Palm oil, together with its related product, palm kernel oil, is derived from the fruit of the oil palm. It is widely used in domestic cooking in Asia and generally as an ingredient for processed food products. Palm oil has many food and non-food uses, principally cooking oil – domestic and commercial – particularly for frying because of its superior heat resistant properties. In non-foods it’s used in soaps, bio-diesel and oleochemicals of which detergents are one of the final products.The palm kernel is also used for its oil and produces speciality fats, such as cocoa butter substitutes, shampoos, cosmetics, ice-cream and animal feed. Oil palms like a humid climate, regular rainfall and sunshine they are mostly grown near the equator. Key national producers include Indonesia and Malaysia with a steady growing contribution from some African nations.
THE PALM OIL INDUSTRY
Production
- Oil palm is the most efficient oilseed crop in the world.
- One hectare of oil palm plantation is able to produce up to ten times more oil than other leading oilseed crops.
- Palm oil production has increased tenfold since 1980 and projections see 50 per cent further growth by 2050.
- The area occupied by palm oil cultivation has expanded globally by 43 per cent since the 1990s.
- The most efficient producers may achieve yields as high as eight tonnes of oil per hectare.
- Palm oil is one of the 17 major oils and fats produced globally.
- China is the largest consumer of oils and fats, followed by the EU, India, and the United States.
- Among the 17 oils and fats, palm oil was the highest consumed oil in 2012, reaching three billion people in 150 countries.
- High palm oil consumption countries include China, India, Indonesia, and the European Union.
- Palm oil is competitively priced against soybean, rapeseed and sunflower oil in the world‘s market for oils and fats.
- The palm oil industry is one of the key economic drivers of the agricultural sector in developing countries such as Malaysia and Indonesia. Its economic potential is greatest in the oil palm growing belt, a region that encompasses 10o north and south of the equator.
- In Malaysia, the industry provides direct employment for about 570,000 people.
- The industry also offers a long-term and stable source of income for its smallholders
- Producers margins can be between 10-50% plus based on the crude palm oil (CPO).
"Challenging times are ahead for the Group and the palm oil industry in general."
These were the words of Ms Siew Kim Lim, major shareholder and non-executive chairman of Anglo-Eastern Plantations (AEP:LON), one of several London listed producers which we will look at in greater detail in due course. Ms Lim made the claim after unveiling their AEPs 2014 interims and a near-tripling in underlying pre-tax profits, to $43.2m,on revenues up 56% at $130mn. Results were boosted both by higher production and a high palm oil selling price in the first half of 2014 compared to the year before. More about AEP in the second post of this series.To understand Ms Lims industry forecast lets look at the risk factors affecting the industry:
Commodity Risk
Significant price movements have always been a feature for the leading oils and fats traded on world markets. Monthly average palm oil prices, CIF Rotterdam, reached a high of $705 per tonne in 1998, then falling to a low of $234 per tonne in 2001 before recovering to trade in the range of $400 to $500 per tonne for the next four years. In the second half of 2006, prices started to rise steeply and reached levels of $1,249 in March 2008. Prices remained high until July 2008 when the developing world financial crisis saw the CPO price reach a low of around $500. Prices have since recovered progressively, reaching levels above $1,000 per tonne in 2011 and 2012 and remaining relatively steady for most of 2013 trading in a range of between $800 and $900 per tonne. The average CPO price for the ten year period 2004 - 2013 has been $764 per tonne. Prices during 2015 have fallen since January due to a combination of factors:
2014 was a record soybean production in North and South America on the back of favourable weather expectations and increased planting acreage. Demand for palm oil has softened as buyers in India and China purchase a greater proportion of soybean as the price difference between the two continues to narrow. The spread was about $98 per metric tonne (mt) on 4 July 2014 down from an average of $244/mt on the same date in 2013.
Ample supplies of sunflower oil are also weighing on palm oil prices, and recent government mandates in both Indonesia and Malaysia have encouraged the increased consumption of vegetable oil.
Surplus crude palm oil is used to develop biodiesel. Recently industry experts have blamed "poor infrastructure for oil distribution and biodiesel blending in some developing countries" has led to disappointment against widely-held expectations for biodiesel to absorb surplus crude palm oil. Another key factor affecting the demand is the cheaper price of Brent oil encouraging people to stick with conventional fuel while prices remain low.It was recently announced by the Indonesian government that will impose a levy on exports of crude palm oil to help pay for biodiesel subsidies, replanting, research and development of oil palm farmers to boost production. Exporters would be levied $50 per metric ton for crude palm oil shipments and $30 for processed palm oil products when CPO prices stand at below $750 a ton. Recent prices are around $590 a ton. The government will keep imposing other tax charges on CPO shipments when prices exceed $750 a ton with rates ranging between 7.5 percent and 22.5 percent for higher prices.
Country & currency risk
Indonesia has the strongest economy in south east Asia. Default probability has been downgraded on a constant basis as the economy strengthens. While the country is still considered a developing nation, it is politically stable.The presidential elections in 2014 were conducted peacefully. Investing in any emerging market scenario should come with a prerequisite analysis of both the political and social aspects of the country. Scenarios can unravel quickly in developing countries like in neighbouring Thailand last year. Most listed CPO companies operate in USD. Both sales in CPO and raw materials are denominated in USD. Adverse movements of the Indonesian Rupiah could negatively affect performance. However, this has not been the case to date.
Chinese state control and sluggish demand
There has been a slowdown in Chinese demand for CPO, although temporary this, many analysts believe orders will revert to normal during the second half of the year. There are also reports that many buyers of refined palm oil in China struggled for funding as the country crackdown on commodity financing in the face of slowing domestic demand. This temporarily lead to lower Chinese CPO imports as the Chinese government loosened financing controls.
Weather risks
Both Malaysia and Indonesia received less than 50 millimetres of rain in January and February, the driest period since 1997. This was followed by significant floods in some key oil producing areas. Malaysian Palm Oil Board director general Dr Choo Yuen May said: “In November, the crude palm oil production was about 1.75 million tonnes. If you look at the annual trend, it is a seasonally declining trend from November to February. Normally, it will decline by about 10%
Future plantation expansion
Low availability of new plantation tracts could hamper producers expansion plans in the near future. Environmental concerns could also bring new regulation on deforestation.
Environmental
There is currently a groundswell in public opinion about palm oil, the industry and it's methods. There are a number of issues which have been adopted by worldwide NGO's and other lobbying organisations particularly focussed on:
- Deforestation
- Animal habitat degradation and cruelty
- Climate change
- Indigenous rights abuses
The industry is now developing a number of initiatives to improve it's image. The certified sustainable palm oil (CSPO) and palm kernel oil (CSPKO) is produced by palm oil plantations which have been independently audited and found to comply with the globally agreed environmental standards devised by the Roundtable on Sustainable Palm Oil (RSPO). These stringent sustainability criteria relate to social, environmental and economic good practice.
The RSPO is group of companies, exporters, governments, NGOs and other stakeholders who develop policy and report on industry environmental progress. The industry still has some way to go to meet consumer demands but should quickly develop CSR standards with pressure from global food companies who will define improved industry norms.
INDUSTRY CONSOLIDATION
Felda Global Ventures (FVG:MK), the palm oil giant emerged as the recent winner of the auction for Asian Plantations, whose sale price reflected the depressed state of sector valuations. Malaysia-based FVG:MK, the world's largest crude palm oil producer, said it had agreed to pay 120mnGBP for Asian Plantations who spoke to a number of interested parties. London listed Asian Plantations was a smaller producer with 24,622-hectare estate in Sarawak, Malaysia where fresh plantation land is much prized and hard to find. The price being paid by Felda, was 2.20GBP per share, offers little premium to Asian Plantations shareholders. The valuation reflected Asian Plantations status as a part-developed project, with much of its land - some 8,000 hectares as of the end of last year was still undeveloped. Furthermore, the offer came at a time of depressed palm oil prices as opposed to the Sime/NBPOL deal.
The final deal of the year was, again London listed Narborough Plantations a small palm oil producer was acquired by Riverview Rubber Estates Berhad (RRE:MK) as the companys ownership level invoked a mandatory takeover at 1.29GBP.
In Indonesia a 2013 law states that companies can only plant up to 100,000 hectares with oil palms, a limit put in place mainly to protect the smallholders that account for about 40 percent of Indonesia's palm oil output. The restriction, however, exempts listed companies majority owned by the public, which makes some of the 11 palm oil firms listed on the Jakarta stock exchange potential takeover targets for others seeking to expand their land bank. Nine of these listed companies have a market value of less than 1bnUSD, according to Thomson Reuters data.
Smaller Indonesian producers are now more willing to sell out as crude palm oil prices have fallen for three of the past four years, and prospects of a recovery are slim. That provides an opportunity for larger agri-conglomerates keen to invest in palm oil in the long term.
CURRENT MARKET CONDITIONS
CPO prices recently hit a six year low, however recently they have bounced back strongly to between $585 - $620USD per tonne. The number of bearish voices seem to be outnumbering the bulls on the future of CPO prices for the remainder of the year. A series from commentators forecasting declining palm oil prices. Liberum, the London broker, has also forecast that "prices are close to a trough given demand, especially from the biodiesel sector, is likely to be boosted by the low prices.But upside will be limited unless [US] soybean harvest forecasts are reined back." One leading analyst, Dorab Mistry at Godrej International, has unveiled a more downbeat assessment, signalling that the price retreat could have a further 20% to go."We know from experience that during bear markets, the price tends to gravitate toward the cost of production," Mr Mistry said, estimating Malaysian and Indonesian output costs at 1,500-1,600 ringgit a tonne.
Despite the outlook, Boustead Plantations Bhd (BPLANT:MK)Vice-chairman Tan Sri Lodin Wok Kamaruddin said it was still able to make a comfortable margin and that its costs were still under control. “The lower CPO price if compared against our average cost of production of about RM1,700 per tonne, is still good business. If CPO prices hover at RM2,200-RM2,300 per tonne, the contribution from the plantation business will be a little bit better than last year (FY14 ended Dec 31),”
Part two of this post will focus on investing in the palm oil industry, focussing on stocks in key palm oil plantation countries...to be continued