CRUDE PALM OIL (CPO)
Introduction
Palm oil is one of the most important edible oils in the world. Palm oil is extracted from the reddish, plum-sized palm fruit and refined into CPO. Due to its abundant availability, low-cost, and diverse functionality, it is the most widely produced edible oil in the world, with just over 37 mT produced in 2007.
Demand
Over 75% of CPO is consumed in food preparation, with the remainder going to industrial uses, such as production of oleochemicals (e.g., inputs in soap) or biodiesel. Edible oil demand has achieved over 7% annualised growth since 1986, while industrial demand has grown by over a 10% annualised rate, resulting in an overall growth rate over 8%.
The largest consumers of CPO are China, India, Indonesia, Malaysia, and the EU. Demand is driven by three main factors. Historically, demand has been driven by GDP (Gross Domestic Product) and population growth, especially growth in markets with both a preference for palm oil and a proximity to major production centers (e.g., China, India). Additionally, tax and trade regimes continue to favour demand growth for CPO. The U.S., historically a minor consumer of palm oil (only 20% of Indonesia’s consumption), has seen annualised demand grow near 30% over the last seven years. This growth has been driven by recent evidence citing the health advantages of saturated fats (high in palm oil) relative to trans-fats (high in palm oil competitors, such as hydrogenated vegetable oils) and stronger demand for biodiesel. In addition, a palm oil producer in Liberia has the advantage of proximity to a large net-importing West African market and favourable freight costs to the U.S. and European market compared to its Southeast Asian competitors.
Increased demand for renewable energy also supports CPO demand growth. CPO is well-positioned to become a key input for biodiesel, given its discounted cost relative to other edible oils, its easy availability and its chemical properties. This has the potential to be a major market for CPO given substantial global mandates and huge installed base of biodiesel processing capacity.
Supply
The palm plant is suited to tropical climates and has typically been grown in equatorial countries in Africa and Asia. Malaysia and Indonesia are the world’s leading producers, accounting for 86% of global production. Both countries have gained market share over the past twenty years, largely at the expense of Africa, which accounted for 27% of palm oil production in 1980 but today accounts for 5%.
Our projections of CPO production are determined by land under production, yield per hectare and extraction rate. Given the modest 2.5% annualized historical growth rate of yield and oil extraction per hectare, land under production is the major driver of the 7% projected growth rate from 2008-2015.
Price
The typical price quoted for CPO is FOB Malaysia (Free on Board), defined as delivery of goods on board the vessel at the named port. At $65-$75/mT, transport costs from Malaysia to the EU and U.S. are equal to or higher than transport costs from potential palm-producing nations such as Liberia. Moreover, were Liberian producers to integrate into a regularly scheduled logistics chain, or if ships en route to West Africa could be filled with goods for import, transport costs would be further reduced, creating a sustained strategic advantage.
The average price of CPO from 1998 to 2007 was $425/mT. Price fluctuations have been driven largely by supply shocks. A poor global palm crop in 1997-98 drove the price to nearly $700/mT, while in 2001, over-supply coupled with poor demand in India drove the price of palm oil to $200/mT. As at the date of this report palm oil is trading at record high prices of over $1,200 m/T. This situation is not driven by a supply shock, but rather by broad based demand from developed markets and emerging markets. Emerging markets demand is underpinned by strong growth in GDP, population and standard of living. Additionally, these markets are initiating substantial trade liberalisation which is removing inefficiencies and roadblocks to palm oil trade. This is an important factor driving increased demand.
In developed markets vegetable oil use is moving forward along with the stable pace of GDP growth. However, palm oil demand is gaining rapidly from health preferences related to transfats. Even more importantly, developed nations have implemented major renewable fuel and renewable energy mandates and incentives. In particular, biodiesel mandates in Europe, the United States, Brazil and Argentina are creating new and large markets for palm oil and other oils and fats. These biodiesel mandates, combined with overcapacity in biodiesel production assets, create a strong linkage between energy prices and palm oil (and other vegetable oil) prices. This linkage creates a floor price for vegetable oil which is tied to diesel fuel prices plus biodiesel production costs and other incentives. Even if biodiesel mandates and incentives were to be repealed palm oil would still have a minimum value substantially higher than its long term average price given the massive amount of global biodiesel capacity and the currently very high crude prices.
Over the period 2008-2012, we anticipate sustained pricing pressure as supply struggles to keep up with demand, especially for CPO as an input to biodiesel and for food in emerging markets. This situation is accentuated by the global land shortage which has recently become evident. Limited arable land has struggled to meet the needs of grain and oilseed demand from ethanol, biodiesel and emerging markets. Given this supply and demand imbalance, prices could continue to reach new highs in coming years. As new CPO production begins to come on-line in 2010, prices should level off and possibly trend lower.
Several uncertainties underlie this pricing forecast. The first is the market for biodiesel which is rapidly growing and remains unpredictable from a policy standpoint. Global biodiesel mandates have been called into question as has the sustainability of various biodiesel feedstocks, specifically palm oil. Weather risk is also a major uncertainty for producing countries. Weather uncertainty in Malaysia and Indonesia can drastically affect supplies in any given year, but in most cases provides upward pressure on prices which could cause divergence from the forecasts. Lastly, palm oil, vegetable oil, agricultural and energy commodities all have prices at record high levels. These elevated prices are at risk of a broad economic slowdown. This has historically been a corrective factor where demand destruction due to price inflation and slower economic growth can curtail further increases in commodity prices.
Despite the uncertainties listed above, we believe the supply and demand dynamics of the CPO market represent an attractive opportunity where bullish fundamentals outweigh risks and therefore present a very optimistic long term outlook for palm oil producers.
(Source: First Risk Capitol Report 22nd May 2008)