Article By Dorab Mistry - I have had a very good run over the last 30 months with each of my crude palm oil price forecasts coming true. The last one made 90 days ago for palm oil prices to reach 4000 ringgits by the end of June very nearly verified but missed its target narrowly.
However, I must confess that my medium term forecast for CPO prices to reach 4500 Ringgits by February 2009 was over-optimistic and that I got the market wrong. The only way we can get to 4500 Ringgits by February 2009 is if we immediately run into an El Nino situation or if Nymex WTI crude oil prices flare up to beyond US$ 150 per barrel or if the Ringgit collapses. Since neither of these possibilities is very likely,
I must say today that my forecast for CPO to reach 4500 Ringgits by February 2009 stands abandoned. At this point I would also like to congratulate my erudite and distinguished friend Dr James Fry of LMC International in Oxford who correctly predicted the sharp drop in vegetable oil prices. The case for attending conferences and listening to analysts with differing opinions has never been stronger. The importance of biofuel demand will become obvious more and more as this market progresses over the next several months. I shall first make some remarks about the happenings in the market during the last 90 days.
The lull before the storm
During June, the level of transactions in our market dropped sharply. It turned out to be the lull before the storm! Our market has been affected by the big macro factors such as:
The turn in the fortunes of the US Dollar, the decline in the price of energy, the dramatic change in sentiment towards energy, the deteriorating outlook for economic growth in the G8 countries as well as in the BRIC economies and
Finally, the approach of the hedge fund community towards commodities. Those of you who attended or read my paper at POC 2008 on 27th February in KL will recall I had highlighted the role of funds and particularly the role of Index Funds in boosting commodity prices.
Signs of Demand Destruction
During the month of June, we could discern signs of “Demand Destruction “as a result of high prices. I believe the strong price rises of the first quarter of 2008 finally began to meet resistance in the second quarter and got reflected in the volume of business transactions during the month of June. We saw strong evidence of this in the case of sunflower oil and soya oil. The palm market was the quickest to take note and palm soon sank to a wide discount to its competitor and that has kept palm export volumes at a high level.
Almost Ideal Weather
Overall in 2008, after the second half of June, we have been blessed with almost ideal weather in all parts of the world. For the first time in recent years, my survey of growing conditions in the 10 major regions of the world did not give me a single cause for concern. The problems of wet conditions in the USA got resolved in the month of June itself. As history has taught us, problems in the early part of the season are the least destructive. Problems in the latter part of the season are the most destructive.
We have seen crops get bigger as the northern hemisphere growing season has progressed. We have been most pleasantly surprised by yields in the EU and the size of expansion in Ukraine and in SW Russia. Above all, the expansion has come in high oil bearing seeds – rapeseed and sunseed.
Palm production has also benefitted from an extension of the High Cycle. My earlier estimate was that the High Cycle would come to an end anytime between June and September this year. It appears that the cycle will stretch to the very end of this window and perhaps even stretch to October and November.
Estimates of CPO production in Malaysia for calendar year 2008 have been revised to 17.4 million tonnes and I shall not be surprised if this estimate is comfortably exceeded. Similarly Indonesian CPO production is likely to comfortably exceed 19 million tonnes. I am told that very generous use of fertilisers, given the high prices of CPO, has done its job together with almost ideal weather.
The Case for Biofuels
Only a few months ago it had become fashionable to blame Biofuels for all the problems of mankind. Exuberant do-gooders were on the verge of saying that Thomas Malthus would be proved right and that mankind would fail in its endeavours to feed the growing population of the world.
How wrong they were. I have always held the view that we should never under-estimate mankind’s ability to innovate and to adjust and to find resourceful solutions to the most intractable of problems. Just when people thought arable land was in short supply and that North and South America were approaching the limits of expansion, Eastern Europe has emerged as a location of enormous potential. Ukraine, South West Russia and parts of Eastern Europe hold out great promise for new investment and bumper profits in agriculture.
The case for biofuels is as obvious as the case for Alternative and Renewable Energy. We all seem to forget that the history of mineral oil dates back only 150 years. There are finite reserves of mineral oil and unfortunately most of these are concentrated in the hands of a cartel which does not hesitate to use its muscle to boost prices. Biofuels and alternative energy sources like Wind and Solar must be encouraged and expanded. Let us not waste time arguing over the pros and cons of biofuels.
Let us instead contemplate how we would be vulnerable without the added security and comfort of biofuels.
In July 2008, the International Energy Agency forecast that world biofuel production in 2008 will be down slightly at 1.35 million barrels per day, compared with its May2008 forecast of 1.5 million barrels per day ( mbpd ). I have no doubt the current easing in prices will once again hoist the figure to 1.5 mbpd. In 2007 it was 1.06 mpbd. By 2013, the IEA estimates production of biofuels will be 1.95 mbpd. As the IEA says, “ Biofuels have become a substantial part of faltering non-OPEC supply growth, contributing around 50 percent of incremental supply in the 2008-2013 period ”.
In a paper of this nature I do not have to state the case for palm as a biofuel of choice. However, there is a widely held misconception that the cultivation of palm is harmful to the environment and that it destroys the tropical rain forests. With respect this is a misconception based on out-dated information. No plantation company in its right mind will resort to Slash & Burn these days. Degraded forests are cleared and re-planted in a sustainable manner and High Conservation Value areas are suitably preserved.
The economic benefits in terms of employment generation and wealth creation are too great to be ignored. The countries and the people of the tropical, equatorial lands have a right to development and to prosperity. They should not be made to pay for the past sins and excesses of people in the more temperate lands on our planet.
There is also a very strong argument that the productivity of palm trees is so high that it leads to the best use of land in a world where arable land was thought to be in short supply.
There is also an argument that prices of agricultural commodities have been falling in real terms over the last 30 years. Agriculture has become the last resort of the uneducated and the under-employed. The sons of farmers do not wish to embrace farming as a profession. They would rather work in the cities. Therefore there is a crying need to underwrite remunerative prices for farmers and planters. That job can either be done by what is called “ Domestic Supports ” or Minimum Support Prices or by finding a market based solution. The use of palm oil as a biofuel is such a market based solution.
The Case for Palm as a Biofuel
World production of oilseeds is expanding as advances are made in technology as well as in acreage. On average, world demand for vegetable oil is expanding at about 6 million tonnes per annum – 4 million tonnes of edible demand and 2 million tonnes of biofuel demand. In some years, with good weather and rainfall, palm oil production alone will expand by more than 5 million tonnes, in other words, by more than the expansion in food demand. In order to preserve remunerative prices, we therefore need the additional demand from biofuels. 5
Otherwise prices will collapse and will have to be either supported by the tax payer – as in the USA and the EU, or farmers will be driven to distress and impoverishment.
World Vegetable Oil Incremental Supply and Demand
In the current oil year, October 07 to September 08, northern hemisphere crops have shaped up extremely well and there have been bumper crops of rapeseed and sunseed whilst soya production in USA has also been good when compared with the planting problems of June. On the other hand, the very high prices of the first quarter of 2008 led to an outcry against biofuels. The new regulatory and tax regimes for biodiesel in Germany and parts of the EU also led to a scaling back of biodiesel production and demand.
My estimate is that on an annualised basis, for the oil year 2007-08 we have already lost 1 million tonnes of food demand and about 500,000 tonnes of biodiesel demand as a result of high prices. Some of this lost demand may be re-captured in 2008-09 but that is going to be the function of price.
For the oil year October 2008 to September 2009, we are already seeing big increases in the production of sunseed and rapeseed.
CHINA
I wish to make a specific point about China. You will have noticed that the sell-off in our markets started from the domestic market in China. I believe many analysts have missed out or overlooked a very significant statistical point with regard to China.
The 2007 Rapeseed crop in China was a disaster. My estimate is that the crop was around 8 million tonnes, at least 2 million tonnes lower than official China government estimates ( which were scaled down from earlier 11 million tonnes ).
This was one of the reasons for the fast pace of 2007 imports by China and the bullishness that came from that direction. The 2008 Rapeseed crop in China is much better and is estimated at a genuine 11 million tonnes. Most analysts never revised their 2007 figures downwards and hence they are taking the 2008 increase at ( 11 minus 10 ) 1 million tonnes.
In actual fact, the 2008 increase over 2007 is 3 million tonnes. This explains why the domestic market in China is over-supplied and suffering from indigestion. The soybean crop in China is also better than expected and with good weather should be in excess of 18 million tonnes. On the other hand, food demand grew in 07-08 by only 3 million tonnes and biodiesel demand by 1 million tonnes. Hence for 07-08, Incremental Supply exceeded Incremental Demand by almost 1.5 million tonnes and the bulk of this excess has come in the second half of the year.
For 08-09, my initial expectation is that food demand should grow again at 4 million tonnes and biodiesel demand by 2.5 million tonnes. I am presuming that mandates will come into force in certain countries. If that were to be the case, Incremental Supply will exceed Incremental demand by a small margin. However it must be borne in mind that all figures for 08-09 are a guess at this early stage. Palm production may or may not be as high as we estimate and bio diesel demand may be higher or lower than expected.
There are several variables with regard to 08-09. The economic outlook for the big population countries is less than what it used to be a year earlier. Prices are already very high and the morale of consumers is lower than a year ago.
The mis-guided outcry against biofuels and the Food versus Fuel debate has eroded or postponed the various Mandates and Incentives that are required to make biodiesel attractive. In the final analysis, Demand growth will depend on Price. What is amply clear is that Biofuel Demand is absolutely essential to ensure remunerative prices. Were it not for biofuel demand, vegetable oil prices would be lower and the industry would not expand and create wealth on the same scale.
PRICE OUTLOOK
We have already seen a big correction in prices but it may not be enough to ensure strong growth in demand. Let us remember that RBD Olein at US$ 900 per tonne FOB is a very high price in a historical perspective. Also, vegetable oils need to be cheaper than fossil fuels if we are to make bio diesel profitable and thus to expand its market.
Ultimately, commercial success is the best guarantee for demand expansion. We have seen in recent months in the case of Corn Ethanol in the USA. Mandatory blending of Ethanol has been doubled by the tonnage of Voluntary blending which has been triggered by the lower price of ethanol as compared with gasoline. We used to see this happen in the case of Rape diesel in Germany until de-taxation was removed. At present bio diesel production in Argentina and in Indonesia is facilitated by virtue of the differential export taxes that are levied. It remains to be seen how this will change when export taxes are reduced.
Export Taxes
On that note, it must be said that the governments of Indonesia and Malaysia did their palm oil industries a huge dis-service when they levied punitive taxes on palm.
The high export tax in Indonesia was particularly unfortunate and immoral. Consumers in developing nations like India, Pakistan, Bangladesh and others in North Africa and Asia had every reason to feel betrayed and exploited. What face will the Indonesian government have when some of these countries now decide to levy or to re-impose punitive import taxes on palm oil?
In Argentina even today, the government, in its mindless lust for revenue, is trying to strangle the industry. Doing business as an oilseed crusher or a Grain exporter in Argentina is an ordeal. Their government reminds me of the famous words of the actress Zsa Zsa Gabor “ I am a wonderful housekeeper; each time I leave a man, I keep his house ! ”
Prices over the next few weeks
We have at present a deadly cocktail of rising production combined with some demand rationing. In such circumstances, prices have to go to the level where they create strong demand growth. At the same time, markets have been over-sold and just at present, the newsflow has turned positive. There are uncertainties with regard to the US crops, relating to a lack of moisture. The India monsoon appears to be withdrawing earlier than in normal years. A lot is riding on the time when the Palm
High Cycle will finally turn.
Until the High Cycle of palm oil production persists, big production and big stocks will weigh on the market. The pressure will come from sun oil and soya oil, particularly soya oil which is at an unsustainable premium to palm oil. The larger than normal stocks of beans, meal and oil in Argentina will need an outlet and world prices will have to do their job. So far, palm has been very fleet-footed and its lower price has managed to grab market share and so keep its stocks at less than burdensome levels.
If crude oil prices stabilise around US$ 100 per barrel with a 10 percent range, then I believe CPO futures need not go lower than 2200 Ringgits for the next few weeks. At that level we should see strong demand growth. Soya oil, on the other hand, needs to decline in price substantially from its current levels. If biofuel use of vegetable oils was not around, the price level would be unthinkable.
I am not going to make a medium term price forecast today. However, I must warn you not to get too bearish. The prognosis for 2009 will depend on many new factors and I shall discuss these in my forthcoming speeches – on 11th September in Singapore and later on 28th September at Globoil India in Mumbai.
This paper was meant to explain Why palm oil needs that additional biofuel demand to ensure remunerative prices and to ensure its long term success. It is a pity that major plantation companies have enriched themselves from high CPO prices but have refused to invest in bio diesel or to invest in creating a market for biofuels.
Almost all plantation companies, with just one or two honourable exceptions, have kept their heads down rather than propagate and explain the case for palm diesel. MPOC is doing a great job but the plantation companies need to do much more. Have they never heard of a term called “ Enlightened self interest ? ”. The current market situation exemplifies what I have said today. We must all realise how important it is for us to ensure that biofuels remain viable and acceptable.
The Round Table on Sustainable Palm Oil is doing a sterling job in this direction even though many in the RSPO do not like palm bio diesel and would rather confine it to edible use.
My point is Unless you pay remunerative prices to the growers, you will not get a flourishing industry that creates wealth and cares for the environment. Let us always remember that the biggest polluter of the environment is poverty. We do not need the crocodile tears of people who wish to keep the developing world poor but environmentally pure.
Poverty is our common enemy. Let us make it our mission to enrich our farmers and our plantation workforces. They are our frontline. Palm is a relatively young industry but a phenomenally successful one. Let us keep it that way. I wish you all great success in the weeks and months ahead.
GOOD LUCK and GOD BLESS. (Courtesy: Solvent Extractors Association of India website)