Commodities: Japan looking to secure Malaysian CPO

This article first appeared in Enterprise, The Edge Malaysia Weekly, on April 8, 2019 - April 14, 2019.

This is a very interesting industry because many of the byproducts — such as palm kernel shells (PKS), palm oil mill effluents (POME) and empty fruit bunches (EFB) — are also in demand. > Morita

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When a 15m wave hit the Fukushima Daiichi Nuclear Power Plant eight years ago, disabling its power supply and cooling mechanisms, the Japanese government promptly started looking at alternatives to nuclear power. It realised that despite every precaution, a freak “Act of God” such as a tsunami could undo everything and place its citizens in grave danger.

It started to actively embrace renewable energy — such as solar, wind and geothermal energy — and even biofuels, or oil from plants that could be used to generate energy. So, at a time when most Western markets are banning or limiting the use of palm oil as part of their biofuel mix because of the perceived environmental damage it causes (palm oil production has been blamed for about 8% of the world’s deforestation between 1990 and 2008), Japan has opened its doors to the oil, providing that it has been certified by the Roundtable on Sustainable Palm Oil (RSPO).

That is why Yutaka Shoji, a 62-year-old Japanese futures brokerage firm, has set up shop in Malaysia. It helps its clients in Japan source palm oil and byproducts at stable prices using crude palm oil (CPO) futures contracts for hedging purposes.

“Many buyers in Japan want access to palm oil. They want a stable supply and they want to fix the price. This is very important as CPO prices tend to be generally unstable,” says Tsuyoshi Morita, managing director of Yutaka Shoji Malaysia Sdn Bhd.

This is where the company’s expertise comes in. “We suggest they use Bursa Malaysia’s CPO futures contracts. Palm oil prices are low now and they can hedge using these contracts,” he says.

“Let’s say they go to Sime Darby Bhd and ask if it can sell them palm oil at the same price for the next three years. Of course, the company will say no. The price may be okay for next month’s shipment. But by next year, it may have gone up again.

“But they can hedge using futures contracts. So even if the price goes up, they can recover their cost through hedging. We show them how to do this. That is our expertise.”

In fact, the existence of CPO futures contracts is why Yutaka Shoji decided to operate in Malaysia rather than Indonesia, which has a greater palm oil inventory and is selling it at lower prices in an attempt to reduce its high stock levels. Indonesia may have a futures market, but it does not have CPO contracts, Morita points out. Only Bursa, which has tied up with the Chicago Mercantile Exchange, has these.

Yutaka Shoji Malaysia has just obtained its licence to operate in Malaysia. It had been working on getting the licence for the last 1½ years.

“We set up here to get more information on the sellers and to introduce our buyers. The market here is mainly the sellers — companies such as Sime Darby, Wilmar International Ltd and FGV Holdings Bhd. Our clients are mainly on the consumer side. So, we are not competing with other futures brokerage firms. We are doing something new,” says Morita.

His explanation is taken up by executive director Lucy Tong. “Our market is different from local traditional brokerage houses, which are more into trading. We are trying to connect buyers in Japan to the producers in Malaysia.

“There are a lot of consumers in Japan. But their lack of knowledge about the palm oil market is what is stopping them. So, we have come in as a conduit.”

Morita says it is not just palm oil they are after but its byproducts as well. “This is a very interesting industry because many of the byproducts — such as palm kernel shells (PKS), palm oil mill effluents (POME) and empty fruit bunches (EFB) — are also in demand.”

He cites the example of a Japanese company that uses steam technology to launder shirts. “The steam is powered by oil, but oil prices are going up. So, it turned to recycled machine oil, which is cheaper and more environmentally friendly. But in Japan, almost all used machine oil has been consumed. So now, the company is looking for suitable alternatives.”

Here is where palm oil comes in. Cheap and easily available, the oil and its effluents or byproducts provide the perfect alternative. So, this company and others like it are looking to secure the supply of it. The total demand can range from 200,000 to 500,000 tonnes a year, says Morita.

This is the way it works. Companies in Japan apply to the government to import palm oil or its byproducts so that it can be used to generate energy. Once someone gets approval to bring in a certain quantity, he needs to guarantee the stability of supply, not just in terms of quantity but also the price.

“Once people apply and get the licence, they are worried about how to secure the materials. Quantity is not a problem. Malaysia and Indonesia have huge supplies. So, pricing is the key. It is our job to guide people on how to use futures contracts to protect their cost, especially now that palm oil prices are very low,” says Morita.

He gives a rough illustration of how the company does this. “Let’s say the current palm oil price is RM2,200 per tonne. If you wanted to buy for immediate delivery, the seller would have no choice but to agree to that price. But a year from now, the price may go up. So, the seller would prefer to wait and the buyer would not be able to secure the price now.

“So, I suggest to the buyer that he can buy via the futures market. If the spot price is RM2,200, the futures contract is also RM2,200. One year from now, if the spot price goes up to RM2,400, the futures contract will also be RM2,400. So, he can sell the futures contract and earn RM200. Nett nett, the price will still be RM2,200 per tonne.

“That is what we call hedging. So, there is no need to negotiate with FGV or Sime Darby to secure the price. Just buy the futures contract and later conduct the usual negotiations with the suppliers. That is how it works with other commodities such as sugar and grain.”

Morita says the firm also wants to support smallholders, even if they are not RSPO-certified yet. “Smallholders are very weak farmers. I have a lot of experience dealing with them when I was working with sugar plantations in other countries.”

Certification is expensive so he suggests a gradual approach to getting smallholders certified. “For instance, they could start with Malaysian Sustainable Palm Oil (MSPO) certification, which is lower than RSPO, to make some money from palm oil byproducts such as PKS, EFB and POME. Japan recognises the MSPO certification for palm oil byproducts.”

When the smallholders start making money from the byproducts, they can use it to obtain the RSPO certification, says Morita.

He adds that sugar used to be a sunset industry until farmers found that there was demand for the waste products, which could be used as biomass. “Suddenly, it was a sunrise industry and the farmers became very rich. Palm oil plantations have the same opportunity. There are so many new applications now — feed for algae, jet fuel and so on. The opportunities are no longer in edible oils but in biodiesel and oleochemicals.”

Tong says, “The Japanese have the technology. What they do not have is the knowledge of the palm oil market here or someone to give them price stability for the next 10 to 20 years.”

Last year, there was significant development in the futures market when the tenor of the CPO futures contracts was increased from two years to three. “Bursa itself recognised the pressing need for long-term price stability,” she says.

Logistically, it is also easier to ship raw materials. “In those days, we had something called carriage in freight at North Port. Now, they have FOB (free on board), which makes it logistically easier to ship products without any hassle,” says Tong.

FOB contracts relieve the seller of responsibility once the goods have been shipped. After the goods have been loaded (passed the ship’s rail), they are considered delivered into the control of the buyer. When the voyage begins, the buyer assumes all liability and can negotiate a cheaper price for the freight and insurance with a forwarder of his choice.

“All these are Bursa’s initiatives because it recognises that the demand from overseas is coming and it needs to make the export of palm oil more business-friendly. But much more could be done. That is why our Japanese friends (indicating Morita) are here,” says Tong.

Yutaka Shoji was started by Masturo Tatara in 1957. “At the time, he was a commissioned broker of the commodities market in Japan,” says Morita.

At the time, the Japanese commodities market was very active. Today, it is a little quieter. But the company has grown into one of the largest commodity futures brokers in Japan and is a member of three exchanges — the Tokyo Commodity Exchange, Osaka Dojima Commodity Exchange and Singapore Exchange. It is also listed on Tokyo’s Jasdaq Securities Exchange.

“We have come to Malaysia because we want to reach out further, because of CPO and because it is a physical delivery product. We are not going for the interbrokers. That is not our game plan. The actual buyers are what we want,” says Morita.