The El Nino weather phenomenon appears to be imminent and may hurt palm oil production.

10/07/2012 (The Sun Daily) - Prices of crude palm oil (CPO) are expected to climb to as high as RM3,500 per tonne next year, as dry weather caused by the El Nino weather phenomenon curbs palm oil production and stoke a surge in prices, analysts said.

OSK Research Sdn Bhd plantation analyst Alvin Tai has upgraded the regional plantation sector to "overweight" from "neutral" on expectation that palm oil price is on the cusp of a three-year upcycle, fuelled by increasing probability of an El Nino.

"The Southern Oscillation Index's (SOI) recent plunge (to minus 11.8) suggests that the El Nino is imminent and may hurt palm oil production. This could be the initial catalyst for the commodity's price rally," he said in a report yesterday.

Tai noted that palm oil is currently trading at a near US$200 discount to soybean oil. This allows room for the price to move higher, especially if supply is disrupted.

"In the longer term, the potential peaking of Indonesia's production will sustain the price uptrend. We continue to prefer companies with younger trees, which are more resilient against adverse weather, namely SOP, Kencana Agri and BW Plantations.

"We also like Kulim (M) Bhd, which is trading at less than 10 times 2013 earnings after stripping out the 93 sen special dividend. We suggest having exposure to both Malaysian and Indonesian plantation stocks as we do not know at this point in time which country will be the worse-off from the impending drought," he added.

OSK is raising its average price assumption for 2013 to RM3,500 per tonne from RM3,100, as well as incorporating a decline in production growth to factor in drought conditions.

"Compared with the 2012 average CPO price of RM3,215 per tonne year-to-date, RM3,500 represents an 8.9% increase, which is consistent with what happened in 2006. However, unlike both the previous episodes, we believe the impact of El Nino will be immediate in the current scenario given that the trees in Malaysia are already experiencing stress due to dry weather in the past two to three months," said Tai.

"We fear that this upcoming El Nino could be a severe one given that the last region-wide El Nino occurred from 1997 to 1998. We are upgrading Kuala Lumpur Kepong Bhd, Astra Agro Lestari and Glenealy to buys, and upgrade IOI Corp Bhd from 'sell' to 'neutral'.

"We now have 'buy' calls across the board, with the exception of IOI Corp. Our fair values are mainly pegged to a 16 times 2013 price to earnings (PE). There is room for a further upward revision as the sector re-rates, bearing in mind it used to trade in excess of 20 times PE," said Tai.

Alliance Research Sdn Bhd is also upgrading the plantation sector to "overweight" from "neutral".

"We take a view that poor weather caused by a developing El Nino is going to hurt CPO production, thus may bring down inventory levels over the second half of 2012, and driving up CPO prices. Also, supply shortages in the soybean market will add fuel to the fire, keeping major oil seed prices like CPO buoyant," it said.

Alliance has raised its average CPO selling prices for 2012 to RM3,300 per tonne from RM3,200 and its 2013 average CPO selling price to RM3,200 per tonne from RM3,000 previously.

"Based on the data from the Australian Bureau of Meteorology, El Nino spells typically last over a six-month period. As such, if an El Nino has commenced over the month of June, we could see it extend until the end of the year," it said.

"This would mean the annual peak production period, which typically commences in September, could prove to be a disappointment this year.

"Going forward, with dry and hot El Nino conditions picking up, we expect that year-on-year production will continue to be low and the peak production period that typically starts in September, may turn out disappointing numbers. Overall, Malaysia CPO output for 2012 may turn out to be 5-10% lower than 2011's record production of 18.9 million tonnes."