"The market hasn't factored in the impact of drought on 2016/17 production," said Harish Galipelli, head of commodities and currencies at Inditrade Derivatives and Commodities.
Industry officials say thousands of hectares of cane have been damaged after India's first back-to-back drought in three decades, as farmers also refrain from planting cane for the next season due to water scarcity.
In the top sugar-producing state of Maharashtra, a recent Reuters visit showed the impact of the drought.
Farmer Vijay Nazirkar harvests cane shoots daily, but they are so withered he is using them to feed his cattle.
"Sugar mills will not buy this dwarf cane with small shoots," said Nazirkar as he chopped cane up for his 22 cattle, one of his few sources of income as other crops such as corn and onions have also been hit by a prolonged dry spell linked to an El Nino weather event.
So far, he has fed nearly half of his cane crop to cattle in his village of Nazare, about 200 km southeast of Mumbai.
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Commodities house Czarnikow puts India's production next season at 28.9 million tonnes and the Indian Sugar Mills Association at 28 million tonnes.
Although after assessing conditions in Maharashtra and the third-biggest producing state of Karnataka, some industry officials and traders see production falling to 26 million tonnes and even below 25 million tonnes in 2016/17.
That compares with a near record 28.3 million tonnes this year and expectations of annual consumption of 25.2 million tonnes in the upcoming season.
Maharashtra's output could drop nearly a quarter to 8 million tonnes next season and be even lower in 2016/17, said Sanjeev Babar, managing director of Maharashtra State Co-operative Sugar Factories.
After a good start in June, monsoon rainfall weakened in July and August and had badly affected the crop, said Babar.
Rains have been 14 per cent below average so far over the four-month monsoon, but in some areas the rainfall deficit has been as high as 46 percent.
Monsoon rains also failed in 2009 due to an El Nino, forcing India to import sugar and pushing global futures to a 30-year peak.
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Since India will start the new crop year with more than 10 million tonnes of stocks, it has room to sustain exports, said Rahil Shaikh, managing director of ED&F Man Commodities India.
India announced new rules on Friday making it compulsory for sugar producers to ramp up exports to at least 4 million tonnes in the new crushing season, up from 1.3 million tonnes in the current season, to cut stockpiles.
But Galipelli of Inditrade Derivatives and Commodities said exports would have to be restricted in 2016-17 to maintain buffer stocks and global prices would likely rise.
Water intensive cane can take 10 to 18 months from planting to harvest so cultivation of a new crop needs to be completed in the next four months for harvesting in 2016/17.
But some farmers in Maharashtra say it's too late.
"I want to plant cane on three acres, but I cannot. My well has dried up and the government is not releasing water from dams," said Popat Kamathe from Khalad village.
India's main reservoirs are holding 59 percent water of capacity, compared with a ten-year average of 77 percent.