18/10/05 (Business Line) - FIRM crude prices and no prospects of a majordownward correction anytime soon have forced all major economies toexamine cheaper alternatives, including bio-ethanol and bio-diesel. Demandfor bio-diesel translates into a diversion of a part of global vegetableoil pool for energy purposes.

For the last four years, the use of bio-diesel - blending diesel withtrans-esterified vegetable oil to the extent of 5-10 per cent - in theEuropean Union and the US has been rising, with policymakers supportingthe mover with tax breaks. With crude market threatening to breach the$70-a-barrel mark, exploration of cheaper substitutes has become all themore urgent and necessary.

For the global vegetable oil market, which by its very nature is volatile,the widespread expectation of the increased use of vegetable oil forbio-diesel purposes has sent bullish signals.

Experts and analysts are going overboard in projecting a massive diversionof vegetable oil from the existing pool for energy purposes and suggestinga huge increase in global vegetable oil prices.

The world usage of vegetable oil for bio-diesel purposes was an estimated3 million tonnes (mt) or just under 3 per cent of the global vegetable oilproduction last year. Major users are the EU (mainly rapeseed oil) and theUS (mainly soyabean oil). The EU usage of vegetable oil for bio-diesel hasbeen rising at about 30 per cent annually in the last two years. The USutilises about 600,000 tonnes of soyabean.

With the crude market ruling firm for the last several months, there is ajustified expectation of a larger diversion of vegetable oil forbio-diesel purposes in the year ahead. This has lent a firm undertone toglobal vegetable oil market.

On the production side, the world is likely to witness a healthy 4.0 mt ofadditional vegetable oil in 2005-06, following a forecast of higheroilseeds output and rising palm oil production. Demand too is likely togrow robustly, primarily for food purposes. Higher demand for bio-dieselwould be a supplementary factor. With the current reckoning and the recenttrends, it may be safe to assume that no more than an additional quantityof 1 mt may be diverted for energy purposes during the year.

The latest US Department of Agriculture (USDA) report has raised globaloilseeds output to a new high of 385 mt (379 mt). Soyabean output in theUS is revised upwards to 80.7 mt. Interestingly, crop size of Brazil isprojected at 60 mt (51 mt) and for Argentina 40.5 mt (39 mt). If thesecrop projections are realised, the world will have enough oil to goaround, including additional demand from the energy sector. Importantly,firm prices will raise oilseeds crush by around 5 per cent to makeadditional oil available to meet demand.

Therefore, while prices are expected to remain firm, the vegetable oilmarket is unlikely to see a bull-run as projected by some analysts.Already, prices of major oils " soyabean oil and palm oil "are at arelatively high level.

Crude palm oil is around 1,450 Malaysian ringgits (MYR) a tonne ($375-380a tonne), soyabean oil is available at $475-480 a tonne, both at theorigin.

There is still an upside for the vegetable oil market, but the upsidepotential is limited. In the short run, one can expect crude palm oil totrade between MYR 1,450 and 1,550 a tonne, which on occasion may cross MYR1,550. But this is unlikely to sustain for long, given the potential ofsupplies to creep up. The same goes for soyabean oil, which canpotentially improve by 5-6 per cent ($20-25 a tonne).

Domestic crop harvest in importing countries (such as India) will alsoslow down purchases by importers during the next 6-8 weeks.

A bull run in the market " palm oil crossing MYR 1,600 a tonne or soyabeanoil moving up to $550 a tonne " can be safely discounted, notwithstandinghigher demand from the energy sector.

The only factor that can catapult prices to a higher trajectory is SouthAmerican weather. If it is unfriendly, vegetable oil prices could shoot upfrom December onwards once the crop prospects become suspect. Thus, anyupward market movement would be the result of weather aberrations and notbio-diesel demand as sought to be projected.

It makes commercial sense for countries that are large producers and netexporters of vegetable oil to create a psychosis of shortage of vegetableoil to prop up prices. But available data suggest that there is nosignificant demand-supply mismatch that can seriously impact prices.

The condition of India's rabi oilseed crop size would also make somedifference. Currently, it is too early to talk of the crop size. But themarket does know that 15 lakh tonnes of rapeseed/mustard stocks are lyingwith the procurement agency for crushing. A bumper crop of cotton (nearly255 lakh bales) is expected to make available 75 lakh tonnes ofcottonseed. Firm prices will encourage crushing.

It is possible that the bio-diesel card is a little overplayed. Caution isnecessary in taking long positions. Continuous monitoring of marketconditions would be beneficial in tracking price-sensitive changes.