When PPB Group Bhd announced it was divesting its entire stake in Malayan Sugar Manufacturing Co Bhd (MSM), the first thing most people would have thought was that Robert Kuok had been forced out of the country’s sugar business.

But was that really the case? Was there any pressure on the tycoon to exit the sugar-refining business that he had owned for 45 years? Only Kuok and his management team will be able to answer these questions, although those close to the “Sugar King” and PBB Group deny vehemently that he was forced out.

“The group was not forced out. They decided to sell out on their own accord because of the changing environment,” says an official close to PBB Group.

What could have changed so much to prompt the Kuok Group-controlled PBB Group to sell its sugar refinery, which is the largest in the region, to Felda Global Ventures Holdings Sdn Bhd for RM1.2 billion cash?

It all started when the prices of raw sugar — a key ingredient — became volatile on the international market, increasing significantly this year.

Prior to that, sugar refining was a stable business. It did not offer exciting growth but  continuously generated steady earnings, given that sugar is a staple.

The big jump in raw sugar prices was due mainly to the severe drought in India, which became a net importer instead of a major exporter to the world market. To make matters worse, the crops in Brazil, which is among the biggest exporters of raw sugar in the world, were affected by excessive rainfall.

Domestic sugar refiners were paying nine US cents per pound for the raw material between 2005 and 2008 under the long-term supply contract that the government negotiated on their behalf with raw sugar producers. The arrangement was only to meet 60% of the refiners’ requirements.

The sugar refiners had to source the remaining 40% from the world market at international prices. Raw sugar is the main cost component for sugar refineries, accounting for about 80% of total output costs.

But because of the price increase on the international market, starting this year until 2011, Malaysian sugar refiners, including MSM which commands 60% of the local market, will have to pay 17.5 US cents per pound for raw sugar, nearly double the previous price. This is lower than the international market price (22 US cents) because it was negotiated by the government.

The spike in raw material costs has created  havoc in the domestic sugar-refining industry. Because sugar is a price-controlled item, the additional costs incurred by refiners cannot be passed on to consumers.

The retail price is fixed at RM1.45 per kilo — a level that is substantially lower than in the neighbouring countries whose prices have gone up in tandem with the surge in input costs.

Thus, higher raw material costs, coupled with a fixed selling price, have made sugar refining a tough business proposition.

This prompted refiners to complain that they would make losses if they sold sugar in the domestic market at RM1.45 per kilo.

Under the circumstances, the government decided to grant a 60-sen subsidy for every kilo of sugar produced for domestic consumption this year.

“This is the first time the government has subsidised the consumption of sugar locally. It didn’t happen in the past when raw sugar prices were low and the refining industry was able to make profit by selling at RM1.45 per kilo,” the secretary-general of the Ministry of Domestic Trades and Consumer Affairs Datuk Mohd Zain Mohd Dom tells The Edge.

The situation seems to have eased after the government’s decision to pay the 60-sen subsidy. The refiners remain profitable, at least for now.

But high commodity prices are here to stay. The commodity boom that went bust last year after the onset of the global financial crisis has returned sooner than expected because of the rising affluence of the highly populated emerging economies. The consumption boom in China and India will continue to drive the prices of commodities such as sugar up.

Based on last year’s production, the government is expected to spend RM720 million on sugar subsidy this year.

Mohd Zain admits that the subsidy is a burden for the government. “We are in a sweet dilemma now,” he quips.

He says the ministry is exploring a few options, for instance dual pricing, to resolve the problem. “But it is still at a preliminary stage,” he adds.

This does not bode well for refiners, given the price-control mechanism and the high raw material costs.

Most likely, if the price remains fixed at RM1.45 per kilo, the subsidy will have to continue, assuming that raw sugar prices remain high. Thus, the perception could be that the refiners’ earnings are being helped by the subsidy.

In such a scenario, MSM, with the lion’s share of the domestic sugar market, will be seen as the biggest beneficiary of the subsidy. Like it or not, eyebrows will be raised, particularly on the political scene. A private entrepreneur like Kuok owning a refinery does not help matters.

However, with Felda stepping into Kuok’s shoes, the picture has changed. It’s a government-owned entity that will get the subsidy and the beneficiary will be the government itself and Felda settlers.

Now, it becomes clear why Kuok has left  the sugar business in Malaysia which he established more than 45 years ago.

This article appeared in the Cover Story page of The Edge Malaysia, Issue 780, Nov 9-15, 2009.