1/3/07 (The Edge News)  -  Crude palm oil (CPO) prices have surged sharply in the fourth quarter of 2006 (4Q06), with prices surging close to RM2,000 per tonne at present from around RM1,400-RM1,500 per tonne for much of the first three quarters of last year.

The high CPO prices fueled an earlier rally in plantation stocks, vindicating our positive view on the sector, as well as our main picks, Batu Kawan and Golden Hope. After a strong rally, and with the El Nino weather phenomenon having officially ended this week, we think it is time to lock in some profits on plantation stocks.

Our biggest concern is that we believe the current high price of CPO is not sustainable. Two of the major drivers of last year's rally were expectations of biodiesel demand, and the return of the El Nino weather phenomenon. Both of these factors have since dissipated.

Palm based biodiesel is unviable at current high CPO and low crude oil prices. The El Nino weather phenomenon, which started in September 2006, has now officially ended, according to the US National Oceanic and Atmospheric Administration (NOAA) on Feb 28, 2007. This will give way to La Nina instead, which brings abundant rainfalls and boosts palm oil output.

Palm biodiesel not viable anymore
Crude oil prices have fallen 24% from a peak of US$78.40 (RM274.85) per barrel in mid-2006 to just over US$60 per barrel. In that same time, CPO rose some 35% from around RM1,450 to RM1,950 per tonne -- and more in US dollar terms given the ringgit's strength. This makes the viability of palm biodiesel very questionable.

After factoring in conversion costs, estimates have placed the current cost of palm-based biodiesel at around US$90 per barrel. The viability of Golden Hope's biodiesel projects for example, is based on crude oil prices of around US$55 per barrel, and CPO prices of RM1,400 per tonne. Crude oil prices are now 10% above those levels, but CPO is nearly 40% higher.

Golden Hope's projections also take into account the fact that it is a palm oil producer, and its actual CPO costs are much lower. That is something not enjoyed by those without a plantation landbank. With questionable viability and volatile crude oil prices (dipping even below US$50 earlier this year), we suspect many of the planned biodiesel ventures will not materialise.

Jatropha, the hottest plant for biodiesel
Indeed, palm oil is now out-of-favour as a biodiesel feedstock due to high prices and also environmental concerns in Europe about forest degradation. The hottest plant is now Jatropha, an African bush plant which Newsweek recently touted as a "Cinderella plant".

Jathropha can grow in the most hostile and hardy conditions –- even in arid or wasteland, or marginal plots of land. They can withstand drought and need little care or fertilizer. As the seeds are toxic, they are also pest-resistant. Jatropha shrubs can start producing oil-bearing seeds after just six months and last up to 50 years. It also doesn't need refining first, unlike palm oil, to turn into biodiesel –- saving one major production step and costs.

The plant is now seen as the catalyst for Africa's revival, making the continent potentially the biggest source of the world's biodiesel supply. Jatropha plantations are now popping up in most parts of Africa, as well as in India and China. Norwegian, Indian and British companies are racing to buy up or lease enormous swaths of African land for jatropha plantations.

In India, nearly half a dozen states have set aside a total of 1.72 million hectares of land for jatropha cultivation and small quantities of jatropha biofuel are already being sold to the public sector oil companies. It is likely that some biodiesel plants that were initially meant to use palm oil as the feedstock will eventually switch to jathropha.

Exports falling every month
Already, high CPO prices have begun to deter buyers and hurt palm oil exports –- one of the country's largest export earners. High prices have led to successive month-on-month falls in palm oil exports since Oct 2006, when CPO prices started to rally sharply.

Monthly exports of Malaysian palm oil products have dropped from 1.97 million tonnes in October 2006 to 1.82 million tonnes in November 2006, 1.76 million tonnes in December 2006, and 1.4 million tonnes in January 2007, according to the Malaysian Palm Oil Board (MPOB). This week, cargo surveyor SGS (Malaysia) announced that February 2007 exports fell 10.3% month-on-month.

Palm oil stock levels are currently high at 1.54 million tonnes in end-January 2007, although off a record high of 1.8 million tonnes in September 2006. Production is also fast rising in Malaysia and Indonesia. Malaysian palm oil production grew 6.1% to 15.9 million tonnes in 2006, and is expected to rise by 5.5% to 16.7 million tonnes in 2007, according to the MPOB.

Indonesian production is estimated to have increased by 14% in 2006 and another 6% in 2007, to reach 16.8 million tonnes, according to PT Astra Agro Lestari. This means Indonesia could surpass Malaysia as the world's top grower of palm oil by this year.

El Nino has ended, enter La Nina
There were earlier fears that a return of the El Nino weather phenomenon, which causes drought in this region, will hurt production. However, as mentioned earlier, the El Nino weather phenomenon has now officially ended, according to the NOAA.

The NOAA, which confirmed the earlier El Nino phenomenon, said that a shift to La Nina, the flip side of El Nino that causes more rains to this region -– was brewing and its effects will be felt in a few months. The end of El Nino will remove fears of possible production shortfalls. La Nina's bumper rainfalls usually boosts palm oil production.

During the last severe El Nino season in 1997-98, Malaysian palm oil production fell 8.3% to 8.3 million tonnes in 1998, while CPO prices surged from an average of RM1,358 in 1997 to RM2,377 per tonne in 1998, albeit helped by a weaker ringgit during the Asian financial crisis (the ringgit traded up to RM4.80 per USD before capital controls were imposed).

As El Nino receded and gave way to La Nina with its abundant rainfalls, Malaysia's palm oil production surged 26.8% to 10.55 million tonnes in 1999. CPO prices then slumped to an average of RM1,449 per tonne in 1999 and just RM997 per tonne in 2000.

China concerns
Fears over a potential slowdown in China's overheating economy -– which sparked the recent plunge in global and commodity stock markets -- may also have repercussions on CPO prices. China has been the biggest buyer of Malaysian palm oil for the past five years, and accounted for 25% of our total palm oil exports.

Fears of a slowdown in China's economy traditionally hit global commodity prices, as China is one of the world's largest consumer of commodities. Indeed, prices of almost all commodities –- from grains to metals have fallen sharply since the recent market slide began. Surprisingly, CPO prices have remained resilient.