09/12/2009 (The Jakarta Post) - The recent Indonesian Palm Oil Conference and Price Outlook (IPOC) forecasted a potential shortage of CPO in 2010, on the back of rising demand and limited growth of supply, caused mainly by the commencement of a low cycle, the El Ni*o effect and the replanting program in Malaysia.

Indonesia's and Malaysia's productivity play important roles in catering to increasing CPO demand.

In its framework for the sustainable development of CPO in 2010 and beyond, the government focuses on promoting CPO-based industrial cluster development and progress.

The cluster area concept is intended to develop regional centers for processing CPO into its derivative products including biodiesel.

An example of a ready and stillgrowing CPO cluster area is Dumai in Riau, where the port, roads and other infrastructure-related facilities are integrated in one particular area.

There are at least three more cluster areas to develop: Kuala Tanjung in North Sumatra, Maloy in East Kalimantan and Kuala Enok in Riau.

The global demand for CPO is increasing, not only as a source of edible oil, but also as a source of renewable energy (biodiesel).

In this regard, Oil World forecasts that the world's biodiesel production will increase by 3.3 million tons in 2010, with Germany's 2.7 million tons leading the field.

The world's 2009 biodiesel production is forecasted to reach 15.9 million tons, with 46-47 million tons of installed capacity.

This means that the total global biodiesel production will increase to 19.2 million tons (up 20 percent year-on-year) in 2010, further supporting CPO demand.

Closer to home, in 2009 Indonesia has a total installed biodiesel capacity of 3.1 million tons, but utilization rate was only 20-25 percent because of a lack of incentives and clear mechanisms in developing the industry.

However, assuming Indonesia can reach its full potential in terms of biodiesel production, the country could add 7.5 million tons in domestic CPO consumption. This would mean we could optimally develop the domestic market as the export market has recently been distracted with environment-related issues.

But then, we realize that to develop this potential domestic market, Indonesia needs to find solutions in dealing with industry barriers with regard to biodiesel

Some issues needing to be dealt with include the need for mandatory regulations on biodiesel usage, a clear government policy to subsidize fossil fuel, the formation of biodiesel pricing formula and the debottlenecking of infrastructure development.

It is also imperative for the government to provide incentives for the development of biodiesel to compete against fossil fuels, which are currently still subsidized.

The urgent need for the government to create clearer regulations and form a regulatory body not only to control the mechanism but also to support the overall development of biodiesel in Indonesia, is also important in our view.

From a supply and demand point of view, the 2010 CPO supply is expected to grow 5.5 percent y-y only, slower than the expected demand growth of 6.3 percent y-y.

With this tight supply condition, vegetable oil prices are expected to rise between US$100 and $200 per ton during Jan-Oct 2010, although uncertainties remain, according to Oil World.

We notice there are key main points related to the CPO supply side, particularly from Malaysia.

Among those is the end of a high cycle (i.e. the biological age of trees) and the commencement of a low cycle, expected to begin around April or July 2010 at the latest, which will affect 2010 production in Malaysia's plantations.

The onset of El Ni*o and the replanting program in Malaysia will also potentially impact next year's CPO production.

Meteorologists have predicted that the El Ni*o effect may last until the first quarter of 2010, with adverse impacts on CPO volume being felt in the second half of 2010.

Under the circumstances, experts forecast Malaysia's CPO production to only reach 17.5 million tons in 2009, compared to 17.7 million tons in 2008, (1.3 percent less year on year), and will decrease further in 2010 because of the above factors.

If a decline in production happens again in 2010, it will be the first time Malaysia has seen its CPO production drop for two consecutive years.

Meanwhile, Indonesia is forecasted a growth of its CPO production in 2010 by around 1 to 1.5 million tons. This will bring Indonesia's total CPO production to around 21 to 21.5 million tons next year.

On the demand side, China remains promising, with 38 percent of its imported oils this year in the form of CPO.

It is also worth noting that China's annual CPO demand grew between 5 and 6 percent.

Meanwhile, the 2010 forecast composition of India's import demand has changed from 6.65 million tons of CPO (77 percent of its total imports) initially, to 6.9 million tons (80 percent of total imports).

With Indonesia exporting around 36 percent of its total exported CPO to India (as of October 2009), this will benefit Indonesia in our view.

CPO demand will also be supported by biodiesel use, with 2010 production expected to increase 20 percent y-y (up 3.3 million tons) to 19.2 million tons (Oil World).

Looking at these conditions, we conclude that 2010 supply will be tight, while demand will still increase, which will support CPO prices in 2010.

Based on Dorab Mistry's predictions, CPO prices will trade between 2,800 Malaysian ringgit ($824) per ton, and 3,000 ringgit per ton, compared to our conservative forecast of $700 per ton.

Several other points are also supportive for the 2010 CPO price outlook, such as positive impacts from the global economic recovery, coupled with higher oil prices going forward.