This article first appeared in The Edge Financial Daily on June 18, 2018

KUALA LUMPUR: The government’s plan to increase the minimum wage by as much as 50% will have a negative impact on the plantation industry as this will raise production costs and shave profit margins of palm oil producers, said Rabobank Group senior analyst for grains, oilseeds, food and agribusiness Oscar Tjakra (pic).

“It will be a bane for the industry. If you look at the basic cost of crude palm oil (CPO) production, fertiliser and labour costs are the biggest components,” Tjakra told The Edge Financial Daily in a phone interview.

“The increase will put pressure on [operating] margins,” he said, while keeping a bearish stance on the overall plantation sector at least for the next three years.

Since taking over after the historic 14th general election on May 9, the Pakatan Harapan government has pledged to fulfil its manifesto promise of higher monthly minimum wage of RM1,500 from RM1,000 currently within the first 100 days.

Human Resources Minister M Kulasegaran said the final decision to raise the minimum wage will be announced in August.

The plantation sector is labour-intensive, with foreign workers making up 85% to 90% of the total labour force.

As at May 2017, data from the plantation industries and commodities ministry showed that there were around 428,000 workers employed in the oil palm sector.

According to an analysis by CIMB Investment Bank Bhd, every monthly increase of RM100 in the minimum wage would increase the palm oil industry’s annual costs by RM304 million to RM514 million.

The report on June 6 noted that the palm oil sector could be one of the worst hit by the increase in the minimum wage, given the labour-intensive nature of the industry.

“Also, the industry will not be able to pass on the higher costs to customers as it is a price-taker industry,” it said.

“Potential cuts to our net profit forecasts for listed plantation companies range from 1% to 14% on net profit in financial year 2019, for every RM100 per month rise in minimum wage,” CIMB added.

In the near term, Tjakra said the seasonality factor and the anticipated high production level are expected to pressure CPO prices in the next three to six months, before clocking in an average of RM2,400 per tonne in 2018 and RM2,300 per tonne in 2019.

Tjakra said the spread between the prices of CPO and soybean oil will stay at the current level, with higher soy oil inventories in the US to continue weighing on palm oil prices.

“In the nearer term, the current low-price environment before 2022 could lead to higher operational efficiency in plantation companies to reduce production costs and accelerate consolidation in the industry,” he added.

On the supply side, Tjakra said the global long-term supply outlook for palm oil remains abundant throughout the next four years, with palm oil production expected at 21 million tonnes in 2018, from 19.92 million tonnes in 2017, and 17.32 million tonnes in 2016.

“Production has been increasing since 2015, and production is anticipated to be normal on steady weather pattern throughout the third and fourth quarters of this year,” he added.

Turning to demand, Tjakra expects palm oil consumption pattern to expand at a moderate pace, supported by the exigencies from two traditional markets: China and India.

“Besides the two traditional countries, demand could also come in from two other South Asian nations such as Bangladesh and Pakistan. And let’s not forget Africa, too,” he added.

As for demand from the European bloc, Tjakra expects it to soften to 5.7 million tonnes this year, from 5.9 million tonnes last year.

“The vote by the European Parliament (EP) to phase out palm oil usage in biofuel has yet to be conclusive,” it added.

Early this year, the EP voted to phase out palm oil usage in biofuel, prompting some observers to describe the unprecedented move as “crop apartheid”. However, Bloomberg reported last Thursday that the EP will soften its rule on the use of biofuel from food crops.

On biofuel, Tjakra said Indonesia is seeing a pickup in the demand of biodiesel products, which will be supported by the government’s effort to increase the fuel blend to 25% (B25), from B20 currently.

This year, Tjakra said, “Indonesia has allocated higher volume for the government procurement at 3.22 million kilolitres, compared with 2.53 million kilolitres previously.”

At the same time, Tjakra noted that the Indonesian government is looking to expand the biodiesel programme into the rail and heavy industrial sector.

As for Malaysia, Tjakra said there is a need for the government to continue its push to support the biodiesel sector, which has been experiencing slow growth due to the lack of strong policies, initiatives and demand.

“Without the support from the government, I don’t think biodiesel implementation will be successful,” he said, suggesting that the government could throw in some incentives to support the sector.

Meanwhile, Tjakra said it will take some time for the plantation industry to see accelerating demand for certified sustainable palm oil, which mostly comes from the European bloc.

“Some nations have yet to look into the sustainable issue more contentiously. The demand is there but at what cost? While pricing plays an important factor, I reckon that the industry will need some time to adjust and absorb the sustainability concept,” he added.

CPO futures closed at RM2,336 per tonne last Friday. Year to date, the commodity has fallen 6.67%.