Tate & Lyle banks on Splenda to sugar the pill of falling prices

Britain's Tate & Lyle must swallow a bitter dose of medicine: sugar prices are going to come down dramatically under proposals launched yesterday by the European Union which aim to break up protectionist trading policies introduced after the Second World War.

While the long-awaited directive will hurt Tate & Lyle - the world's largest sugar refiner - it need not be overly despondent. The company happens to manufacture, from a plant in Alabama, the world's fastest-growing artificial alternative to sugar, called Splenda, which is providing a nice energy boost to the company's bottom line.

Thanks to the sweeping changes to the EU's sugar-trading regime, which may bring down prices by 40 per cent in the next few years, analysts believe companies such as Tate & Lyle will focus even more on the expanding sweetener market, where profit margins can be far higher.

Sweeteners are eating into sugar's market share because of growing health concerns. Nowhere is that more apparent than in the US, the largest consumer of sugar and, because of rising obesity rates, the biggest market for artificial sweeteners. The market is also growing strongly in Asia and Europe thanks to calorie-conscious consumers.

Another trend is also working in Tate & Lyle's favour: people may be becoming more diet-conscious but they are also increasingly keen to consume products they regard to be natural. Splenda, the brand name for the chemical compound sucralose, has been successfully marketed as fitting that bill to a greater extent than many other sweeteners because it is partly made from sucrose, though that ingredient is treated with chlorine.

Splenda, which is also popular in the UK and Japan, is thought to be one of the tastiest alternatives to sugar. And because it retains its properties when heated, it can be used in cooking.

Yet if the historic British company hoped global consumer tastes were going to help it get out of a sticky situation with the EU, it will be disappointed. Tate & Lyle might be the only producer of Splenda on any significant scale, but in recent months, a number of US and Chinese companies have signalled their interest in taking a bite out of its dominance in the sucralose market, and laboratory tests to simulate the wonder sweetener are going on.

Most worryingly, a sweetener called Altern, containing sucralose, appeared on the shelves of two Wal-Mart stores in the summer. Tate & Lyle immediately tested the product and proclaimed it contained sucralose which was identical to its own version of the chemical compound. Wal-Mart withdrew the product, but analysts feel the world's largest retailer might not be inclined to hold back for much longer before putting a version of the popular sweetener on sale.

Tate & Lyle insists its control of the sucralose market will not be undermined for years and says it has patents on the substance until 2020. A spokesman said: "We have 33 global patents and nine pending. They cover blends, applications and product form. We've invested heavily to protect our knowledge." The company, which founded its first big sugar refinery in Silvertown, east London, in 1878, is also pouring increasing amounts of money into its more exotic operations.

To address the fact that demand for Splenda is outstripping its ability to supply the product, it is expanding its Splenda plant in McIntosh, Alabama, and will open a large factory in Singapore in 2007. The expansion will triple its Splenda production from April 2004, when it struck a deal to become the sole manufacturer of the product for Splenda's ultimate owner, McNeil Nutritionals of the US, part of Johnson & Johnson.

Others do not think Tate & Lyle's position is as secure, because of substantial interest among rivals to break into the market and the fact that some of the company's key patents expire next year and in 2009.

In September, NutraSweet, the US sweetener producer, said it was in exploratory talks with potential partners in China and India about the possibility of producing a version of sucralose.

Craig Petray, NutraSweet's chief executive, said: "We would look at getting into sucralose if we could ensure proper quality and reliability and avoid patent issues. We're exploring this with a few potential partners in Asia."

Last month, one of India's largest pharmaceuticals companies, Alkem, highlighted the fact that it was preparing to produce commercial amounts of its own version in January. Goldman Sachs has identified eight Chinese companies claiming to produce generic sucralose.

Tate & Lyle dismisses such threats as insignificant. A spokesman said: "An undergraduate chemist could make a very small amount of sucralose in a laboratory. But to make it on an industrial scale at the same level of quality is totally different."

Vishnu Gopal, at Goldman Sachs, said: "Tate has highlighted it would not have invested so much in sucralose if it was not confident about the barriers to entry a generic competitor may face, but given the number of people advertising alternatives to Splenda on the internet and some patents expiring, it could be exposed to competition sooner than the market anticipates."

To an extent, there is room for everyone. While the sugar market is holding steady, partly because some of it is swallowed up in the production of ethanol-based fuel, demand for artificial sweeteners is growing at 5 per cent a year. The US market is worth $1.1bn (£640m).

Nick Fereday, a sweetener specialist at the consultancy LMC International, pointed out that in soft drinks alone there is still huge growth potential for alternatives to sugar. "In the US 52 gallons of soft drinks are consumed per capita a year. The diet share accounts for 30 per cent of that, and that's the area that is growing." Beverage companies are particularly keen on sweeteners because they can be substituted for sugar more easily in drinks than food, and because by promoting diet drinks their makers are more likely to be able to sell them in schools which are clamping down on high-sugar versions.

But while demand for sweeteners is undeniably growing, Tate & Lyle has a lot to lose from increasing competition. While all sweeteners have juicy premiums when they first hit the market, Splenda really has been gold dust for Tate & Lyle.

When aspartame was launched in the 1980s its maker, NutraSweet, made profit margins of 20 per cent, and it was so valuable buyers would lock it in a safe. After NutraSweet's patents expired, its price plummeted and the story is similar with the earlier sweetener, saccharin.

Analysts believe Tate & Lyle is creaming off a 40 per cent premium on its product. That makes Splenda look too tempting for rivals to ignore.