6/12/05 KUALA LUMPUR (Dow Jones)--Palm oil prices found a new supportive factor when anticipated demand from the biofuels sector altered the dynamics of palm oil pricing in 2005.

Analysts say that is set to continue in 2006.

However, changing U.S food labeling laws and a removal of import quotas in China will play an equally important role in 2006, analysts and industry participants say.

"Vegetable oils are now playing on a much bigger field -- that of energy, not just of food. It is no longer possible to assess their prices by simply analyzing food demand," said Dorab E. Mistry, director of the U.K.-based Godrej International Ltd. and an influential price forecaster.

The benchmark third-month crude palm oil futures contract on the Bursa Malaysia Derivatives closed at MYR1,402 a metric ton Nov. 5, coming off a high of MYR1,504 reached in March amid rising oil prices and talk of demand from the fuel industry.

For 2006, analysts expect CPO to move between lows of MYR1,300-MYR1,350 and highs of MYR1,600-MYR1,650.

The forecast 2006 range is only slightly higher than that of 2005 because production of all edible oils including palm oil, is expected to be rise further.

According to industry projections, Malaysia's CPO output will rise by about 500,000 tons in 2006 from an estimated 15.2 million-15.4 million tons in 2005, while Indonesia's 2006 production is expected to rise to 14.7 million tons from an estimated 13.6 million tons in 2005.

Although supply would be ample in 2006, demand looks set to be just as robust, lending support to palm oil prices, analysts say.

Too Much Hype About Biofuels?

For a large part of the additional demand, the industry is banking on the use of palm oil as an energy source - as a diesel substitute for motor vehicles and as biomass fuel for burning in power plants.

At least some of that optimism is not unfounded.

Crude oil prices are still at levels that render biofuels, which enjoy tax breaks in many major markets, economically viable, analysts say.

"The number of biodiesel projects coming onstream is quite phenomenal," Godrej's Mistry said, adding that with incentives, biodiesel is viable even with crude oil prices at $40-$45/barrel.

Three Malaysian government-initiated plants and two large facilities in neighboring Singapore, separately owned by U.S.-based Archer Daniels Midland and Germany's Peter Cremer GmbH, are among a host of worldwide biodiesel projects in the pipeline in 2006 that would use palm oil as feedstock.

Still, for all the potential biofuels hold, the palm oil market needs to be wary of getting carried away in its expectations, some analysts say.

One obvious area of concern is the direction of crude oil since there is no certainty the environment of high prices would continue throughout 2006.

A lot of hopes are also being placed on key biodiesel consumers such as the U.S and European Union which use palm oil that is traditionally cheaper than soyoil and rapeseed oil.

But there are doubts whether governments in these countries will give full, unimpeded market access to products that compete directly with oils produced by local farmers.

"To what extent they will allow imported oils to go in is (a) question," said Low Mong Hua, executive director of palm oil refiner Southern Edible Oil Industries (M) Sdn Bhd.

Adding to such concerns, European state support for the biofuels sector in general has seen some decline.

The Netherlands plans to slash in 2006 subsidies for biomass used for co-firing in electricity plants to EUR25 per megawatt hour from EUR66 previously.

The cut effectively makes edible oils about $160/ton more expensive, said Ard Van de Kreeke, managing director of Dutch biofuels supplier Biox Group BV.

"The subsidy reduction means that in the Netherlands, consumption of up to a couple of hundred thousand tons may be affected because co-firing may become less feasible," he said.

That would be a blow to palm oil since the Netherlands accounts for around three quarters of the annual volume of about 500,000 tons of palm oil used in power plants across Europe, though increased consumption in other countries may help cushion a drop in Dutch demand, he added.

U.S Food Laws, China Opening To Boost Consumption

Palm oil demand is still expected to grow in 2006 as stricter U.S food labeling laws that may be unfavorable for soyoil comes into effect.

Starting January, the U.S Food and Drug Administration will make it mandatory for food manufacturers to declare trans fatty acid content on nutrition labels of all food products containing more than 0.5 grams of trans fat per serving.

For decades, partially hydrogenated soyoil has been a staple ingredient in U.S food products such as cakes and cookies. But it has gained notoriety recently after studies showed that consumption of trans fats increases the risk of heart diseases, prompting the FDA to take action.

With food manufacturers increasingly looking for substitutes, palm oil is emerging as a viable option as it is naturally semi-solid and doesn't require hydrogenation. It's price discount is another attraction.

"The total consumption of partially hydrogenated oils in the U.S is about 10 billion pounds a year. Half of that amount, equivalent to about 2.5 million tons, would be affected by the labeling laws and potentially needs to be replaced," said Gerald McNeill, U.S.-based director of research and development at Loders Croklaan, a specialty fats maker.

China's removal of an import quota system for edible oils could also boost demand for palm oil. After it joined the World Trade Organization in 2002, China has gradually been increasing import quotas. The quota system will be scrapped in 2006 and replaced with a flat rate of 9% on all imports.

Many analysts believe palm oil, with its lower prices, will be the biggest gainer in an open Chinese market.

"Previously, only selected Chinese traders who were allocated quotas by the government could import. Now, a lot more people would be able to import on their own," said U.R. Unnithan, executive director of Carotino Sdn Bhd.

However, Unnithan and other analysts say upside room for imports wouldn't be limitless as China may set new guidelines to indirectly control supply.