28/07/2011 (Borneo Post) - As production continues to improve due to seasonal improvements and exports continue to weaken, crude palm oil (CPO) prices could commence its down-cycle starting in the second half of 2011 (2H11).

According to the Australian Bureau of Meteorology, the Southern Oscillation Index and cloudiness over the Pacific were all at neutral levels. Effectively, La Nina had ended.

According to an analyst from the research arm of Kenanga Investment Bank Bhd, (Kenanga Research), this boded well for the strong growth of CPO production in 2H11. To recap, Malaysia’s CPO production in May 2011 registered a 14 per cent month-on-month (m-o-m) increase to 1.74 million metric tonnes (MT) due to improving weather with La Nina ending, waning biological stress and seasonal factors.

CPO production had reached the second highest month ever seen over the past eight years in May 2011. It recorded a 12 per cent production rate that was below the 1.98 million MT achieved in October 2009.

Based on the historical seasonal trends, CPO production was expected to continue its uptrend and eventually peak in October 2011 with a new record of production at 2.17 million MT.

“As La Nina ends, we expect palm oil output to recover after erratic weather in 2009 and 2010 stalled yields,” said the analyst.

Exports at the same time, increased at a slower rate of four per cent m-o-m to 1.4 million MT in May 11. In May 2011, the discount of CPO price against soy oil was at US$161, still above its three-year historical average of US$139, hence making it an appealing substitute to soybean oil.

Kenanga Research anticipated a further normalisation in exports growth in 2H11 as soybean oil prices decline, thus reducing the attractiveness of CPO prices as its discount against soybean oil was expected to be tightened.

Hence, as exports fail to cope with higher production growth, inventory might swell above the psychological level of two million MT in 2H11.

Increasing production trend coupled with a slower rate of growth in exports suggested a potential situation of oversupply in the market, hence putting pressure on CPO prices.

As production growth surpassed exports, inventory rose significantly by 15 per cent m-o-m to 1.92 million (MT). With inventory poised to rise above two million MT level, the research firm believed that CPO prices could face an even further downside in 2H11.

“Pursuant to better production and weaker export, we expect CPO prices to decline to average RM2,930 in 2H11,” said the analyst.

Nevertheless, the analyst at the research firm was aware of the adverse weather conditions, which might cause disruption to soybean oil and/or palm oil supply. This could as a whole affect the analyst’s projection of CPO prices.

“We intend to apply lower forward price earnings ratio of 15 times to 16 times to our valuations to reflect potential softer 2H11 CPO price outlook as plantation share prices tend to reflect CPO price sentiments ahead of actual prices by 1.5 years,” Kenanga Research stated.

The research house pegged Sime Darby Bhd at a target price of RM11.06 per share, IOI Corporation Bhd at RM5.45, Kuala Lumpur Kepong Bhd at RM21.92, Genting Plantations Bhd at RM8.77.