Thu, 11 Dec 2008
Achmad Syafriel, Analyst

We attended the 2009 Indonesian Palm Oil Conference and Price Outlook in Nusa Dua, Bali, last week with plenty of participants not only from palm oil companies, but also from different sectors connected to the palm oil industry such as fertilizer producers and investment banks.

But what a difference a year can make.

When we attended the very same conference a year earlier, the speakers were all extremely bullish on the outlook on the crude palm oil (CPO) price. Last week, the same bulls were also present but with their horns pointing down, as they cited a much more subdued price outlook going into the new year.

Indeed there is no denying that CPO price movements have been as unpredictable as oil prices. At the beginning of this year, many believed CPO prices would stay high on strong demand and limited supply, not to mention the prospect of biodiesel consumption.

These factors have, since mid-2006, driven the price of CPO to its historical high of US$1,400/MT in March 2008. At that time, even the skeptics thought that weakening in the CPO price would not take place until 2009.

But the way everything unraveled was undoubtedly unexpected. In a space of 6-7 months, the CPO price plunged 67 percent from its peak, in line with the drop in oil price, to around the $400/MT level at present.

So what to expect going forward? Two major points were discussed in the two-day event: the CPO price outlook and the sustainability of palm oil. The latter discussed how challenging the situation is for Indonesian CPO exporters in fulfilling the requirements set by the European Union.

It has been an issue for many years that oil-palm plantation companies are believed to be contributors to deforestation in Indonesia by commonly burning or cutting down trees in protected forests.

The EU requires that CPO imported to its member countries should be certified with the Roundtable Sustainability Palm Oil (RSPO) standard. Basically, this requires proof that the imported CPO was not produced from oil-palm plantations involved in deforestation activities.

In addition, the EU has also required that only vegetable oils that can reduce carbon emissions by at least 35 percent can be used as biodiesel feedstock. This is bad for Indonesia, as CPO can reduce carbon emissions by only 16 percent, much less than the minimum requirement.

Given the current falling demand for CPO, the stringent requirements from the EU will only increase the pressure on Indonesian CPO players.

On the second day of the conference, the discussion turned more interesting as participants were anxious to try and figure out the direction of CPO prices in 2009, particularly given good weather has thus far also increased production of other vegetable oils such as soybean oil and rapeseed oil.

In contrast to last year's conference, bears such as James Fry, a researcher from LMC, forecast that the CPO price may hit $350/MT or even below, particularly if the oil price (Brent crude oil) was to fall below $35/barrel.

The bulls toned down their expectations significantly, believing that CPO prices will recover to RM1,500/MT or $500-$600/MT, with the successful implementation of mandatory biodiesel usage in both Indonesia and Malaysia to be the key driver in improving the CPO price outlook.

The government has mandated biofuel usage to be as much as 5 percent of total fuel use. With total subsidized fuel amounting to nearly 40 million kiloliters, it is believed biofuels will increase CPO demand by 1.5 million to 2 million MT.

However, we are skeptical about this view and its supporting agreement. Indonesia announced the so-called National Biofuel Development Program in mid-2007. However, this program has not been as successful as expected. When crude oil prices increased in 2007-2008, CPO prices also surged, forcing many new biodiesel projects to be stopped or postponed.

Additionally, it is worth noting that the success of any biodiesel program will require the oil to trade above the $60 level because, below this, biodiesel will be priced higher than regular gasoline. To illustrate, at the current CPO price of $400/MT, the cost to produce 1 liter of biodiesel is around Rp 4,150/liter, suggesting a selling price of around Rp 4,600/liter.

On the flip side, for oil at $45/barrel, the selling price at the pump would amount to just around Rp 4,100/liter.

Furthermore, Indonesia now has only around 1 million tons per annum of biodiesel production capacity. It requires more time and additional investment before more CPO can be absorbed and converted into biodiesel.

Therefore, to ensure the successful implementation of the program, the government should be willing to provide more incentives and rechannel the subsidy for fossil-based fuels to biofuel. Without this full commitment from the government, Indonesia's biodiesel program to push up CPO demand is unlikely to succeed, in our view.

In the end, all of the speakers share the same view: Without respite from the global economic slowdown, CPO demand is unlikely to improve. This will take time. So it appears that time is the only panacea for CPO prices at the moment. But who knows, in a year's time bad weather could create supply shocks on vegetable oils to the benefit of CPO demand.

This is the beauty about time, and what a difference a year can make.

The writer is a researcher at Bahana Securities.



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