19/11/2022 (The Star Online) - COMMODITY markets are awaiting for China to lift its zero-Covid policy to fuel a broad-based rally in commodities.

Analysts believe that the move can trigger a bull cycle in commodities especially industrial metal and energy which have been suffering low investments in the past few years and the lag period needed to achieve a demand-supply balance.

The rise in agricultural commodities prices will be to a lesser extent and duration, but it is something that will be welcomed by Malaysian plantation companies as the change in Beijing’s policy could help raise exports of crude palm oil (CPO) at good prices and offset the lower intake year-to-date.

It could support the current CPO price levels for longer and reduce high local stock levels which have hit 2.4 million tonnes in October (31% higher year-on-year) due to Indonesia’s aggressive push to clear its own high stock levels ahead of an anticipated global economy weakening in 2023.

While the China market moving event is some months away, likely at the end of first quarter of 2023, Malaysian planters need a sustained high price for CPO to cover rising cost pressures.

The Covid-19 pandemic has raised input costs and exposed the soft underbelly for the industry which is the reliance on manpower for harvesting.

The shortage of labour in the sector, estimated at about 55,000, has led to a fall in the yields in the country. While Putrajaya has moved to re-allow the recruitment of manpower from abroad post pandemic, the outcome of the general election could determine how quickly that can be achieved.

Last year, Malaysian CPO production was 18.1 million tonnes as compared with nearly 19.7 million tonnes in 2018. This translates to a fresh fruit bunch yield of 15.5 tonnes or 3.1 tonne CPO per ha. This is a shortfall of nearly one tonne of oil per ha or equivalent to a loss of five million tonnes of CPO considering the country has a mature land bank of 5.2 million ha.

How much was that in loss of revenue?

Based on the average CPO price in 2021, the five million tonnes of CPO loss equated to a loss in revenue for CPO production of RM22bil.

“The lower production for the past two years was largely influenced by labour issues. The oil palm sector is highly dependent on foreign workers. The temporary suspension of the workers during the Covid-19 pandemic years had significantly affected the production of palm oil.

“The severe shortage of labour had not only disrupted the harvesting process, it had also affected the manuring programme of the estates as the existing workers were redeployed to focus on harvesting. Since the temporary suspension of foreign worker hiring has been lifted, the production is expected to improve.

Improved earnings

The improved earnings of plantations companies like United Plantations Bhd, IOI Corp Bhd (IOI), Kuala Lumpur Kepong Bhd (KLK) and Sime Darby Plantation Bhd (SDP) this year are driven by upstream operations enjoying higher CPO and palm kernel oil prices.

CPO price traded 23.1% y-o-y or RM988 higher to RM5,264.50 per tonne during from January to October. The highest monthly average CPO price was RM6,873 a tonne in May following Indonesia’s move to curb exports after sunflower seed oil supplies from the Black Sea were cut off from the market.

The CPO price is also influenced by the higher soy oil and crude oil prices, and the weaker ringgit against the US dollar.

While CPO price may have weakened since the price peak, it remains supported by the elevated soy oil and crude oil prices after the Organisation of the Petroleum Exporting Countries and allies moved to keep crude oil prices high through production cuts.

Soy oil is trading at a historic US$800 (RM3,640) premium to CPO following the fall in CPO on bearish stock levels.

“US soy oil price is mainly driven by crude oil with nearly 40% of the American bean oil going into domestic biodiesel. Strong crude oil price is supporting soy oil, whereas palm thrives in the edible sector. US soybeans prices have been firming mainly on adverse weather trade (hot dry weather during the harvest period in September) and this supported the soy complex (bean, meal and oil) pricing keeping soy oil elevated,” says Sathia Varqa, owner and co-founder of Palm Oil Analytics.

He says the negative crush margin at the world’s largest soy oil exporter Argentina has tightened global supply, causing soy oil to push higher relative to CPO as Argentinian farmers are holding back sales.

Varqa expects the premium to revert to historical levels of US$100 to US$200 (RM455 to RM911) levels once the greenback eases but warns the ringgit may weaken further against the dollar.

While the discount may narrow, MPOA’s Tek expects CPO prices to hold above the RM3,000 a tonne level due to local driven factors.

“The RM3,000 per tonne figure can be considered as the new norm, as cost of production for some plantation companies is already at this level set against their realised oil yields. There can still be a dip in prices set against global supply-demand of any commodity businesses as price takers and not price makers –but perhaps not in the foreseeable future,” he says.

Breaking the RM3,000 level will also attract good demand, Tek adds.

Price volatility

Varqa expects CPO price to remain volatile and subject to weather vagaries and the performance of other competing vegetable oils which are seasonal crops whereas palm is a perennial crop.

“A fall to RM2,000 per tonne for CPO will be a disaster to plantations facing massive rise in input cost driven by fertilisers and crude oil, not to mention hike in interest rates and weaker ringgit inflating repayments on borrowing on plantations that are highly leveraged,” he says.

Ahmad Parveez of MPOB says CPO price is unlikely to fall below RM3,000 per tonne in the short term unless there is a sudden decline in soy oil to below US$1,000 (RM4,549) per tonne but it is difficult to predict if the RM3,000 per tonne level will be a new normal for CPO prices.

The benchmark CPO futures contract on Bursa Malaysia Derivatives closed the trading week at RM3,845.

Cost pressures may not ease too quickly either.

A fertiliser importer and distributor says the local market was short by some 1.2 million tonnes of fertiliser this year as the high prices on the global market saw main distributors buying less with their limited financial means while the Ukraine-Russia conflict made sourcing harder despite fertiliser from Russia not being put under sanctions by Western powers.

The price of potash for instance had jumped to US$1,000 (RM4,550) a tonne in June while ammonium sulfate went as high as US$640 (RM2,914) a tonne after hostilities broke out before settling at US$745 (RM3,393) and US$500 (RM2,277) respectively.

“The local market is likely going to remain short next year because the main local distributors are happy to make more money selling less at higher prices. The high CPO price means plantations companies can afford to pay while the bad pay master will see supply curtailed.

“Smallholders have generally stopped application as they would rather just make as much from selling the fruit,” he says.

Russia’s move to weaponise energy supplies to Europe will hit fertiliser production levels there and keep fertiliser prices high on the global markets in the foreseeable future.

Tight market

While the United Nations (UN) sponsored grains and fertiliser trade from the Black Sea region will ensure fertilisers from Russia, the world largest exporter, have market access, the sanctions imposed on logistics and financing will impede exports and keep the fertiliser market tight, says the importer.

Varqa forecasts Malaysia’s 2023 CPO production to be 18.5 million to 19 million tonnes based on non reduction in the application of fertiliser especially among the smallholders, no adverse weather impact and on labour supply situation improving.The stagnating yields and constraints on plantation expansion due to commitments to policies such as No Deforestation, No Peat and No Exploitation and Roundtable on Sustainable Palm Oil, leave plantations with mergers and acquisitions (M&As) for growth, according to Tek.

Nixon Wong, executive director and chief investment officer of Tradeview Capital Sdn Bhd, says on a price-to-book perspective, the plantation sector is trading at an average of two times price to book (PB) during pre-pandemic period but valuations have compressed to around 1.4 times PB due to issues related to environmental, social, and governance (ESG).

“Newsflow regarding the European Union (EU) ban of palm oil to be used in biofuel production by 2030 and the US Customs and Border Protection ban palm oil import from selected Malaysian companies are among the factors behind the valuation compression,” he says adding the one-off nature of Cukai Makmur, has a limited implication on stock valuation of planters in general.

The discount could be narrowing as a recent CGS-CIMB Research report on fundflows shows foreign funds are net buyers of companies like KLK, IOI and SDP on a year-to-date basis while local institutions were net sellers.

“Value has emerged, however, we believe any re-rating of the plantation industry will hinge on the direction of the palm oil prices. Should the price of palm oil remain range-bound, we think that plantation stocks could remain a value trap, although investors could take comfort in their 4% to 5% dividend yield which will act as a valuation floor as well in the event that CPO price falls,” he says.

The fund inflows into bigger plantation names in Malaysia are based on fundamental considerations such as positive short-term earnings profile, the weaker ringgit which may provide support to CPO prices (demand shift from premium soyoil), easing oversupply issue in Indonesia and rising demand from biofuel usage in the South-East Asian region, says Neoh Jia Man, fund manager at Tradeview Capital.

Neoh believes profit-taking activities among local institutions may explain their net short stand as they seek to reduce risk ahead of the general election.

“There is no universal agreement on whether palm oil should be banned as part of the ESG investing, and note that even among the developed markets, only around one-third of their asset under management are being subjected to ESG policy. Hence, there are still inflows from foreign funds which have no ESG constraints, in our view,” Neoh says.Nixon says any potential M&A involving plantation companies would be valued at an average PB of 1.7 times as a fair valuation point, but at a discount to historical average PB of two times pre-pandemic when less ESG policies were in place.

With the world’s population crossing the eight billion mark, the demand for palm oil for edible usage remains firm and growing in markets like India, China, Bangladesh, Turkey and the MPOB is strengthening its research and development activities to increase the usage of palm oil for the production of high value-added products for the export markets.

Market access

Ahmad Parveez says the MPOB is also involved with the government to increase market access and further increase the usage of palm oil among consumers in importing countries through bilateral or regional or Free Trade Agreement (FTA) negotiations.

Malaysia’s move to ratify the Regional Comprehensive Economic Partnership will ensure Malaysian palm oil products are guaranteed better market access through the elimination or reduction of import duties and more flexible rules of origin by the 11 trading partner countries involved as compared to countries that do not have an FTA agreement.

That could not come at a more opportune time as the palm oil sector’s poor sustainability record and negative reputation in developed markets poses a threat to future demand.

“Although some large plantation companies are making efforts to improve their sustainability record, we note that the reputation of the global palm oil industry has not improved.

“The EU has adopted more stringent sustainability policies in recent quarters, including the REDII policy, which will encourage the phase-out of palm oil based biodiesel use over 2021-2030,” Fitch Analytics says in a recent report.

It added large developed market food and drink conglomerates are moving towards procuring sustainable palm oil in the short term and are putting increasing pressure on their traditional providers who are unable to comply with sustainability standards.

Ahmad Parveez is confident the EU will remain one of the biggest markets for Malaysian palm oil and believes the move to restrict use for biofuels is motivated more by political influence and trade protectionism than science.

“Malaysia remains committed to have bilateral cooperation and negotiation in a sincere and constructive manner in ensuring the observation of the principles of fairness, justice, openness, transparency, and non-discrimination in conducting international trade as well as a prevention of the unnecessary impending barrier for market access of palm products into the EU,” he says.

https://www.thestar.com.my/business/business-news/2022/11/19/planters-need-sustained-high-cpo-prices