Sugar Act by Chadcat

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									CLEANING UP THE ACT:

THE IMPACT OF CHANGES TO
THE SUGAR INDUSTRY ACT 1999




AN OVERVIEW
Main Report: www.thecie.com


Centre for International Economics
Canberra & Sydney
DECEMBER 2002
        AT A GLANCE
        1 Changing the Act - benefits to industry and the community




                      CHANGE THE SUGAR INDUSTRY ACT 1999



    Leads to:                      Leads to:                        Leads to:

    Increased                      Increased                        Improved efficiency
    independence and               opportunities for                and growth
    flexibility for                competition and
    individual                     innovation and
    businesses                     better business
                                   skills and focus



    Leads to increased:
    Productivity                  Production                       Value-added
    •   on-farm (yields)          •    cane yields                 •   market/customer
    •   harvesting                •    sugar yields                    focus
    •   transport                 •    area                        •   product
    •   milling                                                        differentiation
                                                                   •   product
                                                                       development



    Leads to following industry outlook (2006/07)


     Price Outlook          $245/t            $245/t         $270/t         $335/t
                            (no change)       (Act change)   (Act change)   (Act change)
     Comment                Only              Prevents       Maintains      Promotes
                            Burdekin          industry       industry       industry
                            survives          closure        growth         growth
     Output (mt/yr)         1.6               6.8            7.2            7.8
     Industry profit ($m/yr) 37               381            575            1,062
     Sugar jobs             4664              10,240         10,894         11,826




2                                                                                   CLEANING UP THE ACT:
               PURPOSE
               This study analyses the effect of the Sugar Industry Act 1999.

               The Queensland Government has agreed with the Federal Government to
               examine the Sugar Industry Act 1999 (the Act) to determine if the Act is
               preventing the industry achieving greater efficiency or hindering it's ability to
               cope with the difficult trading environment in which it now finds itself.

               To provide an informed basis for decision-making, the Queensland
               Government commissioned the Centre for International Economics (CIE) to
               undertake a comprehensive, quantitatively based impact analysis of possible
               changes to the Act.

               The terms of reference require an assessment of:

               What implications, if any, does the Act have for:

               •   the efficiency and competitiveness of the industry

               •   the industry stakeholders' ability to become more commercial

               •   the industry's ability to become more commercial

               •   the implementation of the recommendations of the Hildebrand Report?

               What would be the costs and benefits on a regional basis of the industry and
               dependent communities of regulatory change in:

               •   the cane production area system

               •   the statutory bargaining system

               •   compulsory acquisition for raw sugar on the domestic market

               including a demonstration of the causal relationship between legislative
               change and predicted implications?

               What would be the statewide/regional economic impacts of significant
               regulatory change in these areas, over and above current trends, and how
               would these impacts change over time?

               This is an overview of the full report.
               The full report is available at www.thecie.com




                                                                                                   3
THE IMPACT OF CHANGES TO THE SUGAR INDUSTRY ACT 1999
    OUR APPROACH
    To understand the effect of the Sugar Industry Act on the industry, we adopt
    the following approach:


    WE ASK KEY QUESTIONS ABOUT PRODUCTIVITY AND THE ACT:
    •   how much would productivity in the industry need to improve to maintain
        its prosperity, even at low world prices?

    •   how these productivity improvements could be achieved, and whether the
        Act is hindering the industry from achieving them?


    WE BUILD AN ECONOMIC MODEL OF THE SUGAR INDUSTRY WHICH:
    •   allows us to measure how changes in the industry will affect the incomes
        of those who depend on it

    •   has five regions - North Queensland, Herbert/Burdekin, Mackay, South,
        and the rest of Australia

    •   uses 1996-97 as a baseline - this was the last good year for the industry,
        before price decreases, weather and disease impacted on it


    WE DEVELOP AND ASSESS A NUMBER OF SCENARIOS USING THE
    MODEL:
    •   Hildebrand said the industry can expect world prices of between $245
        and $335 per tonne, and ABARE says cost will rise

    •   best case, intermediate case and worst case scenarios for 2006-07 are
        modelled based on price, cost changes and productivity gains

    •   measure how changes in the Act would impact on productivity and on
        profits of various parts of the industry using the model

    •   look at regional impacts both for the industry and the wider regional
        economy

    •   summarise the impact of key parts of the Act that are part of this study




4                                                                     CLEANING UP THE ACT:
               NO LONGER THE LEADER....
               For a long time the Queensland sugar industry was the leader in technological
               development in the world cane sugar industry.

               Australia faced fierce competition at times on the world market due to
               subsidised and dumped production elsewhere in the world.

               And as the only developed sugar-producing country truly exposed to
               international market forces, Australia faced greater pressures to adopt cost-
               reducing technologies than any other developed country.

               The Queensland industry long held a premiere position in terms of cost
               competitiveness and was able to adopt new technologies it developed at its
               own pace.

               As technological leader, historically the Australian industry remained largely
               profitable despite fluctuating world prices.


               TOWARD THE END OF THE 1990S, BRAZIL OVERTOOK AUSTRALIA
               Deregulation of the Brazilian industry changed Brazilian producers' incentives:

               •   they suddenly faced incentives to expand and adopted (and adapted)
                   Australian cane and sugar producing technologies

               •   they quickly expanded production and exploited economies of scale and
                   scope of the technology not yet achieved in Australia

               •   their currency was devalued massively, leaving them with a substantial
                   competitive advantage

               •   the volumes they produced and exported to the world market lowered the
                   world price

               Brazil's superior competitiveness and its impact on the world market price
               have greatly altered the outlook for the Australian industry.


                THE QUEENSLAND INDUSTRY MUST CATCH UP TO SURVIVE
               Profitability has been severely eroded. Queensland is no longer the leader. To
               catch up will require big increases in productivity to restore competitiveness.




                                                                                                 5
THE IMPACT OF CHANGES TO THE SUGAR INDUSTRY ACT 1999
    IF THE INDUSTRY DOESN'T CHANGE...
    If prices stay low ($245 per tonne), and productivity doesn't improve, the
    industry could collapse by 2006-07. This is the worst case scenario predicted
    by our economic model.

    In this scenario, industry participants suffer:

    •   Industry profits drop 80 per cent from $456 million to $96 million

    •   Grower profits drop 60 per cent from $231 million to $161 million

    •   Miller profits drop 140 per cent from $224 million to a loss of $64 million.

    Chart 2 shows the impacts of this scenario on grower and miller profits by
    region. Only the Herbert/Burdekin would be viable in the long-term.


    2 THE WORST CASE SCENARIO: AN UNSUSTAINABLE SITUATION




    Data source: CIE model.

    If only the Herbert/Burdekin remains, the short-term regional impacts
    are severe:

                                 Income        Employment

    North                       -$132m            -2794

    Herbert/Burdekin            -$148m            -488

    Mackay                      -$270m            -4575

    South                       -$99m             -2257

    Queensland                  -$650m            -10,114
6                                                                      CLEANING UP THE ACT:
               PRODUCTIVITY GROWTH IS NEEDED
               Looking at the worst case scenario, the only way to restore the industry to its
               1996-97 levels of profitability would be for:

               •   productivity growth in growing (excluding CCS), harvesting, transport and
                   milling to increase by 37 per cent, or

               •   world price (in Australian dollars) to increase by 33 per cent to $326 a
                   tonne

               World price rises are highly uncertain.

               Productivity growth is the only factor directly under the control of the industry
               that could restore profitability. And the indicators are that there is
               considerable scope for improvement.


               AND PRODUCTIVITY GROWTH IS POSSIBLE
               Major industry economic indicators and benchmarks suggest the industry is
               still operating well beneath its potential. For example:

               •   land productivity variations due to management alone suggest average
                   productivity may be only 75 per cent of potential

               •   with larger farms, Brazil is achieving cane growing costs 30 to 40 per cent
                   below Australia's

               •   cane harvester productivity of over 120 000 tonnes a year can be
                   achieved working around the clock, but the industry average is less than
                   30 000 tonnes

               •   restricted cane cutting times require up to 50 per cent more bins to be
                   employed in a mill's tramway system

               •   poor harvesting practices cause 5 to 25 per cent of sugar to be left in the
                   field

               •   in an average season Australian mills crush for only around 21 weeks a
                   year compared with 30 to 35 weeks for Brazilian mills, putting Australian
                   milling capital at a 30 to 40 per cent productivity disadvantage




                                                                                                   7
THE IMPACT OF CHANGES TO THE SUGAR INDUSTRY ACT 1999
    WHAT IS HOLDING THE INDUSTRY BACK ?

    The industry's regulatory structure - the Sugar Industry Act 1999 - has created
    a system that discourages individuals and progressive groups from
    implementing change. This blocks productivity improvements and innovation.


    IT'S THE ACT
    By blocking productivity improvements, the regulatory structure is holding the
    industry back, from

    •   generating greater profits, more employment and larger growth

    •   being viable, even when prices are low

    The Act blocks improvements in a range of ways.


    THE SUGAR ACT 1999 INHIBITS CHANGE BY PREVENTING 'ADVERSE
    EFFECTS'
    The 1999 Act was designed to increase flexibility for growers and millers to
    negotiate (compared with earlier legislation). The reality has been that
    changes to the terms and conditions that govern the delivery of cane
    (collective and individual cane supply agreements) have been difficult to
    change despite expected economic gains from doing so.

    Nothing changes because each change may potentially impose adverse
    effects on growers supplying to the mill under the collective agreement. Those
    adversely affected can block the change under the legislation.


    THE ACT CREATES BARRIERS TO COMPETITIVE BEHAVIOUR
    The Act gives considerable powers to groups of growers which affects how
    other grower, mill owners and harvesting contractors must behave.

    Mill Suppliers Committees (MSCs) can greatly influence or stop individual
    supply agreements between a miller and grower. They can do this because
    they have the power to go to Court and prevent an agreement by arguing that
    it imposes significant adverse effects on growers supplying to the mill under a
    collective agreement.




8                                                                     CLEANING UP THE ACT:
               VOTING PATTERNS MEAN THAT THE ACT CAN BE USED TO BLOCK
               CHANGE
               The growing sector operates on 'one vote, one value'. On average, 80 per cent
               of cane farmers supply only 40 per cent of the cane. This group of smaller
               farmers have majority voting rights over the other 20 per cent who supply 60
               per cent of the cane.

               If it is the 20 per cent of larger farmers who are the most progressive and
               competitive elements in the industry, their attempts to make changes to cane
               supply contracts are likely to be met with opposition if the change imposes
               any adverse effect on the majority. Harvesting contractors are locked out of
               this system.


               DECISIONS ARE MADE ROUGHLY FOR EVERYBODY BUT EXACTLY FOR
               NOBODY
               The powers given to an MSC mean that often decisions are made roughly for
               everybody, but exactly for nobody, and definitely not for the minority that
               produce and mill most of the cane. This is bound to result in bad
               compromises.

               In a competitive system, change cannot be blocked so easily.

               •   more efficient producers would bid away resources from the less efficient

               •   increased efficiency of resource use would be achieved, however

               •   under the Act, however, less efficient producers can prevent competition
                   from more efficient producers by stifling changes that potentially
                   disadvantage them

               Prevention of 'adverse effects' is the wrong economic premise on which to try
               and sustain a vibrant viable and internationally competitive industry.

               For competition to be effective, it must allow 'adverse effects' to ensure that
               better ways of doing things replace less efficient ways.


               'ADVERSE EFFECT' CONCERNS PREVENT BETTER USE OF MILLING
               CAPITAL
               If terms and conditions for delivery of cane were negotiated freely without
               recourse to collective adverse effects concerns, mills would expand their
               season length to supply more milling capacity.

               This would provide economic gains to mills and expanding growers but would
               impose adverse effects on growers who could not expand.

                                                                                                 9
THE IMPACT OF CHANGES TO THE SUGAR INDUSTRY ACT 1999
     Millers gain because:

     •   in a longer season, their fixed resources are better utilised and fixed costs
         are more widely spread

     •   unit milling costs decline with increased volume and season length

     Growers on the whole would gain from producing and selling more cane if the
     season length were extended, however, because of lower sugar content in
     cane (CCS), under the pricing formula of collective agreements, the price of
     cane would fall, so those growers unable to expand would be worse off.

     Smaller growers with no expansion potential would be likely to use the
     'adverse effect' clause to block such a change and the industry's productivity
     growth would be stifled.


     'ADVERSE EFFECTS' CONCERNS REDUCE INCENTIVES TO TAKE UP
     PRODUCTIVITY GAINS
     Increases in cane growing productivity may be resisted by those adversely
     affected. A major increase in cane production productivity (say 20 per cent)
     would:

     •   cause 20 per cent of cane to be stood over, because with a fixed season
         length it could not be crushed

     •   prevent a new crop being grown, so offsetting the productivity increase

     For this reason, growers face reduced incentives to use existing technology to
     expand productivity.


     'ADVERSE EFFECTS' CONCERNS REDUCE OPPORTUNITIES FOR OTHER
     IMPROVEMENTS
     Concerns about adverse effects

     •   prevent changes to the terms and conditions of delivery

     •   and help sustain inefficient harvesting group sizes, scheduling and
         transport




10                                                                       CLEANING UP THE ACT:
               IF WE CLEAN UP THE ACT
               We use our economic model to estimate the benefits of removing the Act's
               restrictions. We make assumptions that include:

               •   season length extension with associated declines in CCS

               •   more flexible terms of delivery

               •   on-farm productivity gains leading to a 20 per cent increase in cane yields
                   and a 0.75 per cent increase in CCS

               •   harvester and transport optimisation.

               These assumptions are conservatively based on published findings and
               claims. If we compare the worst case scenario ($245 per tonne) with and
               without the Act's restrictions, the results are dramatic.

               •   Industry profits increase 664 per cent to $637 million

               •   Grower profits increase 154 per cent to $248 million

               •   Miller profits increase 310 per cent to $133 million.

               The regional picture also shows that the industry can be viable, if it changes,
               even at a sustained low price.


               3 WORSE CASE SCENARIO WITH CHANGES TO THE ACT:
               A SUSTAINABLE SITUATION




               Data source: CIE model.



                                                                                                 11
THE IMPACT OF CHANGES TO THE SUGAR INDUSTRY ACT 1999
     AT TODAY'S PRICES
     If we assume that this year's pool price (approximately $270 per tonne) were
     to remain in place until 2006-97, the benefits of change would be even
     greater.


     4 EFFECTS OF CHANGES IN THE ACT AT $270 PER TONNE




     Data source: CIE model.

     Because the industry is largely restored to its 1996-97 level of profitability,
     the regional losses caused under the worse case scenario are mostly averted.




12                                                                     CLEANING UP THE ACT:
               THE ACT ALSO RESTRICTS COMPETITION IN MARKETING
               Monopoly acquisition powers (the single desk) prevent competition in the
               marketing of raw sugar on the export and domestic markets. Such anti-
               competitive powers have the potential to lessen incentives to:

               •   innovate and develop new products and markets

               •   achieve vertical integration and the opportunity for individual enterprises
                   to develop commercially, differentiating their operations and products to
                   develop their strengths.


               THE MAIN ARGUMENT FOR MONOPOLY ACQUISITION IS TO ACHIEVE
               MARKET POWER
               In 1996, the Sugar Industry Review Working Party concluded that the major
               reason to retain the single desk, both for export and domestic sales, was
               because it enabled Queensland to capture the 'Far East Premium'.

               They argued that the single desk could, by withholding supply to Eastern
               hemisphere markets and redirecting a quantity to the Western hemisphere
               markets, raise the average overall price.

               The argument is that restricting supply to the Eastern hemisphere will cause
               the price there to rise by more than the decrease in price caused by
               increasing supplies to the Western hemisphere. In other words, the single
               desk seller tries to price discriminate between the many markets within these
               two zones.


               BUT THE SINGLE DESK DOES NOT HAVE PERFECT INFORMATION ABOUT
               THE MARKET
               Our model shows that the chance of this market-splitting strategy working is
               not good.

               •   To make it work, the single desk seller needs large amounts of accurate
                   information about:

                   ·   demand characteristics in each market within the Eastern and
                       Western hemispheres in the coming seasons

                   ·   the reactions of competitive suppliers in the coming seasons

                   ·   all other market and macroeconomic factors in the coming seasons




                                                                                                 13
THE IMPACT OF CHANGES TO THE SUGAR INDUSTRY ACT 1999
     •   However, many market factors are very uncertain, continually changing
         and almost impossible to predict accurately. With a small amount of
         uncertainty about any factor above and several others, there is a
         significant risk that attempting to price discriminate will end up reducing,
         rather than increasing, revenue to growers.

     •   Other research conducted on the Victorian and South Australian barley
         industries shows that a claimed price discrimination advantage worth
         around $30 million a year turned out to be a loss of $8.5 million a year,
         because of these risks. There was only a one in a hundred chance of a
         premium being earned, and the barley market is less volatile than sugar.

     Efficient marketing requires:

     •   clear market and pricing signals to move up and down the value chain,
         but single desk selling delivers a pool price to millers

     •   innovation and freedom to test the market, but single desk selling
         prevents easy experimentation

     •   big investors to be attracted to an industry, but single desk selling
         reduces the sort of commercial freedom most investors require to be
         reassured they can respond with flexibility to a wide range of business
         risks

     Single desk selling:

     •   could lead to missed opportunities on the domestic market because the
         'ministerial direction' for export parity makes it difficult (or impossible) to
         pursue market premiums that might be earned from the provision of other
         product features offered

     •   hinders the development of commercial skills and a commercial culture at
         a regional level in terms of:

         ·   further processing of raw sugar

         ·   development of market opportunities

     •   centralises commercial power in Brisbane - a high risk strategy

     •   fragments the value chain, blocking gains from integration and
         discouraging product differentiation and value adding

     •   stifles the development of alternative products such as bioplastics




14                                                                        CLEANING UP THE ACT:
               SHOULD WE CLEAN UP THE ACT?
               The terms of reference ask specifically - what would be the costs and benefits
               to the industry and dependent communities of regulatory change in:

               •   the cane production area system

               •   the statutory bargaining system

               •   compulsory acquisition for raw sugar on the domestic market?


                Verdict 1: the cane production area system
               •   Removal of the cane production area system is a low-risk, high payoff
                   strategy for the industry and regions, because it will encourage
                   competition for cane supply.

               •   The CPA system cannot be viewed in isolation to changes to the statutory
                   bargaining system.


                Verdict 2: the statutory bargaining system
               •   Given the price outlook for the industry, it is hard to see it surviving if it
                   continues to block productivity gains by its reliance on the adverse effects
                   test within the statutory bargaining system.

               •   Removal of statutory bargaining is a low risk economic option that may
                   hold the only promise of the industry's survival, but it is a high-risk
                   political option that will attract opposition from less efficient growers.

               •   Unless the statutory bargaining and adverse effects test are removed, the
                   leadership and management required to implement change and achieve
                   the high rate of productivity growth required, is almost certain to fail.


                Verdict 3: compulsory acquisition on the domestic market
               •   Removal of compulsory acquisition of sugar for sale on the domestic
                   market is a low-risk strategy with some possible small benefits.

               •   The main benefit is to provide increased market orientation to producers
                   and give them some responsibility for marketing.




                                                                                                    15
THE IMPACT OF CHANGES TO THE SUGAR INDUSTRY ACT 1999
THE PRICE OUTLOOK FOR SUGAR IS NOT GOOD

A 37 per cent increase in productivity is needed to restore profitability

Without this sort of productivity growth:
•   only the Herbert/Burdekin might survive

•   regional impacts could be dramatic


Queensland once spearheaded technological developments in cane

Now Brazil uses sugar technology better than Australia

Queensland has considerable scope to increase productivity to catch up

But anti-competitive industry behaviour is blocking change

Provisions within the Sugar Industry Act block competition
•   they prevent any adverse effects affecting less efficient growers/millers

•   but some adverse effect is needed to promote productivity


Only if the Act is changed:
•   is the industry likely to survive and prosper

•   will the leadership that is needed to manage change be effective




Email        CIE@theCIE.com.au
Website      www.theCIE.com.au

								
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