Glut drags on sugar, ethanol seen key to recovery

By David Brough - Analysis

LONDON (Reuters) - A huge global surplus is dragging sugar prices lower, but as the excess is slowly absorbed, rising demand for cane-based biofuel could help prices turn around.

Raw sugar futures jumped almost 40 percent on a storm of investment fund buying in January and February to levels over 15 cents per lb, but prices sank in March and April as bearish fundamentals reasserted their sway over the market.

Currently raw sugar values are up 8 percent since the last trading day of 2007.

"I think sugar is coming back to a more realistic level (in price)," said David Sadler, a veteran London-based sugar futures trader.

A massive sugarcane crop now being harvested in the centre-south of Brazil, a lack of storage space, and a surge in freight rates, are reducing physical buying, putting further downward pressure on sugar prices near-term.

"The front end of the curve (nearby prices) should not have rallied as it did early this year," said Hussein Allidina, vice-president of Morgan Stanley in New York. "It should be pressured because you have a high amount of supply."

However, he noted that raw sugar futures prices were much stronger in distant months.

For example, with the spot month July SBN8 hovering just below 12 cents a lb on Thursday afternoon, July 2009 SBN9 futures stood at 14.35 cents a lb, and July 2010 SBN0 futures were at 15.00 cents.

In its latest Sugar Update report, Morgan Stanley sees sugar prices increasing to average 18.6 cents a lb in 2010/11.

The decisions of funds on sugar investment will be key.

"The tremendous flow of capital from financial institutions into commodity futures to seek diversification away from the sectors affected by the credit crunch has clearly pressured fundamentals," said Peter Baron, executive director of the London-based International Sugar Organization (ISO).

"It is clear that the net inflow of funds in sugar futures is a decisive driver for today's world prices," he said in a speech at the annual Sugar Club dinner in New York.

NEARBY GLUT

Swiss-based consultancy Kingsman SA said Brazil, bringing in a "monster crop", would struggle to store all of its sugar.

The ISO said on Wednesday that Brazil's cane output in 2008/09 would rise to a record 550 million tonnes from 431.2 million in 2007/08.