London, April 16 - World sugar futures prices are historically cheap and could rally in the next two years, but a supply glut could overhang the market for some time as rising prices encourage plantings.
A senior Morgan Stanley agricultural commodities trader said last week that raw sugar prices could more than double to 28-30 cents a lb within two years.
Morgan Stanley's Jean Bourlot, a London-based managing director and head of agricultural trading, said sugar prices could rise due to increased demand for sugarcane-based ethanol and falling sugar output in India.
"In 24 months, the sugar market will likely be a completely different market in terms of supply," he told Reuters in an interview on Friday.
Many analysts believe that sugar is still cheap despite New York raw sugar futures having surged by 17 percent so far in 2008, driven by a hearty investment fund appetite for the sweetener.
Benchmark May raw sugar futures settled at 12.67 cents a lb on Tuesday.
Prices jumped to a high of 15.07 cents a lb on March 3, almost 40 percent up since the start of the year, then sank on a sharp sell-off across the commodities complex in March, before recovering again in April in highly volatile dealings.
"In this current (price) environment anything is possible," said Jonathan Kingsman, managing director of Lausanne-based sugar and ethanol consultancy Kingsman SA.
"Producers and industrial users should have risk management strategies in place due to the likelihood of extreme volatility in the next 24 months."
Kingsman said prices could rally, particularly if dragged higher by events in the wider commodities complex, such as poorly performing equities, record oil prices or a weak dollar.
Toby Cohen, head of analysis at sugar merchant and consultancy Czarnikow, said sugar prices were upwardly biased.
Rising ethanol and sugar demand coupled with investment flows and the risk of shock events such as hurricane damage were driving an increase in forward price risks, in contrast to the short term oversupply.
Cohen believes that sugar prices are likely to be guided by trends in the energy markets.
"With ethanol becoming an ever more important determinant of the sugar market, we are certain to see a closer relationship emerge," Czarnikow said in a recent report.
Some analysts, including Kingsman, believe sugarcane production in the centre/south of Brazil, the world's top producer and exporter, could exceed 500 million tonnes in 2008/09 and hit a record high.
"Overall, the big drivers in price are all quite positive," Cohen said, referring to growing demand for Brazilian cane-based ethanol and expectations of falling Indian sugar output.
Czarnikow sees Indian sugar production falling from more than 27 million tonnes in 2007/08 to 22-24 million in 2008/09, similar to forecasts by Kingsman and the International Sugar Organization (ISO).
SUGAR GLUT
But analysts said a huge supply glut of the sweetener still weighed on the market and could take some time to absorb.
The ISO sees a global sugar surplus in 2007/08 of 9.3 million tonnes, down from a surplus of 11.2 million tonnes in 2006/07 (October/September).
Sergey Gudoshnikov, a senior economist with the ISO, said that if there was no adverse weather, it could take some two years to eat up the sugar surplus, but if India had a bad monsoon the glut could be consumed much faster.
"Assuming there are no meteorological disasters, it could be another two years (before the glut disappears)," he said.
"However, bad monsoon rains in India could easily cut the Indian crop by a few million tonnes."
As an increasing share of Brazil's sugarcane output is used to make ethanol to meet rising demand at a time of surging oil prices, rising sugar prices will encourage further plantings.
Gudoshnikov estimated that well over half -- 56 percent -- of Brazil's sugarcane production could be used to make ethanol in the current 2008/09 crop.
Analysts said the United States and the European Union could decide to encourage more Brazilian ethanol imports if the prices of proteins now used as feedstocks for domestic ethanol production keep rising.
Brazilian fuel ethanol exports are currently reaching U.S. and EU markets despite the hurdle of import tariffs.
"If corn prices rise, Brazilian ethanol will find more homes in the U.S.," Kingsman said.