Sugar Price Risk:

A Tale of Two Mills

Introduction and Background
Sugar is part of our everyday lives. It livens our food and lights up smiles on our
festivals. India is one of the largest consumers of sugar in the world. It is also one of
the world’s largest producers. Sugarcane is largely grown in the states of Uttar
Pradesh, Maharashtra, Karnataka and Tamil Nadu. The sugar mills are also
concentrated in these states.

In India, sugar mills begin to procure their sugarcane from around November every
year. The payments for the sugar procured from the farmers is generally paid over the
next several months. The payment to farmers needs to be completed before the
beginning of the next season. Once the cane begins to be available to the mills, the
crushing of cane begins, undertaking the process to convert sugarcane to sugar. This
is a continuous process over the next few months where the harvested sugarcane
enters mills and is processed into sugar. While bulk of the sugar is manufactured in
the 5-month period of November to March, the sale of sugar stocks generally takes
place over a longer period.

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The Mills
New Sugars is a Maharashtra based sugar mill and produced around 100 thousand
MT of sugar during the 2014-15 season. Nearly 60% of that sugar was produced
during January and February – the peak months.

India Sugars is also a Maharashtra based sugar mill, almost identical in size to the
New Sugars and similar procurement and crushing cycle with around 100 thousand of
sugar produced during the 2014-15 season.

These mills had planned to procure around 1 million MT of sugarcane for the season.
Sugarcane support prices were announced at Rs 220 per quintal by the government,
a rate at which the mills must procure cane from the farmers. Thus at the beginning of
the season, this clearly provided each of these two mills with a sugarcane
procurement cost of Rs 220 crores. Further, both New Sugars and India Sugars had
a recovery rate of around 10%, which can be considered to be average by industry
standards, and would result in production of around 100 thousand MT of sugar.

With the procurement cost to both mills becoming clear at around Rs 220 crores, now
it was all about generating revenue from sales. Depending on how they sold their
produce, the profitability would vary. The physical market prices of sugar had been
soft of late. In the 3 month period from beginning of July-14 to beginning of
October-14, the prices had fallen by 6% to around Rs 3000 per quintal. Which meant
that a production of 100,000 MT would fetch Rs 300 crores at current prices. But Rs
3000 per quintal is current price and is no indication of where the prices will be when
sugar actually begins to get sold in the market. There could be a gain from current
levels, if prices moved in favour and if not, then it would result in lower realization
compared to current level of Rs 3000 per quintal. Add to the cane costs, another Rs
75 crores, not relating to raw material, but coming from interest costs, wages, power
bill etc.

Thus, just at the beginning of the season, the costs, sale proceeds and profits:

Costs In ` Crores Sales realization In ` Crores

Sugarcane Pro curement 220 Sugarcane sales
Other costs 75 Profits In ` Crores
Total costs 295 PBT ?-295=unknown

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New Sugars
Believed firmly that prices of sugar are at an artificial low and will recover soon.
Farmers have to be paid for the cane prices within a stipulated time, failing which
these will turn into arrears and an interest will have to be provided to the farmers on
the arrears. Even as procurement started on full swing along with the production of
sugar, New Sugars decided to wait before beginning to sell the piling inventory. The
physical market prices of sugar however continued its downward trend and lost
another 9% from beginning-October levels, to Rs 2717 per quintal by mid-December.
Meantime, need for liquidity was rising as running costs had to be paid off. On top of
it farmers needed to be paid soon. New Sugars’ management now decided that as
and when the market situation improves, good amount of sugar will be offloaded in the
market to gain liquidity. On gaining liquidity from sale proceeds, the farmers’ dues will
be paid off as a first step. New Year could hold reason to cheer after all. But by
end-January 2015, even such optimism waned with prices remaining depressed. The
farmers’ arrears had accumulated to a large figure by then. The management decided
that now it could not wait any more and needed to sell sugar stock to generate the
cash needed to pay creditors. In February, 15000 MT was sold at an average price of
2686 per quintal, to generate 40 crores. But as southward movement of prices
persisted, there was fear that if more was NOT sold immediately, the sales realization
would not be sufficient to pay-off the farmer dues of Rs 220 crores, ignoring any
interest payable thereupon. Thus sugar was sold aggressively over the next 3 months
as well.

Average Price Realization

Sale of Sugar (MT)
(Rs. per quintal) from sales
Feb-15 15,000 2686 40
Mar-15 20,000 2539 51
Apr-15 40,000 2537 101
May-15 20,000 2495 50
Jun-15 5,000 2318 12
Total 1,00,000 Total 254

New Sugars could get a sales realization of Rs 254 crores, while costs were of the order
of Rs 295 crores. New Sugars ended in a loss of Rs 41 crores.

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India Sugars
Held a belief similar to the New Sugars and started the season thinking that the prices
would recover. India Sugars had been stung by a rocky ride of physical sugar prices
in the preceding year 2013-14. This year it had lower appetite for a loss. The
management wanted a guarantee of minimum level of profitability and said that it
particularly wanted no loss, even if that meant having low profitability.

It was planned in early-October to sell the entire sugar’s physical stock in the 7-month
period from December-14 to June-15.

Physical Sales
Month
Planned (MT)
Dec-14 10,000
Jan-15 10,000
Feb-15 15,000
Mar-15 15,000
Apr-15 15,000
May-15 15,000
Jun-15 20,000
Total 100,000

This schedule of continuous sales would give the necessary liquidity to meet farmers’
payments, debt servicing and other costs. But one major concern still remained. That
the actual prices may continue to fall during this period. This poses a problem. So
prices need to be frozen in such a way that the objective of guaranteeing India Sugars
of protection from a loss this year is achieved. After hectic discussions, it was decided
to put in place a massive Hedge Programme. A programme to cover all of its sugar
selling price risk, by going short in futures market. This was to be achieved by selling
sugar futures on the NCDEX futures platform.

At this point in time sugar futures available on NCDEX were contracts with expiries in
December-14, March-15, May-15 and July-15 and so on. It was planned to enter into
futures contract over the next few days and for physical sales in a given month,
square-off an equivalent quantity of futures contract i.e. futures sale positions to be
discontinued as and when physical sales took place. To avoid complications and to
maintain control on execution, it was decided to do square off related to a month’s
quantity, in the middle of the month i.e. on 15th of every month. Sugar’s physical sales
would happen in bits through the month, giving an average price. The futures could be
squared-off in the middle of the month. This would leave a few days’ worth of price risk
open anyway as physical sales date and the Futures cancellation date in a month do

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not match, but it was preferred because such risk would be small and at the same time
would facilitate ease in execution.

Futures were to be sold for different quantities for various Futures expiry months.
Starting October 20, the mill started selling futures contracts on the Exchange, and
completed selling futures for a quantity of 100,000 MT by end of October as follows:

Price at which
Futures Quantity contract entered*
Contract (MT) ( ` per quintal)

Dec-14 10,000 2,795

Mar-15 40,000 2,842
May-15 30,000 2,891
Jul-15 20,000 2,940
Total 100,000

*rates from hedging between 20-oct to 31-oct, as contracts entered

The mill kept producing sugar every day in season and inventory accumulated.
Simultaneously, the sales and hedging plan was executed with discipline at India
Sugars. On the 15th of December 2014, it squared-off the December-14 futures contract
entirely (10,000 MT) at a rate of Rs 2538 per quintal, giving an MTM gain of Rs 2.6
crores. Physical sales were made through the month of December at the going physical
market prices, for 10,000 MT, earning Rs 27.5 crores. On January 15th, 10,000 MT of
March-15 futures position was squared off to coincide with the plan of physical sales of
sugar of 10,000 MT. The physical sales earned Rs 27.3 crores, while the futures
cancellation provided a gain of Rs 96 lacs. In the same way, 15,000 MT of March-15
futures were squared-off on 16th February and another 15,000 MT on 16th March to
coincide with actual physical sales of 30,000 MT of sugar in those months. This exercise
was completed as follows:

Earning Futures Cancellation Futures Futures Gain(+)/loss Total

From Futures Contract quantity price at price at (-) from realisation
Quantity Physical futures (INR Cr)
Cancellation that is (MT) cancellation entry
(MT) Sales* hedges
Date being (Rs per (Rs per
(Inr Cr) cancelled quintal) quintal) (INR Cr)
(A) (A) (A)+(B)

Dec-14 10,000 27.52 15-Dec-14 Dec-14 contract 10,000 2538 2,795 +2.57 30.09

Jan-15 10,000 27.29 15-Jan-15 Mar-15 contract 10,000 2746 2,842 +0.96 28.25

Feb-15 15,000 40.29 16-Feb-15 Mar-15 contract 15,000 2664 2,842 +2.67 42.96

Mar-15 15,000 38.08 16-Mar-15 Mar-15 contract 15,000 2481 2,842 +5.42 43.50

Apr-15 15,000 38.06 15-Apr-15 May-15 contract 15,000 2435 2,891 +6.83 44.90

May-15 15,000 37.42 15-May-15 May-15 contract 15,000 2290 2,891 +9.01 46.43

Jun-15 20,000 46.37 15-Jun-15 Jul-15 contract 20,000 2166 2,940 +15.49 61.86

Total 255 Total 43 298

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The physical sales took place from December-14 to June-15 as was planned by the
management in October-14. The physical sales took place at the going rates in the
physical markets, ranging from 2,752 per quintal in December-14 to 2,318 per quintal
in January. However, even as physical rates fell from December-14 to June-15
resulting in lower cash realization, the futures hedges when squared-off provided
gains to offset the lower realization.

India Sugars could get a sales realization of Rs 255 crores (similar to New Sugars),
but adding to it Rs 43 crores of gains from futures hedges gave it a total inflow of Rs
298 crores, while the costs were of the order of Rs 295 crores. New Sugars made a
minor profit of Rs 3 crores, achieving its objective of NOT making any losses.

Realisation Gain(+)/loss Raw

from (-) from Total Material Other Total Profit (+)
Physical Futures inflow (Sugarcane) Costs Costs /Loss(-)
sales hedges Costs
(INR Cr)
(A) (B) (A) - (B)
New Sugars 254 - 254 220 75 295 -41
India Sugars 255 +43 298 220 75 295 +3

CONCLUSION
In the end, with both the mills having similar procurement, production and costs,
ended up with very different profitability. One ended in a loss as market prices
worsened. The other averted losses even when market prices fell by hedging its
sugar price risk.

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