Temporary Correction


Economic News

22 Jul 2010
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Palm oil prices continue to slide, with worrying short-term consequences for Malaysia, the world's second biggest palm oil producer. Over the longer term, though, stabilisation and subsequent steady growth seem likely to prevail.

On August 26, Datuk Peter Chin Fah Kui, Malaysia's plantation industries and commodities minister, announced that the government was willing to take "immediate measures" if palm oil prices fell below RM2000 ($590) a tonne. That day, the price dropped to RM2409 a tonne on the Malaysia Derivatives Exchange, an 11% fall in two days and a 46% slide since a record high of RM4468 in early March. Singapore-listed Wilmar International, the largest palm oil trader active in Malaysia, also saw its stock fall to a five-month low, while Sime Darby, the world's largest publicly listed oil palm grower, fell 1.5% on the Kuala Lumpur exchange.

Prices for palm oil had risen on the assumption that some of it will be used as a natural substitute for non-renewable crude, the price of which has soared in the past few years due to a combination of demand, geopolitical instability and speculation. Given these factors, many companies and governments had started to focus their efforts on developing alternatives such as palm oil. However, the cost of crude oil fell from $147 per barrel in July to $115 in early August, causing the palm oil price to follow suit.

Chin said that the authorities were already taking measures to tackle oversupply in order to counteract the price fall. It is seeking to encourage palm oil firms to clear their inventories before bringing new stocks on stream and to discourage imports (neighbouring Indonesia is the world's largest major palm oil producer).

What further "measures" the government is looking to take remains unclear. Analysts are sceptical about how much the authorities can do to prevent the slide, given the fact that high prices have spurred palm oil producers to boost output significantly.

"Production is improving in 2009 and 2010 so prices will continue to fall," Nirgunan Tiruchelvam, assistant director at ABN Amro Securities in Singapore told the international press. "Even if they want to intervene, it may not dent overall supply."

In July, Malaysia registered oversupply of 2.1m tonnes of palm oil. Meanwhile, it has been reported in the local press that buyers from China and India have either cancelled or renegotiated deals involving around 800,000 to 1m tonnes of palm oil on the basis of lower prices.

Projected total output for this year is 17.4m tonnes. This may still represent overproduction if prices do not fall to meet demand, Dorab Mistry, director of Godrej International, an Indian food and beverage firm, told a conference in Kuala Lumpur on 25 August.

Contrary to Chin's sentiments, Mistry has argued that the price must fall further if the industry is to bounce back quickly. "We have at present a deadly cocktail of rising production combined with some demand rationing," he said. "Prices have to go to the level where they create strong demand growth."

While the sharp drop in the palm oil price has come as a shock to the sector in Malaysia, it does not constitute a crisis. A speculative bubble in crude oil has driven the cost of its palm "alternative" up in parallel, therefore, a correction looks only natural. A further inflation of the price would arguably have led to an even harder landing.

Over the long-term, the future of the palm oil industry seems secure enough. While the crude oil price has dropped of late, the spike of the past year has intensified the global focus on alternatives. Furthermore, given demand in emerging markets, and increased geopolitical tension between Russia and the West, crude oil prices may trend gently upwards again over the next few months and years. Malaysian palm oil futures for November rose 3.8% on August 27, following a similar increase in crude oil.

While the biofuels cultivated in the West are becoming increasingly unpopular in the international community, given their suspected impact on food prices, palm oil may be seen as a suitable option compared to other sources such as corn, although it is the least efficient of biofuels.

Palm oil remains a South East Asian staple, and with a growing and increasingly affluent population in the region, steady non-industrial demand seems likely.

While output is also expected to increase, the recent price drop may curtail overproduction and channel investment to other growing sectors. With Malaysian plantation players looking to expand abroad, the scope for upping domestic supply excessively (and flooding the market) is probably limited. The palm oil sector has taken a hit, certainly. But a more stable future is likely to lie ahead.

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