8/8/06 (The Edge News) - After taking huge bets on industrial commodities, hedge funds are now angling to reap returns on Malaysia's newly trendy palm oil market.

As the world's appetite for green fuels grows, the volatility in palm oil prices is increasingly drawing hedge funds to a market which they once shunned.

Biofuel plants are sprouting at a dizzying pace as nations from Europe to Asia seek ways to cut dependence on soaring crude oil, curb greenhouse gas emissions and boost agriculture. Oil has rallied 25% this year on supply worries.

And with demand from the food sector for palm oil also growing sharply, the Malaysian market in coming months will likely see more demand from hedge funds -- which like to make money when markets post wild swings in either direction.

"Funds have never been active in this market because there was nothing to really trigger prices," said an analyst with CIMB Securities. "But now the situation is changing."

Prices have been swinging widely in recent weeks on the market known as the Bursa Malaysia Derivatives, which has been reacting to news on the growing demand for biofuels.

Malaysian palm oil surged 3% in a few hours of trading on one day last month when Malaysia and Indonesia announced that that in the future they would pledge 40% of their output to make biodiesel.

Since then, daily volumes have nearly doubled, with open interest on certain days climbing to as high as 60,000 lots of 25 tonnes each.

Palm oil prices have risen about 13% so far this year. On Aug 8, the benchmark October contract was trading at around RM1,632 a tonne, or US$445.

"This kind of volatility is new to palm oil markets. Volumes have doubled. It's clear new players are in the market," said Amir Chitta, marketing director with Singapore-based trading firm Agritrade International.

Mike Coleman, a partner at a Singapore hedge fund, Aisling Analytics, said funds were aggressively investing in palm futures. "Clearly there is fresh money coming in. It's a changing environment. My money would be on increasing volatility."

Traditionally, palm oil supplies have remained at comfortable levels, with buyers not worrying about stockpiling to make their products that range from cooking oil to cosmetics.

But as biodiesel firms are hedging their risk before they actually start production, the traditional buyers, fearing increasing volatility ahead, do not want to be left behind.

"A lot of people are suddenly worried that there are not going to be enough supplies," the CIMB analyst said.

"Food buyers have new competition. They don't know what these new guys think, when and how much they are going to buy."

Biodiesel manufacturers are finding it equally tough.

"I am trying to lock supplies for our Holland biodiesel plant but nobody is willing to commit," said Sabri Ahmad, chairman of Golden Hope, one of Malaysia's top plantation firms.

"If at all they quote, they quote a very high price of RM1,800 or something."

Golden Hope is setting up four biofuel plants, including one in Holland, which is due to start production in 2008.

Societe Generale de Surveillance, a cargo surveyor closely watched by the market, said last month that exports of Malaysian palm products in July rose 11.8% from a month earlier.

Analysts added the palm oil market in coming months could go the way of the rubber and base metal markets, where prices in recent months saw huge swings and were no longer determined only by production and actual demand.

"Palm oil markets are about to make a transition. The issue will be at what level consumers will stop buying vegetable oils," said Coleman.

And this has made it difficult for some leading forecasters and analysts to even hazard a guess on where prices could go.

"We are into a different game; we are now in RM1,600 to who-knows band," said the head of research at a plantation house.

Traders added palm oil reserves in Malaysia and Indonesia would not decline immediately but supplies could be tight towards the end of the year with new biodiesel plants expected to come on stream. -- Reuters