Sugar Industry Co-Dependency

The decision to grow sugar is a bit like the decision to get married and have kids. Both raise issues of bilateral dependency and asset specificity.  Once you marry someone, you are locked in, or at least it’s hard to redeploy -- likewise with growing sugar.

While, in theory, you can grow other crops, in practice, those other crops will severely reduce the value of your land, and there is little choice but to send your sugar to the closest mill. 

This co-dependency is both good and bad.

It is good because once a marriage is made, or a cane supply agreement is signed, each party may be more willing to invest in assets which are productive but specific to the relationship, such as kids or a centre pivot.

It is bad because, once the parties are locked in, each has the incentive to act opportunistically, to take advantage of each other’s dependency and investment in assets specific to the relationship.

Knowing this beforehand, there are inventive contractual tricks that promote cooperation over opportunism. In marriage, pre-nups and no-fault divorce are examples. In the commercial world, third-party dispute resolution, co-investment and vertical integration are common features.

These have all been used in the sugar industry. Until recently, mills tended to be co-operatively owned by canegrowers. This aligned the incentives between the mills and growers so as to completely remove the benefits of opportunistic behaviour. These arrangements, however, limited investment in mills to the resources of growers, so over the last few decades most mills have been sold to private investors so that equity can be injected.

Nonetheless, a co-dependent relationship was maintained through the notion of grower economic interest, which has been a feature of Australian sugar markets for more 100 years. That gave canegrowers a stake in the sale of sugar beyond their own farm gate.

In practice, it was characterised by two main features. First, that returns to growers were dependent on the net sale price of sugar, and thus that they had a co-interest in ensuring a productive milling process, marketing and supply chain. Second, through the use of a jointly-owned marketing company, Queensland Sugar Limited, both growers and millers had control of the premiums that could be received for Australian sugar and the costs of marketing and achieving those premiums. (In total, these amounts can add up to a third of the value of the sugar sold.)

These arrangements have helped to maintain an alignment in interests between growers and millers in the decade since single desk marketing arrangements were scrapped. It was an elegant solution to a common economic problem.

Last year, Wilmar – which owns eight of the 24 Queensland and northern New South Wales mills and produces more than 40% of the total sugar output – announced that it wanted to scrap these arrangements. Instead, it wants to market the sugar itself and remove growers from the joint marketing arrangements. To reassure growers, Wilmar has proposed a Joint Marketing Company that will give growers some transparency over the marketing of their sugar.

To paraphrase canegrower Steve Kirby from the Burdekin, appearing at a recent hearing of the Senate inquiry into these arrangements: “The very fact that Wilmar is proposing to establish these auditing requirements shows there is a problem.”

That Senate inquiry held hearings in Murwillumbah, Mackay and Townsville a few weeks ago. More than 300 people showed up, most of them concerned with the proposed changes. 

It’s not just marriage and canegrowing impacted by issues of co-dependency.  The supply of coal to ports or power stations raises similar issues. In a famous 32-year contract between the Nevada Power Company and the Northwest Trading company, the contract stated “In the event an inequitable condition occurs which adversely affects one Party, it shall then be the joint and equal responsibility of both Parties to act promptly and in good faith to determine the action required to cure or adjust for the inequity and effectively implement such action.”

Good advice for anyone that wants to stay married.

It is also why most ports are regulated. Indeed, Wilmar wants to maintain such regulation on its access to bulk sugar terminals, yet it does not want regulation of grower’s access to its mills.

It would be best that the courts or the Parliament do not have to get involved in sugar contracts. But if there is no reconciliation, then it is the legitimate task of the government to set the rules such that mutually beneficial outcomes can be reached. 

This article was originally published in Queensland Country Life 26 March 2015

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