Assessing the economic benefits and costs of regulation in Australia’s sugar industry

The Issue

The Australian sugar industry has been characterised by an evolving regulatory framework, at both the State and Federal levels, since the early 1900s. The reform of the statutory single desk arrangements in 2006 fundamentally changed the industry’s structure, with Queensland Sugar Limited (QSL) no longer being the sole marketer of raw sugar. This led to several entities offering marketing services, including several large sugar mill owners.

The entry of sugar mill owners into the marketing of raw sugar raised concerns regarding the potential for market power to be misused to the detriment of cane farmers. These concerns led to the Commonwealth Government undertaking two reviews to assess the need for formal powers to be introduced under competition and consumer laws in order to provide oversight of the conduct of cane growers, sugar mill owners and sugar marketers.

The Sugar Code of Conduct

These reviews led to the implementation of the Sugar Code of Conduct in 2017. The purpose of the Code is to regulate the conduct of participants in the Australian sugar industry and establish a process for pre-contractual arbitration where parties fail to agree to terms of contracts or agreements. The Code complements regulatory provisions under the Competition and Consumer Act 2010 and the Sugar Industry Act 1999, which ensures the supply of cane and payment for sugar are governed by supply contracts.

As the Code was implemented without a detailed Regulation Impact Statement being conducted, it was necessary for a review of its operation to be conducted within 18 months of its commencement. Synergies was engaged by Canegrowers and the ACFA to prepare a report assessing the economic benefits and costs of the Code to inform this review.

The problem

There are challenges to assessing the economic impacts of a regulation that has only been in place for a limited period of time. The limited duration makes it difficult to observe changes in the conduct of industry participants and to assess the extent to which these changes impact on the efficiency of market outcomes.

This problem was addressed by a literature review of regulatory impacts in similar industries and industry stakeholder consultation.

The four key components of the industry are sugarcane production, sugar milling, marketing and storage, handling and transport. There are several key characteristics of the industry which impact the balance of market power. Namely:

• Nature of the crop – Sugarcane is a highly perishable crop therefore growers need to be closely located to mills. Sugarcane is also a long-term commitment, so farmers are unable to make annual decisions on crop mix based on market and climate conditions.
• Concentration of and vertical integration by milling companies – Eight companies operate the 24 sugar mills in Australia, leaving growers often little choice of who to sell their cane to. Millers have also become heavily involved in the marketing of raw sugar and some have also integrated into sugarcane production.
• Complexity of sugar marketing – Prices vary significantly over time and the realised return for a grower can depend on a wide range of factors. A large proportion of raw sugar marketing occurs in forward markets and pricing outcomes are determined by trades in a volatile market. To a grower who is not involved in the trades and whose returns are dependent on marketing performance, there is limited transparency and clarity in terms of the quality of marketing outcomes and returns.

Assessing the economic benefits and costs of the Code

Benefits and costs were assessed drawing on the analysis of the sugar industry and its participants in terms of their conduct, market power and incentives.

The key issue considered was the Code’s impact on the economic efficiency and productivity of the Australian sugar industry. The efficiency and productivity benefits of the Code are largely attributable to the removal of misaligned incentives between mill owners and growers and the improved transparency and accountability of marketing outcomes.

Whilst there was limited quantitative evidence available as the Code was only implemented in April 2017, there was available evidence of the Code’s impact on industry participants’ conduct to inform the economic assessment.

The key public benefits of the Code arose from improving the competitiveness of sugar marketing and with it:

• Improving the transparency and accountability in market;
• Encouraging innovation in product development and risk management;
• Avoiding industry disruption arising from tension between millers and growers;
• Instilling greater confidence in marketing outcomes for growers and improving the economic climate for cane production, enabling scale economies in milling to be achieved; and
• Avoiding the adverse effects on communities arising from the conflict of interest millers face when marketing sugar in the absence of competition.

The implementation of the Code has imposed costs on industry participants, including upfront costs in adjusting to the Code, in particular the re-negotiation of Cane Supply Agreements (CSAs) and establishment of On-Supply Agreements (OSAs), that are now largely sunk. The Code will result in future costs being incurred associated with:

• Competition in the market for the marketing of sugar, which is part of the process required to achieve the efficiency gains from competition;
• Contracting and negotiating costs being the costs of contracting and negotiating CSAs and OSAs under the Code, which are unlikely to be similar to what would arise in the absence of the Code, especially over time;
• Product development costs, which are the costs associated with product innovation as part of the competitive process and integral to the realisation of gains from this process; and
• Grower education costs, which are necessary to ensure that growers understand the impact of the Code, in particular the implications of grower choice provisions on the opportunity to enhance their enterprises. A significant component of these grower education costs is likely to be one-off costs.

Conclusion

In an industry where abuses of market power can arise from one participant assuming monopoly control over another participant’s financial return and bargaining power, regulatory intervention is necessary.

The assessment found that the Code has provided a light-handed, industry specific and a cost effective and efficient means of addressing market power issues arising from miller marketing sugar. It efficiently maintains an alignment of growers’ and millers’ interests that encourages efficient operations and investments in the industry.