The government has put a spanner in the plans of oil companies like Reliance Industries [Get Quote] Limited and Hindustan Petroleum Corporation [Get Quote] Limited to make ethanol directly from sugarcane, without producing sugar.

Pollution control rules require these companies to spike diesel and petrol with five per cent ethanol.

The government issued a notification on 28 December 2007 amending the Sugarcane (Control) Order, 1966 that, in effect, allows only sugar mills to produce ethanol from sugarcane.

Both RIL and HPCL have bid for closed sugar mills in Bihar and planned to produce ethanol there for their own consumption. While HPCL has emerged as the highest bidder for three mills, RIL is leading the race for one.

The move will benefit leading sugar companies like Bajaj Hindusthan, Renuka Sugars, Balrampur Chini [Get Quote] and Triveni Engineering that have made huge investments in beefing up their ethanol production capacity.

Ethanol, unlike sugar, is a source of fixed revenue for sugar mills. While sugar prices have crashed by 30 per cent in the last one year and are expected to soften further in 2008 because of a record sugarcane harvest, the price of ethanol has been fixed by the government at Rs 21.50 a litre.

Mandatory ethanol blending with petrol at 5 per cent has been introduced in October 2007 and the government plans to increase it to 10 per cent from October 2008.

Blending at 5 per cent requires 600 million litres of ethanol a year and the requirement will double at 10 per cent.

According to the Indian Sugar Mills Association, the country's total distillery capacity is 3,700 million litres. Of this, the ethanol capacity is 1,587 million litres and the rest is alcohol and rectified spirit.

With the growing demand from oil companies, sugar mills have been able to divert excess sugarcane to ethanol production and thereby adjust sugar production to the demand.

Every one-ton reduction in sugar production results in 600 litres of additional ethanol if mills use sugarcane juice directly.