Tracking CPO’s slippery slide

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It has been a tough couple of years for crude palm oil (CPO) players, with specialists citing that the golden crop no longer having its sheen of the past.

So far this year, plantation firms continue to face negative sentiments such as the US-China trade war, uncertainties from European countries and prolonged elevated oil palm stockpiles.

This was the reason why the sector’s profitability dropped in the last five quarters caused by sustained weakness in CPO price.

Public Investment Bank Bhd (PublicInvest Research) in an April note highlighted the fact that Malaysia’s CPO is losing its competitive edge.

“Malaysian CPO producers had all the while enjoyed a premium pricing of more than RM100 per MT than its Indonesian counterparts.

However, the deadlock was broken when the spread started narrowing in September 2018 and has since turned negative,” it said.

According to MPOB statistics, the Malaysia-Indonesian CPO price spread started turning negative since Oct 2018 and the discount has continued to widened.

On June 21, 2019, the prices of Malaysian palm oil futures edged lower to RM1,998 per MT.

AmInvestment Bank Bhd analyst Gan Huey Ling in a special report last month highlighted changes in CPO’s price cycle.

“The cycle (from the bottom to the peak) for CPO prices is getting shorter. The recent recovery in CPO price from November 2018 to February 2019 lasted only four months,” she said.

“In comparison from 1996 to 2011, the cycle for CPO prices lasted for two years, at least. After 2011, the cycle for CPO prices lasted for only slightly more than a year.

“CPO price experienced its major surge during the commodity boom from 2006 to 2008.

“The uptrend in CPO prices lasted for two years and two months from January 2006 to February 2008.

“During this period, CPO price based on MDEX futures hit a record high of over RM4,000 per tonne in March 2008.

“During the commodity boom, the price of almost every commodity surged.

“For instance, West Texas crude oil price shot up to US$145.29 per barrel in July 2008. The cycle for CPO prices started becoming shorter from 2012 onwards.

“This coincided with China’s clampdown on commodity financing and money laundering. China’s palm imports hit a high of 6.3 million tonnes in 2012 and a low of 4.5mil tonnes in 2016.”

“We believe that the CPO price cycle has changed for several reasons.

“First, global CPO production started surging from year 2008 onwards on the back of the jump in output in Indonesia. Indonesia overtook Malaysia as the largest producer of oil palm in 2006.

“CPO production in Malaysia and Indonesia climbed by 23.9 per cent to 33.2 million tonnes in 2006 from 26.8 million tonnes in 2005.

“Indonesia started planting oil palm aggressively in the 1970s.

“Second, we believe that there has been a structural change in palm demand from China. Going forward, there will be a change in palm demand from the EU.”

 

CPO price downturn is getting longer

While the uptrend in CPO prices is getting shorter, the period when CPO prices are in a downturn is getting longer.

From 2004 to 2008, the trough period for CPO prices was less than 12 months compared with more than a year after 2011.

After reaching a high of over RM4,000 per tonne in early 2008, CPO prices plunged in line with the weaker global economic growth resulting from the subprime crisis in the US.

However, the trough period for CPO prices lasted for only 10 months as unfavourable weather conditions led the recovery in CPO prices in early 2009.

From February 2011 to December 2012, CPO price experienced a downturn for a year and 11 months while the trough period was a year and six months from March 2014 to December 2015.

“We believe that the downturn is getting longer due to ample global stockpiles.”

Soybean prices were dragged by expansions in planting areas in Brazil and higher supply asUS farmers switched to soybean from corn.

The supply of CPO surged as plantation companies increased their new plantings of oil palm in Indonesia.

“We believe that the aggressive expansion of oil palm in Indonesia took place from the 1970s onwards and only started easing from 2009.”

 

The highs for CPO prices are getting lower

CPO price (MPOB price) hit its record monthly high of RM3,811 per tonne in February 2011.

Looking at MDEX prices, the record high CPO price was over RM4,000/tonne in March 2008. In subsequent price cycles, the highest level of CPO price became lower and lower.

In the CPO price upcycle from 2012 to 2014, the highest monthly level (MPOB price) was RM2,855 per tonne.

From 2015 to 2017, CPO price’s highest monthly level was

RM3,268 per tonne. From November 2018 to March 2019, monthly CPO price was its highest at RM2,101 per tonne in February 2019.

At the same time, CPO price’s lowest levels have been consistently close to or below RM2,000/tonne.

During the global financial crisis in 2008/2009, CPO price’s lowest monthly level was RM1,517 per tonne.

From 2011 to 2012, monthly CPO price hit a low of RM2,052 per tonne. From 2014 to 2015, its monthly lowest point was RM1,970/tonne.

From 2016 to 2018, monthly CPO price’s trough point was RM1,795 per tonne in December 2018.

From 2014 to 2018, the average five-year CPO price (MPOB price) was RM2,449 per tonne.

In contrast from 2009 to 2013, the average five-year CPO price was RM2,696 per tonne.

The average 10-year CPO price was RM2,573 per tonne from 2009 to 2018.

This is higher than the average 10-year CPO price of RM1,686 per tonne from 1998 to 2008.

 

Structural changes in palm oil demand, supply

Structural changes are taking place in the plantations sector which AmInvestment Bank’s Gan believe are negative for the sector in the long term period.

A key structural change in demand is China’s consumption patterns. According to the US Department of Agriculture, China is transitioning from “eating full” to “eating well”.

“As such, middle-class consumers are choosing snacks and foods perceived to be healthier rather than the traditional snacks and instant noodles of the rural and older consumers,” Gan explained.

“We believe that more than 20 per cnet of palm oil are used to fry instant noodles in China while another 30 per cent are blended with other vegetable oil to make

cooking oil.

“Also, during the Palm Oil Conference in Kuala Lumpur early this year, an industry expert said that in spite of the increase in disposable income, China is consuming more meat instead of vegetables.

“This has increased China’s imports of soybean, which are used to produce feed meal for the poultry and hog industries. China’s soybean imports rose by 67.2 per cent to 88.03 million tonnes in 2018 from 52.6 million tonnes in 2011.”

This contrasts with China’s palm imports fallign by 16.1 per cent to 5.3 million tonnes in 2018 from 5.9 million tonnes in 2011.

“We believe that even if China increases its palm imports, the level of imports would not return or exceed the record high of 6.3mil tonnes in 2012.”

Another structural risk – this time to supply – is if China successfully produces CPO on a big scale. This would reduce China’s demand for palm oil from Malaysia and Indonesia, and thus affect CPO prices.

“Recently, China’s news agency Xinhua reported that the Chinese Academy of Tropical Agricultural Sciences has selected the first palm tree species for mass production in China.

“The tree species realised an oil yield of 2.8 tonnes per ha in trial plantation. The academy has plans to expand cultivation of palm oil in the southern provinces of Yunnan and Guangdong.

“In spite of this, palm oil does not face an existential crisis. In spite of the sombre prognosis, we believe that the palm oil sector does not face an existential risk as cooking oil is a food staple.

“Although there are anti-palm oil campaigns in the EU, which may affect demand from the food segment, we reckon that there are new markets to explore such as Africa.”

India will also remain as a key consumer of palm oil, the analyst added, as it is unlikely that the country’s consumption patterns will change like China.

Finally, palm oil is the livelihood of smallholders in Malaysia and Indonesia, accounting for 40% each of the two countries’ CPO production. In the worst-case scenario, we believe that there will be some form of government support.

However, Gan forewarned that “the good old days are over”.

“We think that it is unlikely that CPO prices would return to its record level of more than RM4,000 per tonne (MDEX price) achieved during the commodity boom in March 2008.

“As such, operating profit margins for the plantation companies are unlikely to return to the highs of 40 to 60 per cent (upstream segment only) as production costs such as labour, are rising every year. Planters also have to grapple with sustainability costs and compliance.

“At the same time, CPO prices are staying low for a longer period.

“Global supply may slow down but timing is uncertain.We conclude that the long-term outlook for CPO may not be as exciting as 10 years ago. However, a silver lining is that global palm supply may slow down due to the decline in new plantings of oil palm in Indonesia.

“The issue is the timing. It is not known when CPO production in Indonesia would start to stagnate. In the coming two years, we think that CPO output in Indonesia would still continue to rise on the back of increases in mature areas.”

 

Uncertainties emanating from the West

A spate of uncertainties come from the US, Africa And Europe.

MIDF Amanah Investment Bank Bhd (MIDF Research) in its June 7 report said the recent announcement by US on its decision to increase the tariff rate – from current rate of 10 to 25 per cent on US$200 billion worth of Chinese goods – has further exacerbated trade tension between the world’s two biggest economies.

“We view that this will have negative repercussion on the US soybean inventory which is at historic high of 24.5 million MT as at April 2019. To recall, historically China is the biggest purchaser of US soybean.

“The heightened uncertainty of the trade deal has also caused commercial buyers to adopt a ‘wait and see’ approach. Should the trade war persist, we view that there will be no reprieve in soybean price which will in-turn inhibit the recovery of palm oi price.”

Notably, the soybean price has hit near decade low subsequent to the announcement of upward revision of US tariff rate on China goods.

Meanwhile, African swine fever virus (ASF) places further dent on the global soybean market. According to China’s Ministry of Agriculture and Rural Affairs, China’s hog industry has been severely affected by the ASF.

“The hog population has shrunk by 20 per cent since ASF was first reported in early August 2018. The mass mortality of hog herd is expected to lead to a significant reduction in soybean imports, which serves as a feed meal for the hog.

“In view of this, the US Department of Agriculture is expecting China’s soybean demand to reduce by 17 million tonnes and 22 million tonnes in 2018/19 and 2019/20 respectively.

“Conversely, the USDA’s data shows that the global production of soybean is expected to reach a new high of 362.1 million tonnes, primarily stemming from the US (123.6 million), Argentina (56 million) and Brazil (117 million).”

Meanwhile, the discriminatory Renewable Energy Directorite II (RED II) palm oil ban commenced on June 10, 2019.

“We expect negative spill over effects from the ban, especially on the palm oil-based food and household products which made up of approximately 70 per cent of global palm oil usage.

“France, which consumes the largest amount of biodiesel, is planning to phase out palm oil from its list of biofuels tax break from 2020 onwards. The ban is also supported by major UK supermarket and retailers.

“For instance, an Iceland supermarket has called for its own-brand products to be free of palm oil. Subsequently, major UK retailer, Selfridges, announced in May 2019 that all of its 300 products in its Selfridges Selection range are now free of palm oil.

“This will hurt the palm oil industry.

“To recall, the EU is the second largest trading partner for Malaysia’s palm oil. The share of export demand from the region has been on a declining trend to 11.6 per cent in 2018 from 13.9 per cent in 2014. On a year-todate basis, 4MCY19’s palm oil export to EU has tapered further by -4.5 per cent y-o-y.

 

Negative outlook persists

At present, the monthly average CPO price remains subdued, averaging at RM1,954 per metric tonne (MT) for the month of May 2019.

MIDF Research did not expect any significant recovery in CPO price in view of the multiple headwinds hampering the industry is facing.

“The overall weakening palm oil outlook to be primarily coming from sustained downward pricing pressure from record high competing oils and subdued export demand which is unable to significant reduced the stockpiles,” it said on the sector in its Strategy Report 2019.

“The prolonged US-China trade war and widespread African swine fever lead to high soybean inventory which in-turn depressed the price of soybean. In view of this, CPO price has been pressured to remain at low level to maintain its competitiveness.”

Meanwhile, expect production to peak in 3QCY19, in-line with historical trend. This could potentially reverse the gradual decline in inventory. Note that CPO price normally trended lower in view of the high
production.

“The deepened negative sentiments from the EU is also likely dampened the demand of palm oil. While there are the palm oil purchase intent deals from China, we view that the demand is insufficient to overcome the elevated stockpiles issue.

“All factors considered, we are downgrading our sector recommendation to negative (previously neutral) with a revised CPO target price of RM2,090 per MT.”

Going into the second half of the year (2H19), Kenanga Investment Bank Bhd (Kenanga Research) believe CPO prices will remain under pressure in 2H19 – potentially trading in the range of RM1,800 to RM2,100 per MT and averaging only RM2,000 per MT in 2019 – given rising stockpiles in both Indonesia and Malaysia possibly revisiting the three million mark.

“Additionally, while biodiesel mandates seem to be panning out well – expected to absorb circa 13 per cent of CPO production in Indonesia and about four per cent in Malaysia – the intensifying US-China trade war tensions are likely to discourage soybean oil prices like what happened last year.

“In our opinion, this will dwarf any positive trade/demand impact on CPO and keep its prices under pressure in the near term, as the two commodities are close substitutes with their prices highly correlated.”

Kenanga Research believe planters’ earnings will hit a rough patch in coming quarters due to the depressed CPO price environment, which will likely overshadow any production pickup in 2H19 – but likely to remain within expectation as it has already been reflected in our latest earnings adjustments.

“We reiterate our underweight call on the plantation sector.”

 

Repairing palm oil’s image

It is no easy feat trying to repair the negativity surrounding palm oil, more so in the West, whereby palm oil exports to the region is at stake.

The European Commission’s (EC) draft regulation suggests to capped the usage of palm oil-based biofuels at 2019 levels until 2023 and, subsequently, reduce the usage to zero by 2030.

Based on the draft legislation, France will be the first country within the Eurozone to phase out palm oil biofuel in 2020.

This indicates that Indonesia and Malaysia, the two top palm oil producing countries, will gradually lose its grips on the European Union (EU) market, said MIDF analyst Martin Foo in a March note.

“Notably, the EC is allowing a number of exceptions. Producers who could show that they had intensified yields may be exempted as it could be argued that the crops cover demand for biofuel without needing expansion onto non-agricultural land.

“The exemption would indicates that there is possibility that Europe could also keep use the same amount of palm oil in diesel as it does at present.

“This would suggest that EU’s interest in palm oil is still holding up in order to keep up with the rising of biodiesel usage due to its pricing advantage as compared to other competing vegetable oils.”

EU is one top export destination. In 2018, the EU market is one of the top the second largest export destination of Malaysian palm oil which constitutes 11.6 per cent of total export. The demand is similar to that of China.

Globally, EU is the third largest consumer of palm oil, accounting for approximately 11 per cent of total global palm oil consumed. This is after Indonesia (16 per cent) and India (13 per cent).

“However, we view that the consumption pattern could change should: EU implement the ban, Indonesia implement more aggressive biodiesel mandate, and higher exports are made to Africa and Middle East.

Tapering demand from the EU will likely have negative repercussion on palm oil price. However, this could potentially lead to higher demand outside of EU as export of palm oil product will be directed to other potential destination.

In addition, lower palm oil price will make the commodity more attractive as compared with other vegetable oils. However, we view that industry players who advocate sustainable production practices could be at the losing end as other export destination may place lower importance on buying Certified Sustainable Palm Oil (CSPO).

The EC concluded that palm oil cultivation is the main cause of deforestation.

However, according to studies done, oil palm use the least of harvested area to produce the most oils and fasts in the world due to its high-yielding properties.

To put in in perspective, oil palm needs nine times less land as compared to its closest substitute, specifically soybean, to produce the same quantity of oil.

Moreover, cattle farming activity is the main cause of forest and land deforestation. Generally speaking, livestock occupies approximately 83 per cent of the total land are used for agriculture as opposed to oil palm which is only about 0.3 per cent.

“Given that the ban is still at proposal level, Indonesia and Malaysia would have some time to take proactive and/or offensive countermeasure. Indonesia has threatened to launch a challenge at the World Trade Organisation (WTO) against the EU and also encouraged companies and industry associations to combat through legal means.

“Meanwhile, Malaysia is looking at restricting imports of French products over French plan to remove palm oil from biofuel in 2020. This latter could include sourcing of fighter jet imports from China rather than EU.

“To counter the risk of declining demand from Europe, The Primary Industry Minister Teresa Kok has taken initial steps to further deepen its reach in Middle East and Africa.

“She also acknowledged the need to quickly capture these markets, considering other competing oil products like rapeseed oil have also made entry in several of the countries eyed by Malaysia to compensate the possible loss of demand in Europe.

“In 2018, export of palm oil to Middle East and Africa regions amounted to 1.7 million and 2.8 million tonnes respectively. This constitutes 10.4 and 16.7 per cent of total palm oil export.

“The Malaysian Government has begun implementing the biodiesel mandate via the B10 and B7 programmes for the transportation sector and the industrial sector respectively to drive the demand for palm oil and increase the sustainability of energy resources.

“The B10 programme has commenced in February 2019 while the B7 programme is schedule to be implemented from July 2019 onwards. These programme are expected to double the usage of palm oil to 761,000 tonnes annually.

“Furthermore, the government has also plans to accelerate the biodiesel mandate to B20 by 2020.”

 

Task force to monitor CPO prices

The Federal government has formed a special joint committee headed by the Ministry of Primary Industries to monitor and ensure that crude palm oil (CPO) prices will remain stable when the country implements the B20 biodiesel fuel next year.

The Primary Industries Minister said the special committee, which also consists of the Ministry of Finance, Ministry of International Trade and Industry and Prime Minister’s Department, would discuss the subject before its implementation by 2020.

“So, yesterday during the cabinet meeting, all the ministries in the joint committee have agreed to work together as it involves rules and laws in different ministries and government agencies,” she told reporters after officiating the FMM-MPOB Second Seminar on Biodiesel (B7) Implementation in Industrial Sector on June 13.

She added that Malaysia was looking into establishing a biodiesel stabilisation fund to help contain biofuel prices, as well as to make the fuel more attractive to consumers.

“We will discuss with other ministries and come up with a new mechanism to ensure that when the CPO prices are high, we are able to stabilise the biofuel prices in the market,” she said.

This was due to public concern that higher biofuel usage would cause palm oil prices to go up.

However, Kok said before implementing any mechanism, her ministry would consult all the stakeholders including petroleum companies and car manufacturers to ensure the plan will proceed smoothly after the implementation of the B20 biodiesel.

“The implementation will make available B20 biodiesel oil at all petrol stations nationwide
for market consumption,” she said.