(Source: This excerpt is from OSK Investment Bank Berhad Research report, Analyst: Alvin Tai)
Palm oil price continued to weaken with the improved production outlook in 2H this year. At the same time, exports have been weak, suggesting that the current palm oil price is excessive and will inevitably lead to demand destruction. We believe that palm oil price already hit a peak in the 2008 – 2011 upcycle and is now in a downcycle, which will last some 6 to 9 months at the very least. As there have been no fresh catalysts to spur palm oil price further, prices have to correct to a level where demand starts to kick in...
Start of the downcycle. We are convinced that palm oil price had peaked when it hit RM3,967 per tonne (3rd month futures) in February 2011 and may have started a downcycle,judging from the recent negative price action. In our sector update last month, we indicated that our average CPO price assumption of RM3,200 per tonne this year implies that the commodity’s price will weaken to RM2,700.
Market now convinced of production recovery. It appears that the market is now convinced that palm oil production will recover significantly in 2H this year. This is not surprising given the typical lag effect of dry weather on palm oil production. Our plantation consultant/agronomist has warned since last year of a potential bumper crop developing in the later part of 2011, particularly in Indonesia.
Discount to widen. Palm oil’s discount to soybean oil has been extremely narrow in the past 2 years but is now starting to widen. The spread, which now stands at USD78 per tonne, has room to widen as a typical discount ranges from USD100 – 200. Normalization of the spread to a mid-point of USD150 will bring palm oil price down to RM3,290 if soybean oil stays where it is.
Demand destruction in the making. The high palm oil price has likely caused a slowdown in demand, as affordability is reduced, particularly in the poorer developing nations. Malaysia’s shipment fell by some 20% for the first 10 days of March, indicating that prices above RM3,500 have been excessive and high enough to cause demand rationing.
High crude oil price will not help palm oil price. We do not believe the spike in crude oil price to over USD100 per barrel will help palm oil price much, if at all, as the price spread between palm oil and crude oil is still too big for the biodiesel factor to come into play to support palm oil price. Crude palm oil is now trading at an equivalent of USD155 per barrel compared to USD103 for crude oil, bearing in mind that while crude oil price stayed stagnant most of 2010, agriculture commodities had enjoyed a bull market.
A very good comment.