Refining Reform: Deregulation of the European Sugar Market

Background

In the 18th century, European scientists found that the “white gold” their kings had been scouring the world for could be produced locally. The high sucrose content of the sugar beet means that the root can be refined into white sugar practically indistinguishable from cane-derived sugar. A few decades after the discovery, Europe began to produce sugar beets in large amounts. Production was highest in France, which was the world’s leading producer of beet sugar from the 19th century until 2010, when Europe’s major sugar reforms were fully realized.

The discovery of the sugar beet and Europe’s early lead in its cultivation meant that the continent was a major exporter of white sugar until relatively recently. In 2003, for example, the EU-15 exported more than 4.6 million tonnes of sugar. This was roughly equivalent to the amount exported by powerhouse Brazil, and ahead of both Australia and Thailand. That year, however, marked the start of the first serious challenge to

Europe’s sugar dominance. In 2003, the three aforementioned competitors launched a case with the World Trade Organization (WTO), arguing that the EU’s sugar export subsidies exceeded what was allowable under WTO rules and that preferential agreements with countries in the African, Caribbean, and Pacific Group of States (ACP) violated WTO obligations.

At the Doha round of WTO negotiations (which began in 2001), several of the plaintiffs in the above case, chiefly Brazil, fiercely maintained their commitments to seeing a change in European sugar policy, vowing not to budge on any subsequent negotiations without concessions on sugar trade.

The implications of these accusations were complex. On one hand, Europe’s heavy-handed support of farmers through significant subsidies in the Common Agricultural Policy (CAP) made it difficult for other countries to compete. Organizations like Oxfam released reports accusing the EU of effectively robbing millions of farmers in poor countries in order to aid a handful of big agricultural conglomerates. On the other hand, the EU’s policy of guaranteeing its purchase of ACP-produced sugar at prices that were above-market helped keep many ACP farmers afloat, even where sugar production was not efficient.

In a 2005 EU appeal, the WTO ruled definitively in favor of the plaintiffs, instigating broad European reform. The EU had already signaled their intent to modify CAP on a sector-by-sector basis, but the WTO ruling made the need for reform urgent. By 2006, many of the EU reforms went into effect, affecting not only Europe but all producers and consumers of sugar around the world.

A Bittersweet Reform

Before 2006, the EU was a top sugar exporter. Following that year’s reforms, it alternated between being the world’s largest (2008-2011) and second-largest importer (2012-present) of the good.

The 2006 reforms were wide and multifaceted. The pre-existing sugar quota system, which had “A” quotas for internal demand and “B” quotas for the excess quota sugar exported with subsidies, was simplified and merged so there was only one quota system. The policy shift also reduced the price that European sugar factories were required to pay for their sugar—which had been pegged artificially high. The pre-2006 policy contained export refunds, which covered the difference between the inflated EU price and the world price of sugar. This allowed the EU to export sugar competitively, and allowed for the re-export of sugar from ACP (and India) countries at competitive prices, despite the higher prices paid by the EU for such sugar. The WTO ruling found that the levels of these refunds exceeded what is permissible under WTO rules, forcing a reduction in refund size.

In order to help farmers deal with the change, the EU also set up a direct payment scheme via a restructuring fund to partially compensate farmers for income lost due to the reform measures. The latter stages of the reform (2009/2010) abolished the European Commission’s obligation to buy any unsold quota sugar at guaranteed prices, and instead shifted to supporting producers to use private storage systems. And finally, the WTO dispute resolution meant that Europe had to reduce the level of preferential access that ACP countries were afforded to its markets—shifting these non-reciprocal, preferential agreements to reciprocal, free trade ones.

The dumping allegations also led the EU to institute a sugar production quota in 2006, which stipulated that total EU production could not exceed 13.5 million tonnes of white sugar equivalent. Prior to the reform, 23 EU nations produced sugar; after the reform, this figure dropped to 18. This meant that sugar beet production, which had already been concentrated in just a few member states, most notably France and Germany, grew even more concentrated.

In addition to limiting the production of sugar beets, the quotas also affected the production of isoglucose—another term for high fructose corn syrup. Under the new policy, the EU could not produce more than 0.72 million tonnes of isoglucose, meaning that the product has not yet had the opportunity to compete seriously with sugar, as it has in many other markets. That could change after these measures are eliminated in 2017.

A lot is poised to change across the European and world sugar markets in 2017. First off, prices are projected to fall as supply increases on an EU production climb. This may already be a reality: last month’s sugar prices were at a six-year low, and although that fall was on the back of Brazil’s bumper crop announcement, the impending EU deregulation is widely cited as contributing downward pressure on world sugar prices.

Post-2017, Europe’s sugar imports are likely to drop as production is slated to increase by over four percent following the elimination of production quotas. While Europe will continue to import sugar, the trade partners will change thanks to the WTO ruling. The reduction of ACP countries’ preferential access to European markets means that their cane exports to Europe are likely to be crowded out by more competitive producers like Brazil.

Secondary demand drivers, such as surges in biofuel or beet bioplastics demand could support EU sugar consumption. Given that these commodities’ associated emissions are small and that many bioplastics are biodegradable, the increase in environmentalism in places like Europe is likely to translate to an increase in bioplastics. According to Rabobank, Europe’s bioplastics production may require 1.2 million tonnes of sugar by 2020. In terms of biofuel, the EU has indicated the intention to work its blend ratio up to 10 percent in the coming years from the current cap of six percent.

Despite these potential demand boosters, several regulatory and union bodies including the ACP Sugar Group, have formally requested the European Parliament to vote in favor of extending the production quotas until 2020, with the basis that the additional time would allow exporters to find alternate markets. While the European Parliament Agriculture Committee voted in 2013 to extend EU sugar quotas until 2020, and despite commissioned reports including one by the Department of International Development (DFID) which suggest a 2017 reform would likely increase the number of farmers in poverty, the Council of Agriculture Ministers and the European Commission upheld the 2017 deadline.

Price and Volatility

The 2006 reforms transformed the EU from being a net exporter of sugar to a net importer. The shift resulted in a broad supply shock and increased market volatility. In 2006, the price of sugar shot up to 25 year highs, and in 2010 prices increased even further on reduced Indian production. In that year prices reached their highest levels in nearly 30 years at $0.30 cents per pound before receding back to $0.15 cents per pound later in 2010.

Prior to 2006, the EU and Brazil together set the tone of the global sugar market. But the policy change, which effectively removed the EU from the list of sugar exporters, meant that Brazil became even more central to the global sugar trade. The prices of raw and refined sugar are highly correlated with Brazilian production costs, such that when the US dollar gains against the Brazilian real, the relative cost of production in Brazil falls and the country’s sugar exports become even more competitive. Indeed, the current global sugar glut that sees prices at a six-year low is in large part attributable to the continuing collapse of the Brazilian real. The rise in the aforementioned “secondary” demand drivers for sugar such as bioplastics and biofuels may also play a role in growing market volatility. Although oil prices are currently low, many countries remain committed to increasing use of biofuels such as ethanol. A policy shift in a number of major markets towards an increased blending requirement could help boost global sugar prices.

Beet vs. Cane

Sugar cane is necessary to produce certain types of specialist sugars, like soft brown and turbinado. But for refined white sugar, both sugar beets and sugar cane can produce nearly identical products despite the fact that the nature of production for these two crops is drastically different.

Sugar beet is a root crop, and can withstand much cooler temperatures than sugarcane. Sugar beet is almost exclusively cultivated in temperate regions of the world which have temperatures between 14 and 26 degrees Centigrade, and annual rainfall around 460 millimeters. The crop is typically planted in the spring and harvested in the autumn, as long hours of sunshine are required. For all these reasons, the bulk of sugar beets are grown in the Northern Hemisphere. Notable producers include Russia, Western Europe, and the United States (US).

Sugarcane, on the other hand, is typically grown in tropic and subtropic climates. Cane has a much greater need for warmth, sunlight, and rainfall than sugar beet. The optimum growing temperature for sugarcane is between 22 and 30 degrees Centigrade, and optimum annual rainfall between 1,100 and 1,500 millimeters. And because the crop is so exposed to the elements, the distribution of rainfall becomes even more important, as rain can actually be harmful during certain parts of the development cycle. During ripening, for example, rainfall can lead to the formation of shoots and additional vegetative growth which ultimately reduce quality and yield. Several major emerging markets, including Brazil, China, and India, are among the world’s top producers of cane sugar.

Although the sugarcane growth cycle depends on the location of the crop, it typically is in the range of 12 and 24 months. Sugar beet, on the other hand, has a typical growth of between four and six months. This distinction is an important one, as the comparatively short growth cycle of beet puts growers in a better position to react quickly to market signals.

Winners and Losers

If the EU sugar market reform goes according to plan in 2017, competitive sugar producers—both in Europe and outside the region—are poised to reap the benefits, while smaller and less efficient producers and refiners are likely to face challenges.

Competitive European producers will be able to take advantage of newfound production flexibility, and to ramp up or scale down production—or even shift to different commodities altogether— according to market demands. The ability of larger-scale producers to do this more effectively than smaller-scale ones may lead to a widening in the competitiveness gap between the two. And in terms of non-European producers, the policy change may benefit the world’s most competitive and efficient producers of sugarcane, like Brazil and Thailand, who will be in a better position to meet Europe’s sugar cane needs.

The reforms are also poised to benefit the isoglucose market. The current production cap of 720,000 tonnes per year means that isoglucose is restricted to less than four percent of the EU sweetener market. Most isoglucose is derived from corn, although some European producers also derive the product from wheat—which means that producers of these two crops may benefit too. In many major sugar-consuming countries, including Mexico, China, and the US, isoglucose’s share of the sweetener market is close to 40 percent, especially since it has replaced sugar in most beverages. The EU projections suggest that isoglucose’s share of the sweetener market will be about 11.5 percent by 2023, far below the share in places like the US. Isoglucose production is slated to nearly triple by 2023 to 2.4 million tonnes in order to meet this increase in demand. Consumer preferences, as well as the comparative price of isoglucose and beet sugar will ultimately determine the extent to which these projections will ring true.

Finally, European consumers stand to gain from the reform, as the price of sugar will decrease as it becomes more reflective of the world average.

However, the new policy spells trouble for smaller European producers, those within ACP/ Less Developed Countries (LDCs), and many refiners. They may face increasing difficulty under the new trade environment. European producers operating on a small scale, or those operating inefficiently, stand to lose out to larger-scale producers better capable of responding quickly to changes in the market.

With the reform, ACP countries that are dependent upon sugar production and exports to the EU, like Cuba, Belize, Guyana, Jamaica, Mauritius, Swaziland, and Fiji, are likely to be left scrambling to find alternative markets for their goods

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In Guyana, sugar production is highly inefficient. As a result, the country’s sugar industry risks collapse without artificial support from preferential trade agreements. In small markets like the French overseas territory of Réunion, where sugar can account for up to 85 percent of exports in some years, the results could be particularly devastating. LDC’s may not be as affected by the policy change, given that countries can maintain their preferential trade relationship with the EU under the “Everything But Arms” (EBA) agreement. But even in those markets that can continue their preferential trade status with the EU, the effects of sugar deregulation may be severe, given that supply increases may help push down the global price of sugar.

Finally, sugarcane refiners are also concerned about the post-2017 landscape, given the looming drop in cane imports. Some small European sugarcane refineries have already closed due to staunch competition and the anticipated collapse in margins that will come as world sugar prices fall. The concerns are even reaching some of the larger players: Südzucker’s Saint Louis Sucre, a major French refiner, has announced plans to close a cane refinery in Marseilles, and Tate & Lyle Sugars has announced reductions in operations across a number of plants. Staunch refining competition outside of Europe, especially in North Africa and the Middle East, will only exacerbate the situation. Refiners of sugar beet, on the other hand, are likely to gain from the reform.

Conclusions

Economic policies often have far-reaching impacts beyond the intended region or results. Sugar reforms instituted between 2006 and 2009 in the EU have added complexity to an already volatile world sugar market, and the retraction of several of these reforms will lead to additional disruption in the industry. Market participants must remain vigilant for policies that seemingly would have minimal impact on their respective markets. The EU sugar reforms have demonstrated how difficult it is to remain isolated from international trade policy in an increasingly global marketplace. When production quotas and guaranteed price minimums for EU sugar come to an end in 2017, there will be several winners and losers. While this may come as a bittersweet ending to a decade-long sugar saga, perhaps it is also the beginning of the next chapter in the industry’s turbulent history.