Commenting on CCP’s Sugar Order, BR Research explained yesterday that while “PSMA needs to explain why it allowed dissemination of information concerning firm-wise stock position to its member undertakings – even if it occurred sporadically”, classifying such information exchange as “highly sensitive” is a bit of a stretch. Especially when considering the peculiar dynamics in which the sugar industry operates.
To understand this better, let’s examine a hypothetical scenario. Company A and company B operate sugar milling units located in Rahim Yar Khan district, southern Punjab. Both companies operate in a single business segment and produce and sell only white refined sugar and its by-products. Because the mills are located in the same geographic region, it may be fair to assume that under ordinary circumstances, Company A and company B would compete to procure raw material (sugarcane) from the same suppliers (farmers). Similarly, they would also compete to sell sugar to similar buyers, whether they are market intermediaries such as stockists and dealers, or B2B buyers such as beverage bottling plants and confectionary manufacturers. Due to similar climatic conditions, the quality of raw material supplied, and cost structure of sugarcane production is also similar.
By any definition, Company A and Company B are rivals. Thus, if Company A had access to inventory position of Company B as of June end, “it could potentially adapt its business strategy”. For example, if Company A found that Company B is sitting on surplus stocks, Company A could lower its future output - reducing overall supply - leading to an increase in the market price of sugar, benefiting both parties. If both Company A and company B regularly engaged in such information exchange, they could potentially enter agreements to reduce supply by allocating production quotas, and ensure that market price remains higher than it would if market were adequately supplied, and rivals had not engaged in information exchange.
Right? Not exactly. For nearly 8 out of 12 months every year, sugar mills are not engaged in production. Sugarcane crushing usually takes place between Dec – Mar, of which 80 percent of production takes place in less than 90 days. This means that from April to October, company A cannot make the decision to increase/reduce the output, even if it has learned that the rival is sitting on surplus/low inventory, as raw material is simply unavailable. But what if this information exchange takes place at a different time. As an example, what if Company A and Company B exchange information concerning carryover inventory (from previous year) before the beginning of next crushing season?
Consider that if Company B finds that Company A has excess carryover inventory from last year, it could lower the purchase price it offers to suppliers for raw material in the following crushing season, fleecing them off fair remuneration. Right? Again, it is not as simple.
Under the existing regulatory framework, sugar mills are required by law to purchase all sugarcane sold to them by farmers at minimum support price and pay quality premium for any sucrose recovery over 8.7 percent. Both minimum support price and quality premium are fixed by provincial governments. In fact, because government has the power to forcibly enforce crushing (once the date is notified), mills can only cease crushing if they can prove that farmers’ asking price for raw material exceeds MSP (which includes 25 percent ROI above average cost of production during any season).
Which leaves a possible scenario where regular exchange of information regarding stock position may enable market players to restrict supply to buyers, even when sufficient stocks are available. Hoarding at mill level is possible, but market structure makes it unlikely. Why?
Because mills are required by law to settle farmer dues within 15 days of raw material purchase, or face criminal action. This is a statutory requirement, where Lahore High Court has held that the ownership of any sugar produced belongs to farmers until their dues are fully settled by the mill. As sugar produced during 3-4 months of crushing cycle is sold and consumed over a 12-month period, the statutory requirement to settle farmer dues within 15 days of purchase abnormally exacerbates mills’ liquidity requirements.
Thus, mills either have the option to sell sugar against immediate cash payment in open market, or pledge the inventory with commercial banks to obtain working capital financing. Most mills follow a combination of both practices. Because inventory pledged with banks is held in third-party godowns with muqaddims (until sold) and reported to SBP on monthly basis, the probability of hoarding is low, even if the incentive exists to engage in same.
BR Research will not assume the odious role of defending any vested commercial interest. In the past, some mills have avoided enforcement of these regulations where beneficial, but the very fact that these anti-competitive regulations exist allow them to escape culpability. The industry has many faults, chief among which is failure to conduct effective advocacy for market reforms and overhaul of the archaic regulatory structure under which it operates. As ambassadors of the industry, trade associations have the ethical responsibility to secure compliance with law, and ensure that their conduct does not bring harm to collective reputation of member firms.
Having said that, it appears that CCP is mistaken in applying technical definition of “sensitive commercial information” as used in developed markets to a local industry that operates under regulatory framework that is anything but competitive. As an enforcement agency, the Commission is only doing its job by enforcing competitive practices where they may be lacking. CCP cannot be held accountable for legislature’s failure to reform laws that inhibit competition in a highly politicized industry. But unless the legal framework is reformed, a competitive sugar industry will remain a distant dream.
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