28/ 8/06 (Bloomberg) -- The best-performing oil investment comes from trees in Malaysia, not the deserts of Saudi Arabia.

Vegetable oils from palm trees normally used in Hellmann's mayonnaise and Snickers chocolate bars are being converted to diesel for Mack trucks after oil more than doubled in the past three years and governments encouraged renewable fuels. Palm oil reached a two-year high this month and rose 15 percent in the past year, outperforming the crude oil used for most diesel.

Palm oil in Kuala Lumpur may rally 20 percent in the next six months as factories making so-called biodiesel sprout from Beijing to Seattle, said Michael Coleman, who helps run a $370 million hedge fund in Singapore. At Schroders Plc in London, Christopher Wyke expects a 25 percent gain in the next year.

``It's a very attractive investment,'' said Wyke, who helps manage $85 million of commodity investments.

In Europe, where one of every two new cars sold burns diesel, biodiesel output will double by 2008 to meet European Union targets for alternative-fuels use, the International Energy Agency in Paris forecasts. Fuel from palms, soybeans and rapeseed now supplies less than 1 percent of the world's diesel.

The European Union ordered that 5.75 percent of all fuel for trucks and autos must come from renewable sources by 2010. Fuel production from vegetable oils worldwide is expected to triple by 2008, with most of the growth in Europe, the IEA forecasts.

Production Surges

Supplies of diesel fuel from vegetable oils soared 80 percent in 2005, the agency said in July. That outpaced a 14 percent increase in production of ethanol, a fuel derived from corn and sugar that's used as an alternative to gasoline.

Crude oil reached a record $78.40 a barrel last month and has driven up the cost of diesel and gasoline, making biofuels more competitive. Palm oil costs $507.50 a ton in Europe, less than about $680 for a ton of crude oil-derived diesel. Governments are subsidizing biodiesel to diversify energy supply and reduce greenhouse-gas emissions.

Vegetable oil-based diesel is made through a chemical process where the glycerin is separated from the fat, or vegetable oil. The process leaves behind two products -- methyl esters, the chemical name for biodiesel, and glycerin, a byproduct usually sold for manufacturing in soaps and antifreeze.

Palm oil comes from bunches of plum-sized fruit on the tree, which becomes productive from about 30 months after planting.

In Europe, biodiesel costs the equivalent of 72 U.S. cents to produce, according to New Energy Finance Ltd., a London-based advisory company. A liter of diesel fuel sells for 81 cents on the wholesale market.

`Critical Mass'

``As long as crude oil is above $50 a barrel, there is a momentum to biofuels that is unstoppable,'' said Coleman, of the Cayman Islands-domiciled Merchant Commodity Fund, which has returned 42 percent in the past year. ``It doesn't matter what happens to crude.'' Oil has traded above $50 since May 2005.

``The industry has got to a critical mass whereby it can weather downturns in the price of crude,'' said Andrew Owens, chief executive officer of Greenergy International Ltd., a biofuel supplier in London to retailers including Tesco Plc, the U.K.'s largest supermarket company. ``That wasn't the case two years ago.''

Palm oil isn't just for trucks and cars. A U.K. unit of RWE AG, Europe's third-largest utility, may convert a power plant to burn palm oil after it evaluates the costs and technical issues, spokesman Leon Flexman said.

Biox Group BV, a biofuel producer based in the Netherlands, will have the first of four power plants running near Vlissingen, the country's third biggest seaport, early next year. The power will be sold to a Norwegian aluminum smelter.

Malaysia, Indonesia

``Right now, palm oil is the cheapest and most efficient of vegetable oils,'' said Group Finance Director Edgare Kerkwijk, who moved to Singapore last year to be closer to the suppliers in Malaysia and Indonesia. ``We need 100,000 tons a year. We can switch to other fuels when palm oil becomes too expensive.''

Malaysia and Indonesia produce 85 percent of the world's palm oil, the most consumed vegetable oil, and the U.S., Brazil and Argentina grow 80 percent of the soybeans. In Europe, palm oil is gaining market share, though most plant fuel comes from local harvests of rapeseed, sometimes called canola.

Fuel demand is adding to already booming consumption of vegetable oil for food and chemicals. China will import 8.5 million tons of vegetable oils this year, of which 64 percent will be palm oil, Standard Chartered Bank said in a report. Food use of palm oil will rise 4.5 percent this year and industrial use 9 percent, the bank said.

Prices and trading volume have soared on the Kuala Lumpur palm oil futures market. Palm oil rose 16 percent in three months to reach 1,677 ringgit ($456) a ton on Aug. 9. The commodity fell 1.5 percent to 1,575 ringgit a ton today.

`Phenomenal' Growth

``The growth has been phenomenal in my experience, in all my 27 years of being in this market,'' said Kelvin Lee, a broker with Palma Commodities Sdn. Bhd. in Kuala Lumpur.

The number of outstanding contracts on the exchange, called open interest, has doubled to 65,000 in the past four months. That's 1.6 million tons, or 10 percent of Malaysia's crop.

``We'll see open interest reaching 100,000 by the end of the year,'' because of the European push on biofuels, Lee said.

The shares of plantation owners in Malaysia and Indonesia have surged. PT Astra Agro Lestari, the largest plantation company in Indonesia, has jumped 79 percent this year. IOI Corp., Malaysia's biggest oil palm plantation company, has gained 33 percent.

Carlyle Likes Biodiesel

Fuel from vegetable oils is a better investment than fuel from sugar or corn, said Charlie Thomas, who helps oversee $754 million in so-called green investments at Commerzbank AG's Jupiter fund unit in London.

``Biodiesel is behind the curve, so there are substantial returns to be made in this area,'' Thomas said. He expects annual returns of 60 percent in biodiesel investments over the next two years, compared with 30 percent at most in ethanol.

U.S. use of vegetable oils for fuel is increasing too. Nationwide, 65 plants have a total capacity to produce 395 million gallons of diesel fuel from soybean oil and other supplies, according to the National Biodiesel Board in Jefferson City, Missouri. An additional 714 million gallons of capacity is expected to be completed in the next 18 months.

Carlyle Group, which oversees more than $40 billion of private-equity funds, and Riverstone Holdings LLC, the manager of $6.5 billion, have announced plans for a controlling stake in Green Earth Fuels LLC, which will build two plants in the U.S., each capable of producing 43 million gallons a year.

Willie Nelson

Singer Willie Nelson set up Biodiesel Venture GP with Peter Bell of Distribution Drive and three partners in December 2004. Distribution Drive is a unit of Earth Biofuels Inc., whose shares have gained nine-fold in the past year. The Standard & Poor's 500 stock index rose 6.8 percent in that time, and the S&P Integrated Oil & Gas Index gained 18 percent.

The growing use of palm oil as fuel may threaten virgin rainforest in Southeast Asia and quicken deforestation, raising the likelihood of legal challenges from environmentalists, say some investors.

``The biggest challenge to palm oil is sustainability,'' said Domenic Carratu, managing director of commodities at Rabobank Groep in London. ``Biodiesel aims to be environmentally friendly, but this would not be the case if the feedstock were only grown at the expense of virgin rainforest.''

Vegetable oils will meet some of the world's energy demand and may help curb growth in consumption of crude oil, say energy analysts. It won't solve a lack of refining capacity.

``There's a place for biodiesel,'' said John Baize, president of John C. Baize and Associates, an advisory company in Falls Church, Virginia. ``But it's not the solution because we don't have the feedstock'' to meet demand.