Crude oil slump to impact CPO, biodiesel mandates

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WHILE a recent initiative by the Malaysian government, namely the waiver of tax on exports of crude palm oil (CPO) since September, seems to have its intended effect of shoring up prices, the recent slump in crude oil prices could put a damper on long-term CPO price recovery.

Analysts say the recent rebound in CPO prices could be short-lived due to the commodity’s historical correlation with the movement in oil prices. Brent crude oil plummeted to a four-year low of US$82 per barrel on Oct 16, or a 27% decline since June.

Some signs point towards CPO prices weakening again. The benchmark three-month forward CPO futures contract for January closed at RM2,116 per tonne last Thursday — the lowest price since Sept 23.

CPO prices had initially shown a mild recovery since early September, when the government of Malaysia implemented a tax exemption on CPO exports. This has now been extended to December this year. Indonesia followed suit in October.

According to the Malaysian Palm Oil Board, the settlement price for CPO on Oct 16 was RM2,126 per tonne, compared with RM1,933.50 on Sept 2 (see Chart 1).

The correlation between CPO and crude oil is attributed to the two commodities’ status as fuel alternatives. The prospect of cheaper oil means importers would buy crude oil for feedstock instead of biodiesel, which is a by-product of CPO.

Rabobank International food and agribusiness research director Pawan Kumar believes that biodiesel is one of the key catalysts for stimulating long-term demand growth in CPO. However, he adds that the sharp drop in oil prices will lead to a softening in CPO prices due to lower demand.

“Biodiesel margins have been contracting over the past two to three weeks, making it less economically feasible to cultivate as a fuel source. It is worth noting that this segment is mainly driven by government policies, but the present situation could slow down the process of achieving biodiesel consumption growth.”

Rabobank has set its current target CPO price at RM2,140 by the end of this year, which is a slight premium to the latest settlement price.

Maybank Kim Eng Research adopted a cautious tone for CPO in its Oct 13 note. “CPO has again lost its price competitiveness due to the slump in crude oil prices. A US$10 per barrel fall in crude oil price equates to a decline of RM220 per metric ton for CPO,” says Maybank analyst Ong Chee Ting.

In fact, when converted on a ringgit per metric ton basis, as at Oct 16, oil prices have become cheaper than those of CPO. On that day, the generic one-month forward contracts for Brent crude were traded at RM2,043.47 per metric ton, compared with RM2,135 per metric ton for the equivalent CPO contract (see Chart 2). And this is before accounting for the cost of further processing the CPO into biodiesel.

Coupled with the long-delayed biodiesel initiatives in countries such as Malaysia and Indonesia, the lack of demand growth from this segment could cause CPO prices to stagnate or even decline further.

The actual demand from the biodiesel segment has largely underwhelmed expectations. In Indonesia, its ambitious biodiesel consumption target of four million kilolitres has been bogged down by operating challenges, such as making the fuel available in more remote provinces.

Meanwhile, countries such as Malaysia and Brazil have delayed their respective biodiesel mandates, which were intended to raise the minimum bio content in diesel fuel and thus lead to higher CPO usage.

DBS Vickers Group Research plantations analyst Ben Santoso says CPO prices will continue to rebound due to the seasonal decline in palm oil production towards the end of the year. However, the crude oil price slump should cap CPO’s price upside for the time being.

“Regionally, we do not foresee a sharp rise in demand for CPO from the energy sector. Biodiesel only makes up 13% of global palm oil demand, and its growth will depend on the policies and initiatives coming into effect. However, governments are under pressure to reduce fossil fuel subsidies, so biofuels remain an important catalyst.”

Improving fundamentals may have justified the recent rebound in CPO prices. In an Oct 13 industry report by Kenanga Research, the firm says export demand will finally begin exceeding palm oil supplies this month.

“October total demand of 1.9 million metric ton should outpace total supply of 1.84 million metric ton. On the supply side, September production actually declined 7% month on month, which implies that the production this year has changed and actually peaked in early August,” it says.

On the other hand, there are clear indications that the move to implement zero export tax on CPO is having its desired effect. For the month of September, overall exports jumped 13% m-o-m to 1.63 million metric ton. The bulk of the increase in demand came from India, whose CPO imports jumped 23% m-o-m to 444,000 metric ton. Exports to China also saw a significant increase of 5% m-o-m to 164,000 metric ton.

The zero tax scheme by palm oil exporters has widened the spread between CPO and refined, bleached and deodorised palm oil, which provides an incentive to the importing countries’ refineries to process CPO locally.

“However, negative margins remain an impediment to Indian refineries, which is detrimental to the overall vegetable oil complex. It is too early to tell how the falling crude oil price would impact CPO demand from India and China, but it looks like the correlation between the two commodities will remain intact,” says Rabobank’s Kumar.

This article first appeared in The Edge Malaysia Weekly, on October 20 - 26, 2014.