16/03/2010 (Reuters), Chicago - Investment funds are betting U.S. soyoil futures, up 9 percent since February, will keep rallying as the Obama administration pushes for greater use of biofuels to reduce dependence on crude oil.

The United States is set to reinstate the $1-a-gallon tax credit for biodiesel, with recent approval from the U.S. Senate as part of a jobs creation package. The tax credit expired on Dec. 31, sharply reducing production of biodiesel made from soyoil.

Soyoil's recent rally was also partly fueled by the strength of Malaysian palm oil, which has climbed as dry weather from the El Nino weather pattern threatens vegetable oil production in Asia.

Index funds are betting heavily on soyoil, expanding their long holdings of soyoil at the Chicago Board of Trade by about 80 percent since the start of the year. Open interest has risen about 35 percent over the same period.

The new money helped fuel a 9 percent rise since February in CBOT soyoil compared with a 3 percent gain in soybean futures and a 4.5-percent drop in soymeal.

The funds are banking on growth in biodiesel as the U.S. government continues to promote green fuels with strong tax incentives. About 12 percent of U.S. soyoil is used to make biodiesel.

"Soyoil has been getting support from the biofuels sector, not just from the U.S. but globally, with palm oil leading the way up. The margin between soyoil and palm oil was getting too narrow so soyoil had to go up," a cash-connected soyoil trader in Chicago said.

The spread between soybeans, soymeal and soyoil usually does not vary that much and are not usually as volatile. But the demand for soyoil has been outstripping the demand for soybeans and meal as the government moves closer to reinstating a $1-per-gallon tax credit for biodiesel blenders.

SOYOIL, AN ADVANCED BIOFUEL
In addition to the $1-a-gallon tax credit, soyoil got an added boost in early February from being classified as an advanced biofuel that could help reduce greenhouse gas emissions.

The new classification by the Environmental Protection Agency means that soyoil used to make biodiesel will meet the U.S. Renewable Fuels standard, which calls for producing 36 billion gallons (136 billion liters) of biofuels by 2022, up from only 13 billion gallons this year.

Research firm AgResource Co in Chicago said it estimated the classification could boost demand for soyoil by an additional 250 million to 450 million lbs (100,000 to 200,000 tonnes) in the current marketing year that ends in September, and by 700 million to 900 million lbs (300,000 to 400,000 tonnes) in 2010/11.

"The soyoil lows were made right before the EPA signed off on the mandate and now we're waiting for reinstatement of tax credits to make oil profitable for biodiesel use," said Roy Huckabay, analyst for Chicago-based trade house The Linn Group.

KEEPING UP WITH PALM OIL
Malaysian palm oil futures have rallied on weather concerns, prompting soyoil futures to rise to keep pace. However, soyoil has been losing ground, with the spread narrowing to $70 from $120 at the start of the year.

"The tax incentive situation is one supportive factor for soyoil but No. 2 is the strong palm oil market. The spread between palm and soyoil is usually around $100 per tonne but it's much narrower than that now so soyoil is trying to stay ahead of palm," said Vic Lespinasse, analyst for GrainAnalyst.com.

Palm oil rose more than 50 percent last year, its biggest annual climb in more than a decade, and has held onto the gains so far in 2010.

The El Nino weather pattern has led to dry weather in parts of Malaysia and the Philippines and continued dryness would further lift Malaysian palm oil futures and could further boost CBOT soyoil futures.

Also there is increased demand for soyoil for the cooking and baking industries versus palm since studies have shown it to be a healthier vegetable oil for human consumption than palm oil.

"People want to own soyoil because it's better quality than palm. They want to own a Cadillac instead of a Ford," Lespinasse said.