Trends In Palm Oil 2007

a) Rising Bad News Bears - There appears to be a slowly but surely rising group of detractors over the prospects for palm oil in 2007 and 2008. For a sector that has seen almost all buys and overweight recommendations only for the past 2 years: this would be almost tide turning.

b) La Nina - The region is seeing the La Nina effect (more rain) now, the flip side of El Nino. Even nowadays, we are seeing a lot more rain, thus boosting palm oil production. For example in 1999 when dry spells gave way to a similar La Nina effect, CPO production jumped nearly 27%, causing CPO prices to drop by 30% over the next 12 months.

c) Viability of Biodiesel - Following the mad rush into setting up biodiesel plants, now it looks a bit silly. For biodiesel to be viable, CPO needs to be about RM1,400 per tonne while oil must be US$55 or above. Yes, oil price is now in the US$60-65 but CPO is almost 40% higher. A product such as biodiesel which is so dependent on the prices of two seperate products is likely to bring about a difficult business model to work on. Both have to be in sync for them to sell, if one is out of sync, what then? Do production stops, or do you continue and just bottle up the biodiesel in tanks? What about capacity utilisation rates? How does that affect payback on capital invested? It also is dependent on favourable rules and tax benefits from EU and Malaysia, for how long... what if a better and cheaper substitute is available? After all that, biodiesel does not even give you supernormal profits, not enough to justify the risks involved.

d) The Smart Ones - I have mentioned this many times before, biodisel should be regarded as just one of the by-products of CPO, not the saviour or new demand factor. In fact, the business mechanics of producing biodiesel is so weak, its not surprising that the smart ones DID NOT jump in, e.g. IOI Corp and KL Kepong.

e) The EU Factor - The EU wants 5.75% of transport fuel to be biofuels by 2010 and 10% by 2020. Well, CPO is not the only biofuel in town. There is a new and hardier version, an Africa plant called jastropha. It can start producing oils in 6 months and the plant can lasts for 50 years. Needing little care or fertilizer, pest resistant, plus the oil does not even need refining. They are already planting loads of it in Africa, India and China.

f) Trade Friction - As global trade of biofuels heats up, European biodiesel producers charged that they have uncovered an "unfair" loophole for biodiesel sourced from Brazil and Malaysia to enter the EU: shipment via the U.S. where the biofuel qualifies for a hefty U.S. subsidy. Since 2004, U.S. biodiesel producers have been eligible for a subsidy of $1 per gallon for biodiesel blended with diesel fuel. Third countries such as Brazil and Malaysia are shipping biodiesel to U.S. harbors to be blended with 1% diesel, and then shipping it out afterwards to the EU.

g) High CPO Prices - Despite the La Nina and jastropha effects, most are still seeing an upswing in CPO prices. Some even see RM2,400 per tonne this year, which blows the biodiesel equation out of the water. Golden Hope may say that since they own the plantations, they can get the feeder stock at cheaper prices - Brains 101 would dictate that using palm oil for biodiesel instead of selling into open market at RM2,400 involves opportunity cost of RM1,000 per tonne. So let's not hear any of that silly logic again.

Despite the negatives, the major demand factors are still strong, i.e. buying by China and India. Especially from India since the cutting of the import tariffs. IOI Corp and KL Kepong are still OK, particularly IOI Corp with its huge dividend coming up and excellent property exposure. Those with exposure to biodiesel plants should be avoided owing to the uncertainty and possible writeoffs - Carotino, Mission Biofuels, Carotech, Kulim, Golden Hope, Wilmar, PPB, etc ... in fact they will be in for a sustained period of negative divergence from IOI Corp and KLK. Would not be surprising if a few months down the road, all the palm oil biodiesel plants will be retooled to use jastrophas as feeder stock ...