Macquarie sounded an upbeat note on sugar prices even as futures set a five-month low, forecasting that an inventory build in Brazil will rapidly reverse, thanks to an "extreme lack of precipitation" in the key cane-growing region.
Brazilian sugar inventories ended June at around 6.0m tonnes, nearly double those a year before, a factor which has helped depress New York raw sugar futures to 16.12 cents a pound on Tuesday, the lowest since February.
However, the rise in stocks reflects one-off factors, such as a shift of export facilities towards grains and soybeans – shipments of which approached record levels in the April-to-June period– at the expense of sugar volumes, which fell 21% to 4.6m tonnes.
"Relatively weak" sugar exports "may not just be a function of demand", Macquarie said.
Furthermore, consumption of gasoline, and by implication ethanol, has been growing faster than expected, by 8.3% year on year in April-May, with price signals implying strong prospects in particular for use of hydrous ethanol.
The price of hydrous ethanol – the type used neat, rather than anhydrous ethanol mixed with gasoline – has fallen to 66% of the gasoline price, suggesting a "response in terms of demand".
Higher use of hydrous ethanol, demand for which could increase by 2.4bn litres this season, would imply less cane for making sugar rather than the biofuel.
And Macquarie also stressed the drought damage to the cane crop which many observers, including industry group Unica, believe will spell an early finish to the crushing season.
With rains 40% below normal in the October-to-June period in Sao Paulo state, at the heart of Brazil's key Centre South cane growing region, "the risk is that dryness through these states has not only impacted sugar cane yield potential, but is still continuing to impact later-maturing cane".
"In the last decade we have only seen rains be as much as 20% below normal for this period, suggesting that the crop production loss could be more severe than we currently estimate," Macquarie said.
The bank is forecasting Centre South cane production, usually about 90% of the Brazilian total, at 564m tonnes, down 32m tonnes year on year.
Brazil faces a "very tight situation" for both sugar and ethanol, which "should be good enough to give good support to prices".
While sugar futures are "rangebound at present, given heavy inventories, all of the current risks are skewed to a break-out at the top of the range".
The bank also noted other potential price supports, including from the Indian monsoon.
Indian sugar cane plantings have been delayed thanks to the rain but, as of July 25, had caught up to 4.64m hectares, 210,000 hectare below the year-before figure, according to government data.
Another threat to Indian sugar production is a plan by mills in Uttar Pradesh, India's top cane producing state, to suspend operations in 2014-15, starting in October, over the high costs of the crop, farmgate prices of which are fixed by federal and state governments.
The state's mills are losing 5.5 rupees ($0.09) per kilogramme of sugar due to the price of 280 rupees per 100 kilogrammes they are forced to pay for cane.