21/10/2008 (Commodity Online) - The best thing to happen to the Palm oil industry in recent years was the establishment of the Round Table on Sustainable Palm Oil. This is the most clear cut signal to the world that Palm oil and Sustainability and Green Issues can co-exist to mutual benefit. It would be a step in the right direction if more Chinese entities joined the RSPO and participated in its deliberations. My company GODREJ was the first Indian company to join the RSPO and we have been followed by a host of others. The major markets for Palm – China, India and the developing world need to participate more energetically in the RSPO so that the Round Table becomes a win-win proposition for all stake holders.

Competitive Advantages of Palm
I believe Palm’s greatest competitive advantage is its sheer size, its very high productivity per hectare and consequently, its relatively low cost of production. At this stage I express my appreciation of the work done by many plantations and particularly Malaysian and Indonesian companies in raising productivity. The recent news of London Sumatra developing an F1 Hybrid which will produce upto 18 tonnes of palm oil per hectare is extremely exciting. We hope and pray that this development will be successful and that in the projected time interval of 10 years, we shall be able to celebrate its successful commercialisation and its consequent benefits for mankind.

Wisely, I shall not factor this hugely productive Hybrid into any of my current Price Outlook papers otherwise Heaven knows what it will do for Palm oil prices and more importantly for the valuation of plantation companies!

Productivity & Cost
Major facts about the productivity of Palm plantations vis a vis other oilseed crops are in the public domain and I shall not refer to them here. My aim today is to highlight the versatile nature of Palm oil and Palm Kernel oil for use as Edible oils as well as Industrial oils and of course the recent use of Palm oil as a bio fuel.

Given the current rise in the price of fertiliser, I believe the current marginal cost for an average medium sized plantation, of producing CPO is about 1000 Ringgits and the all in cost is about 1200 ringgits or USD 350 per tonne. I understand that the cost of producing soybeans today, based on current fertiliser, seed and land rent cost, is about USD 8 per bushel or USD 294 per tonne of beans. This when translated into 40 percent oil contribution will relate to USD 735 per tonne.

These costs will come down as the cost of fertiliser reduces and the land rent diminishes as oilseed prices fall. This is a dynamic situation. However, what it demonstrates quite clearly is that Palm oil will continue to be profitable and viable long after soya oil becomes unviable and unprofitable. I believe this is the greatest competitive advantage of Palm oil.

This advantage will drive Palm oil into new uses for industrial application and above as an energy source. At present there are fetters or restrictions on palm oil use in energy due to the lack of certified Green credentials. That problem is being expeditiously addressed. Once Certified Green palm oil is available in sufficient quantity, a vast new market will open up.

I have not even considered the extraordinary strides being made in the productivity of palm trees. As a result of re-planting, productivity per hectare is increasing at a very healthy rate, far in excess of that seen in any other annual or tree crop. The latest news from London Sumatra also needs to be borne in mind.

I believe in 5 years time, Palm has the prospect of giving us an additional 20 to 22 million tonnes of production. We must also expect some expansion in production of other oilseeds. Therefore, it is quite possible that a large chunk of this additional 22 million tonnes of Palm production will be available for uses other than food. This will be the major service that Palm oil will provide to produce environment friendly, bio degradable Oleochemicals to replace petro-chemicals. Palm will also make huge strides to give the world energy security through bio fuel use.

World Economic Scenario & Demand Growth Outlook
Analysts like me have estimated food demand for oil year October 2008 to September 2009 to expand by 4 million tonnes and bio fuel demand to expand by 2.5 million tonnes. The estimate of expansion relies on the projection of the rate of economic growth for world economies. This has now become an area of debate.

The IMF has projected that the world economy as a whole will expand by 3% in 2009. For this to be achieved, emerging markets like China and India will have to expand much faster. China has to grow by about 9% and India by 7%. The contention of the IMF forecasters is that even in 2001 and 2002, despite the events of 9/11 and the Dot Com Bust, the world economy expanded at about 2.25 percent. My contention is that the IMF’s estimates are very optimistic.

With great respect I submit that the events of 9/11 and the Dot Com Bust were local to California and New York and at best affected the US economy. Emerging markets like China and India were relatively unscathed. What we are seeing today is much more perverse and will affect the developing world to a much greater extent. At no time since the Great Depression has there been such pessimism about the world economy. A liquidity crunch or de-leveraging will curb demand growth. Therefore, we may have to reduce our expectations of demand growth.

There is the story of the prominent Hedge Fund manager who was heard complaining last Friday after the market meltdown “This is worse than divorce, I have lost half my fortune and I still have my wife”

Let me quote to you what several eminent economists have written recently about the current world economic situation. Tim Mercer wrote last weekend “This downturn is going to make 2001 look like a walk in the park. This is the bursting of a 25 year asset-credit bubble. People have really stopped spending money, everywhere”
The eminent Princeton Professor, Paul Krugman, the winner of the 2008 Nobel Prize for economics, said on TV last weekend “People in the USA are only buying Treasuries and Bottled Water”

The distinguished Harvard Professor Kenneth Rogoff said whilst talking of the possibility that the world may slip into Depression “There is no hyperbole that can describe it. It is very unlikely that the world economy will fall into depression but we have taken 5 out of the 10 steps we need to get there. Hopefully we won’t take the other 5.”

Today, when it comes to forecasting, we are not so much concerned with Supply Growth as with Demand Growth. It is very likely that Demand Growth will be less than expected and Consumers will tend to buy hand-to-mouth until they see the economy turn for the better.

We have been too sanguine so far.Analysts including myself, have to admit that we have been far too sanguine about the world economy and its prospects. The sub-prime crisis erupted in July –August 2007. Yet, ironically World Stock markets peaked on 9th October 2007- a full 6 weeks after the sub-prime problems manifested themselves.

In other words, investors placed too much faith in the powers of the FED and were extremely complacent. We all thought Chairman Ben Bernanke would find a solution which would be relatively painless. I must admit we were all hopelessly wrong. What has emerged in the last few weeks must make us change our prognosis about the world economy and its prospects for 2009.

What is even more relevant is that in times of economic difficulty farmers usually take the line of least resistance and plant more rather than less. They may cut down the use of fertiliser but they will not reduce plantings. The closest parallel that comes to mind is that in times of low crude oil prices, OPEC production tends to expand rather than contract – because the weaker countries cheat on their production quotas in order to earn more revenue.

Growth in Bio fuel Demand
I also wish to make a point about the expected growth in bio fuel demand. Palm prices have come down but so have the prices of fossil fuels. Each time the price of CPO declines and bio fuel becomes viable, the market demonstrates a Death Wish and prices flare up almost immediately. The cheer leaders for this perverse price action are usually over-optimistic stock market analysts who follow plantation shares.

I cannot emphasize enough that bio fuel demand is NOT a One Minute Wonder. Low prices are not just a matter of Touch & Go. A bio diesel producer will not re-commission his plant unless he can tie up at least one year’s supply at the low workable price and also lock in his selling price. On the other hand, traders will not be able or willing to sell one year forward at current low price.

So our bio diesel producer has to go to the plantation companies and deal with their Byzantine procedures and approach. Plantations want to tie in the MPOB average rather than boldly buy new demand. They have hardly ever shown any inclination for demand creation or winning new markets. Thus, in many cases we have seen a stalemate and no new demand is captured. Therefore, I have to repeat today once again, for Palm to capture bio fuel demand, we need low prices to remain low for at least 8 to 10 weeks.

Each time prices fall, we have noticed the proverbial Five o’Clock Phantom come in and ramp them up. This may be very good for the short term benefit of speculators and day-traders but it is will simply prolong the agony of high stocks and poor demand.

Export Taxes
The concerned governments almost killed the goose that laid the golden egg by imposing high Export Taxes. Now I am afraid the pendulum has swung the other way and importing countries will soon have the upper hand.

There are 2 other factors which have emerged in the last 2 weeks. The magic of Splash & Dash by which palm bio diesel produced in Malaysia or Indonesia used to catch the US subsidy and then get re-exported to Europe has been abolished. A rough estimate suggests that almost Three Hundred Million Dollars of subsidy has been lost by bio diesel producers in Argentina, Indonesia and Malaysia. This could be an exaggeration or an over-estimate but the demise of Splash and Dash must be bad for palm bio diesel.

Secondly, Germany has reduced its mandated level of bio diesel for blending by 1 percentage point. This is also not good for bio diesel producers though some of the loss may be taken up by greater use of B100, now that Rapeoil prices have declined.

Other Supply side developments
Since my last paper at Globoil India in Mumbai, the USDA has increased its estimates of the US soybean crop. The Canadian rapeseed or canola crop has been upgraded and we have also seen some very beneficial rains come to Argentina and also to the all important Matto Grosso province of Brazil. We have also seen the strength of the US Dollar and the weaker Brazilian Real give the Brazilian farmer a welcome boost. There are problems for Brazilian farmers with credit but the weaker Real should help to overcome this difficulty. Australia also appears to be on course to give us much bigger rapeseed and wheat crops this year, as we have been expecting so far.

That brings me to the forthcoming prospects for PALM. The production of Palm in September in Malaysia as well as in Indonesia turned out to be more or less as expected. The Ramadan festival had its effect but this was largely expected by the market. I still expect October production in Malaysia to be at a peak with Indonesian monthly production peaking in November.
Post Ramadan and post Indian and Chinese harvest and given winter weather, we shall see some deceleration of demand and exports. Therefore, I continue to believe that in the first half of November, the combined stocks of Malaysia and Indonesia will exceed 5 million tonnes.

INDIA
During September and October, India has remained the one market for Palm where importers have enjoyed a good back-to-back margin. This is due to the high price of local oils and the bottlenecks in the distribution of oil imported by the public sector. As a result, India imported almost 700,000 tonnes of vegetable oil during September. October imports will also be heavy. It is now almost certain that the Indian government will move quickly and impose an import duty once again on crude and refined vegetable oil imports.

The only question is whether the import duty will be 10 percent or 30 percent. Prices of new crop oilseeds in India have collapsed and are almost at the Minimum Support Price and farmers are extremely angry. Fortunately, India’s Agriculture ministry is headed by an extremely able and vigilant minister and the top official is possibly the best and most responsive civil service official we have had in a long time. Together, they will have to move fast to ensure that farmers are not demoralised and Rabi crop plantings come up to expectation. (Mr Mistry is Director, GODREJ International Limited. Excerpted from paper presented at CICSC 2008 & Malaysia –China POTS 2008 On Friday 17 October 2008)