05/01/2009 (The Edge Daily), Kuala Lumpur - It was a roller-coaster ride for oil palm players in 2008, as crude palm oil (CPO) started the year at RM3,050 a tonne, gaining momentum to scale new heights at RM4,486 and then a freefall to RM1,390 a tonne.

With the exuberance in CPO prices tapering off, what is in store for planters this year? Will the price of the commodity recover to above RM2,000 a tonne?

Macroeconomic conditions would be the key to gauge where CPO prices are headed, said Dorab Mistry, director of Godrej International Ltd, a unit of Godrej Industries Ltd, one of India’s biggest buyers of vegetable oils.

“By the second quarter of 2009, the world economy will be on the mend. The massive financial stimuli administered by each country could be powerful drivers of recovery and of growth.

“If that were to happen, we shall see higher commodity prices in general. On top of that, the fundamentals of palm are per se improving dramatically,” Mistry told The Edge Financial Daily via email.

He also predicted that CPO prices at or above RM2,000 a tonne would be “attainable at some time in 2009”.

Plantation players prefer to adopt a cautionary stance. Kuala Lumpur Kepong Bhd (KLK) expected the average CPO price to be RM1,700 to RM1,800 a tonne on slowing demand for the commodity while United Plantations Bhd predicted prices to remain at current levels.

“2009 is going to be a tough year. Let there be no doubt about this. It is better that we accept the fact and take mitigative measures, so we can come out stronger,” said United Plantations vice-chairman Datuk Carl Bek-Nielsen.

A palm oil trader said a rally in CPO prices would only be seen towards the second half of 2009 as the world’s economies recovered with the various stimuli introduced by their governments.

At around RM1,500 a tonne, plantation firms are still making profits. However, this holds true only for the more efficient and bigger companies.

For the smallholders and the less efficient players, it would be another story. According to industry players, the break-even point for smallholders is RM1,500 a tonne.

“The number of plantation companies wishing to exit the business is likely to increase in 2009 as the credit crunch, coupled with lower CPO prices, will force some players to exit this business,” said Bek-Nielsen.

“We can therefore expect to see a bit of consolidation taking place within the industry where some of the smaller players will be taken over by better-consolidated players.”

The top executives at KLK and conglomerate Sime Darby Bhd have spoken of their plans to continue their expansion plans, although KLK’s group plantation director Roy Lim said the company would be more conservative in its expansion, focusing on good and strategic green fields.

KLK intends to expand its plantation landbank with the planting of 10,000 hectares of new palms every year in Indonesia. Currently, it owns some 210,000ha of plantation land in Malaysia and Indonesia. Of its total landbank, some 170,000ha are planted. The company has a cash pile of RM1.1 billion.

Sime Darby aims to double its landbank to one million hectares by 2011 from the present 522,363ha.

While the ups and downs of CPO prices had been fuelled by speculative elements, the biodiesel appeal, the competition with soybean oil, and its relation to crude oil prices, what matters ultimately is the fundamental law of supply and demand.

“CPO prices are viewed to remain around this level until there is a change in the supply and demand scenario. There is a strong correlation between world gross domestic product (GDP) growth and the demand for vegetable oils. When global GDP contracts, generally the demand for vegetable oils would decline,” said Bek-Nielsen.

China, the world’s biggest buyer of CPO, posted a GDP growth of 9% — the first single-digit pace for the country in the last three years. The lower growth has dragged down China’s imports, including palm oil.

Palm oil exports to China dropped to 256,030 tonnes in November from 320,282 tonnes in October, according to a recent report by independent cargo surveyor Societe Generale de Surveillance.

The report also showed Malaysia’s palm oil exports to the European Union declined to 256,030 tonnes from 317,668 tonnes and sales to the US declined to 110,817 tonnes from 162,927 tonnes. Exports to India, however, rose to 112,020 tonnes from 82,080 tonnes.

While demand dropped, production of CPO rose to new records on improved yields and ideal weather conditions, creating an oversupply.

Data released by the Malaysian Palm Oil Board (MPOB) showed CPO stock rose to 2.27 million tonnes in November from 2.1 million tonnes in October. This could very well boost Malaysia’s 2008 production to 18 million tonnes, Mistry said, from 15.8 million tonnes in 2007.

Nevertheless, the high production cycle would have ended and a downcycle would have begun in December.

Palm oil, which competes with soyabean oil, has always had the edge as it is traded at a discount to soyabean oil. However, the discount is likely to narrow as supply of palm oil decreases.

Cutting production to boost prices
In a bid to reduce CPO stock in the market, Malaysia and Indonesia — both major producers of palm oil — have adopted a replanting strategy to cut short-term production. By replanting trees that are 25 years and older, CPO output from both countries could be reduced significantly by some 800,000 tonnes this year.

Indonesia plans to replant some 50,000ha of oil palm land while Malaysia aims to replant some 200,000ha.

To encourage replanting, MPOB has allocated RM200 million from its price stabilisation fund for the effort where six plantation firms — KLK, United Plantations, Sime Darby, IOI Corporation Bhd, Boustead Holdings Bhd and state plantation authority Felda — have pledged their commitment to the replanting plan.

The six have also announced plans to reduce the use of fertilisers in a move to cut costs and to reduce production. Fertilisers became very costly when oil rallied to a high US$147 a barrel in July. While prices of oil had dipped, the same could not be said of fertilisers.

Biodiesel mandate
To boost demand for palm oil, the Malaysian government had issued a mandate for a biodiesel blend of 5% at pump stations from next month. Should the plan kick off, Malaysia would require some 500,000 tonnes of CPO to produce palm-based biodiesel. When oil was trading at US$100 a barrel, it was feasible to produce biodiesel. That viability has dimmed, as crude continues to tumble.

The question is, at what price levels (for crude oil and CPO) would it be profitable to produce palm-based biodiesel? Biodiesel firm Platinum Energy Group’s chief executive officer Edward Leong said the business model for the palm biodiesel industry had always been on the basis of its mandated use in the European Union (EU) and US.

“It has never been a question of commercial competitiveness of palm biodiesel versus fossil and petroleum-based diesel. Rather it is the mandated use, which would dictate the profitability and sustainability of the palm biodiesel industry,” he said.

Commenting on Malaysia’s biodiesel mandate, he said: “The current efforts by the government address goals, the first being a mechanism to bolster CPO prices and the second, to assist this industry.

“Most of the plants which were up and running, or which were ready to run were built on a model where the main market would be EU and US. To an extent, we are fortunate that interest is picking up in this region.”

To date, 86 of the 91 licensed biodiesel plants had stalled their production plans given the costly palm oil feesdstock and low margins. That leaves only five plants actively running, out of the 14 biodiesel plants that have been fully constructed in the country.

RHB Research remained cautious on the biodiesel sector on uncertainties surrounding the Biofuel Act. “There are no set timelines and the variability of the Act to potentially change the mandated blend could result in greater risks faced by potential biofuel manufacturers,” it said.

“Unless palm-based biodiesel is more widely accepted globally, Malaysia may continue to have an oversupply of biodiesel capacity.”

Meanwhile, analysts said planters such as IOI Corp and Kulim Malaysia Bhd would ride out the storm this year.

“In light of the weak CPO price, especially in the first half of 2009, those with strong downstream — IOI Corp and Kulim — would fare better,” OSK Research plantation analyst Alvin Tai said.

Although falling CPO prices would be negative for the plantation business, these two companies’ strong downstream activities would serve as a natural hedge and cushion the sharp drop in prices. Tai maintained a trading buy on both IOI Corp and Kulim, with target prices of RM4.22 and RM6.90, respectively.