El Nino and threat of soy oil bears on palm oil prices

The Malay Mail, 17 March 2014

LAUNCESTON, March 17 — Benchmark Malaysian palm oil futures have retreated from 18-month highs, and while prices may struggle in the next few months, the longer-term prognosis is tilted toward further gains.

Palm oil is currently caught in a classic tug-of-war between bullish and bearish factors, but the negative influences are likely to be more short term than the positive drivers.

The bearish side is being led by concern over demand from the world’s top two importers, China and India, ample supply of competing oils such as soy oil and the narrowing of palm oil’s price advantage over other edible oils.

The bullish side can point to falling inventories in major exporter Malaysia, rising domestic demand in top producer Indonesia and the threat of lower supply as the likelihood of an El Nino weather event increases this year.

El Nino is shaping up as the biggest risk for palm oil output this year, with meteorologists saying there is an increased chance of the weather pattern striking this year.

El Nino – the Spanish word for boy – is a warming of sea-surface temperatures in the Pacific that occurs every four to 12 years, causing dry conditions in Australia, Southeast Asia and parts of Africa and wetter weather in North America.

A strong El Nino would cut palm oil output in Malaysia and Indonesia by as much as 30 percent, although forecasters haven’t as yet warned of a severe event.

Nonetheless, the likelihood is that output will be lower this year in Southeast Asia.

El Nino also tends to make India’s monsoon rains erratic, which may affect the country’s domestic oilseed output given that 55 percent of agricultural land isn’t irrigated and is dependent on rains.

This could boost Indian imports of palm oil, which sank to an almost three-year low in February, dropping 27 percent from January to just 403,685 tonnes.

India’s oilseed imports have been muted on expectations of a bumper harvest of the main rapeseed crop this month.

However, if this winter’s rapeseed crop is affected by El Nino, it could result in a boost to imports in the second half of 2014, just as palm oil output may be slowing inMalaysia and Indonesia.

China’s imports of palm oil rose in January to 556,523 tonnes, a gain of 17.7 percent over the same month a year earlier. This was also higher than the monthly average in 2013 of 498,256 tonnes.

The concern in China is that slower economic growth will hurt demand, but this is based on the assumption that February’s weaker-than-expected exports, industrial production and retail sales numbers are the start of a sustained trend.

Assuming that one month’s weak data in China will result in a string of poor numbers is risky, as the authorities have shown they will turn on the stimulus taps if they feel the growth outlook is slipping too much.

PRICE SPREAD NARROWS, BUT BIODIESEL MANDATE TO SUPPORT

What may be of more concern for demand is the shrinking price advantage of palm oil over soy oil.

Converting Malaysian-traded palm oil and Chicago soy oil futures to dollars per tonne shows the discount for palm oil was US$83.40 (RM273.35) a tonne on March 14, down from US$309 (RM1,012) at the start of 2013.

However, the narrowing of the gap is more of a return to historical trading norms, with the premium for soy oil having been anchored around US$100 a tonne for the last five years.

The exception was of a period of widening from mid-2012 to the first quarter of 2013, which coincided with ample palm oil supplies and inventories in Malaysia andIndonesia.

But palm oil prices may draw support in the second half of this year from Indonesia’s biodiesel mandate, which was raised in August 2013 to a minimum 10 percent bio fuel in diesel from the previous 3-10 percent range.

However, the Indonesian Palm Oil Association believes it will be difficult for the mandate to be met, given the price increase in palm oil so far this year.

Indonesia is expected to use 2 million tonnes of palm oil for blending instead of an initial target of 3.4 million tonnes, association executive director Fadhil Hassan said March 5.

Even so, with the production outlook uncertain because of El Nino fears, any increase in domestic palm oil demand will lower the amount available for export.

Benchmark Malaysian palm oil futures have gained around 4 percent so far this year, and are currently trading at RM2,763 a tonne, off an 18-month peak of RM2,916 reached on March 11.

Overall, the outlook is for downward pressure on prices in the short term given the question marks over Indian and Chinese demand and the narrowing of palm’s price advantage to soy oil.

But this dynamic could reverse in the second half of the year, especially if an El Nino event does materialise.

The shape of the Malaysian futures curve is currently a mild backwardation, with the June contract at RM2,763 a tonne on March 17, and the September contract at RM2,693, a discount of 2.5 percent.

This suggests that the market is expecting some price weakness in the next few months, but isn’t yet expecting a supply squeeze later in the year.

In short, the market isn’t yet priced for an El Nino event.

The last El Nino in 2009 and 2010 resulted in lower palm oil production in Malaysia, even as the area under cultivation increased. — Reuters

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