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Queensland sugar – The case of lost opportunities

 By Dr John Williams, Executive Director of the Australian Commodity Research Institute

 T. +61 428 260549 This email address is being protected from spambots. You need JavaScript enabled to view it. www.commodityinstitute.com

 December 2016

Price transparency, risk minimization, and product differentiation might be considered the business success fundamentals for agricultural producers. Maximizing the strengths of these and minimizing the weaknesses are often perceived to be the essence of business management.

Despite the growth in Queensland sugar production since regulation began in 1915, the industry has tended to be contrary by maximizing its weaknesses and minimizing its strengths. The industry has generally maximised the commoditization of sugar through least-cost pathways, and minimized product traceability or identity preservation that would differentiate product, which has resulted in complete price-taking dependency on global sugar markets.

The Queensland sugar industry remains one of the last bastions of Australian agricultural commodity mentality, whereby the 12 months of old-crop sugar takes precedence over the 18 months of new crop cane. Pricing of new crop cane generally commences only when mature cane is delivered, thereby ignoring 18 months of new crop cane price risk. Much emphasis is then placed on old-crop sugar pricing which is exemplified in cif destination-port pricing and disguised by natural price premiums through shorter freight distances (far-eastern ‘premium’), inherent product quality attributes due to soil and climate (polarisation, colour, starch, and dextrin), and hedging old-crop prices.

Sugar is one product that is totally polarized between its opportunities and its threats. Positives for sugar include international price transparency at the port of export, identical international free-on-board origin-port pricing (little basis difference that is completely unlike other commodities), well-established global price discovery, and a high-volume forward market. However, these positive attributes for sugar arise because of one serious negative – a homogenized sugar crystal that tends to undermine product differentiation and commoditizes the supply chain, thereby reducing pricing to global parity.

Opportunities that do arise are generally lost through the price-product pooling system. The problems of pooling in each of the three areas of price transparency, risk minimization, and product differentiation will now be examined.

Lack of price transparency. Title transfer of cane ownership occurs from the grower to the miller under deregulation at the cane delivery point. Spot cash prices upon delivery are the essence of price discovery for most agricultural prices, providing growers with benchmarks for price comparison, basis determination and transparency with international export port-prices, and clear signals as to whether to produce and invest. However, the Queensland sugar industry almost demonises the spot cash price upon delivery, instead generally preferring a multiple pool pricing system that is not finalized until 12 months after delivery, which provides the grower with no clear market signals in farm decision making. Unnecessary complication plus doubt over price and pool cost obfuscation leads to much grower angst and industry confusion.

Cash prices for cane can be made relevant by the subsequent addition or subtraction of price premiums-discounts based on final ccs of the sugar derived from the cane. There should be a clear local mill-based cane price transparency from international sugar prices to cane through the ccs formula. There should be a direct relationship between the miller and grower through direct end-user based pricing. As well, the international forward sugar prices can be directly related to forward cane prices offered by the mill to growers for new crop before cane delivery.

However, any benefits from the cane pricing formula to ensure international sugar price transparency are lost though old-crop pool pricing. This applies to all commodity pooling, irrespective of whether the pool is based on sugar, wheat, dairy, rice, or oilseeds. Pool pricing translates into price averaging over time based on sales and possibly some mixed hedging performances, less costs that are frequently non-transparent, obscure, and confusing, especially when it involves cif destination-port pricing. Clear price signals to enable growers to make well-judged farm decisions are lost in the process.

This lack of price transparency through pooling is all supposedly incurred to enable some misguided growers delude themselves that they have some control over international prices in a commodity price-taking market. Alternatively, many Queensland cane growers have the vain hope that by becoming old-crop price speculators via the pools, the international market will somehow respect their increasing cost of local production and profit expectations. Playing the pools is probably a better metaphor.

Risk maximization. Many growers feel despondent in a falling market because they regret what they should have done. However, many growers are similarly unhappy in a rising market because they always want to maximize their price by doing nothing with pricing. It is a no-win situation because growers want prices skewed more to the high end, but the reality is that commodity prices are skewed more to the low end. The more the miller is perceived as a conduit to ensure grower profitability, the more likely millers will get blamed when the market price falls or growers become unprofitable.

Grower price speculation on an old crop product that they do not own has completely distracted growers from managing new crop product which they do own. Few growers avail themselves of the cash price offered by mills for new crop, either as a spot price on delivery or forward prices during the cane production season. Most cane growers ignore the cash price offered by the mills, preferring to speculate on price post-delivery for a product (sugar) that is now owned by the mill and was not delivered by growers.

The traditional method of price deferment (speculation) in the Queensland sugar industry is hoarding. Growers cannot hoard unsold cane on farm, which means that the only other method to hoard is through unsold-sugar pools, despite growers not owning the sugar. The rationale for price deferment on a product they do not own or even delivered is embedded in the speculative psyche of many cane growers.

Pricing off someone else’s product (millers) and giving the benefits to a third party (growers) is extremely unusual from a legal ownership perspective, yet this is exactly what Queensland Sugar Ltd (QSL) is doing with its old-crop pools through its registration as an Australian not-for-profit charity. This charity management of price on a product (sugar) that is owned by the miller but for the benefit of a third party (growers) and with supply chain responsibilities through to destination-port (Asian buyer) has created a very unusual precedent in Australian legal and legislative history of both companies and charitable organisations. It is akin to the Red Cross pricing off a Woolworth’s product for the benefit of Coles’ suppliers, then delivering the Woolworth’s product to an overseas buyer for a commission fee, and then wondering why Coles’ suppliers have industry angst and confusion over the pricing method. Blame and responsibility can then be conveniently passed from the grower to miller to QSL, especially when QSL is registered as a charitable company.   

Financing old-crop advance payments to growers is the mainstay of pooling and price speculation post-harvest. However, financing unsold unpriced pooled product is considered high risk by lenders which then attracts the highest rates of loan interest. The last-resort highest-cost pool financing method is where the financier purchases the pool product at a low price and then sells it back at a high price, with the margin being deducted as pool costs to the grower. Pool financing costs are always borne by the speculative grower through pool deductions.

Queensland cane growers have generally borne the whole of the price-product risk to destination port for most of the last 101 years. Retaining control over the international supply chain has often resulted in the grower bearing all the logistics-shipping costs and risks on sugar, irrespective of ownership of the product. The risks associated with sugar product, price, and cost should have been the responsibility of the miller, refiner, buyer, and the freight forwarder.

Proprietor millers have no incentive for pooling, yet many do so to provide a ‘service’ to growers to enable them to speculate on price, well after delivering the old cane crop. It is irrational and illogical for growers to force millers into sugar pools when the growers do not own the product, and when the sole motivation by growers is price speculation for another 12 months. This is particularly the case when cane growers have already speculated 18 months on price during cane production before delivery. Therefore, the time span for price speculation by growers is frequently up to 2.5 years.  

Commodity pool pricing may stack up when prices are coming off peaks, depending on pool management hedging performance and cost control. However, what is gained post-peak from the old-crop pool has been offset from the potential loss by growers in not pricing new crop into the price peak using mill forward prices that reflect the international forward market. Pricing opportunities by cane growers for new crop are obfuscated by the predominance of attention to old crop price speculation.

Third party management (such as Queensland Sugar Ltd) of old crop pricing when growers do not own the product is a complete distraction for growers to manage their new crop pricing when they do own the product. As well, growers become completely dependent on external management performance to maximise old-crop price in a price-taking international market, and to minimize operating and supply chain costs which in the past have extended through to the destination port.

Undifferentiated product. Distractions on old crop after delivery have destroyed incentives for growers to better market their product prior to delivery. There has been very little attempt by grower supplier committees to integrate supply chains with local millers to benefit from the advantages being offered in Asian markets by district traceability, regional identity preservation, food safety, or the benefits offered through the Smartcane BMP program.

Regional generic branding such as Bundaberg Rum may benefit distillers, but it provides little benefit for local Bundaberg cane growers unless there is clear identification of suppliers. Similarly, Bundaberg Sugar is a product brand for the miller, but not the growers. Even the co-operative mills do not have brand identification for growers or traceability to regions/districts, preferring instead to lose individuality in the subsumption of co-operative commoditized ‘common good’ through a homogenized sugar crystal.

The problem historically is that growers have adopted the least-cost supply chain pathway which inevitably has reduced them to commingled blended undifferentiated pooled product, which can then attract only a price-taking international commodity price. Possible premiums associated with Asian markets through district traceability, regional identity preservation, food safety, and environmental sustainability are foregone by growers either through old crop price distractions or general apathy. 

The consumer world is quickly changing which creates opportunities for those willing to recognise and accept the challenges. The Chinese Government is requiring that all food imports (including sugar) after 1st October 2017 to be certified as safe food. This necessitates traceability and identity preservation, which are an anathema to the Queensland sugar industry. Other countries are quickly following suit, with the Food Safety Modernization Act already being implemented in the USA.

Growers need to partake in a program of product brand marketing that reflects local uniqueness, district traceability, regional identity preservation, food safety certified through the miller, and environmental sustainable practice certified through industry. Some opportunities may involve toll refining and containerization, which may lead to less traditional bulk handling and port commoditization. Benefits arise when Asian consumers are made aware of special product attributes and perhaps are willing to paid a higher price. Miller-grower cooperation and agreements are then required to reward supply chain participants, which include growers. Alternatively, failure to adhere to increasingly discerning Asian consumer expectations could result in loss of market share and discounted prices.

The biggest weakness of agricultural product marketing is pricing. Therefore, price needs to be separated from product marketing because farmers have a habit of chasing higher prices. Pricing should be done by the grower either on the actual delivery day of cane, or before the delivery date of the new crop either through the mill or through over-the-counter products such as a bank Tripartite Agreement.

Conclusion. There are major deficiencies in the current least-cost pathway approach in the selling and pricing of sugar. The potential for transparency from international market prices to local cane prices in the current cane pricing formula is obscured by pooling. Pricing through old crop pooling also lacks cost transparency, distorts price signals to growers, and increases grower costs including pool financing costs, especially when growers are made responsible for supply chain costs-risks to destination port. Speculating on old crop is an anathema to good management, and distracts growers from new crop pricing. Product commoditization inevitably leads to a farmer poverty-trap of higher farm costs and lower average prices.

Solutions involve avoiding speculation through pools on an old crop product which growers do not own, and differentiate their product to Asian consumers through grower-miller agreements and certification to reflect a product with local uniqueness through district traceability, regional identity preservation, food safety, and environmental sustainability certification. Asian consumer awareness for differentiated product may be the salvation for Queensland cane growers in the longer term.