The crude palm oil price has been through a roller-coaster journey in 2008. The journey started with prices at $995/ton in January, a peak was reached at $1,395/ton in March, then a steep drop to $435/ton in October, and the price is finally settling at around the $510/ton level in December; definitely not for the faint hearted!
Looking behind the ups and downs, what are the causes of this daredevil ride? Price speculation, high expectations on biofuel, and a close relationship with oil prices have been discussed as a few of the culprits. In the end though, it all comes back to the basic law of supply and demand.
CPO prices have reverted back to the $500/ton level because demand has declined, while supply keeps rising. Lower demand is expected to persist on the back of slower economic growth, especially in China, the biggest CPO importer in the world.
In quarter three, China's GDP grew 9 percent, the first single digit GDP growth rate for the country in the last 3 years. The Economist Intelligence Unit projects that China's 2009-10 GDP growth will be lower at between 8 and 7.5 percent.
This will decrease disposable income growth, which will result in lower import demand, including for CPO. Demand (for CPO) has reverted to just food and manufacturing products, since biofuel prospects have been clouded by lower profitability resulting from cheaper crude oil prices.
As a result, oversupply has occurred. If we look at Malaysian data as a proxy (Malaysia is the second biggest CPO producer in the world), stocks at the end of November swelled 8.3 percent to 2.65 million tons from the previous month.
Meanwhile, CPO production in November 08 was at 1.7 million tons, the same as in October. If we assume that Indonesia, the biggest producer, experienced similar trends, this would mean our current stock would be 4 million tons, which is a huge number.
Malaysia and Indonesia now plan to work together to rectify the situation. They have joined hands in a replanting strategy to cut short term production. Replanting is done by cutting down trees aged 25 years and older and then replacing them with new plants.
Malaysia aims to replant 200,000 hectares of oil palms, while Indonesia aims to replant only 50,000 hectares. This is expected to cut CPO output from both countries by 800,000 tons next year.
On the demand side, the two countries have issued biofuel mandates to increase domestic demand and reduce reliance on exports. Malaysia will make a 5 percent biodiesel blend mandatory starting in next February, while Indonesia will make a 1 to 2.5 percent biodiesel blend mandatory starting also in January.
The response from the Malaysian community is positive. Six major oil palm plantation firms in Malaysia have agreed to undertake the replanting of 200,000 hectares. This is expected to reduce output by 700,000 tons.
Furthermore, these companies are backed by the Malaysian Palm Oil Board which has allocated 200 million ringgit for the replanting efforts from its price stabilization fund. Success for the Malaysian's biofuel mandate looks likely too. The mandate should represent about 500,000 tons of additional CPO demand when it is fully implemented.
What about Indonesia efforts to replant 50,000 hectares of its palm oil next year and another 75,000 hectares in 2010? A small amount compared to Malaysian efforts, it is still not clear who will implement this.
State owned plantations companies could be appointed by the government to take up this replanting program, since they are estimated to own about 11 percent of the total 6.8 million hectares of palm oil plantation area in Indonesia.
The Indonesian CPO industry has stated that about 1 million hectares of palm oil plants need to be replanted in the next 3 years and most of this on estates owned by smallholders; smallholders and private companies own about 90 percent of the land available for palm plantations (each owns about 45 percent). This means 300,000 hectares will need to be replanted each year; The question is who will bear the cost?
Smallholders are unlikely to carry out this rejuvenation program, since it would cost them about $3,000 per hectare. And unlike Malaysia, Indonesia does not have funds set aside for this purpose. Thus, the burden will be on private companies. Since there are no incentives or penalties from the government, risks on the replanting targets are high.
To try to help, the government has stated it plans to subsidize the interest rate on bank loans to planters for replanting. Planters will only need to pay 10 percent interest and the rest will be paid by the government.
In the light of tight liquidity as well as low CPO prices, will banks still want to lend to the agriculture sector? While bank non-performing loans in the plantation sector have risen by only 1.63 percent month on month in October, it is possible that the number is not up significantly yet since loans can only be classified as NPLs when they are unpaid for at least 90 days.
For the biodiesel mandate, while the Energy and Mineral Resources Minister, Purnomo Yusgiantoro, signed regulation number 32 in September making biodiesel use mandatory in 2009, the incentives and penalties associated with the mandate remain unclear. Moreover, the low crude oil price has made the biodiesel industry much less attractive.
One way to push the success of this program would be a subsidy for the biodiesel producers.
If Indonesia can rejuvenate 300,000 hectares per year and implement the biodiesel mandate, the industry projects Indonesia can reduce CPO supply to the international market by 3 million tons. If this is combined with the Malaysian moves, these efforts would be expected to reduce production by about 10 percent next year.
If the basic law of supply and demand then comes into effect, lower supply will boost CPO prices. While Malaysia seems confident to achieve their end of the deal, what about Indonesia? Let's wait and see.
Find Article by Date