28/09/05 KUALA LUMPUR (Dow Jones)--The Malaysian palm oil industry, whichstill produces and exports the majority of the oil, is facing increasingchallenges as costs escalate and competition from rival producers andcompeting oils intensify, a senior industry official said Tuesday.

Lee Yeow Chor, group executive director of Malaysia's IOI Corporation Bhd,one of the biggest plantation companies in the country, said one key areathat could help make the country more competitive is faster integration.

Companies should expand into all segments along the supply chain such asplanting, milling, refining, specialty fats and oleochemicals, he said.

Although Malaysia's palm oil output is ahead of that of rival Indonesia,its industry is lagging in other areas, he said.

"Indonesia is actually more integrated in terms of the industry structurethan us," Lee said in an interview on the sidelines of an industryconference.

Companies in Malaysia should move beyond purely being an upstream ordownstream player and get involved in other areas of the business, hesaid.

The onus would be on the larger companies to "spearhead" integration sincethey have more financial clout, he said.

Smaller players, however, wouldn't be left out from reaping the benefits,he added.

"Ultimately, all this integration is to achieve market competitiveness forpalm oil all over the world. If you have better access and better costs,eventually all players will benefit," he said.

Lee said integration is already happening and he expects that trend tocontinue, not only with producers expanding into downstream activities butalso downstream players like refiners moving upstream into the plantationsbusiness.

"We ourselves, (IOI), started in just upstream, but we are nowintegrated," he said.

Already one of the largest CPO producers, IOI has in recent years acquiredrefineries, specialty fat makers and oleochemical companies both at homeand abroad.

For producers, diversification into downstream activities allows them tohedge against CPO price fluctuations and can help them improve theirunderstanding of supply and demand trends, Lee said.

As for refiners, getting involved in upstream operations can give them thecertainty of raw material supplies and put them in a stronger position tolock-in their purchase price, he noted.

Need To Improve Oil Palm Yields

Lee also said increasing production costs in recent years have made itmore pressing for Malaysian palm oil producers to improve yields.

Production costs have been on an uptrend, especially in the last 2 years,due to higher fertilizer costs, increasing freight and transport costs andrising fuel prices, he said.

"One way to offset higher input costs is by increasing yields andproductivity, which has shown to be effective in reducing the overallproduction cost," Lee said.

The average industry oil yield in Malaysia has been rather stagnant atunder 4 tons per hectare, per year, over the past few years.

More efficient producers such as IOI, United Plantations and others haveyields of about 6 tons/hectare.

He said the divergence in performance between various players in theindustry mainly boils down to the efficiency of management.

"Sometimes different planting materials can be the cause (of loweryields). But we have seen cases where planting materials are at the samelevel, but still we see big difference in yields between the individualproducers," he said. "It is simply due to management practices all theway."

Another way for Malaysian palm oil companies to compete more effectivelyis by gaining accreditation as an approved supplier to large globalmultinational food makers, he said.

Accreditation can help boost the image of the supplier and guaranteeregular sales. However, he said, accreditation can often be a difficultprocess.

"It takes a long time because you are only one of many potential suppliersand conditions are becoming more stringent due to concerns about foodsafety, traceability, et cetera," he added.

He said the easier route, which some companies have taken, is to acquireother already-accredited firms as a quick way of becoming an approvedsupplier.

On a brighter note, he said production costs have probably about peaked,though he didn't provide specific figures.

EU Biodiesel Policies "A Worry"

Meanwhile, Lee said IOI is one of the 10 companies that have submittedbids to take part in the Malaysian government's biodiesel project.

However, he said he wasn't aware if IOI is among one of the threesuccessful bidders.

Plantation Industries and Commodities Minister Peter Chin Fah Kui Mondaysaid the government has selected three companies to enter into jointventures with the Malaysian Palm Oil Board to build the country's firstbiodiesel plants.

He didn't name the companies.

Construction of the plants are expected to begin soon, with two located inPort Klang in central Malaysia and one in Pasir Gudang.

Each plant is expected to produce around 60,000 tons of palm diesel peryear, mainly to be exported to Europe.

European biodiesel industry officials have said, however, that while palmoil's position as the cheapest edible oil in the world may make it aneconomically attractive source of diesel, political pressure may limitimports of palm oil into Europe, where rapeseed production is subsidized.

Political barriers "may be a worry," Lee conceded, without elaborating.