Friday July 22, 2005, KUALA LUMPUR (Dow Jones)--Malaysian palm oil pricessaw the sharpest decline in more than a month Friday after the governmentlate Thursday put the Malaysian currency under a managed float regime,moving away from a fixed exchange rate of 3.8 to the dollar.

So far, the ringgit has made only modest gains against the dollar, tradingin the 3.7800-3.7850 range, contrary to earlier fears of a sharp move up.

However, ringgit-denominated crude palm oil futures on Bursa MalaysiaDerivatives fell sharply on fears that a gradual appreciation of theringgit would make Malaysian palm oil less competitive in theinternational market.

Malaysia produces around 14 million tons of CPO every year and nearly 90%is exported.

As producers, refiners and traders scrambled to figure out the impact ofthe removal of Malaysia's 7-year old currency peg, the benchmark OctoberCPO futures contract fell to MYR1,385/ton at the midday close, down MYR23from Wednesday, hitting its lowest level since mid-June.

Malaysia's move to let its currency fluctuate against a wider basket ofcurrencies came after China announced a long-awaited currency-policychange with broad symbolic significance, helping ease tensions withtrading partners.

Thursday, the People's Bank of China said the yuan's de facto peg to thedollar would be dropped in favor of a managed float against a basket ofcurrencies. In the process, the yuan was initially revalued about 2% toCNY8.1100 to a dollar from CNY8.2765. That went part way to satisfycritics who say the yuan has long been significantly undervalued, makingChinese goods cheaper abroad and thus giving the Chinese an unfair tradingadvantage.

More Competition From Indonesian CPO Likely

While a stronger yuan could be termed positive for palm oil, which Chinabuys in large quantities, much of that benefit will be negated by astronger ringgit which will make rival Indonesia more competitive in theinternational market, traders said.

Indonesia is the second largest exporter of palm oil after Malaysia.

Meanwhile, weaker CPO prices would translate to reduced earnings for CPOproducers in Malaysia.

Competition from Indonesian palm oil and other edible oils such as soyoilis expected to limit the room for product prices to be raised to offsetthe potential reduction in ringgit earnings following a stronger currency.

The ringgit-denominated CPO, therefore, is bearing the brunt of theadjustment.

"Of course there will be an impact on us (because) we earn less income"said Azizi Meor Ngah, chief executive of the Malaysian Palm OilAssociation, a lobby group for producers.

However, a stronger ringgit also brings with it some positive factors forthe industry that may help cushion the impact from a drop in CPO prices.

"What is visible to most people is the lower income because of thestronger ringgit. But what is not seen is that the cost of imports willalso be lower," he said. "There will be checks and balances."

An appreciation of the ringgit will make key imports like fertilizer,chemicals, pesticides and even foreign labor cheaper for producers.

Refiners See Near-Term Problems

While refined product prices, denominated in dollars, have largelyremained unchanged, refiners may face a near-term, transitional cash flowproblem.

Many who have been caught unawares by the surprise ringgit announcementstand to make losses if they honor commitments made before the currencypeg was changed.

"In the commodity business, we always trade ahead, three to four monthsforward. We have already made commitments to buy in ringgit andcommitments to sell in dollars up until the end of the year," said thehead of a mid-sized refining and processing company.

In short, refiners will have to buy CPO in ringgit and sell products indollars at prices agreed upon prior to the change. But those dollarcontracts will be worth less now, squeezing their refining margins.

Difficulties in hedging their foreign exchange exposure have added torefiners' woes.

"We are now trying to go to the banks to cover our forex exposure but itis not that easy. Banks will not give forex lines for deals that are yetto be performed. Maybe they will give if we can provide evidence of ourtransactions like letters of credit, but that is something we can't getnow for a deal that will only be done, say, in November or December," therefining company head said.

This has slowed activity in the Malaysian cash palm oil market, as therisk of unexpected foreign exchange exposure is keeping refiners away forthe time being.

"For the moment, refiners dare not commit to supply any more quantitiesbecause who knows, the ringgit may just keep getting stronger andstronger. They are more concerned now about working with the banks to tryto fix their exchange rates," a Singapore-based trader said.