are equally profitable
Sugar price 15,000 16,000 17,000 18,000 19,000 Source: CRISIL Research Ethanol price 25.8 27.3 28.8 30.3 31.8

As manufacture of ethanol from cane juice is unprofitable at current sugar and ethanol prices, we do not expect ethanol to be manufactured from cane juice over the next two sugar seasons. Ethanol price would need to be Rs 25.8 per litre for ethanol production from cane juice to be profitable at sugar realisation of Rs 15,000 per tonne. As sugar prices rise, ethanol price will also have torise for ethanol manufacture, from direct route, to remain profitable. The direct route has been a feasible alternative for manufacturing ethanol in Brazil, primarily due to the lower cost of sugarcane in addition to the low processing cost. Sugarcane cost is estimated to be about Rs 600 per tonne in Brazil as against Rs 1,250-1,350 per tonne in India. In addition, Brazil enjoys economies of scale benefit for producing ethanol. The overall cost of producing one litre of ethanol is about Rs 15 in Brazil as against Rs 26-28 per litre in India.

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It may be noted that cane to juice route would not have any major impact on sugar production and consequently, on sugar prices. For example, alcohol demand for ethanol blend at 10 per cent would be about 1,722 million litres in 2009-10; only about 22.7 million tonnes of sugarcane is required for satisfying this requirement. This would result in a loss of sugar production of only 2.3 million tonnes.

Pricing and tendering system

It is our opinion that it is not feasible to fix ethanol prices for a three year period (as is presently done) given that the prices of related products (sugar, rectified spirit and crude oil) are volatile in nature. There are two possible solutions to this problem, either ethanol prices must be market determined or a pricing mechanism must be evolved wherein ethanol prices are periodically reset given the prevailing prices of the related products.

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