ETHANOL, Finally regaining its sweetness. SPA Securities Ltd. October 03, 2013

Transcription

1 ETHANOL, Fuel for the future future SUGAR, Finally regaining its sweetness Controls on sector prior to reforms Rohit Agarwal Ph. No / 839 SPA Securities Ltd. October 3, 213 Controls after partial decontrol Minimum Distance Criteria between mills Cane Area Reservation GOVT. POLICIES Levy Sugar Obligation on mills Regulated Release Mechanism Minimum Distance Criteria between mills Cane Area Res ervation GOVT. POLICIES Tariff rates on trade 4% sugar to be packed in jute bags only Dual Cane Pric ing: Centre/State State Govt. Controls Compulsory sugar packing in jute only Import and Export Central Govt. Controls Dual Cane Pricing: Centre/State State Govt. Controls Central Govt. Controls

2 SECTOR INITIATION REPORT SUGAR SECTOR Structurally poised for sweet time Sensex: Nifty: 578 Sharp correction witnessed in sugar stocks have thrown up significant value buying opportunities for long term investors. We initiate coverage on Mills and with an Outperformer rating, our preferred exposure in the industry, as they remain best proxies to ride out of the current sugar cycle. We have selected the companies based on their competitive positioning on long-term structural factors such as size, geographical presence, operating efficiencies and we strongly believe that both these companies are geared to capture emerging opportunities with their integrated business models. Domestic production to decline by 5% in India's sugar production is expected to decline by 5% to 23.7 mt in after production of + 24 mt for 3 consecutive years (production of +2 mt for 3 consecutive years has not happened over the past many years). Sugarcane area is set to fall to the lowest in 4 years to ~4.85 million hectares, 3% lower than last year's 5. mh. Moreover rupee depreciation in addition to squeezing imports has turned exports viable, thereby further improving the overall demand supply scenario. Ethanol Blending Program gains momentum - To completely transform the industry EBP in India has the potential to transform the sugar industry given significant visible demand for ethanol (~1.5 bn litres for mere 5% blending). Sugar industry has contracted to supply.55 bn litre of ethanol to INR 35/litre by Mar 214 and bidded for supplying further 1.34 bn litre by Dec 214. Realisations can increase further given a) the scope of enhancing ethanol prices by ~INR 12/litre at the current petrol prices and b) lowest price quoted by foreign suppliers are ~INR 75/litre. Assured realisation coupled with the commitment of lifting of full potential can lead to significant improvement in profitability of sugar producers. Partial decontrol of sugar - Will lead to rerating of the sector We expect the sector to get rerated over medium to longer term following the partial decontrol of sector. The GoI has removed the levy obligations on sugar and abolished the regulated release mechanism in April 213. While removal of levy obligation would lead to ~INR 1.3/kg increase in blended realisation of sugar manufacturers, abolition of regulated release mechanism will allow mills to capitalize on better sugar realizations and better manage their working capital requirements. Ray of hope emerging for adoption of cane pricing formula Karnataka government has recently enacted an Act prescribing that the sugarcane price will be based on the revenue sharing model in line with Rangarajan Committee report (7% of total revenue/75% of sugar revenue). Maharashtra is also readying to consider a similar move. We view these policy changes as a game changer for the entire industry and expect this to have a positive influence on UP government. Otherwise these two states, which account for ~49% of the country's sugar output, would out-price UP sugar mills due to their lower cost of production. World sugar surplus to decline significantly to 3.5 mt in 214 The global sugar surplus is expected to narrow significantly to 3.5 mt in due to less supply emulating from Brazil, thereby supporting prices. Total sucrose content diverted for sugar is expected to decline from 5% in 213 to 45% in 214. Given the ethanol price parity coupled with several encouraging measures introduced by Brazilian Government, ethanol demand can significantly increase in Brazil. This holds importance as 2% increase in Brazil's ethanol consumption has the potential to completely eliminate the world sugar surplus. By 222, OECD is expecting ethanol production in developing countries to increase by 3 bnl to 72 bnl, with Brazil accounting for 8% of this supply increase. Sugar prices to remain steady We expect global prices to bottom out and find a floor around USD 16 cents/lb, as slump in prices below these levels will spur Brazilian millers to produce more of ethanol and less of sugar. Prices are expected to edge up higher gradually in due to significant expected decline in global sugar surplus. Domestically prices are expected to remain stable and marginally improve in the short term following abatement of supply pressure with end of crushing season and an increase in import duty from 1% to 15%. Depreciating Rupee has also made export realization marginally competitive thereby partly relieving pressure on stocks. Valuation Summary Company CMP MCAP APAT (INR mn) EPS P/E (x) P/BV (x) EV/EBIDTA INR INR bn FY14E FY15E FY14E FY15E FY14E FY15E FY14E FY15E FY14E FY15E Source: SPA Research 2

3 TABLE OF CONTENTS Background... 5 Indian sugar cycle... 6 Domestic demand supply situation Production to remain +24 mt for third consecutive year... 7 Production to decline by 5% in Acreage under Sugarcane to touch four-year low on drought... 8 Export & Import - Ceteris paribus, currency playing an important role... 1 Sugar Manufacturing & Its By-products Ethanol Blending Program gains momentum - To completely transform the industry Regulatory Framework Partial decontrol of sugar - Leading to rerating of sector Trend in domestic sugar prices Global scenario World sugar dynamics Main producing countries Main exporting countries Main importing countries World Ethanol Dynamics Ethanol & Its advantages Demand drivers & Growth potential Crude oil has little direct impact on ethanol prices... 2 So with all of these benefits, is ethanol the fix-all solution? Ethanol from sugarcane stands out Global demand supply situation - Sugar Global surplus to decline significantly in Brazil - The Potential game changer Thailand - Continues to remain 2nd largest exporter Australia: Output to decline by 6.5% Mexico - Largest exporter to the United States China becoming the 'buyer of last resort' for the world sugar market Indonesia - Imports expected to more than double Russia - Rare setback for world output prospects International sugar prices at 3 years low Companies Section Mills Ltd

4 India is the second largest producer & largest consumer of sugar in the world Sugar is one of the most valuable agricultural commodities. In 211 its global export trade was worth $47bn, up from $1bn in 2. Of the total $47bn, $33.5bn of sugar exports were from developing countries and $12.2bn from developed countries. About 8% of global production comes from sugar cane (which is grown in the tropics) and 2% comes from sugar beet (grown in temperate climates, including Europe). More than 123 countries produce sugar worldwide, with 7% of the world's sugar consumed in producer countries and only 3% traded on the international market. Brazil plays an important role in the global sugar market, as the world's largest sugar producer with 12-14% recovery rate, the world's major exporter (contributes 45% of world exports) and one of the highest per capita consumers, at around 55 kg a year. Top 5 sugar producers in the world, namely Brazil, India, the EU, China and Thailand, account for over 6% of total production. Top 1 sugar producing countries between E Brazil 22.15% India 16.79% EU 9.65% China 7.22% Thailand 6.1% US 4.42% Mexico 3.18% Pakistan 2.44% Australia 2.39% Russia 2.67% Source: USDA FAS Sugar: World Markets & Trade, SPA Research World sugar consumption growing at CAGR of 2.7% over the past 5 years The top five consumers of sugar use 51% of the world's sugar. They include India, the EU-27, China, Brazil and the US. Asia consumes 45% of world sugar production and produces approx. 36% of world production. World consumption of sugar has grown at an average annual rate of 2.7% over the past 5 years. It is driven by rising incomes and populations in developing countries. Sugar cane cultivation is labour intensive and an important source of rural employment. The Brazilian sugar cane industry employs over 1 million people, or nearly a quarter of the country's total rural workforce. In South Africa - Africa's largest producer - around half a million people depend on sugar for a living. Sugar mills employ around 15 per cent of workers in Switzerland and two-thirds of rural workers in Mauritius. 4

5 World Per Capita Consumption of Sugar (kg) Brazil Australia Source: ISMA Thailand Russia South USA Pakistan India China World Background India is the second largest producer and the world's largest sugar consumer, consuming onethird more sugar than the EU combined and 6% more than China. Bulk consumers (soft drink manufacturer, bakeries, confectionary, hotel and restaurant consumer) account for 6% of India's mill sugar demand. Low per capita consumption at 19 kgs against 33 kgs in USA, 4 kgs in Thailand and Russia and 7 kgs in Brazil. The industry plays a pivotal role in rural economic development, supporting over about 5 million sugarcane farmer, dependents and agricultural labourer. About 2.4% of cultivable land is under sugar cane. Sugarcane was cultivated in over 5 million hectares in 211/12, with Uttar Pradesh and Maharashtra accounting for a combined 65% of the total acreage. Percentage Share of Indian States in India s Sugarcane Production (SY212) Maharashtra 37.4% UP 27.4% Source: ISMA, SPA Research Over 664 sugar factories in India widely dispersed with an average crushing capacity of roughly 3,8 Tonnes Crushed per day (TCD). Maharashtra, the country's largest sugar producer produced 9 MT sugar in , followed by UP at 7 mt and Karnataka at 3.8 mt. Ownership of sugar sector - 55% private sector and 45% in co-operative & Govt. Sector. Domestically, six major states namely Uttar Pradesh, Maharashtra, Karnataka, Tamil Nadu, Gujarat and Andhra Pradesh contribute to over 85% of the sugar production in the country, with UP & Maharashtra alone contributing ~62%. 4% 35% 3% 25% 2% 15% 1% 5% % 26.9% 3.8% Source: ISMA, SPA Research 34.6% Statewise sugar production as a % of total sugar production 31.6% 14.6% 12.4% 8.7% 8.8% UP Maharashtra Karnataka TN Gujarat AP Others SY212 SY213E 3.8% 4.% Karnataka 13.5% Tamil Nadu 6.8% Gujarat 6.3% AP 2.7% Uttarakhand 1.5% Bihar 1.4% Haryana 1.3% Other states 1.7% 3.8% 4.% 7.5% 8.4% 5

6 Cane price in UP has gone up by 7% in the last 3 years, but sugar prices have increased by just 11% in the same period Cane price arrears directly impact the sugar production. Cane arrears are higher in case of UP because of a political SAP and no relationship with returns on sugar sales. INR bn Cane price arrears during last 5 years SY27 SY28 SY29 SY21 SY211 SY212 Uttar Pradesh Maharashtra Gujarat Rajasthan Jamu & Kashmir Punjab Maharashtra Karnataka Kerala Haryana Himachal Uttaranchal Madhya Pradesh Andhara Tamil Nadu Source: SPA Research Uttarpradesh Chhattisgarh Sugar Producing States of India Orissa Bihar Jharkhand Sikkim Assam Arunachal Pradesh Meghalaya Manipur Tripura Mizoram West Bengal High Medium Low While consumption is 4% over last 1 years, production is cyclical Nagaland Source: ISMA The domestic sugar industry is estimated at INR 8 bn in size, supporting over 5 crore sugarcane farmers. Size of Area under sugar cane cultivation Sugar cane production Number of sugar mills 664 Average capacity of mills 5 million hectares 34 million tons 38 tons cane per day Production of sugar 25 mt estimated for season Average per capita Refinery Source: SPA Research 21 kgs of sugar and 6 kgs consumption of other sweeteners Refineries have been set up to process raw sugar subject to govt of India's policy for import & exports. Capacity : 4.5 million tons [ season, off-season and stand alone combined ] Cycle A typical feature of the sugar market in India is the cyclical nature of production, where 2-3 years of surplus are followed by 2-3 years of deficit. Against this backdrop of recurrent large swings in production, consumption growth has been linear, growing steadily at about 4% per year over the past 1 years. This results in huge swings in overall sugar equilibrium. The year-wise swings: Since 2-1 Period No. of seasons Production Range (mt) Swing from previous high/low (mt) Swing % -1 to to to to 13.5 (-) 6.6 (-)32.8% 5-6 to to 28.4 (+) 14.9 (+)11.4% 8-9 to to 18.9 (-) 9.5 (-) 33.5% 1-11 to to 26.2 (+) 7.3 (+) 38.6% Source: SPA Research Monsoon plays a key role in sugar production as sugarcane yields are greatly affected by the level of rainfall, notably during the critical monsoon season. The other most important factor is the domestic sugar policy that amplifies the cycle through its impact on incentives along the sugar value chain, including for farmers and sugar factories. 6

7 Cycle High sugar price/ Improved profitability Lower sugar production Low cane arrears/high cane cultivation Lower cane production Source: SPA Research High cane production Up cycle (2 3 years) Decline in area under Cultivation Down cycle (2 3 years) High sugar production We are here High cane arrears Decline in sugar prices Lower profitability The cyclicality of sugarcane production causes large swings in the area under cultivation of sugarcane and hence its availability to the sugar industry. During the stage of high sugarcane production, profitability of sugar manufacturers decline due to lower realisations, resulting in untimely payments to the farmers and increasing cane arrears. As a result, farmers reduce their sugarcane acreage and opt for other crops, which can give them higher returns. Consequently, it leads to lower sugarcane production and supply deficit of sugar in the market, leading to decline in sugar prices. This again improves their profitability and enables them to clear the arrears. As the incidence of default declines, sugarcane cultivation becomes attractive once more, shifting the domestic sugar balance into the upside phase of the cycle. Over a period of time there is overproduction and the prices fall again. Thus, the infamous ' Cycle' is set in motion again. For instance, after an increase in 26/7 to 28.4 mt, 41% over the record 22/3 crop, sugar output declined to 14.5 mt in 28/9 and is currently estimated at 24 mt for 212/13. Higher production leading to accumulation of cane arrears Higher production leads to depressed sugar prices, resulting in higher cane arrears SY21 SY SY SY24 SY25 SY26 Production (mt) SY27 SY SY SY21 Cane Arrears (INR bn) RHS SY211 SY212 SY213E Source: ISMA, Directorate of Economics &, SPA Research Domestic demand supply situation Production to remain +24 mt for third consecutive year India's sugar production has increased by 6.6% in (Oct-Sep) to 26. mt from 24.4 mt in the previous year. Drought in Maharashtra, India's biggest sugar producing state, in the last year is likely to pull down India's overall sugar production by 3.8% to 25. mt in This will be the third consecutive year that sugar production will remain more than 24 mt due to remunerative cane prices vis a vis other crops. Production of more than 2 mt for 3 consecutive years has not happened over the past many years and only cumulative exports of 7.3 mt in 211 and 212 have helped lower domestic inventory. Domestic Sugar Balance (Million Tones) F26 F27 F28 F29 F21 F211 F212 F213E Opening Stock Production Growth YoY 51.8% 47.2% -7.% -45.1% 3.3% 29.1% 6.6% -3.8% Internal Consumption Growth YoY 3.2% 7.6% 5.% 3.8% 5.1% 2.2% -1.3% 2.2% Exports Imports Closing Stock Stock to use ratio 29.2% 61.3% 6.8% 35.5% 33.8% 21.5% 19.6% 27.7% Source: ISMA 7

8 Production in two sugarcane growing states of Maharashtra and Karnataka (which together accounted for 49% of India's sugar output), is expected to decline by 12.2% and 18.4% to 7.9 mt and 3.1 mt respectively in Un-favourable climatic conditions have negatively impacted sugarcane acreage and sugar production in Karnataka and Maharashtra, where sugar recoveries at 1.9% and 11.3%, respectively, are among the highest in the country. The loss in these two States is expected to be made up by India's top sugar producing state, Uttar Pradesh, where farmers buoyed by higher returns last year have planted cane on an additional area of 2.2 lakh hectares (lh). Production in UP is expected to increase around 1.% to 7.7 mt in the current season. State wise sugar production (mt) % 33.1% % 8.7% 7.9% 3.9% 3.9% % 3% 25% 2% 15% 1% 5% % UP Maharashtra Karnataka TN Gujarat AP Others SY212 SY213E % of total production (Avg.) Source: ISMA, SPA Research Production to decline by 5% in Early and above normal rains have curtailed damages to some extent and now sugar production is expected to decline by 5% to 23.7 mt in Importantly some of the farmers have already switched to other crops inspite of higher cane prices due to water unavailability as unlike other crops sugarcane production requires abundant water. Production is expected to decline by 25.3% and 12.9% to 5.9 mt and 2.7 mt in Maharashtra and Karnataka respectively in SY214. Acreage under Sugarcane to touch four-year low on drought Sugarcane is the India's third largest crop, next to rice and wheat. The sugar yield is not only related to the industry's manufacturing capacity but also to the availability of sugarcane. Acreage under Sugarcane has not increased much in the last 1 years. In fact there is a huge fluctuation in area under cultivation because of the uncertainty over payments from the millers and erratic monsoon, which prompts farmers to shift to other crops. Area under cane cultivation was the highest ever (5151 thousand hectares) in the year The yield per hectare was also the highest that year. 8

9 Area under sugarcane production & Recovery trend SY2 SY3 SY4 SY5 SY6 SY7 SY8 SY9 SY1 SY11 SY12 SY13E Sugar Production (In mt) Sugarcane Area (In lac ha) Sugarcane Production (in 1 mt) Sugarcane Yield (In mt/ha) % Sugar Recovery Source: ISMA, Directorate of Economics &, SPA Research Cane plantation set to fall to the lowest in four years to ~4.85 mh, 3% lower than last year s 5. mh and below the government's target of 5.3 mh for this year Cane Yield & Sugar Recovery (211-12) Regions Area Cane Sugar (' ha) Yield (t/ha) Rec.(%) Tropical Maharashtra Karnataka Gujarat TN AP Sub-tropical UP Bihar Punjab Haryana Source : Cooperative Sugar Journal, November, 212 SPA Research The total cane area across the country is set to fall to the lowest in four years to ~4.85 million hectares (mh), 3% lower than last year s 5. mh. That's the lowest since the season and below the government's target of 5.3 mh for this year. However, early monsoon and proper distribution of rains have eased some concerns over sugar cane acreage for sugar season Though India is among the largest producer of sugarcane, yield from the crop and sugar recovery is ~66 tonne per hectare and 1.2%, respectively, which is much lower than the world average. Also, there is a high variation in the yield within the country across different regions. This is mainly because of variation in the climatic conditions prevailing in the country. The average cane yield in tropical region is about 85.1 tonnes while in the subtropical region, it is only about 6.7 tonnes per hectare. Despite Maharashtra and Uttar Pradesh being the top two Indian states in terms of the area under cultivation as well as their contribution to sugar production in India, Tamil Nadu has the highest yield of 13 tonnes per hectare in The second place in productivity is taken by West Bengal, followed by Karnataka. Uttar Pradesh, with the largest area under cultivation, ranks 14th in productivity. Percentage Share of Indian States in Area under Sugarcane Cultivation UP 47.1% Maharashtra 17.5% Karnataka 7.8% Tamil Nadu 7.5% Gujarat 4.6% AP 3.8% Bihar 2.8% Uttarakhand 2.3% Haryana 1.8% MP 1.4% Punjab 1.4% Other states 2.1% Source: ISMA, SPA Research 9

10 Export & Import - Ceteris paribus, currency playing an important role India's status as a net importer or exporter frequently changes as a result of imbalances caused due to cyclical nature of production, with imports exceeding 2 mt during the deficit phase of the cycle, replaced by large exports during the surplus phase. Import & Exports across cycles Import (mn tn) Exports (mn tn) Source: ISMA, SPA Research In addition to the infamous Cycle, currency factor and global fundamentals also influences the Indian trade scenario. After exporting ~3.5 mt of sugar last year, Indian exports have suffered drastically this season on the back of weak international prices which has made overseas shipments unviable. Importing sugar has mostly been unviable for the domestic players as the landed cost (import duty of 15% + freight charges+ handling charges) of sugar is largely higher that domestic prices. However given the sharp decline in global sugar prices to three years low, Indian players has already imported ~.7 mt of sugar till date in this season despite holding comfortable stocks which has resulted in a downward pressure on domestic sugar prices. However with the increase in import duty from 1% to 15% coupled with sharp depreciation of rupee, the prospects of further imports seems limited at the moment. Despite weak international prices, rupee depreciation in turning exports viable Moreover rupee depreciation in addition to squeezing imports has turned exports viable. Given low international prices at this point in time, it is extremely favorable for export from costal millers. In fact, Indian traders have signed deals at $ 5-51 per tonne (FOB) to export 75, tonnes of white sugar in July, on the back of strong demand in Gulf and African states due to the Islamic fasting month of Ramadan. This in addition to already lower sugar production forecast for SY14, will lead to further tightening in domestic sugar availability, thereby presenting a bullish scenario from overall demand supply perspective. 1

11 Sugar Manufacturing & Its By-products To Grid Cogeneration Sugar Plant Weighed & Prepared Cane Power Steam Bagasse Turbines Boilers To Factory Press Mud Bio-Composting Spent Wash Molasses Alcohol Fermentation Distillery Cane Milling / Crushing Juice Defecation & Clarification Juice Sulphitation Syrup Boiling Centrifuging Factory Raw Sugar Manufacturing Process The process of manufacturing sugar starts with pressing of sugarcane to extract the juice. It is followed by boiling the juice resulting in thickening of the juice and sugar begins to crystallize. The crystals are spun in a centrifuge to remove the syrup, thereby producing raw sugar. The raw sugar is then transported to a refinery where it is washed and filtered to remove remaining non-sugar ingredients and colour. It is then followed by crystallization, drying and resultant packaging of the refined sugar. Source: SPA Research Water 51% Sugarcane By-products Source: SPA Research Production of Molasses (mt) SY SY SY9 6.5 SY1 8.4 SY SY Source: SPA Research Press mud 4% Bagasse 3% Sugar 1% Molasses 5% By-products - An integral part of industry In sugar manufacture, the major byproducts comprise of bagasse, molasses and press-mud, which are utilized to generate power and produce industrial alcohol/ethanol and fertilizers. The byproducts account for about ~4% of crushed sugar cane by weight. India has achieved considerable progress utilising these by-products. A) Bagasse The fiber (3-33% per tonne of sugarcane crushed) derived from crushing sugarcane is known as bagasse. Bagasse is used as a combustible in furnaces to produce steam which is used to generate power. The power generated is used in processing sugarcane and surplus power is supplied to the grids. B) Molasses Molasses is used primarily for production of rectified spirit and extra neutral alcohol. It accounts for ~5% per tonne of sugarcane crushed. Alcohol serves as raw material for industrial manufacture of potable alcohol and fuel ethanol. Sugarcane is generally regarded as one of the most efficient sources of biomass for bio fuel (ethanol) production. The demand of ethanol is generated due to its compulsory blending with petrol. C) Organic manure Organic manures accounts for around 3%-5% of the sugar cane crushed. Sulphitation press mud is mainly used as manure. The press mud organic manure is free of inorganic elements present in the traditional form of organic manures, commonly used by the farming community. Crops yield good results when applied during early land preparation. It increases soil porosity and helps the crop in the uptake of chemical fertilisers (NPK). 11

12 By products de-risk the business model & acts as savior to the bottomline during the down cycle Free pricing will help to implement the ethanol blending programme Overseas players offering ethanol at INR 75/ litre, double the domestic offer price Need to change the sugar - alcohol production combination A significant part of the total revenue and profits of sugar mills comes from by-products, especially in the case of forward integrated entities. In down-cycle these products act as a savior to bottomline de-risking the business model. Greater the level of integration, better is the ability to wither the downturn and de-risk the business model from cyclicality. Most of the sugar mills are integrated having power generation and facility for alcohol production. The forward integrated model aids in generating enhanced realisations and optimum resource utilisation. We feel by-products will remain important part of the industry due to improving macro scenario for these products. Prices of by-products such as bagasse and molasses continue to remain remunerative driven by healthy demand from consuming sectors such as power, paper and alcohol. Higher realizations for fuel ethanol in the current financial year will further result in improved returns from by-products. Ethanol Blending Program gains momentum To completely transform the industry In November 212, the Cabinet Committee on Economic Affairs (CCEA) has made it mandatory for three major oil marketing companies (OMCs) - Bharat Petroleum, Hindustan Petroleum and Indian Oil Corporation to blend 5% ethanol with petrol. Although this mandate has been there since last two years, it was partially implemented due to the absence of any clear directive and largely due to low procurement price of INR 27/litre fixed by the CCEA in August 21. To remove this bottleneck, the committee has approved market-based pricing of ethanol (to be implemented from June 213) as a result of which sugar producers will willingly supply ENA at market determined price. This has resulted in Ethanol Blending Program (EBP) gaining momentum and it can potentially transform the industry given significant visible demand for ethanol (~1.5 bn litres for 5% blending with petrol). OMCs have floated first tender for 1.1 bn litres of ethanol in Jan 13, out of which they could finalise procurement of only.55 bn litres at an average price of INR 35/litre from domestic sugar companies (to be supplied in the current sugar year ending September), as most the sugar mills have already contracted for the supply of molasses and rectified spirits for producing potable achohol. Importantly to meet the gap OMCs floated a global tender to import.5 bn litres, but the lowest price quoted by foreign suppliers of ethanol was about ~INR 75 a litre, double the preferred domestic quote. This resulted in OMCS floating second domestic tender to procure 1.34 bn litres of ethanol between the period 1st Dec 213 to 3th Nov 214, which was fully met by sugar companies. Moreover in the second tender prices offered might be higher because of high imported cost and 5% increase in sugarcane price by central government in FRP regime. Assured realisations coupled with the commitment of lifting of full potential will positively impact the profitability of sugar producers. Out of the world's total ethanol production, around 8% is used for fuel purpose. However Ethanol market in India is driven more by beverage alcohol market rather than fuel alcohol market unlike rest of the world. Newer players especially global alcohol majors are entering Indian market seeing the growth opportunities and the beverage alcohol investment is not showing any slow down. Taking clues from the way the sugar industry has diversified in Brazil, it is high time that India starts planning for radical shifts in the sugar alcohol production combinations, so that we meet at least a part of the domestic requirements of petrol. This would help in saving valuable foreign exchange outgoes and in reduction of current account deficits, which have been of concern in the country. As indicated in table given below, there is scope for enhancement of ethanol prices by a margin of INR per unit at the current petrol prices and more than that there is a sound case for premium pricing on ethanol due to its renewable/green status. 12

13 Scope for enhancement of ethanol prices by a margin of INR 11-12/Lit remains Price Rs 59 per USD as on 24th June'13 for imported Petrol and domestic Ethanol Sr.No Particulars Unit Petrol Ethanol Remarks 1 FOB Gasoline Price at Arab Gulf $/bbl Calculated 2 Add: Ocean Freight from AG to Indian Ports $/bbl Assumed for Petrol as taken for Diesel 3 C&F (Cost & Freight) Gasoline Price $/bbl Taken from IOCL website as on 16th June'13 C&F (Cost & Freight) Gasoline Price Rs/Lit At Rs 59 per USD 4 Import Charges Rs/Lit.4 - Assumed for Petrol as taken for Diesel 5 Basic Customs 2.575% (2.5% + Assumed for Petrol as taken 3% Education cess) Rs/Lit for Diesel 6 Import Parity Price (at 29.5º C) (Sum of 3 to 5) Rs/Lit Export Parity Price (at 29.5º C) Rs/Lit Calculated 8 Trade Parity Price (8% of (6)+2% of (7)) Rs/Lit Refinery Transfer Price (RTP) 9 (Price Paid by the Oil Marketing Companies to Refineries) Rs/Lit Calculated 1 Add: Excise Duty & 12.36% Rs/Lit Add: Freight Rs/Lit Freight may vary from Depot to Depot 12 Add: Premium recovered for BS-IV Grade over BS-III Grade Rs/Lit Add: Inland Freight, Delivery Charges etc. Rs/Lit.95 - Assumed for Petrol as taken for Diesel 14 Add: Marketing Cost of OMCs Rs/Lit Calculated 15 Add: Marketing Margin of OMCs Rs/Lit Calculated 16 Total Desired Price (Sum of 9 to 15)- Before Excise Duty, VAT and Dealer Rs/Lit Calculated Commission 17 Price Charged to Dealers (17-18)- Excluding Excise Duty & VAT Rs/Lit Calculated 18 Add: Specific Excise Duty & Rs 9.48 per Lit- Petrol Rs/Lit Sub-Total Rs/Lit Difference b/w Petrol & Ethanol- Rs 11.6 per Lit 2 Add: Dealer Commission Rs/Lit It may vary from state to state 21 Add: VAT Rs/Lit Tax remains same as ethanol will be sold as petrol 22 Add: Cess & Service Tax- Ethanol Rs/Lit As per invoice taken from HPCL petrol pump 23 Retail Selling Price at Delhi - Rounded off (Sum of 18 to 24) Rs/Lit Source: Report of the Working Group on Sugarcane Productivity and Sugar Recovery in the Country, SPA Research Crushing of 1 ton of sugarcane yields either a) 1kg Sugar along with 11 litres Ethanol, or only 76 litres of Ethanol. This results in a price parity of 1:1.53 between Ethanol and Sugar. Hence depending upon the prevailing prices, sugar manufacturers will enjoy the flexibility to divert sugar capacity to ethanol production. 13

14 Regulatory Framework The Indian sugar industry is one of the most regulated industries. Till few months back, its entire gamut of activities starting from procurement of sugarcane and ending with the sale of sugar were governed by Indian government. However after years of deliberation, Indian government has finally decontrolled the sugar sector albeit partially, in April 213. The major pertinent regulations and policies still adopted by the Government are given below: Controls on sector prior to reforms Controls after partial decontrol Minimum Distance Criteria between mills Levy Sugar Obligation on mills Minimum Distance Criteria between mills Tariff rates on trade Cane Area Reservation GOVT. POLICIES Regulated Release Mechanism Cane Area Reservation GOVT. POLICIES 4% sugar to be packed in jute bags only Dual Cane Pricing: Centre/State State Govt. Controls Compulsory sugar packing in jute only Import and Export Central Govt. Controls Dual Cane Pricing: Centre/State State Govt. Controls Central Govt. Controls 14 Source: SPA Research Dual pricing contributing largely to cane arrears & cyclicality in sugar industry Dual sugarcane pricing (FRP/SAP) The industry is subject to fair and remunerative price (FRP) for sugarcane fixed by the Central Government from year to year, taking into account cost of production of sugarcane, return to growers from alternative crops, fair consumer price of sugar, etc. In addition to the FRP, 5 States in the country viz. UP, Haryana, Punjab, Uttarakhand and Tamil Nadu (together accounting for ~38% of total sugar production), fixes a price (generally higher then FRP) known as the State Advised Price/SAP (on political considerations, without any transparent laid down criteria and no relation to sugar price). Dual cane pricing distorts cane and sugar economy and is contributing majorly to cane price arrears and cyclicality. This is very unlike than all the major sugar producing nations in the world like Brazil, Australia and Thailand, where there is a direct linkage between sugarcane and the sugar prices. Sugarcane grower s revenue share in the total industry revenue is 62-67% in Australia; 56-61% in Brazil and 7% plus in Thailand. A look at the sugar economy and growth of sugar sector, including investments in the farm and factory, will clearly distinguish states following SAP from the others like Maharashtra, Karnataka, Gujarat etc, which have never followed the system of SAP. The sugar sector therein has grown in leaps and bounds in comparison to the SAP States, where either the growth is flat or negative. A higher price for cane is sustainable only if the sugar recoveries compensate for the high costs, like for Maharashtra or Karnataka, but not if the recoveries are the lowest in the country, as for example in UP. Share of cane price as percentage of ex mill sugar price % SS5 SS6 SS7 SS8 SS9 SS1 SS11 SS12 Source: Committee report on sugar deregulation, SPA Research UP MAHARASTRA

15 The SAP in UP has been increased from INR 165 per quintal of cane in 29-1 sugar season to INR 28 per quintal in , which has meant: Political Agenda destroying UP's sugar economy An increase of INR 115 per quintal in just 3 years (@ INR 4 per quintal yearly). It has increased the average cost of production of sugar in UP from INR 24 per kg in 29-1 to INR 35 per kg in season. As compared to these very high costs, the sugar prices which were INR 28 per kg in 29-1 increased to only INR 31 per kg in Cane price in UP has gone up by 7% in the last 3 years, but sugar prices have increased by just 11% in the same period Sugarcane Production & Price trend UP Sugarcane Prod. (mt) TN Sugarcane Prod. (mt) Sugarcane FRP (INR) TN SAP (INR) UP SAP (INR) Source: ISMA, SPA Research Import-export of sugar Depending on mill-wise monthly production and stocks, local production levels and world market conditions, the Government regulates the import (through import duty) and export [through open general license (OGL) and advance license scheme (ALS)]. Minimum distance criteria and Cane area reservation Each sugar mill is allocated a command area in its vicinity (which usually varies from 15 km to 25 km radius, depending on the state). The mill is obligated to purchase sugarcane from cane farmers within the cane reservation area, and conversely, farmers are bound to sell to the mill. This is intended to serve the twin purposes of giving a minimum assured supply of the highly-perishable raw material to a mill, while committing the mill to procure at a minimum price (FRP/SAP). Jute Packaging mandate for sugar Jute Packaging Materials Act mandates that sugar be packed only in jute bags. It is estimated by the sugar industry that this leads to an increase in cost by about ~4 paise per kg of sugar besides adversely impacting quality on account of ingress of jute fibers of jute bags. Further there is often a shortage of jute bags. However this has now been relaxed for 6% of production. Controls on sale of by-products There are several regulatory hurdles in respect of the by-products of sugar industry. In respect of molasses, these are at the state level, in terms of state government decisions relating to fixation of quotas for different end uses of molasses, restrictions on movement (particularly across state boundaries), etc. 15

16 Financial burden before decontrol Production for mt Levy share 2.4 mt Financial burden on company Levy Price INR 19.7 Market price of sugar INR 32. Loss on levy quota INR 12.3 Total Burden INR mn Source: SPA Research Karnataka & Maharashtra finally showing interest for adopting revenue sharing formula for cane pricing Partial decontrol of sugar - Leading to rerating of sector The expert committee headed by Dr. Rangarajan submitted its recommendations on the deregulation of the sugar sector to the government in Oct 212. The key proposals suggested were a) abolition of levy sugar, b) doing away with monthly/quarterly release mechanism of non-levy sugar, c) sugarcane price to be linked to 7% of realized value from sugar, molasses and bagasse with FRP forming a floor and no state-wise SAPs, d) removal on quantitative restriction on sugar exports and imports, e) removal of controls on sale of by-products, and f) gradual phasing away of cane area reservation and minimum distance criteria for mills. The GoI accepted the Rangarajan Committee report on April 4, 213 and announced a partial decontrol of the sugar industry by:- a) Removing the levy obligation to supply part of the sugar production at subsidized prices - Earlier, central government used to procure 1% of the sugar production at subsidised price of INR 19.7/kg, which resulted in financial burden to the tune of ~INR 3 bn on the sugar industry. The removal of levy obligation will have a substantial impact on profitability as it would lead to ~ 1.3/kg increase in blended realisation of sugar manufacturers. b) Abolishing the regulated release mechanism to sell non-levy sugar in the market - The abolition of the monthly release mechanism will facilitate the free play of market forces for the commodity. It will benefit sugar mills in the medium to long-term by enabling them to manage their working capital requirements better while also enabling financially stronger sugar mills to capitalize on better sugar realizations. Importantly other key recommendations of Rangarajan Committee namely, the revenue sharing formula for sugar cane pricing, the minimum distance between factories and the reservation of area for factories etc, have been delegated to the State Governments to take a considered view. The revenue sharing formula for sugar cane pricing entails that 7% of revenues (sugar, molasses and bagasse)/75% of revenues for non-integrated mill, should be shared with farmers and payment would be made in 2 stages; FRP within 14 days of cane purchase and balance on half yearly basis on ex-mill price declared by respective states. It has been gathered that the Government of Karnataka has already enacted an Act in May 213 deciding to form a sugar board and prescribing that the sugarcane price will be based on the revenue sharing model. Maharashtra is also readying to consider a similar move prior to the start of the next season. This is a remarkable initiative taken by these two State Governments and we hope that this will have a positive influence on the Government of UP. Otherwise these two states, which account for ~49% of the country's sugar output, would out-price UP sugar due to their lower cost of production. We view these policy changes as a step in the right direction and expect the sugar industry to get transformed and re-rated in the coming years. 16

17 Significantly beneficial for sugar mills, particularly UP based Units Uttar Pradesh Maharashtra Cane crushed mt Sugar Recovery rate 9.5% 11.% sugar prodn/sales mt sugar realisation (Ex-mill) INR/tn Sugar revenue INR mn Molasses Recovery rate % 5.% 5.% Production mt.4.4 Realisation (assumed) `/t Molasses Revenue INR mn Bagasse Recovery rate 3.% 3.% Production mt Captive cons 3% Exportable surplus mt Realisation (assumed) INR/tn 8 8 Bagasse Revenue INR mn Cane price estimation Total revenue (sugar+molasses+bagasse) INR mn Cane cost (% of total revenue) % 7% 7% Total Cane cost INR mn Cane crushed mt Cane cost per tonne INR/tn as % of sugar realisation % 75.3% 85.8% Trend in domestic sugar prices India has been witnessing higher sugarcane price over the last few years, however sugar prices have not risen in direct proportion leading to severe margin pressure on the industry. Sugar prices during did not increase sharply and ranged between INR 29 to INR 31 per kg, due to an expected rise in sugar production and more than sufficient availability of stocks. Prices have inched northward in early between May 212 to November 212 (peaking at around INR 36/kg, due to expectation of lower sugarcane production in Maharashtra and Karnataka in current sugar year. However with consumption remaining at ~23.5 mt in addition to higher global production and subdued global prices (restricting export attractiveness), sugar prices has remained under pressure since H2FY13. There were several other factors also that led to decline in prices. While the initial decline in the period January- March 213 was driven mainly by seasonal supply pressure from new production and sale of sugar in the domestic market by shore based refiners having access to cheap raw sugar, the continued decline since April 213 has been driven mainly by the announcement of partial decontrol in April 213, which resulted in large scale releases of sugar by financially weak mills with large cane dues. In addition, competition from sugar produced by processing raw sugar (whose prices remained weak globally because of supply pressures) also continued to prevent any rally in sugar prices. Sugar prices at NCEDX declined around 18% and touched a low of INR 29.8/kg in the month of April 213 and has finally stabilized at ~INR 31/kg on concerns over lower cane acreage. 17

18 Prices stabilising INR per tonne CAGR in sugar consumption to Africa Asia South America Source: Rabobank 213 Oceania N&C America Europe World Source: Bloomberg, SPA Research World sugar dynamics World consumption of sugar has grown at an average annual rate of 2.7% over the past 5 years. Sugar consumption has been declining in developed countries - partly due to the availability of substitutes and concerns about obesity and health. At the same time, it has been increasing in developing countries, which now account for around 7% of world sugar consumption, driven by rising incomes, population growth and changes in diet. Sugar crops in many parts of the world are projected to expand in response to rising demand for sugar and other uses. World sugar production is expected to increase by 3 mt to reach over 21 mt in The bulk of the additional sugar production will come from the developing countries and the main burden of growth will continue to fall on Brazil. Brazil has expanded production rapidly in the past two decades, but a slowdown in investment in new mills occurred after the financial crisis of 28, slowing the overall growth in the following years. The use of sugar in the development of ethanol as an alternative fuel is also an important factor in the sugar supply-and-demand equation. Brazil is both the largest exporter of sugar and the largest producer and consumer of ethanol. Any decision that Brazil takes to expand ethanol production - for example, when a large sugar crop is forecast - can affect the balance of supply and demand in the global sugar market. Main producing countries Raw sugar is derived from both sugar cane and sugar beet. Brazil and India are the world's two largest sugar producers. Together, they have accounted for over half the world's sugar cane production for the past 4 years. The EU is the third-largest producer and accounts for around half the world's sugar-beet production. World production of raw sugar has increased by 2% YoY to mt in By 218, production is projected to reach 22 mt - slightly higher than the projected consumption of 198 mt Major sugar producing countries contribution (%) in total world sugar production Brazil India EU China USA Australia Thailand Mexico Pakistan Russia Rest of world Aug 7 Jan 8 Jun 8 Nov 8 Apr 9 Sep 9 Feb 1 Jul 1 Dec 1 May 11 Oct 11 Mar 12 Aug 12 Jan 13 Jun 13 Source: USDA, SPA Research 18

19 Main exporting countries World exports of raw sugar increased by 1% YoY to 58 mt in led by Brazil (24.6 mt) and Thailand (9 mt). Largest exporters of Raw sugar as a % of total exports by volume, Brazil 44% Thailand 12% Australia 6% India 5% EU 4% UAE 3% Guatemala 3% Mexico 2% Columbia 1% Cuba 1% Others 19% Global Ethanol Production in 212 China 2.39% India 2.53% Brazil 23.99% Canada 1.93% Source: USDA, SPA Research Other Countries 9.94% USA 59.22% Source: USDA FAS Sugar: World Markets & Trade, SPA Research Main importing countries Import of raw sugar stood at 49 mt in The EU, US and Indonesia are the leading importers, at around 3 mt each per year. World Ethanol Dynamics Ethanol & Its advantages With ever-rising cost of petrol, global warming, peak oil and so on, there has been a growing need for sourcing alternative sources of energy and ethanol seems to be a product that many economies are putting much of their hopes into. The use of ethanol as a blended fuel component in gasoline is steadily increasing. Ethanol's main attraction comes from the fact that it burns cleaner than petroleum oil, and that it is more cost and fuel-efficient. Ethanol is also a renewable energy resource, an important factor considering our high dependence on petroleum, being non-renewable, which is entering into a stage of scarcity, or peak-oil, driving the price of petrol up. Furthermore, the production of ethanol may have a role in easing the global economic crisis. The financial worth of ethanol producing crops will drive up the prices of vegetation such as corn, so farmers can enjoy a significant profit. These same crops need to processed, meaning there will be an increased need for factories and workforces. Demand drivers & Growth potential The US, Brazil and to a smaller extent, the European Union, together dominates global production of fuel ethanol producing ~89% of the world's output. The US product is largely distilled from corn, while Brazil makes ethanol from its sugar cane crop. Production and use in the United States and the European Union are mainly driven by the policies in place (i.e. Renewable Fuels Standard (RFS2) and the Renewable Energy Directive (RED), respectively). The growing use of ethanol in Brazil is linked to the development of the flex-fuel industry (FFVs) and the import demand of the United States to fill the advanced biofuel mandate as well as to their increase in blending minimums. Global ethanol production has fallen in CY12 for the first time since 2, due to declines in the United States and in Brazil. With lower prices of maize and sugar anticipated in , a large increase in production is anticipated in both countries. In addition to the pivotal 3 markets - the 19

20 US, Brazil and the EU -rising transport fuel demand in other countries, together with additional governments expressing mandates and targets for ethanol inclusion in gasoline, point to considerable potential for fuel ethanol demand over the remainder of this decade. Renewable Energy & Nuclear Power are fastest growing sources of energy consumption world energy consumption by fuel quadrillion btu 25 History 21 Projections 28% 27% 2 Liquid fuels (including biofuels) 34% Coal 23% % 22% Natural gas Renewables 15% 11% (excluding biofuels) 5 7% Nuclear 5% Share of world total Source: EIA, International Energy 213, SPA Research By 222, OECD is expecting world ethanol production to increase by almost 7% compared to the average of and reach some 168 bnl. Out of this, production in developing countries is projected to increase from 42 bnl in 212 to 72 bnl. in 222, with Brazil accounting for 8% of this supply increase and a large part of the rest coming from China, where less than half of their ethanol production is consumed in the fuel market, the rest is consumed as alcohol in many food and nonfood preparations Production to grow at 6% CAGR China 6% EU 7% Regional distribution of world ethanol production and use in 222 Production India 2% Thailand 1% India 2% China 6% Consumption Thailand 1% Other 8% World ethanol production (bnl) World ethanol trade (bnl) Brazil 28% USA 48% EU 1% Brazil 21% USA 52% Source: OECD-FAO Agriculture 213, SPA Research Crude oil has little direct impact on ethanol prices Increasing gasoline prices lead to surge in demand of ethanol because it makes ethanol more competitive. Ceteris paribus, blending ethanol is cost effective as long as ethanol price is at 3% discount to the price of gasoline due to its lower energy content. Demand for crude oil has a minimal impact on the price of ethanol. In the world market for crude oil, an individual country's supply and demand decisions are small relative to the market as a whole-even for a country the size of the US. To put this into perspective, the US consumes roughly 2% of world oil. Roughly half of the US oil consumption goes toward gasoline and ethanol comprises roughly 1% of gasoline-blend fuel. Thus, on a volumetric basis, US ethanol constitutes about 2% of world oil use. Crude-oil supply and demand would need to be very inelastic before such a quantity had a noticeable effect on price. 2

21 CBOT Ethanol Nearest-Futures versus NYMEX RBOB Gasoline Nearest-Futures 7% CAGR in world gasoline prices to result in 8% CAGR in world ethanol prices Source: SPA Research OECD is expecting the world gasoline price to increase in real terms by 7% between 212 and 222, as a result of which ethanol will become increasingly competitive with petrol. This will lead to an increase in demand and consumption of ethanol by owners of flex-fuel cars thereby putting upward pressure on the world price of ethanol in the medium-term. As a result OECD is expecting an increase of 8% in the world price of ethanol in real terms between 212 and 222. So with all of these benefits, is ethanol the fix-all solution? Unfortunately, it is not as production of ethanol has many negative points working against it in its potential role as the next major source of fuel. The most important is the fact that creating ethanol is thought to consume more energy than its overall output. The amount of crops needed to fuel a car for only one day could go a long way towards feeding a person for considerably longer. Also, although ethanol is being advocated as environmentally friendly, the amount of farmland needed to satisfy the global thirst for fuel is staggering. This need for fuel means that more farmlands must be created, resulting in considerable deforestation. There would also be less of an incentive for farmers to grow other crops, when ethanol-producing harvest would fetch more of a price, or even using vegetation, such as corn, for food products instead of as fuel. The result would be overinflated prices on all food products, an expense that could further damage populations already dealing economic distress. Earlier this year the USDA reported the largest corn planting in history. Yet record temperatures and drought throughout the country means this year's crop could be far lower than originally expected. Weather is uncontrollable, but we can influence demand for corn supplies. Government incentives for corn ethanol increase demand at a time when corn is expected to be in short supply and that has made global hunger advocates worried. CBOT Ethanol Nearest-Futures versus CBOT Corn Nearest-Futures Source: SPA Research Hence instead of relying entirely on ethanol as alternate fuel, it can be used to take strain off of the environment by being implemented in ethanol-gasoline, or ethanol-electric cars. 21

22 Ethanol from sugarcane stands out The development of ethanol in Brazil has helped the country overcome a historical dependence on foreign oil while curbing its greenhouse gases emissions and diminishing local air pollution. The overall success of Brazil's ethanol program has resulted in calls for its replication abroad, including in the United States. However, reproducing Brazil's ethanol success in other countries would not be that easy. According to agroecological zoning In Brazil: - Sugarcane (for sugar & ethanol) occupies 9.8 mn ha out of 65. mn ha possible for cane, - Sugarcane for ethanol occupies 5.1 mn ha or 1.6% of total arable land. Ethanol can be produced from corn, sugar cane, and other starchy agricultural products, as well as cellulosic materials in agricultural wastes (e.g., waste woods and corn stalks). The most important differentiation between Brazil and other countries is that Brazil produces ethanol from sugarcane, while other large producers produce ethanol from other primary agriculture crops. Brazil has vast lands available and suitable for planting sugarcane without displacing other crops. Thus it can easily increase its ethanol production. However for other countries to do so, they have to divert substantial portion of their primary agriculture crops to ethanol production, which will almost certainly affect food prices. Thus mass production of ethanol from sugarcane does not cause the same impact on food markets in Brazil as ethanol from other food products does. Ethanol from sugarcane is cheaper and more energy efficient than from others. Further the cost of producing sugarcane ethanol is also much cheaper, which allows Brazilian ethanol to compete with gasoline without the substantial subsidies generally provided to other countries to make ethanol competitive. For all of these reasons, if other countries were to pursue ethanol as a substitute for gasoline on the same scale as Brazil did, and if it were to do so with an eye toward real environmental gains and minimizing impacts on the food supply, it would have to seek source plants other than corn. Ethanol yields per ha Gross feedstock costs per litre of fuel ethanol Energy balance by feedstock France (beet) France (beet) Sugar cane Biomass Brazil (cane) Brazil (cane) Sugar beet US corn USA (corn) USA (corn) Wheat RME (Biodiesel) Production (lt/ha) Costs (US Cents/litre) Energy output/energy input Source: USDA, SPA Research 22

23 Global demand supply situation - Sugar Global surplus to decline significantly in 214 Production deficits in 28-9 and 29-1 were followed by surpluses in and as sugar crop areas expanded on the back of higher prices. The International Sugar Organisation has forecast a 1.1 mt global supply surplus in on account of more supplies from major exporting countries like Brazil (+6.8%), Australia (+9.%), Thailand (although -2.9% on YoY but substantially higher than previous estimates) and high production in major importing countries like China (+17%). Global production is projected to rise to a record high of mt in , while consumption is expected at mt, leading to a surplus of 1.1 mt, more than 8.5 mt anticipated earlier. World sugar surplus to decline significantly to 3.5 mt in % increase in Brazil s ethanol consumption can completely eliminate the world sugar surplus. Importantly the global sugar surplus is expected to decline significantly in 214 with ISO estimates indicating 3.5 mt of surplus for the period Sugar price declines in recent years have created incentives for a new equilibrium in the sector. On the demand side, cheaper prices boost consumption. On the supply side, lower prices squeeze profit margins, causing farmers to opt for other crops and to invest less in the remaining sugarcane plantations. World sugar output is expected to decline by 2.8% to mt while consumption is expected to grow by around.8% to mt in The expected global sugar surplus for the fourth consecutive year can totally be eliminated also depending on the amount of cane that is used in Brazil for ethanol. A 2% increase in Brazil s ethanol consumption has the potential to completely eliminate the world sugar surplus Demand Supply Dynamics (.1) (1.6) (14.) FY7 FY8 FY9 FY1 FY11 FY12 FY13E FY14E Production Consumption Surplus/Deficit (5) (1) (15) (2) Source: USDA, SPA Research Brazil - The Potential game changer Most important factor for the world sugar & ethanol market Positioned in the world as (212): - No. 1: sugarcane producer (35% of world) - No. 1: sugar producer (23% of world) - No. 2: ethanol producer (28% of world) - No. 1: sugar exporter (49% of world) - No. 1: ethanol exporter (55% of world) Brazil - Sugar production to cross 4 mt in Brazilian cane production increased by 5.4% to mt in season while sugar production surged by 6.8% to 38.6 mt YoY, showing a strong upturn of the cane crop from a sharp drop in yields in & resulting from adverse weather conditions. In , Brazilian sugarcane production is expected to increase by 8.3% to 64 mt, while sugar production is expected to surge by 4.7% to 4.4 mt. The center-south (CS) region is expected to harvest 585 mt of sugarcane (+9.8% YoY) and crush 36.4 mt sugar (+6.6% YoY) in , due to expected higher agricultural yields as a result of good weather conditions and adequate renewal of sugarcane stocks. Brazilian sugar exports are expected to increase by 6.% to 29.3 mt in to meet projected international demand. Raw sugar should account for 23. mt, whereas the remainder represents exports of refined sugar. 23

24 Brazil Ethanol & Sugar Production E Ethanol (bn lt) Sugar (mt) Source: USDA, SPA Research Mills are seen to be allocating much more of the cane they harvested to ethanol production than they did last year. Total ethanol production is forecast to increase by 14.9% to 26.8 bn liters (12.6 bn liters of anhydrous ethanol and 14.2 bn liters of hydrated ethanol) Forecast of Brazil's Sugar+Ethanol Demand (in mt) Source: Datagro 213, SPA Research Relative prices favouring Ethanol production over Sugar Jan-12 May-12 Sep-12 Jan-13 Source: Bloomberg, SPA Research Higher Ethanol Prices over Sugar might eliminate world sugar surplus Brazil has a unique system of producing competing tradable products - sugar and ethanol - from non-traded sugarcane. Modern "flex-plants" produces either sugar or ethanol from sugarcane based on the prevailing respective prices. Throughout 212, relative prices favored sugar output. But in the early months of 213, the drop in international sugar prices led relative prices to favor the production of ethanol, pushing a greater part of the harvested sugarcane into ethanol production. This is expected to result in higher production of biofuel over the sweetener in the current season. Total sucrose content diverted for sugar and ethanol production is forecast at 45% and 55%, respectively, as opposed to an equal split of 5/5 in If ethanol prices continue rising, millers may well prefer to produce ethanol and sell it in the domestic market, which will provide them with cash quicker. 24