Commodities

High prices in palm oil may not sustain

G. Chandrashekhar Mumbai | Updated on March 16, 2011

An official checks various grades of oil palm fresh fruit bunch at Peddapuram in Andhra Pradesh's East Godavari district. — M.R. Subramani

The bullish fervour fanned by some analysts during the recently concluded palm oil price outlook conference in Kuala Lumpur may fail to result in a further price rise going by market fundamentals and rapidly changing global sentiment. Indeed, the world is rather worried about general slowdown following the recent spate of problems including sovereign debt, credit tightening, currency debasement and gathering inflation signals, not to talk of high crude oil prices.

Many palm oil forecasters have been bullish primarily because of high crude oil prices as a result of geopolitical instabilities in the MENA region for now. There is invariably a tendency to correlate crude oil prices and vegetable oil prices via the biodiesel route. One has also found that some analysts tend to confuse correlation for causation.

In a perceptive analysis, Barclays Capital Research has pointed out that while prompt Brent contract prices have risen over 20 per cent since the beginning of the year, crude palm oil futures prices have actually declined 5-10 per cent.

On a macro level, a steep and sustained rally in crude oil prices actually dims the prospect for global economic recovery and creates a risk of hurting global economic growth. In the longer run, it hurts the demand for crude palm oil from the oleochemicals sector.

Suggesting that in the shorter term the link may be more tenuous, a question has been raised whether higher fossil fuel prices alone could reignite calls for increased biodiesel usage. To suggest that high crude oil prices will lift palm oil prices ignores the fact that not all biodiesel is derived from palm oil and that the relative price of palm oil to other biodiesel feedstock such as soyabean oil and rapeseed oil matters, it is argued.

Both Europe and the US tend to use indigenously produced oils for their biodiesel requirement. While Europe uses rapeseed oil, it is soyabean oil in the US.

Lastly, projections of steep growth in biodiesel demand may disappoint as consumption has continued to stay below what is mandated in most countries largely on demand rationing as vegoil prices have remained high.

Importantly, the economics of biodiesel production remain dependent on government incentives in a world of fiscal tightening, especially in the EU, Barclays pointed out.

Referring to the recent movements of crude palm oil futures and ICE gas oil prices, the analyst asserted that the relationship suggests that higher fossil diesel prices may not warrant higher FCPO prices. While the premium of palm oil usually widens when Malaysian palm oil stocks fall, the rally in FCPO prices since June 2010 has widened the premium significantly while stocks did not fall to historic low levels.

“This suggests that the recent rally in ICE gasoil towards the end of 2010 (as markets awakened to the strength of oil demand) may not drive FCPO prices much higher beyond current levels. Further, price upside would more likely come from lower palm oil stocks or higher prices of other substitute vegoils,” the report asserted.

Talking to a cross section of traders who participated in the palm oil price outlook meet, one is left with the impression that there is a concerted effort to sustain palm oil prices at a high level. There is also belief that demand is being overstated and supplies under-reported.

If anything, high crude oil prices are currently supporting crude palm oil as otherwise palm oil prices should have declined by at least 10 per cent from the current levels. If crude oil were to decline for whatever reason including renewed growth concerns or regulatory tightening in the US (Dodd-Frank Act), the possibility of a steeper correction in CPO prices would increase.

Published on March 16, 2011

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