Growing Palm Oil Demand

Malaysia

Economic News

22 Jul 2010
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With the price of crude palm oil continuing to reach record prices, and demand forecast to surge at a higher pace than supply, Malaysia's palm oil sector is poised to continue its recent run of strong revenue and export performance.



The price of crude palm oil (CPO) reached a record high of $807 per tonne in June, and is forecast to average $729 for 2007, an almost 60% increase on the 2006 average price of $458.



While palm oil production is used in many applications, its selling price is mainly determined by that of competing edible oils such as corn and soy. The price of crude oil also helps set the price as palm oil is used as an additive in making biofuel, an increasingly popular alternative to petrol.



With the demand for edible oils expected to increase by 5m tonnes in 2008, and supply expected to rise by only 3.9m tonnes, prices for both soy and palm oil, which tend to move in tandem, are forecast to rise even further for the rest of the year. Rival soy bean, for example, recently reached a 23-year high of $900 per tonne. A recent rise in the price of wheat to $9 per bushel is encouraging farmers in North America and Europe to grow the grain instead of oil seeds such as corn, rapeseed or soy beans.



The surge in demand for CPO is coming mainly from China and India, growing markets that are the world's first and second consumers of edible oils respectively. There is also a surge in demand for palm and soy due to the commodities' usage in creating biofuel, which in addition to the environmental benefits, is becoming an affordable alternative to petrol due to the soaring prices of crude oil. In Europe, biofuel is expected to comprise 10% of motor fuels by 2020.



Palm oil is a key contributor to Malaysia's economy, accounting for 6% of the country's total exports. The recent strong run of CPO price is expected to make 2007 Malaysia's strongest year for palm oil earnings to date, and palm oil export revenue is expected to exceed the contribution of oil. Overall, including the sale of accumulated reserves, the palm oil sector is forecast to generate exports of $11bn, a 48% increase on the $7.3bn it contributed last year. Crude oil, meanwhile, is forecast to contribute $10.2bn in export earnings.



On the supply side, output for 2007 is expected to reach 14m tonnes, the lowest in two years. This is mostly due to large flooding over the past year and the life cycle of palm trees, which reach maturity at 25 years. With 65% of Malaysia's total land area being forest, from which palm oil plantations use 12% and the remaining land is protected, Malaysia is running out of available plantation land.



With the possibility for the expansion of domestic production limited, Malaysian companies are looking to move further into Indonesia, which is expected to surpass Malaysia next year as the world's largest producer of palm oil. Already, Malaysian companies account for one in every five tonnes of production coming out of Indonesia.



Together, the two countries account for 85% of world palm oil production, but with the price on the rise, countries such as Thailand and the Philippines are continuing to invest in developing their output. While Indonesia will soon surpass Malaysia in production, Malaysia will still remain the world's leading exporter, as a larger proportion of Indonesia's output is consumed domestically.



In addition to the strong global demand for palm oil, another development for Malaysia's palm oil sector will be a merger of Golden Hope Plantations, Kumpulan Guthrie and Sime Darby Group. Following shareholder approval in August, the new company, Synergy Drive, is expected to be fully listed in November. While the participating companies are involved in multiple business units, each has significant plantation interests. Once listed, the company is expected to produce an estimated 8% of the world's total supply and is anticipated to have a market capitalisation of $22bn.



Sime Darby has a significant presence in Southeast Asia, with plantations, property, heavy equipment, motors, and energy and utilities as its core businesses. The company has expanded into Singapore, Hong Kong, China and Australia, and will take the mantle of leading Synergy Drive. Ahmed Zubir Murshid, current group CEO of Sime Darby and soon to be group CEO of Synergy Drive, told OBG, "People say that big does not necessarily mean beautiful, but I think in this case, big is beautiful as it creates economies of scale. As a merged entity, we expect to receive synergy savings of between RM4m to RM5m ($1.2m to $1.5m) a year from 2009 onwards."



In a sector in which analysts have said there are too many players and are calling for consolidation, having a clear industry leader is expected to put Malaysia in a position of power moving forward. Chan Seng Fatt, acting CEO of Tradewinds Plantation, the plantations arm of Malaysian conglomerate Tradewinds Corporation, told OBG the merger will make Malaysia "a clear leader and this will help the local industry get a louder and clearer voice in the world spectrum".



Mamet Salleh, chief executive of the Malaysia Palm Oil Association said he believes that having fewer larger and stronger players is critical for the advancement of Malaysia's local palm oil sector, telling OBG, "with mergers, we can do more".



Overall, with the price of palm oil expected to continue its rise, and Malaysia's palm oil sector growing in strength through consolidation and further investments in land in Indonesia, palm oil should continue to be a vital contributor to the country's export earnings for years to come.

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