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Ethanol: Is it feasible? - Views on News from Equitymaster
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Ethanol: Is it feasible?
Oct 5, 2006

The government is pushing to introduce 5% mandatory ethanol blending by the start of the next sugar season from October in order to cut down on its oil import bill and switch to greener fuels. The blending is likely to be raised to 10% later. Viability from sugar companiesí perspective
In October 2005, the Indian Sugar Mills Association (ISMA) and Indian Oil Corporation (IOC) on behalf of all OMCs had entered into an agreement to purchase ethanol from sugar companies at a fixed negotiated price of Rs 18.75 per litre. One tonne of molasses produces around 220 litres of alcohol. Ethanol is a 99.99% purified form of alcohol, which is made from rectified sprit (95% purity) in the distillation process.

Particulars          
Molasses Prices (Rs/tonne )   3,200    3,200    3,200    3,200    3,200
Excise duty (Rs/tonne) 750 750 750 750 750
Net Realisation from Molasses (Rs/tonne) 2,450 2,450 2,450 2,450 2,450
Ethanol production (Litres per tonne of molasses) 220 220 220 220 220
Ethanol realisation (Rs/litre ) 14.00 16.00 18.75 20.00 21.00
Excise duty (Rs/litre) 1.0 1.0 1.0 1.0 1.0
Net Realisation from ethanol (Rs/litre) 13.0 15.0 17.8 19.0 20.0
Cost of conversion (Rs/litre) 6 6 6 6 6
Net profit (Rs/litre) 7 9 12 13 14
Net realisation from ethanol (Rs) 1,549 1,989 2,594 2,869 3,089
Viability of ethanol (Rs) (901) (461) 144 419 639

The table above shows the incremental contribution to the sugar manufacturers from ethanol. At a price not below Rs 18.75 per litre, it is profitable for integrated sugar companies to produce ethanol. However, given the increase in prices of all related commodities domestically as well as internationally (namely sugar, molasses and crude oil) and strong demands by sugar companies to raise prices of ethanol, the government is considering re-looking and finalising a new pricing policy for ethanol by end of 2006. It should be noted that, given the inherent volatility of commodity prices, crude oil as well as sugar prices have come under strain in the past month or so.

Viability from oil companiesí perspective

Viability of purchasing ethanol at various petrol prices for OMCs
Petrol prices (US$ per barrel)    45.00    55.00    60.00    62.50    65.00    70.00    75.00    80.00
Domestic Refinery gate prices per litres inRs 14.33 17.44 16.18 19.77 20.55 22.10 23.66 25.21
Normative selling prices of ethanol 18.75 18.75 18.75 18.75 18.75 18.75 18.75 18.75
Gain/ loss before considering tax benefit (4.42) (1.31) (2.57) 1.02 1.80 3.35 4.91 6.46

We have tried to explain in the above table as to whether it would be feasible for the oil companies to pay higher prices for ethanol considering different price levels of crude. The table shows the gain/loss made by the OMCs at different levels of crude, and at a payable rate of Rs 18.75 per litre of ethanol. Only at a price of US$ 62.5 and above per barrel of oil, its feasible for the oil companies to buy ethanol.

Benefits accruing from differential excise rates for petrol versus ethanol
Petrol prices (US$ per barrel)    45.00    55.00    60.00    62.50    65.00    70.00    75.00    80.00
Variable Excise on petrol ( 8%) 1.15 1.39 1.29 1.58 1.64 1.77 1.89 2.02
Fixed component of excise 13.00 13.00 13.00 13.00 13.00 13.00 13.00 13.00
Total excise duty on petrol 14.15 14.39 14.29 14.58 14.64 14.77 14.89 15.02
Exercise duty on excise on ethanol (16%) 2.29 2.79 2.59 3.16 3.29 3.54 3.79 4.03
Excise duty differential 11.85 11.61 11.71 11.42 11.36 11.23 11.11 10.98
Benefits at 5% blending 0.59 0.58 0.59 0.57 0.57 0.56 0.56 0.55
Benefits at 10% blending 1.19 1.16 1.17 1.14 1.14 1.12 1.11 1.10
Blended viability @ 5% blending 14.92 18.02 16.77 20.34 21.12 22.66 24.21 25.76
Blended viability @ 10% blending 15.51 18.60 17.35 20.91 21.68 23.23 24.77 26.31

If we factor in the tax benefits, OMCs are bound to benefit further, due to the differential tax rates of ethanol versus petrol. The government has levied 16% excise duty on ethanol while petrol attracts 8% + Rs 13 specific duty. At a crude price of US$ 62.5 per barrel, the total excise duty on petrol is Rs 14.6, while that on ethanol is Rs 3.2, thus amounting to savings of Rs 11.4 per litre of ethanol. Therefore, at 5% blending, the benefit to the OMC in tax is Rs 0.6, while the benefit would obviously double at 10% blending. Hence, the price the OMCs would be ready to pay for ethanol at US$ 62.5 per barrel is the domestic refinery gate price + the excise benefit. (19.8 + 0.6). This shows that if the crude price falls below US$ 62.5 to US$ 60 per barrel, it would be feasible to pay Rs 16.18 per litre of ethanol, which, however, would not be feasible for the sugar companies. Hence, at that level of crude oil and ethanol, the whole program of ethanol would not be economically viable for sugar companies.

However, certain initiatives on the part of government for environmental purposes might reduce the excise duty on ethanol. In such a scenario, the viable prices for ethanol for the oil marketing companies will further increase. If the excise duty on ethanol is reduced to 8%, the benefit from such a move will increase the benefits at 5% blending to 65 paise per litre. If the excise duty on ethanol is to be phased out in such a scenario, the benefits from the blending at 5% blending will be 75 paise per litre.

It should be noted that the viability is also affected by the below-mentioned facts, which are not considered:

  • The blending cost of ethanol for the domestic OMCs

  • The transportation cost of ethanol from factory to refineries.

  • Regular supply is an issue, as the ethanol is contingent on sugar and that is again dependent on cane output, who takes the price to say that earlier roll back of ethanol blending will not occur again. Capacity is fine, but cane availability is an issue.

In the end...
Sugar mills (producers of ethanol) and oil-marketing companies have their differences on pricing. Also, the department of chemicals and fertilisers has opposed mandatory blending of petrol, saying domestic production of ethanol is not even meeting demand from chemicals industry and alcohol manufacturers. Any diversion for petrol blending will aggravate the woes of the chemicals industry. Considering the environment-friendly characteristics of ethanol-blended gasoline as an automobile fuel, the pricing of ethanol needs to be viewed not only in terms of a financial cost-benefit analysis, but also in terms of an environmental cost-benefit analysis.

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