* Govt wants oil companies to achieve 5 pct blending of ethanol in gasoline
* Hopes to reduce record current account deficit by cutting crude imports
* Demand for ethanol will give sugar mills a shot in the arm
* Oil firms float tender for 1.33 bln litres of ethanol
* With Brazil as inspiration, ethanol blending could keep growing
MUMBAI, Oct 15 (Reuters) - Struggling sugar mills in India are seeking solace in producing ethanol from crushing sugarcane, as the government ramps up pressure on oil retailers to cut fossil fuel imports by blending gasoline with the biofuel.
New Delhi, scrambling for ways to cut nearly $20 billion off its oil costs as it battles a record current account deficit, could save around $1 billion on annual imports of crude as it pushes oil firms to hit a goal of 5 percent blending of ethanol in gasoline.
Reaching that blending target in 2013/14 for the first time since its introduction over six years ago would lift earnings at indebted mills in the world's No.2 sugar producer and help curb a notorious cycle of glut and deficit in Indian sugarcane planting.
With Indian mills making ethanol from molasses, a byproduct of sugar production, the fading of that cycle would also ensure more consistent output of the sweetener. That would provide greater stability to global sugar prices with India less prone to swinging between net exports and imports of sugar.
"Since oil companies have floated tenders ahead of the sugarcane crushing season and there are no tussles over ethanol pricing, 5 percent blending can be done this year," said Sanjay Manyal, an analyst at Mumbai-based brokerage ICICI Direct.
Disagreements between mills and oil companies over pricing stymied progress after India launched its ambitious ethanol blending programme in 2006, trying to emulate the success of Brazil's booming biofuel industry.
But state-run oil firms such as Indian Oil Corp Ltd , Hindustan Petroleum Corp and Bharat Petroleum Corp have been far more amenable to mills' demands on pricing since the rupee plumbed record lows in August, driving up their crude oil import costs. These firms import crude to produce refined products like diesel and gasoline, which they sell through their fuel pumps.
"Oil companies won't find any problem in paying higher prices for ethanol (than last year) as they are buying imported crude oil at much higher prices due to the weak rupee," said Deepak Desai, chief consultant at Ethanol India, a private company that helps set up ethanol production units.
Mills were supplying ethanol at around 38 rupees per litre in the latest tender, with imported gasoline costing 46 rupees per litre.
The matter has taken on greater urgency since Oil Minister Veerappa Moily told Prime Minister Manmohan Singh in August that 5 percent blending could be achieved in 2013/14, helping preserve the country's precious foreign exchange. India's crude import bill was $144 billion last fiscal year - the largest part of its overall import costs.
SLOW AS MOLASSES?
The new crushing season, expected to start in November, could lead to record ethanol output if oil companies finalise tenders for 1.33 billion litres of supply from December 2013 to November 2014. That would dwarf the 80 million litres they bought in the 2012/13 sugar year that ended on Sept. 30.
But some millers cautioned that oil marketing companies were dragging their feet in finalising tenders, although oil firms said deals would likely be sealed soon.
"We also want to achieve 5 percent blending as early as possible. We will try to award tenders by the end of this month," said an official with a state-run oil retailing company, who declined to be named as he was not authorised to speak with media.
That is good news for mills that have been struggling with low sugar prices due to a surplus in production of the sweetener for the fourth straight year.
Indian sugar output usually plunges after a few years of surplus as the glut in supplies drags on prices and mills' ability to pay cane farmers. That prompts farmers to switch to other crops such as wheat, leading to a cane shortage that lifts sugar prices and attracts more farmers in subsequent years.
A successful ethanol blending programme would weaken that cycle by providing more consistent demand for cane, said Ashok Jain, president of the Bombay Sugar Merchants Association.
"Ethanol is more reliable source of income than sugar," he said.
And market participants reckon that ethanol blending in India has room to grow beyond 5 percent, citing compulsory blending in Brazil which stands at 25 percent. Although raising blending above 10 percent is unlikely in the short-term as it would require modifications to automobile motors, while any strengthening in the rupee could also make blending less appealing as crude imports would become cheaper again.
"If 5 percent blending becomes successful, there is scope to increase it to 10 percent without any change in car engines," said ICICI Direct's Manyal, who has been tracking sugar companies for seven years.
(Editing by Joseph Radford)