Commercial Production and Distribution of Sugar in Kenya - Essay Example

Table of Contents 1.0.INTRODUCTION 2 1.1.Historical Background 2 1.2.Current State of Affairs. 2 1.3.Significance of the Sector to the Kenyan Economy 3 1.3.1.Local Population. 3 1.3.2.Government. 4 1.3.3.Investors 4 1.4.Conclusion 4 2.0.ALTERNATIVE FORM OF INVESTMENT. 5 2.1.Dairy Value Chain. 5 2.1.1.Collection and Transportation. 5 2.1.2. Processing and Value Addition. 5 2.1.3.Marketing and Distribution 5 2.2.Resulting Employment Provided. 6 2.3.Flow-on-Benefits from Alternative. 6 3.0.ECONOMIC ANALYSIS OS THE NEW INDUSTRY 6 3.1.Introduction 6 3.2.Methodology 6 3.3.Results from Excel NPV Analysis. 7 3.3.1.Discussion 7 Bibliography 8 1.0. INTRODUCTION 1.1. Historical Background More than 150 countries in the world currently produce sugar. Sugar forms a major part of exports accounting for nearly 25 percent of the global production[Ken10]. In Kenya, production is mainly concentrated in the western region where white sugar gets primarily produced. It also gets produced in the coastal province. Up until the 1900’s there was no commercial production and distribution of sugar in Kenya. It all began in 1902 when Miwani Sugar was set up as the first cane factory in the region. The increased demand since then has sparked an array of sugar companies as illustrated below, Company Year Founded Miwani Sugar company 1902 Ramisi Sugar factory 1927 Muhoroni 1966 Chemelil 1968 Mumias Sugar Company 1973 Nzoia Sugar 1978 South Nyanza Sugar Company (Sony) 1979 Figure 1: Establishment years for Kenyan Sugar companies It has resulted in socioeconomic improvement in the lives of the rural population through job and wealth creation. The agricultural sector for which sugar farming forms a substantial portion has a significant economic importance both to the Kenyan economy and the East African region. Currently, annual sugar demand stands at 750,000 million tonnes compared to a supply of 500,000 million tonnes (Otieno, et al., 2005). The deficit can get attributed to adverse market forces such as low prices. Farmers have become discouraged and no longer supply sugar as before. Meanwhile, to cover the deficit, imports have been increasing at more than 20% annually, with Ugandan sugar being the most recent source. 1.2. Current State of Affairs. Recently, an increased number of proposed investments in the Kenyan sugar sector has been witnessed. One being the Tana River Sugar Company to get located at the coastal region, Busia Sugar Mill and others that have been a subject of bureaucracy in the licensing process (Stephanie, et al., 2012). The Kenyan Law does not provide a clear-cut criteria for licensing new investments, and the opponents of the proposition have taken advantage of the loophole. They have cited various bogus reason for rejecting new project some being; Negative environmental impact was cited as the primary reason for rejecting the setting up of the Tana River Sugar Company. A debate on the same is still ongoing between proponents of the project and conservative environmentalist. Opponents to the development cited · Inadequate supply of sugar cane to the proposed Kibos Sugar Mills in Kitale. The existing sugar factories on their part have been experiencing debts and losses in their books. Such downturns can get attributed stiff competition from readily available and cheap sugar from global suppliers. It has influenced the decision by stakeholders to pursue sugar importation instead of production that gets associated with high costs. Relative to Zambia and Malawi, the cost of production in Kenya is high thus sugar import is lower than the production costs thus Kenya a high-cost country (Mireri, et al., 2008). The sugar sector is currently profoundly indebted to as much as Ksh 20 billion. The debt gets comprised of monies owed to producers, unpaid advances both from international and local banks. For that reason, most sugar factories either need aid, possibly bankrupt or under receivership circumstances. (Otieno, et al., 2005) Such adverse state of affairs makes it difficult to attract new investors into the sector. The majority of investors insist on profitable ventures and are unwilling to invest in any of the areas of the sugar industry. The areas comprise co-generation, biofuel, ethanol products sugar refining amongst others. These subsectors are significantly underdeveloped, and the Kenyan Government could view it as room for improvement. 1.3. Significance of the Sector to the Kenyan Economy Sugar is considered a strategic commodity with a multifunctional role in the growth of an economy, both locally and globally. It therefore gets accorded preferential trading regimes and is highly protected from adverse market conditions through special waivers and incentives by the World Trade Organization 1.3.1. Local Population. The sugar sector is composed of over 250,000 small scale farmers whose supply alone contributes more than 92 percent of all cane processed by the existing companies. The remaining 8 percent gets provided by factory-owned sugar estates (KSI, 2009). The sector is therefore clearly important to the local population with an estimated 25 percent of the country’s population depending on the industry for their livelihood. The sector has the following benefits to the local community; i. Provision of employment to those employed as cane planters, harvester, security guards, farm managers, truck drivers and other sugar processing related jobs. ii. Enables local farmers to economically use their lands since local factories provide extension services that arms farmers with modern farming techniques. iii. Trading in sugar products encourages local interactions among farmers and other members of the community thus fostering community integrations. 1.3.2. Government. The Kenyan sugar industry in its part contributes roughly 15 percent of the agricultural Gross Domestic Product (KSI, 2009). It is a major source of revenue in form of taxation and currently accounts for 7 percent of the exchequer. It therefore cannot be taken lightly. 1.3.3. Investors Local and international investors get attracted to invest in Kenya thus improving the value of the Kenyan shilling. This however is a sensitive component since it is easily affected by the political stability and local market conditions[Keg05]. 1.4. Conclusion The 2008 Kenya Sugar Industry Study indicates that “while there has been a great deal of interest in protecting and promoting the Kenyan sugar industry to achieve the country objective of self-sufficiency and in such case, of becoming an exporting country, the results haven’t been what was expected, and Kenya sugar industry production costs are still the highest in the region” (KSI, 2009). Figure 2: Cost of Sugar Production in COMESA and Selected EAC countries For that reason, as a chief engineer working for an international firm in Kenya, I would advise alternative forms of investments. The Kenyan sugar sector got faced with a lot of challenges that seem endless and costly to deal with. 2.0. ALTERNATIVE FORM OF INVESTMENT. As a result of low income in sugarcane farming, wrangles with cane factories and the challenges facing the sugar sector in Kenya, farmers are likely to switch to other forms of investment. My advice would be Dairy Farming. Dairy farming would be ideal especially in the Western region that is mostly cool and wet in terms of the weather. The type of agriculture positively contributes to human well-being in a number of different possible ways: source of nutritious food products, income and employment, organic fertilizer as well as assets and savings (Ratamu, 2007). There is a baseline to start from due to the already existing level of cattle keeping in the region for subsistence purposes. I would, however, recommend commercial dairy farming that can justify high levels of investment. Milk is by far Kenya’s most economically vital livestock product. It provides a gross value of Ksh 250 billion annually, that represents 70% of the gross value of livestock’s portion of the agricultural industry. Milk also contributes roughly four times more in terms of agricultural GDP compared to meat. 2.1. Dairy Value Chain. Initially, Kenya Creameries Cooperative (KCC) was the sole collector, processor and distributor of milk and dairy products. However, there has been a liberalization of the sector and investors now pride themselves with being stakeholders in the industry. 2.1.1. Collection and Transportation. The transportation of milk usually depends on the quantity and the level of investment the buyer has put in place. For an investment that would substitute sugar farming, the level of investment should be such that the investors have their collection, bulking and transportation systems. Usually, the investors would require; Lorries and Tractors, Stainless steel cans, plastic cans, employ truck drivers and collection assistants, refrigerated tanks. I would advise an investment of Ksh 2 billion for this stage of the value chain 2.1.2. Processing and Value Addition. The level of investment required for the processing stage also depends on the quantity of milk to be processed. Given the current cattle population in Kenya, milk production is above 500million litres per annum. A substantial investment of about Ksh 10 billion would be enough to cover assets and processing machines. 2.1.3. Marketing and Distribution Milk is a stable commodity in most Kenyan households. A substantial investment would, therefore, be necessary to cover marketing and advertising costs together with transportation and delivery services. I would recommend an investment of Ksh 3 billion The most likely level of investment would, therefore, be Ksh 15 billion. 2.2. Resulting Employment Provided. Dairy farming would be an excellent tool for job creation in the Kenyan economy. It would ultimately mean an improvement in terms of the overall GDP from the 25% from agricultural activities. Some of the employment opportunities that would get created include; i. Employment opportunities for collection and delivery truck drivers. ii. Opportunities for herdsmen. iii. Farm managers and foremen. iv. Factory workers and administrators. v. Marketing officials. 2.3. Flow-on-Benefits from Alternative. Being a profitable growth industry, dairy farming as an alternative to sugarcane farming can profoundly contribute to employment-led economic growth in Kenya. The stated potential gets greatly extrapolated by the fact that dairying activities trans-sectoral in nature (Ratamu, 2007). It, therefore, enhances growth in those sectors. Additionally, employment in certain areas of the informal milk market is especially beneficial to women. Clearly, it is an important sector of the economy. 3.0. ECONOMIC ANALYSIS OS THE NEW INDUSTRY 3.1. Introduction The golden rule when considering mutually exclusive projects such as the case of Sugar and Dairy industries based on NPV alone, is to invest in the industry with the greatest NPV. The future profitability of the Dairy farming industry got determined so to access the appraisal potential of the industry. 3.2. Methodology i. The NPV analysis got determined based on the interest rates of borrowed money from financial institutions in Kenya and grants from the Kenyan government. ii. The interest rates got used as the discounting rates for determining the future cash flows thus profitability of the Dairy sub-sector. iii. The rates used were 3,6,9,12,15 and 18% from which all six curves then got plotted on the one graph. The six standards enormous range was necessary so as to cover all eventualities that could result in the case of a sudden collapse of the economy. iv. The assumptions made include the fact that commodity prices increased uniformly with an annual growth rate of 3 percent, and population growth rate stood at 7 percent throughout the analysis period. 3.3. Results from Excel NPV Analysis. Figure 3: Graphical Analysis of Dairy Farming over a projection of 50 years. The future value of cash flows from the dairy sector got determined using the payback period method of NPV analysis, i.e. Where; BO is the initial Cash flow B1, B2, B3…Bn represents the annual cash flows R represents the discounting rate used. n is the number of years for which discounting was performed. 3.3.1. Discussion It is evident from the above graphical illustration that with a borrowing cost of 3 percent, the industry first breaks even after 8 and half years. It represents quite a significant payback period given the magnitude of the initial investment. The investors ought to have surplus cash to facilitate the operations during the period of no profitability. The rates of 15 percent and 18 percent are impracticable since they the industry would never break-even. The investors, therefore, ought to source funds whose interest is at most 12 percent. Due to the unavailability of loans with such low-interest rates, the investors should consider applying for government grants as it would significantly reduce the borrowing cost. It in turn improves the profitability of the sector in the long run. Based solely on the length of the payback period, it would appear that the undertaking is not feasible. However, considering the long run profitability of the sector, of above Ksh 5 billion per annum for 12 percent borrowing, it certainly is better than the fluctuating sugar industry. Bibliography Ken10: , ( KSI, 2010), Keg05: , (Kegode, 2005), Read More