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Important disclosures can be found in the Disclosures AppendixAll rights reserved. Standard Chartered Bank 2012 research.standardchartered.com
Abah Ofon, +65 6596 8651Abah.Ofon@sc.com
Koun-Ken Lee, +65 6596 8256KounKen.Lee@sc.com
SCout is Standard Chartereds
premium research product that
offers Strategic, Collaborative,
Originalideas on Universaland
Thematic opportunities
Global Research |30 April 2012
Crude palm oilA price storm is brewing
Highlights
A severe structural slowdown in palm oil output is under way. The downtrend will
worsen over coming seasons and is one the market can no longer afford to ignore.
The deceleration in palm output is caused largely by the ageing profile of estates in
South East Asia, which accounts for over 90% of the market, as well as sub-
optimal farming practices across much of the region. Our conservative estimate is
that more than 20% of trees in Malaysia are over 25 years old. In reality, this could
be more.
US prospective plantings for 2012 suggest soybean output will remain tight for the
rest of the year. The resulting decline in palm yield alongside a production shortfall
in the soy complex will necessitate strict demand rationing in the edible oils sector.
As before, we continue to see upside momentum building in 2012, but contrary to
consensus, we expect Q4-2012 to be mostly bullish. Despite current enthusiasm,
markets are likely to rally to even higher levels in 2013.
Our long-term bullish view on crude palm oil (CPO), relatively accommodative
global interest rates and a deteriorating age profile of trees in Malaysia should help
to convince owners, particularly in Malaysia, that the replanting decision is best not
delayed.
We recommend shorting the September 2012 BMD crude palm oil futures at the
current price of MYR 3,450/tonne (t), with a target of MYR 3,250/t. From Q3-2012,
we recommend looking for any reversal in prices to the upside with a target of MYR
3,700/t.
Contents
Summary 2
Hedging and trade recommendations 3
Building blocks 5-7
Declining CPO yields 8-13
CPO supply forecasts 14
Higher industry costs 15-19
Fungibility and demand 20-25
CPO balance sheet 25-26
CPO price outlook 27-29
Conclusion 31
Appendix 32-35
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Crude palm oilA price storm is brewing
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Summary
Why we are bullish on CPO
Productivity and supply, substitutability and import demand are important factors
determining the CPO price. In this report, we focus largely on supply and leverage off
historic fundamental data that shows supply has a material impact on price trends in
the CPO industry.
We believe there is a price storm brewing in the industry due to a deceleration in yields,
the severity of which will be bullish for the market. First, we highlight the crucial
decoupling between weather events and CPO output, which suggests that La Nia (wet
weather in South East Asia) will not, as in the past, lead to higher CPO output (see
Chart 1). We believe this phenomenon has been exacerbated by the sub-optimal profile
of some plantations in South East Asia. We estimate that more than 20% of oil palms in
Malaysia are already over 25 years old (Chart 2), after which yields plummet and trees
generally have to be replanted. We recommend that estate owners not delay replanting.
We find evidence to suggest that a large proportion of estate owners in South East
Asia have underinvested in their estates, largely to limit overhead costs. Yields have
been adversely affected as a consequence. Further yield erosion can be halted by
replanting schemes, using higher-yielding seedlings, through the application of more
fertiliser, the use of a more efficient and motivated work force or a combination of all
three. Whatever the strategy employed, these essential investments will raise the
cost curve for palm and provide a higher price floor.
On the other hand, CPO consumption has been trending higher in an almost linear
manner relative to global edible oil consumption, driven in part by population growth.CPO consumption has been enhanced by its fungibility across a wide range of
applications, as well as its price competitiveness versus other vegetable oils. We
assume this ratio will continue through the forecast period.
We believe the market is entering a period of stringent demand rationing. We model
CPO prices based on our CPO balance sheet estimates and, factoring in external
market risks, arrive at a price forecast of MYR 3,450/t for 2012, MYR 3,620/t for
2013, MYR 3,228/t for 2014 and MYR 3,456/t for 2015. Our annual average forecast
for 2012 is unchanged, but now adequately reflects upside risks further along the
curve (Table 1).
Chart 1: Correlation between the SOI and change in CPO
output in Malaysia has broken down
Chart 2: Age profile of oil palms in Malaysia
We estimate over 20% of trees are over 25 years old, mn ha
Source: Standard Chartered Research Sources: MPOB, Standard Chartered Research
Corr
Corr t-stat
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
-10%
0%
10%
20%
30%
40%
50%
60%
70%
Jan-84 Jan-88 Jan-92 Jan-96 Jan-00 Jan-04 Jan-08
t-stat 5% (RHS)
Mature area 25 yrs
% >25
0%
5%
10%
15%
20%
25%
0
1
2
3
4
5
6
2000 2002 2004 2006 2008 2010
We bel ieve the market is enter ing a
per iod of demand rat ioning; ini t ial ly
this wi l l be fel t most acutely in Q4-
2012
We highl ight the crucial decoupl ing
between weather events and CPO
outpu t; wet weather in SE Asia wi l l
not, as in th e past, lead to h igher
CPO outpu t
Essent ial investment in th e CPO
industry w i l l raise the cost curve for
palm and pro vide a higher pr ice
f loor
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Crude palm oilA price storm is brewing
30 April 2012 3
Hedging and trade recommendations
Producers
Producers should take advantage of the current market near MYR 3,500/t to lock in
some profits. Although we are bullish on CPO, we expect significant volatility at
current prices. Risk-averse clients should consider buying put options, which will give
them the right but not the obligation to sell at an agreed price, thereby protecting
against price drops.
Consumers
We have a bullish long-term outlook on CPO on account of tight global edible oil
stocks and an anticipated deceleration in CPO yields. However, we believe the
market is approaching a near-term top and will dip briefly in Q3-2012. Consumers
should look to buy dips on the basis that any weakness is likely to prove short-lived.
Trading (short-term)
We recommend shorting September 2012 BMD crude palm oil futures at the current
price of MYR 3,450/t, with a target of MYR 3,250/t, below our average Q3-2012 price
target of MYR 3,350/t (prices above Q3-2012 price target will need to fall below
target to ensure our average is met). MYR 3,241/t represents the 61.8% Fibonnacci
retracement level and also appears to be significant since it has served as a support
and resistance level for the past year. We place our stop-loss at MYR 3,590/t.
After the northern hemisphere summer months, yields are expected to decline, but to
lower levels than usual, which is a reflection of the sub-optimal profile of plantations
in South East Asia. From Q3-2012, we would recommend looking for any reversal
prices to the upside, with a target of MYR 3,700/t (about a 10-15% gain).
Table 1: Standard Chartered CPO forecasts
We see significant upside risks in Q4-2012
Chart 3: BMD CPO futures, MYR/t
We recommend shorting September futures
New forecastMYR/t
Previous forecastMYR/t
Q2-2012 3,500 3,400
Q3-2012 3,350 3,600
Q4-2012 3,700 3,600
2012 annual average 3,450 3,450
2013 annual average 3,620 3,800
2014 annual average 3,228 3,900
2015 annual average 3,456 3,950
Source: Standard Chartered Research Sources: Bloomberg, Standard Chartered Research
Daily
Qtr avg
Qtr Fcst
Fwd
2,700
2,900
3,100
3,300
3,500
3,700
3,900
4,100
Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12
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Crude palm oilA price storm is brewing
30 April 2012 4
Chart 4: A graphic introduction to CPO, its value chain and applications
Sources: MVO, Standard Chartered Research
Plantation
UPSTREAM
Fresh fruit bunches
(FFB)
Crude palm oil/
Palm kernel oil
Milling
Trading/transport
MIDSTREAM
Refining
DOWNSTREAM
RBD palm oil
RBD Olein(80%) Stearin(20%)
Fractionation
Splitting
Glycerol/fatty acids
Double
fractionation/palm mid
fractionation
Oleo chemical
processing
Hydrogenation/
interesterification
Reduction
Fatty alcohols
Amidisation
Fatty nitrogen
Applications
Food (75%):
Cooking oils and frying fats
Margarine and spreads
Shortenings
Confectionary and bakery fats(specialty fats)
Vanaspati (vegetable ghee)
Ice cream, coffee creamersand filled milk
Emulsifiers
Vitamin E supplements
Non-food (25%):
Soap , shampoo anddetergents
Animal feed
Energy generation, biodieseland lubricants
Cosmetics
Pharmaceuticals
Organic fertilisers and biomass
Paints
Plasticisers, stabilisers forrubber and PVC
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Crude palm oilA price storm is brewing
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Three building blocksproductivity, fungibility and demandAn imp ortant star t ing poin t in our discussion on th e out look for CPO pr ices is
to introdu ce bui lding bloc ks we wi l l use to form ulate our CPO pr ice forecast.
Oi l palm produ ct iv i ty (yield) , i ts fungib i l i ty with other vegetable oi ls and impo rt
demand are key elements that shape the pr ice out look . To demonstrate this
view we analyse the CPO markets evolution in 2011 where these three factors
contr ibuted to generate signi f icant p r ice volat i l i ty . We believe these three
factors wi l l cont inue to sh ape CPO pr ices over the long term and w e develop
this argum ent fur ther in ou r report to arr ive at our CPO pr ice forecasts.
CPO prices started 2011 on a bullish note, rallying 9% in mid-January to close at a
peak of MYR 3,990/t on 10 February 2011. Thereafter, the market traded lower,
slumping nearly 30% to reach a floor around MYR 2,800/t on 7 October. Three key
events helped to shape the outlook for CPO prices in 2011, as well as set the
platform for events in 2012.
An unprecedented increase in CPO yields in South East Asia
This was most evident in Malaysia, where fresh fruit bunch (FFB) yields rose
significantly between March and December 2011. It is important to put the
improvement in Malaysian FFB yields into context. Overall, FFB yields declined
counter-seasonally in 2010, with the trend persisting until it reached a floor in
February 2011. This tightening in output prospects was particularly prominent in Q4-
2010, when yields were around 14% lower than the average yield in the same period
in 2006-09. Lower output in Q4-2010 provided a bullish platform for markets, with
nearby CPO futures rising 38%.
The drop in yields in 2010 coincided with an intense La Nia, the worst in over
35 years. Monsoon flooding caused by La Nia tends to limit harvesting, particularly
in low-lying areas near riverbanks. Flooding can significantly distort the palm oil
supply chain in the short term, but boost yields in the longer term. The sharp
improvement in yields in South East Asia after La Nia subsided had an inverse
effect on market prices. FFB yields in Malaysia improved significantly in Q2-2011,
with average yields 14% higher than the five-year average for the same period.
Yields peaked seasonally in September at 1.95t/ha and have since trended lower
(Chart 5).
Chart 5: 2011 CPO yields vs. the five-year average
Malaysian yields saw unprecedented growth in 2011, t/ha
Chart 6: High yields boosted inventories in Malaysia
Month-end closing stocks, mt
Sources: MPOB, Standard Chartered Research Sources: MPOB, Standard Chartered Research
2011
1.0
1.2
1.4
1.6
1.8
2.0
Jan Mar May Jul Sep Nov
5 yr average yields
1.0
1.2
1.4
1.6
1.8
2.0
2.2
2.4
Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11
FFB yields in Malaysia peaked
in September 2011 and
have since trended lower
Low er CPO output in Q4-2010
provided the market with a bul l ish
platform; nearby CPO futures
subs equently ral l ied 38%
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Crude palm oilA price storm is brewing
30 April 2012 7
The past four years had three significant periods in which a narrowing of the
SBO/CPO spread was followed by a sharp slowdown in CPO imports and, as a
consequence, a sharp drop in the price of CPO.
Using data from January 2004 in China and from January 2007 in India, we find
some correlation between the average monthly SBO/CPO spread and the volume of
imports. This relationship is more established in India, which mainly imports crude
CPO, but we also see a similar pattern in China, which mainly imports refined CPO
(Chart 8). The sharp improvement in CPO demand in Q2-2011 coincided with a
larger soyoil premium over CPO. Conversely, the recent decline in CPO demand
coincided with a tightening of the soyoil premium over CPO. The soyoil premium hit
its lowest level in nine months in January 2012, and now looks to have reached a
floor. The improvement in the SBO/CPO spread reflects bullish momentum in the
soybean complex (seeSpecial Report, 31 October 2011, Soybeans The case for a
bull market in 2012), which has so far provided significant upside impetus for CPO
prices in 2012.
Over all, the impact of these three key events (the trend in CPO yields, the trend in
the SBO/CPO spread and CPO import dynamics in Asia) set the stage for CPO
prices in 2011. These events, along with significant fiscal changes in Indonesias
CPO market and energy prices, will continue to drive the outlook for CPO prices in
2012 and beyond.
The sharp impro vement in
CPO demand in Q2-2011 coincided
with a larger soyoi l premium
over CPO
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Crude palm oilA price storm is brewing
30 April 2012 9
shortfall in the CPO market. This is not to say there is not healthy interest in the
supply outlook, particularly for the key producing regions of Indonesia and Malaysia,
which together account for around 90% of global output (Chart 11). There is; which
we noted at a recent industry conference in Malaysia, where on average the threekey industry speakers estimated 2012 output in Indonesia and Malaysia at 26.5mt
and 19mt, respectively. However, we advocate greater market focus on supply as
this will be a key game changer in the industry in the near to medium term.
Government estimates in Indonesia put 2012 CPO output at 25.7mt, up from 22.5mt
in 2011 while in Malaysia official figures indicate that output will rise by around 2.3%
y/y to 19.3mt as more trees enter maturity. Central to output projections is the age
profile of trees in producing countries. Indonesia is expected to benefit from young
trees (4-6 years old) entering their prime (7-12 years old). This will partly compensate
for the slowdown in yield from older trees. In Malaysia, yield is likely to drop despite a
larger mature area due, in part, to a planting campaign in 2008-09, particularly in thestate of Sarawak on Borneo Island (Chart 12).
Data and comments from industry consultants highlight the fact that the industry is in
the middle of a down-cycle. Consultant, Oil World, forecasts CPO yield in Indonesia
of 3.94t/ha in 2012, flat compared with 2011. In Malaysia, yield is forecast to drop to
4.36t/ha compared with 4.42t/ha in 2012. In both Malaysia and Indonesia, palm trees
are likely to show signs of stress after strong production in 2011.
Globally, Oil World forecasts output at 52.3mt in 2012, up from 50.2mt in 2011, with
global yields dropping marginally to an average 3.72t/ha, down from 3.73t/ha in 2011.
Global mature acreage is forecast to rise to 14.1mn ha, up from 13.44mn ha in 2011.Comments from major industry player Godrej International supports the view that the
industry is in a low cycle which will last from March 2012 until around November 2012.
The occurrence of this low cycle, should it be realised, will be of particular significance
because CPO yields usually start trending higher in March before peaking in October
(we briefly discuss seasonality below). However, we believe this low cycle will last
even longer than currently estimated due to what we perceive to be a crucial
decoupling between weather events and CPO output, a phenomenon which has been
exacerbated by the sub-optimal profile of some plantations in South East Asia.
Chart 11: Malaysia and Indonesia are top CPO producers
The countries together account for about 90% of global output
Chart 12: Output growth is slowing
This is particularly true in Malaysia, % y/y
Sources: USDA, Standard Chartered Research Sources: USDA, Oil World, Standard Chartered Research
0
10
20
30
40
50
60
1990/91 1993/94 1996/97 1999/00 2002/03 2005/06 2008/09 2011/12
Indonesia Malaysia ROW
Indonesia
Malaysia
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
1990/91 1993/94 1996/97 1999/00 2002/03 2005/06 2008/09 2011/12
The general market consensus
is that outpu t wi l l fal l
in South East Asia but we bel ieve
the decl ine wi l l last longer
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NE monsoonweather
Palm oil seasonality
Seasonality in agricultural commodities is well known, and CPO is no different.
Looking at the forward curve, we see signs of seasonality, with peaks occurring in the
run-up to the summer (Chart 13). Seasonal troughs look as though they occur aroundSeptember.
As an exercise and to quantify our expectations, we analyse front-month futures
prices for seasonality, using our multiplicative model (see Commodity Focus
Quarterly, 21 June 2011, Aseason for everything). This assumes that prices can be
broken down into three components: trend, irregular and seasonal. Simplistically, it
takes the following form:
We use S to refer to the average seasonal component for that time of the year. The
irregular term I is the random noise component, while the trend term T captures, andultimately removes, any price trends. Estimations of trend and removal of the
irregular component allow us to isolate the seasonal component. The seasonality for
palm oil, based on the last 10 years of data, is shown in Chart 13 and has been
normalised to be between zero and one, with zero representing the seasonal low and
one representing the seasonal high. What we find is that seasonal upward bias is
seen in the run-up to the summer, peaking around April. Prices remain seasonally
high around summer time and then descend to a trough in September-October.
There is then an upturn at the end of the year. This is roughly what we expected from
the forward curve (Chart 14).
The reason prices exhibit this seasonality is linked to yields that start to trend higherin March and peak around October. Higher yields at this time would drive prices
lower, as seen in our price seasonality. We calculate the normalised seasonal month
average yield and overlay this with our price seasonality to demonstrate the
relationship and show it inverted in Chart 13. While the relationship is clear, it is worth
highlighting that seasonality in yields is largely a function of the weather. The North
East monsoon weather runs from November through March, disrupting harvesting
and production due to heavy rainfall.
Chart 13: Estimated relative seasonality
CPO and average seasonal yield (inverted, normalised)
Chart 14: BMD CPO forward curve, MYR/t
9 April 2012
Sources: Bloomberg, MPOB, Standard Chartered Research Sources: Bloomberg, Standard Chartered Research
Priceseasonality
Avg yield(inverted,
RHS)
0.0
0.2
0.4
0.6
0.8
1.00.0
0.2
0.4
0.6
0.8
1.0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
3,350
3,400
3,450
3,500
3,550
3,600
3,650
Mar-12 Jun-12 Oct-12 Jan-13 Apr-13 Jul-13 Nov-13 Feb-14
Yield seasonal i ty is clo sely l inked tothe dis rupt ive impact of mon soon
weather in SE Asia
CPO pr ices are seasonal ly hig h
around March to A ugust and trough
around September/October
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Weather and CPO, a marriage gone sour
Oil palms thrive best in countries with high rainfall (minimum of 1,600mm p.a.) in
tropical climates within 10 of the equator. According to the UNs Food and
Agricultural Organization, low moisture is the most common reason for tree stress,which is why it is important to examine weather events over the last 24 months.
Between June 2009 and May 2010, weather events were dominated by El Nio
developments that led to moisture stress and occurrences of bunch failure, floral
abortion and sex differentiation. In contrast, the weather over the last 24 months has
been volatile, dominated by La Nia weather conditions stretching from July 2010 to
April 2011. La Nia weather is associated with wetter-than-normal conditions in
South East Asia, and El Nio with drier-than-normal conditions. La Nia weather
conditions again gained momentum in July 2011, lasting until January 2012. Climate
models surveyed by the Australian Bureau of Meteorology (ABM) show a continuing
weakening of the event, with neutral conditions expected over the coming months.
There is some uncertainty over the outlook for the rest of 2012, a feeling echoed by
the World Meteorological Organization (WMO) and consultants, Browning. In
February, the WMO wrote that although historical precedence and the latest output
from forecast models suggest that the current La Nia reached its peak in late 2011
and early 2012, after May there is a wide range in the model forecasts. Browning has
a similar view while the Pacific is expected to be neutral by mid- to late spring,
opinion is divided on whether the ocean will warm, remain neutral or cool again in the
autumn.
For the purposes of this report, we will adopt the opinion of the ABM that sea surface
temperature anomalies will likely return to a neutral state from March to May 2012
(temperate spring). We also assume conditions will remain neutral into December
2012. When we plot the Southern Oscillation Index (SOI) against annual output in
Chart 15: Oil palms thrive in tropical climates within 10 of the equator
Sources: FAO, Standard Chartered Research
Climate models by the Au stral ian
Bureau of Meteorology show a
con tinu ing weakenin g of La Nia
CPO yields r ise fol lowing
La Nia ev en ts
It is uncertain how s ea
temperatures wi l l evolve after May
2012
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Crude palm oilA price storm is brewing
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both Malaysia and Indonesia (Charts 16 and 17), we see that palm output y/y tends
to rise during La Nia events and fall during El Nio episodes. Sustained positive
values of the SOI are indicative of La Nia conditions.
Assessing the current shape of the SOI curve, and taking into account forecasts for a
drop in the SOI to neutral conditions, we expect yields will return to trend between
May and October but, contrary to market expectations, we look for yields to fall below
trend in Q4-2012.
What reinforces our conviction that CPO yields will be tighter than expected beyond
Q4-2012 is the noticeable decoupling in the relationship between CPO output and the
SOI in both Malaysia and Indonesia (Charts 16 and 17). The recent de-coupling is
noticeable; however, we look for more concrete evidence. We calculate the rolling
correlation between CPO output and SOI for both countries (Charts 18 and 19). For
each correlation we evaluate the accompanying t-statistic that tells us if thecorrelation is significantly different from zero for a particular confidence level (5%). A
result above the t-statistic 5% level would mean the correlation was significantly
different from zero.
Chart 16: SOI vs. change in CPO output in Malaysia
Palm yields tend to rise during La Nia events
Chart 17: SOI vs. change in CPO output in Indonesia
More recently, this relationship has decoupled
Sources: USDA, ABM, Standard Chartered Research Sources: USDA, ABM, Standard Chartered Research
Chart 18: Rolling correlation between SOI and change in
CPO output in Malaysia
Chart 19: Rolling correlation between SOI and change in
CPO output in Indonesia
Source: Standard Chartered Research Source: Standard Chartered Research
SOI index
-0.1
0.0
0.1
0.2
0.3
0.4
1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
-15
-10
-5
0
5
10
15
Chg CPO output(% y/y, RHS)
SOI index
-0.1
0.0
0.1
0.2
0.3
0.4
1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
-15
-10
-5
0
5
10
15
Chg CPO output(% y/y, RHS)
Corr
Corr t-stat
t-stat 5%
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
-10%
0%
10%
20%
30%
40%
50%
60%
70%
Jan-84 Jan-88 Jan-92 Jan-96 Jan-00 Jan-04 Jan-08
Corr
t-stat
t-stat 5%
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
-10%
-5%
0%
5%
10%
15%
20%
25%
Jan-84 Jan-88 Jan-92 Jan-96 Jan-00 Jan-04 Jan-08
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For Malaysia, we see a correlation ranging from 40-60%, which remained
significantly different from zero until 2002. Beyond 2002, and particularly after 2008,
we see a strong correlation decoupling, which backs up our initial expectations.
Interestingly, when we do this for Indonesia, we see a much smaller and variedcorrelation, which statistically is close to zero for the whole period we studied (1984-
2011). It would appear that the SOI, and hence La Nia/El Nio, has not had a
significant effect on Indonesian CPO output in the past compared with Malaysias
output. We attribute this to the younger profile of trees in Indonesia compared with
Malaysia and the use of relatively improved seedlings in many parts of Indonesias
CPO industry. However, since 2008, it would appear there has been a lack of
influence from the SOI.
What this means to us is that La Nia weather conditions will not naturally, as in the
past, lead to higher output. The impact of the weather will remain important, but the
scale of its effect on output will depend on the severity of the weather event, as wellas prior and subsequent weather conditions. In the near to medium term, output will
depend even more on plantation management and practices, including the age profile
of trees, labour, fertiliser and manure use, and planting procedures. These will have
important cost implications for estate owners who may be inclined to stagger costly
innovations and initiatives and, in the process, keep CPO yields depressed
for longer.
Other factors have lessened the
impact of the weather on yield
outcom es in the CPO sector
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Our CPO supply forecasts
We assume global yields will stay on par with a three-year average, but with
downside risks. We calculate that output will grow 7% and 3%, respectively, in
Indonesia and Malaysia through the forecast period. Production in the rest of theworld has been more chequered over the last three years, dropping 2% in 2009/10,
stagnating in 2010/11 and forecast to grow 6% in the current season. We believe
supply prospects outside Indonesia and Malaysia are good given increasing
investment in oil palms in Latam and Africa. We believe growth of 6% can be
maintained over the forecast period, particularly given the low output base. Our
supply forecast is more aggressive than market conditions suggest. While our core
view is for tighter global output in the medium term, we believe our forecast captures
unpredictable upside risks. Our supply projections are shown in Table 2.
Table 2: CPO supply forecasts, mt (BASE CASE)
World production % growth y/y Of which Indonesia Of which MalaysiaOf whichrest of the world
2010/11 47.9 4.51 23.6 18.2 6.1
2011/12E 50.6 5.50 25.4 18.7 6.5
2012/13F 53.3 5.49 27.3 19.2 6.9
2013/14F 56.3 5.53 29.3 19.7 7.3
2014/15F 59.4 5.5 31.5 20.3 7.7
CPO supply forecasts, mt (HIGH CASE)
World production % growth y/y Of which Indonesia Of which MalaysiaOf whichrest of the world
2010/11 47.9 4.51 23.6 18.2 6.1
2011/12E 50.6 5.50 25.4 18.7 6.5
2012/13F 54.8 8.30 27.9 19.7 7.2
2013/14F 59.4 8.39 30.7 20.8 8.0
2014/15F 64.5 8.59 33.7 21.9 8.9
CPO supply forecasts, mt (LOW CASE)
World production % growth y/y Of which Indonesia Of which MalaysiaOf whichrest of the world
2010/11 47.9 4.51 23.6 18.2 6.1
2011/12E 50.6 5.50 25.4 18.7 6.5
2012/13F 52.7 4.15 27.5 18.8 6.7
2013/14F 55.0 4.36 29.2 18.9 6.8
2014/15F 57.5 4.55 31.4 19.0 7.1
Sources: USDA, Standard Chartered Research
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Higher industry costsAn indication of yield erosion
Low production costs in South East Asia are transient; the market should not get too comfortable
High industry margins mask structural deficiencies
The age profile of estates in Malaysia is sub-optimal; replanting will increase output costs
We see evidence to su ggest that a large proport ion o f estate own ers in South
East Asia have under invested. In m ost cases, this is due to the relat ive cost of
invest ing and long lead t imes between plantat ion establ ishment and
prof i tabi l i ty . Smal lholders, part icular ly in Indon esia, have l imi ted their use of
fer t i liser on p ropert ies that general ly have infer ior stock. As a co nsequence,
yield has been adversely affected. Growth in yield can be remedied, but at a
cost throug h plant ing h igher-y ielding seedl ings, invest ing in fer t i l iser or both .
These essent ial investments wi l l raise the cost curve for palm and p rovide a
more elevated f loor for p r ices.
Malaysias headache is Indonesias, too
Malaysia and Indonesia find themselves at a crossroads. After years of buoyant
output, yields are showing greater signs of stress. However, before exploring the
resulting cost implications from the drop in yield in both countries it is important to
note the following:
1. The cost structure of oil palm plantations is made up largely of labour, fertiliser
and diesel on a per hectare (ha) basis. Oil palm plantations are extremely labour
intensive and are costly to establish and manage.
2. Fertiliser is the largest cost item for an immature estate, we understand. Once
trees reach maturity, labour takes the No. 1 spot, with fertiliser dropping to No. 2.
As a result, the price of fertiliser is a significant yield and profit driver.
3. Palm trees typically begin flowering and producing fresh fruit bunches (FFB)
after three to four years, with a substantial increase in yield three to four years
later. Oil palm plantations generally remain profitable for 25 years, after which
they need to be replanted. Yields are therefore central to profitability as they
impact on the cost of CPO per hectare (or per tonne).
Chart 20: Typical yield profile of oil palms
Trees peak at around 7-12 years, FFB yield in t/ha
Chart 21: Annual change in CPO import demand
Indonesia now supplies over half the annual change in use
Sources: Oil palm industry journal, Standard Chartered Research Sources: USDA, Standard Chartered Research
0
5
10
15
20
25
30
4 8 12 16 20 24 28
-2
-1
0
1
2
3
4
5
1991/92 1994/95 1997/98 2000/01 2003/04 2006/07 2009/10
World CPO exports ex-Indonesia, annual change, mt
CPO exports, Indonesia, annual change, mt
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4. Peak palm oil yields occur when trees are between 7 and 12 years of age, and
gradually decline thereafter (Chart 20). As a plantation ages, it also tends to
experience declining tree populations as a result of pests and disease. Newly
established plantations might have 130-145 trees/ha, whereas an old plantationmight be reduced to about 100 trees/ha.
The long lead time between plantation establishment and profitability are huge
impediments to many plantation owners.
Growing pains in Indonesia and Malaysia
Over the past decade, Indonesia has not only overtaken Malaysia as the top
producer of CPO, but now supplies over half of the annual increase needed to meet
growing demand global demand (Chart 21). Using data from the US Department of
Agriculture (USDA), we calculate that Indonesias CPO growth averaged 12% p.a.
between 2001 and 2010 compared with 6% p.a. in Malaysia. The primary reason forthis remarkable growth in Indonesias CPO output was due to reforms in Indonesias
CPO industry, which included the allocation and issuance of around 10mn ha of new
land licences between 2000 and 2009. Land lease terms were also liberalised and
extended from a limit of 25 years to a new limit of 95 years to motivate investors.
What is fascinating about the growth in palm planted acres in Indonesia during this
period is that the rate of growth was greatest among smallholders. The annual growth
rate at smallholders was over 17.4%, compared to 4.6% at private commercial
estates, according to the USDA and the Indonesia Palm Oil Commission (IPOC). By
2010, smallholders numbered over 1.5 million, with a typical farm size of two ha,
compared with over 10 government companies operating around 185 plantations withan average farm size of 3,900 ha, and around 820 private operators operating 1,020
plantations with an average size of 3,500 ha. Consequently, smallholders now
account for more than 40% of the planted area in Indonesia. This compares with
around 14% in Malaysia (Charts 22 and 23).
Evidence on the ground suggests that smallholders find labour to be a more
manageable cost than other inputs required for an immature estate. As a result,
smallholders apply minimal fertiliser to their land and genetic stock on their properties
is generally inferior to that grown by government and private estates. Additionally,
official data indicates that around a third of oil plantations, mainly smallholders, are
Chart 22: Oil palm planted area by category
Private estates dominate Malaysias oil palm acres
Chart 23: Oil palm planted area by category
Smallholders form a large part of Indonesias palm acres
Sources: MPOB, Standard Chartered Research Sources: USDA, IPOC, Standard Chartered Research
0%
10%
20%
30%
40%
50%
60%
70%
Privateestates
Independentsmallholders
Felda Stateagencies
Felcra Risda
0%
10%
20%
30%
40%
50%
60%
Private estates Independentsmallholders
State agencies
Unl ike Malaysia, smal lholders in
Indonesia form a sizeable
propo rt ion of oi l palm areas
Indonesias remarkable CPO output
owes largely to reforms in the
industry between 2000 and 2009
Tree stress from bump er produ ct ion
over the last decade in Indon esia is
now coming to bear on estates
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Like Indonesia, the profile of oil palms in Malaysia is also damping output, although in
Malaysia we are more concerned about the age profile of trees. Farmers have not
been persuaded to replant in earnest, despite attractive international prices.
According to USDA estimates, around 25-30% of Malaysian oil palms are 20-30years old. According to our own estimates, more than 20% of oil palms in Malaysia
are over 25 years old (Chart 26). To arrive at our estimate, we used data from the
MPOC, and publicly available information on major replanting schemes over the last
five years. We also use an industry assumption that 5% of stock in private estates is
replanted annually.
Industry officials indicate there is potential to boost yields with new higher-yielding
varieties, but there is a need to replace up to 50% of the Malaysias current national
crop. Labour constraints and high CPO prices are severely limiting replanting rates,
so it may take time before a big replanting scheme can be undertaken. In the short to
medium term, yield growth in Malaysia seems to have reached a plateau, with thepossibility for output to stagnate (Chart 27). Indonesia has been a popular alternative
for the expansion of Malaysian plantations, but there is increasing interest in Africa
and South America. While land lease costs are more competitive in these regions,
the investment required to integrate upstream and downstream operations will be
significant.
There are also other factors exacerbating the pressure on yields in Malaysia,
including acute competition with Indonesia for labour, as Indonesia is also expanding
its palm oil industry. This shortage of plantation workers, most of whom are from
Indonesia, has adversely affected harvests and is creating wage pressures in the
industry. Plantation owners we spoke to on a recent trip to Malaysia have been
compelled to raise worker wages over the last 12 months. Labour costs on
plantations estates now account for around 30-40% of total costs (depending on the
level of mechanisation and location) and are likely to trend higher at a rate of 10-15%
annually. This poses a significant cost challenge for estates where labour contributed
only around 20% of total costs in 2002. The Malaysian government last year
increased the minimum wage for workers by 10% y/y to MYR 850/month.
Chart 26: Age profile of oil palms in Malaysia
We estimate over 20% of trees are over 25years old, mn ha
Chart 27: Malaysia CPO yields
Yield growth seems to have plateaued, t/ha
Sources: MPOB, Standard Chartered Research Sources: MPOB, USDA, Standard Chartered Research
area 25yrsold
% trees >25years old
0%
5%
10%
15%
20%
25%
0
1
2
3
4
5
6
2000 2002 2004 2006 2008 2010
3.0
3.2
3.4
3.6
3.8
4.0
4.2
4.4
4.6
2000 2002 2004 2006 2008 2010
CPO investors are increasingly
looking outside Malaysia and
towards Afr ica and Latam for new
acreage; the investment n eeded to
integrate operat ions w i l l be cost ly
Acute com peti t ion with Indon esia
for labour is fu el l ing wage inf lat ion
in the CPO sector
Accord ing to our est imates, over
20% of palm oil trees in Malaysia
are older than 25 years
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On our trip to plantations in the region, we noted that plantation costs in Indonesia and
Malaysia are starting to converge. Costs per tonne of CPO produced in Indonesia have
typically been lower compared with Malaysia, reflecting lower labour costs and different
farming practices. This differential was not immediately obvious in our review ofplantation costs, with some plantation costs in Indonesia higher compared with their
Malaysian counterparts (Chart 28). This is partly because wages in some areas of
Indonesia are now comparable to those offered in Malaysia. What we found, however,
was that the cash cost of production in Indonesia is typically lower ex-mill compared
with Malaysia. This is in line with the view that Malaysia has a more efficient
downstream sector compared with Indonesia, but struggles to contain higher upstream
costs that are caused partly by labour shortages.
Further validation of costs on an industry- and country-wide basis is needed given the
comparatively small sample size, accounting for differences in the treatment of
plantation costs and the fragmented nature of the industry. At current prices, we foundthat plantation margins are healthy, ranging from around USD 451-642/t (Chart 29).
We believe that current healthy profit margins in the palm sector are compounding
structural deficiencies in the industry that will significantly limit downside risks. The
prospect of slowing output in an industry that is vital to edible oil consumers in Asia,
Africa and the Middle East who have few viable and affordable substitutes is a
significantly bullish event in the industry.
Chart 28: Unit costs per tonne of CPO, USDAt select companies operating either in Indonesia, Malaysia or
both countries
Chart 29: Oil palm profit marginsProfit margins are high on well-managed estates
Sources: USDA, Oil World, Reuters, Standard Chartered Research Source: Standard Chartered Research
0 100 200 300 400 500 600
Indonesia
Malaysia
Indonesiaand Malaysia
Monthlyaverage CPOprice USD/t
0
200
400
600
800
1,000
1,200
1,400
Jan-03 Jan-05 Jan-07 Jan-09 Jan-11
Estimated CPO costs on a well-managed estate
(USD/t)
Product ion c osts in Indonesia have
typical ly been lower compared
to Malaysia, but the differential
i s no longer obv ious
Plantation m argins are heal thy
given current CPO pr ices
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Fungibility and demand
Global CPO consumption stands at around 49.5mt, up from 5.3mt in 1982
Markets face the prospect of a much tighter soyoil market in 2012 Growing biodiesel mandates should provide a bullish signal to edible oil markets
The consum ption of palm o i l as a percentage of the consum ption of edible oi ls
has been trending higher in an alm ost l inear manner over the last 30 years.
Demand for palm o i l is closely associated with i ts fungibi l i ty with o ther edible
oi ls. However, palm oi l consumption has grown faster relat ive to other
vegetable oi ls because of i ts p r ice advantage. We expect the relat ionship
between CPO and other edible oi ls to cont inu e over the forecast per iod. To
mod el demand, we also incorporate our view on sustainable CPO and bio diesel
demand g iven that CPO is a feedstock for the latter . We expect CPO demand to
outstr ip su pply b y 2013.
Global consumption of palm oil has grown in leaps and bounds over the last 30
years. In 1982, global consumption of palm oil stood at 5.3mt, with per capita
consumption of just 1.2kg. Global per capita consumption of palm oil now stands at
around 7.2kg, or around 49.5mt. Growth in palm oil consumption has been driven by
rapid urbanisation, a young and growing population and rising per capita incomes.
This is boosting out of home eating and the consumption of packaged food, for which
CPO is a core ingredient. These trends are most evident in Asia, Africa and the
Middle East. Biodiesel demand is also a key driver of CPO use, although this is
mainly in Europe, but increasing in Latin America. We also expect demand for
sustainable CPO to grow, as more consumers demand environmental accountability
from food manufacturers.
The top six CPO importers are India, China, the EU, Pakistan, Malaysia and Egypt,
while the top six consumers are India, Indonesia, China, the EU, Malaysia and
Pakistan. Nigeria lies just outside the top six consumers and is Sub-Saharan Africas
largest importer and consumer of palm oil (Chart 30). Demographics in Indonesia,
Egypt and Nigeria show a steady rise in the percentage of the population between
the ages of 15 and 34 (Chart 31). Younger people, particularly in urban areas, tend to
consume more packaged foods, which use significant quantities of palm oil.
Chart 30: Top 10 consumers of palm oil, 2011
Asia is the dominant user of palm oil, mt
Chart 31: % of population between the ages of 15 and 34
Selected countries, men (M) vs. women (W)
Sources: ERS,CONAB, Standard Chartered Research Sources: World Bank data, Standard Chartered Research
0 2 4 6 8
IndiaIndonesia
China
EU-27
Malaysia
Pakistan
Nigeria
Banglade
USA
M, Nigeria
W, Nigeria
M, Egypt
W, Egypt
M, Indonesia
W, Indonesia
30
31
32
33
34
35
36
37
38
39
1980 1985 1990 1995 2000 2005 2010
Nigeria is Africas largest importer
and consumer of palm oi l
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Overview of CPO demand in China
China is the second-largest importer and consumer of palm oil and accounts for
around 13% of global palm oil consumption. Per capita demand in China rose to
around 4.5kg in 2011 from under 20 grammes in 1982. While per capita consumptionof edible oils in China has improved significantly over the last five years we
currently estimate it at 25kg and on par with the global averageit is still significantly
below per capita consumption in OECD countries such as Canada (41kg), the US
(50kg) and the EU-27 (61kg). Edible oil consumption is higher in urban areas
compared with rural areas. Soyoil is the most used edible oil in China, accounting for
around 22% of total edible oil consumption. Soyoil is a derivative of soybeans, which
is used to make soy meal, and Chinas robust demand for soybeans for meals
implies a relatively good supply of soyoil.
The popularity of palm oil in China is due largely to its price competitiveness compared
with other edible oils such as soybean and rapeseed. This makes CPO attractive foruse in both the food and non-food sectors. Data from the MPOC shows that instant
noodles account for around 20% of CPO use in China, food processing for 33%,
cooking for 22%, soap for 16% and the oleo chemical industry for 6% (Chart 33).
Reports from both the MPOC and the USDA point to the strong use of CPO in the
production of instant noodles. Industry sources show a significant rise in instant-
noodle production to over 8mt in 2011, up over 22% y/y. Instant noodles are popular
with younger people including students, migrant workers and office workers as
they are easily prepared and eaten.
We believe that instant-noodle consumption in China will remain robust, although ourin-house research takes the view that increasing disposable income and changing
lifestyles are encouraging consumers to move from the mid- or low-end market to the
high-end market. This trend is especially true in top-tier cities where many young
professionals will switch to high-end noodles instead of dining out.
The place that instant noodles occupies on the menu in China is intimately linked to
the need for convenience and competitively priced food. In that regard, Chinas brisk
pace of urbanisation, combined with the growing intensity of urban consumption,
augurs well for the development of a large and buoyant fast-food/out-of-home food
market that will support CPO demand in the longer term.
Chart 32: Per capita use of CPO in India
India has stepped up its use of CPO (kg)
Chart 33: Allocation of CPO use in China, 2011
The bulk of CPO goes into food processing
Sources: USDA, Standard Chartered Research Sources: USDA, Standard Chartered Research
0
1
2
3
4
5
6
7
Jan-80 Jan-84 Jan-88 Jan-92 Jan-96 Jan-00 Jan-04 Jan-08 Jan-12
0%
5%
10%
15%
20%
25%
30%
35%
Food processing/catering
Cooking Instantnoodles
Soaps Oleochemicals
Chinas edible oil consumption
is on p ar with the global average
but lags OECD countr ies
The popular i ty of CPO for use in
Chinas food and non- food sectors
is due largely to i ts pr ice
com peti t iveness relat ive to
subst i tu te edible oi ls
Instant-nood le consu mptio n wi l lremain robust, al though cons umers
are mov ing from th e low-end to the
high-end market
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Chart 34: CPO trade flow from Indonesia and Malaysia
Sources: MPOB, GAPKI, Standard Chartered Research
Malaysia
mt Imported from
Indonesia
15
10
20
INDONESIA
CHINA
NEA / SEA
INDIA
AND
SOUTH
ASIA
PAKISTAN
MENA
SUB-SAHARAN
AFRICA
EU
US
MALAYSIA
Profiling CPO demand in India
Sources: POC, Standard Chartered Research
India is the top importer and consumer of palm oil
Per capita consumption of palm oil is 6.4kg compared with
4.5kg in China (Chart 32)
India is a price-sensitive edible oil market
Imposes zero import duties on crude edible oil/ nominal import
duties on refined oils
CPO demand has been boosted by government schemes,
including mid-day meals
Refined soyoil is preferred by upper- and middle-income
households
Palm oil is mostly consumed in the out-of-home sector (mainly
food outlets)
Out-of-home consumption will drive CPO demand over the long
term
Palm oil is mainly consumed in lower-income households
CPO is consumed mostly in the summer months
CPO consumption drops during winter months as CPO
becomes semi-solid
CPO imports tend to increase in Q4 due to lower domestic
output and festival demand
South India is the largest consumer of CPO relative to other oils
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Demand for sustainable palm oil and why it matters
Another perennial concern in the industry is the environmental impact of palm plantations,
and the trade-off between expanding plantation area to meet growing demand and the
environmental and social pressures that it creates. It is against this backdrop that theRoundtable on Sustainable Palm Oil (RSPO) was formed in 2004. According to industry
reports, palm oil plantations account for around 8.2mn ha of land in Indonesia, with this
area forecast to increase by around 2.4% annually over the next decade (or 200k ha
p.a.). This will be fuelled by the countrys ambitious output target of 40m t by 2040.
Membership in the RSPO is open across the entire supply chain, and in its inaugural
qualitative review, the organisation cited a strong increase in membership and sales
of certified palm oil. Among consumer goods manufacturers and retailers,
membership has grown primarily in the EU, particularly multinational food processors.
The reason we articulate trends in the RSPO is because consumers, a large swathe
of whom are in middle- and high-income countries, are increasingly interested in
products that are sustainably sourced. In that regard, demand for sustainable palm oil
is growing and likely to continue to grow as consumers reach the middle-income
bracket. Producers are also able to charge a premium for certified sustainable palm
oil (CSPO) (Chart 35).
The palm oil growers association for Indonesia (GAPKI) and Malaysian Palm Oil Council
(MPOC) have both opted out of the RSPO. This decision is partly because of uncertainty
regarding the operation of the scheme and partly because of comparatively slow sales of
CSPO. This could affect consumer perception about the sourcing of CPO by these two
markets. However, both Indonesia and Malaysia have indicated they will establish
domestic certification schemes that should allay some of these concerns. Despite
anticipated domestic certification schemes, 90% of CSPO annual production capacity is
from Indonesia and Malaysia, and as of December 2011, data from the RSPO shows
that Indonesia and Malaysia together had 72 oil palm growers adhering to the scheme
(Chart 36).
Sustainable palm oil is also key to accessing markets such as the US where demand
for biofuels is growing. The US Environmental Protection Agency (EPA) in 2012 raised
its annual renewable fuel mandates by 9.4% y/y to 15.2bn gallons. The EPA in
January said CPO converted into biofuels in Indonesia and Malaysia fell short of
cutting greenhouse gas emissions by the required 20% necessary to access the US
market. This is particularly important for Indonesia, which subsidises biofuel output
Chart 35: Certified sustainable palm oil uptake (% y/y)
There has been a pick-up in market interest
Chart 36: Top 10 RSPO member countries
By number of members as of December 2011
Sources: RSPO, Standard Chartered Research Sources: RSPO, Standard Chartered Research
0%
20%
40%
60%
80%
100%
Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 0 20 40 60 80 100 120
UKMalaysia
Indonesia
Germany
France
Netherlands
USA
Switzerland
Singapore
Belgium
The trade-off b etween expanding
plantat ions and the environmental
pressures i t creates is of concern
to the industry
We expect consumers to become
increasingly interested in produc ts
that are sustainably sourced
Althou gh Indonesia and Malaysia
have both opted ou t of the RSPO,
90% of sustainable palm oi l
i s f rom b oth countr ies
The US EPA has ruled that CPO
conv erted into biofuels
in Indon esia and Malaysia
fal ls short of i ts benchmark
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and therefore has been more competitive in the biofuel trade compared with Malaysia.
Limited domestic market absorption has also created export opportunities, particularly
to southern Europe, where technical problems associated with the use of palm methyl
ester at low temperatures are less relevant than in northern European countries. Theattraction of investing in sustainable palm oil is also being promoted elsewhere in
Europe. The Dutch Board for Margarine, Oils and Fats has asked the government to
lobby the EU to exempt sustainable palm oil used in food from an import tax in Europe.
We believe that Indonesia and Malaysia will press ahead with their own certification
schemes. The impact on demand of opting out of the RSPO will be limited given
growing regional consumption. However, the need to expand to other markets
outside of Asia and the changing profile of CPO consumers will add urgency to
national and global certification schemes in the longer term.
Biofuel demand
Demand for liquid biofuels has grown sharply in recent years in response to high
energy prices. In absolute terms, consumption has risen from 300,000 barrels per day
(kbd), or 15.3 million tonnes of oil equivalent (mmtoe), in 2000 to 1.77 million barrels
per day (mmbd). The US International Energy Agency (IEA) forecasts consumption will
reach 280mmtoe in 2030 and 750mmtoe in 2050. The IEA expects biofuels share of
the total supply of road transport fuels globally to rise to 9.5% by 2030 from 1.5% in
2009, driven in part by supportive government policies. The growth is expected to come
predominantly from Europe, Latin America and Asia. Although international policy
targets the use of second-generation feedstock to cover biofuel output, we believe that
conventional biofuels that use first-generation feedstock such as soyoil and CPO will
continue to play a crucial role in the supply of biodiesel in the near to medium term.
Current biodiesel mandates are shown on Table 3.
Biodiesel currently accounts for around 18% of the biofuel market, with the top three
producing regions being Latam, Europe and Asia. Using IEA data, we calculate that
biodiesel output used around 17.5mt of edible oil feedstock in 2010. Given buoyant
growth in biodiesel mandates, we forecast that biodiesel output will use around 20.7mt of
edible oil feedstock in 2012. This equates to around 13% of total edible oil consumption
and will contribute to a tighter edible oils market. In arriving at this estimate, we assume
global biofuel output will increase by an average of 9% in 2011 and 2012. This is flat
from 2010, but well below the 10-year average growth rate of 38%.
Table 3: Biodiesel mandates
Country Feedstock Current blending targets
Argentina Soyoil 7% biodiesel blend
Brazil Castor oil/ soyoil 5% biodiesel
Canada Animal fat, vegetable oils 2% biodiesel
China Used and imported veg oil, jathropha Aspirational 10% biofuels blend by 2020
EU Rapeoil, sunfloweroil, soyoil 10% biodiesel share of transportation by 2020
India Non edible oil seeds in wasteland Min. 20% ethanol blended petrol and diesel by 2017
Indonesia Palm oil, jathropha An on-off 2.5% biodiesel mandate
Malaysia Palm oil 5% biodiesel started in June and to be phased in over time
Thailand Palm oil, used veg oil 3% biodiesel blend
US Soyoil, tallow, recycled fats and oilsThe EPA proposes to mandate the blending of 15.2 billion gallons of renewable fuel intothe US fuel supply in 2012
Sources: Biofuels digest, Standard Chartered Research
Limited domestic market absorp t ion
of biofu els has created
oppo rtuni t ies in Europe
There wi l l be l imi ted short- term
fal lout from op ting out o f the RSPO;
this wi l l change in the longer term
due to the need
to inc rease market share
We calculate that biodiesel outpu t
wi l l use around 20.7mt of edible oi l
feedstock in 2012, which shou ld
provide a bul l ish sign al to markets
Biofuel demand is forecast to grow
strongly o ver the long term; we
bel ieve f i rst-generat ion feedstoc k
such as CPO wi l l cont inue to be
widely used in the near term
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While we highlight outright demand for CPO as a feedstock for biodiesel, it is also
worth underlining the intrinsic price relationship that exists between energy markets
and edible oils (particularly CPO). As the cheapest edible oil, CPO needs to be priced
at a premium to crude oil to keep it in the food space. So, in its simplest form, CPOrelative to crude oil provides a floor at a price ratio of 1:1. This will be important in
forming price expectations for CPO.
Our CPO balance sheet
We forecast palm oil consumption in two steps. First, we look at consumption of palm
oil relative to the consumption of all edible oils. The consumption of palm oil as a
percentage of the consumption of edible oils has been trending higher in an almost
linear manner over the last 30 years (see Chart 37). We assume this ratio will
continue (R2= 97%).
Second, we do a regression between global edible oil consumption and global GDPper capita using historical data between 1980 and 2011. Based on Standard
Chartereds Global Research long-term forecasts for global GDP, we can forecast
global edible oil consumption. Using this result along with our forecast CPO to edible
oil consumption ratio, we can forecast global CPO consumption for the next few
years. The results are shown in Table 4. As GDP per capita increases, it is apparent
that the use of palm oil increases as a share of global edible oils.
Research from the UN Food and Agricultural Organisation (FAO) supports our view
that demand will largely come from developing countries, particularly in Asia, on
account of per capita income and population growth. Against that backdrop, China
will remain the leading consumer of vegetable oil in the longer term, followed by the
EU, India and the US. An important differentiation, and one that we have previously
highlighted, is that in China and India, consumption is largely for food, while in the EU
and US the biodiesel industry represents a significant source of demand.
Chart 37: CPO to edible oil consumption ratio
trending higher in an almost linear manner
Chart 38: CPO and edible oil consumption
historical and forecasted, mt
Sources: USDA, Standard Chartered Research Sources: USDA, Standard Chartered Research
CPO to Edibleoil ratio
Forecast ratio
0.10
0.15
0.20
0.25
0.30
0.35
0.40
1980 1985 1990 1995 2000 2005 2010 2015
World CPOConsumption
CPO Forecast
Edible OilConsumption
(EOC)
EOC forecast
0
20
40
60
80
100
120
140
160
180
1980 1985 1990 1995 2000 2005 2010 2015
Table 4: Results of consumption and supply analysis
World CPO
consumption, mt
CPO supply,
mt
CPO supply
balance, mt
Edible oil
consumption, mt
CPO to edible
oil ratio
GDP % y/yGDP per capita,
USD2012E 49.6 50.6 1.0 150.8 0.329 4.40 6,244
2013F 54.7 53.3 -1.4 159.7 0.342 4.51 6,421
2014F 59.5 56.3 -3.2 170.6 0.349 4.54 6,637
Sources: USDA, Standard Chartered Research
Research from the FAO sides with
our view that CPO demand wi l l
largely com e from developing
coun tr ies, part icular ly in Asia
As GDP p er capi ta increases, i t isapparent that the use o f CPO
increases as a share of edible oi ls
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Compared with the FAOs estimates (Table 5), our model on demand (and on supply)
is more aggressive. Although the FAO forecasts an increase in CPO consumption as
a share of edible oil demand as we do, we are comfortable with our projections given
higher actual demand and supply numbers in 2011, which overshot the FAO forecast.
Strong demand for biodiesel will be an important driver of CPO demand in the
medium to long term. Demand for non-food use of vegetable oil (in particular for
biodiesel) should account for about one-third of global consumption growth,
according to the FAO. By 2020, biodiesel production should account for 15% of total
consumption, compared to 10% in 2008-10. This will be fuelled by higher mandatory
use in both developed and developing countries.
Table 5: FAO global edible oil consumption forecasts
World CPOconsumption, mt
Edible oilconsumption, mt
Of which food Of which biofuelsCPO to edible oilratio
Edible oil output,mt
2011/12 49.3 149.4 123.6 18.8 0.329 146.3
2012/13 51.1 153.0 126.0 19.8 0.334 150.2
2013/14 52.9 156.2 128.1 20.7 0.339 153.4
Source: UN FAO
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CPO price outlookLooking at fundamental supply data since 1992, it is clear that the y/y supply of palm oil
has a material effect on the price of palm oil (see Chart 39). The correlation between
annual price changes and y/y supply changes is calculated to be -83%. Our forecasts for
supply are estimated to be 50.6mt in 2012, 53.3mt in 2013 and 56.3mt in 2014. We
forecast that the resulting supply balance in CPO in 2013 will be at its lowest in 20 years.
However, our earlier model showed CPO consumption increasing 5.2%, 10.2% and
8.9% in 2012, 2013 and 2014, respectively. We have found that consumption as
approximated by import figures is not a significant driver of CPO prices. In fact,
annual changes in prices show a negative correlation (-48%) with changes in imports,
which is highly unexpected.
Trying to derive CPO prices in isolation from other edible oils will not lead to credible
outcomes due to their fungible nature. Their fundamentals have a material impact onone another, with soyoil and CPO prices having a 69% correlation. With soyoil being
the dominant and most liquid edible oil, this suggests it would be the price leader
rather than the price follower in the edible oils market.
We use Granger causality to determine the dependency of soyoil and CPO on lagged
(historical) values and other variables. We use a 4-lag vector autoregressive (VAR)
model on differenced CPO and soyoil prices (CPOtand soyoilt) and conduct F-tests
to determine the explanatory power of each variable. The results are in Table 6.
The results show that CPOtand soyoiltare both dependent on lagged changes in
soyoil price (soyoilt-1, etc). However, lagged changes in CPO (CPOt-1, etc) only
affect CPOt and not soyoilt. This asymmetry is partly a reflection of the size of the
soyoil market compared to palm oil. We can build a CPO price model that
incorporates soyoil prices without worrying about a feedback mechanism to equalise
with soyoil (i.e., CPO pushes soyoil prices higher, then soyoil pushes CPO prices
higher, and so on). The mechanism appears to be unidirectional.
We factor soyoil prices into our model without having to worry about the feedback
effects of CPO prices on soyoil prices. We use an autoregressive model using y/y
soyoil price changes and y/y CPO global supply changes as variables. The results
are reported in Table 7. The Durbin-Watson test for first-order serial correlation is
2.09, which is close to the theoretical absence of serial correlation.
Chart 39: Change in annual average CPO price and supply
Percentage changes
Chart 40: CPO medium-term forecast price
Historical and forecast, MYR/t
Sources: USDA, Standard Chartered Research Source: Standard Chartered Research
Avg % pricechg
Forecast
Supply y/y(inverted,RHS)
-8%
-4%
0%
4%
8%
12%
16%-60%
-40%
-20%
0%
20%
40%
60%
80%
1988 1992 1996 2000 2004 2008 2012 2016
0
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
1999 2001 2003 2005 2007 2009 2011 2013 2015
Bull case Base case
Bear case CPO price
Trying to d er ive CPO pr ices in
isolat ion from o ther edible oi ls wi l lnot lead to credible outcom es
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All variables are deemed to be significant at the 1% level. The goodness of fit for our
model is R2=88%. Standard error of the model is 203. Our forecasts for soyoil based
on our previous studies are USc 65/lb for 2012, USc 66/lb for 2013, USc 54/lb for
2014 and USc 60/lb in 2015. Our model forecast prices are capped and floored bythe historical relationship with other oils. We discuss this in the next section.
Table 6: Granger causality between soyoil and CPO using a 4-lag VAR model
F-Statistic Significance
Soyoil granger causes Soyoil 2.9413 0.02170
Soyoil granger causes CPO 2.5599 0.03999
CPO granger causes Soyoil 2.0064 0.09522
CPO granger causes CPO 5.6314 0.00026
Source: Standard Chartered Research
Table 7: Model coefficient statistics
Variable Coefficient Std error T-stat Significance (two-tail)
CPOt-1 1.29 0.04 31.00 0.000000000
CPOt-1. Soyoil(y/y)t 0.76 0.11 6.87 0.000000199
CPOt-1. CPO Supply(y/y)t -3.51 0.42 -8.36 0.000000013
Source: Standard Chartered Research
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Ratios to show price boundaries
As discussed before in previous sections, ratios between CPO and other oils provide
natural boundaries to future CPO prices. Based on our ratios from historical data, we
can estimate these boundaries for various percentiles of historical ratios (summarisedin Table 8).
Factoring in CPO supply and soyoil forecasts, and the cap and floors, our CPO
forecast model (R2=88%) arrives at prices of MYR 3,450/t for 2012, MYR 3,620/t for
2013, MYR 3,228/t for 2014 and MYR 3,456/t for 2015 (Chart 40).
We have long been aggressive in our forecasts on CPO, and our model vindicates
our bullish view. Our forecast is also based on our expectation of a drop in CPO
yields, a decline in inventories, an increase in import demand and firmer energy
prices in Q4-2012 through 2015. We also expect the soybean complex market, which
is seasonally stronger in Q4, to add a bullish tone to CPO prices. We continue to see
upside momentum building in 2012, but we now expect most of the upside inQ4-2012 rather than in Q3-2012 as normal price seasonality in Q4 is reinforced by
the weaker impact of La Nia weather.
We expect the market to average MYR 3,500/t in Q2-2012 (MYR 3,400/t previously),
MYR 3,350/t (MYR 3,600/t previously) in Q3-2012 and MYR 3,700/t (MYR 3,600/t
previously) in Q4-2012, for an annual average of MYR 3,450/t (MYR 3,450/t
previously). Our annual average forecast remains unchanged from our previous
forecast, but now adequately reflects upside risks further along the curve.
Our forecasts suggest a tighter spread between soyoil and CPO over the medium
term. We believe this will be a reflection of the supply premium in CPO and its
growing importance in the global diet. Our forecasts suggest CPO will remainadequately priced relative to crude oil prices and near the middle of the 2008/11 price
ratio. We do not believe our forecasts are mispriced relative to soyoil (Chart 41) and
crude energy prices (Chart 42).
Table 8: Snapshot of relative ratiospalm oil (CPO), crude oil (Brent) and soyoil (SBO)
2000-2011 Average 2000-2011 range 2011 Now 2012F 2013F 2014F 2015F
SBO/CPO 1.26 1.01 - 1.76 1.15 1.07 1.32 1.17 1.01 1.01
CPO/Brent 1.40 0.742.31 1.32 1.31 1.23 1.39 1.30 1.37
CPO MYR/t 1,944 3,272 3,500 3,450 3,620 3,228 3,456
SBO USc/lb 31.1 55.5 56.0 65.0 66.0 54.0 60.0
Brent USD/bbl 59 111 120 121 123 127 130
Sources: Reuters, Standard Chartered Research
Chart 41: SBO/CPO spread
within range, but suggesting a near-term ceiling for CPO
Chart 42: CPO/Brent crude ratio
CPO appears adequately priced relative to energy prices
Sources: Reuters, Standard Chartered Research Sources: Reuters, Standard Chartered Research
0.9
1.01.1
1.2
1.3
1.4
1.5
1.6
1.7
1.8
1.9
Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12
SBO/CPO ratio
3-year averageSBO/CPO ratio
0.5
0.70.9
1.1
1.3
1.5
1.7
1.9
2.1
2.3
2.5
Jan-00 Aug-01 Mar-03 Oct-04 May-06 Nov-07 Jun-09 Jan-11
3-year averageCPO/Brent ratio
CPO /Brent ratio
We remain bul l ish CPO, but we now
expect p rices to rally in Q4-2012
rather than stay f lat
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Estate owners should no longer delay planting decisions
Histor ical ly, farmers are pessimist ic o n the ou t look for p r ices and tend to d elay
replant ing due to uncertaint ies over pr ices and costs. Our long-term bul l ish
view on CPO, relat ively accommodative global interest rates and thedeter iorat ing age pro f i le of trees in Malaysia should help to persuade own ers,
part icular ly in Malaysia, that replant ing d ecis ions are best n ot d elayed.
We recommend estate owners employ the deterministic approach highlighted in
academic literature to establish the optimum replanting age for their trees. This is to
maximise net revenue over time and is done by comparing marginal net revenue
(MNR) from the current batch of plantings to the estimated amortised present value
of net revenue (AVNR) from the subsequent batch of plantings.
The optimum replanting age is determined when the MNR in year n of the current
batch of plantings is equal to the AVNR in year n of the subsequent batch ofplantings (see Chart 43). On the chart, these points are x and y. However, after point
y, the MNR from the current batch is lower than the AVNR from the subsequent
batch, meaning profits obtained would be higher on the subsequent batch. The
relevant equation is sourced from the oil palm industry journal. This approach is best
used by individual estate owners with knowledge of gross revenue, interest
payments, annual costs, field establishment costs and the age of their estates.
MNRn = Yn[(an1 i) + bn + cn]
where
Yn = Gross revenue
an-1 i = Interest on unpaid balances for establishment and land costbn = annual costs
cn = field establishment costs
n = age in years
In order to make a valid comparison of revenue, it is necessary to compare
anticipated revenue at the same point in time. This arises from the fact that a sum of
money received or paid at the present time is worth much more in the future. Future
net revenues (NR) are discounted to their present value to make possible their
Chart 43: Determining the optimal replacement age of oil palms
Source: Oil palm industry economic journal
MNR
x
y AVNR
-6,000
-5,000
-4,000
-3,000
-2,000
-1,000
0
1,000
2,000
3,000
4,000
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35
Year
Estate owners sh ould u se the
determinist ic approach to establ ish
the opt imum replant ing age for their
trees
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comparison with the present value. The present value (PV) of future NR forthcoming
at the end on n years in the future can be expressed as follows:
Where i is the market rate of interest. To obtain the amortised PV, the PV of the NR
is accumulated and then multiplied with an amortising factor (AF) of:
From the above equation, we deduce that the optimal replanting age of an estate will
be shorter the higher the CPO prices as costs incurred at replanting are recovered
over a shorter period.
Conclusion
A storm is brewing in the edible oils industry, generated by a shortfall in CPO (and
soyoil output) in 2012. CPO productivity in South East Asia has been trending lower
over recent years, and we believe this trend will worsen in the coming seasons due to
poor farming practices and the ageing profile of trees. Some market participants are
aware of this, and most cannot afford to ignore it. The market is entering a period of
severe demand rationing.
Rationing CPO will be difficult as its versatility and its growing use in food, biofuels and
industrial feedstock has enhanced its consumption over the last 30 years. We believe
that demand for edible oils, including palm oil, is set to grow even more in the near to
medium term as per capita consumption increases.
While supply continues to grow to meet that need, we believe oil palm estates in South
East Asia that supply the bulk of global demand need a facelift to reverse a severe
slowdown in yields. This will lead to rising costs for estates, which will add to the price
aspirations of producers in the palm oil sector in the near to long term. With
productivity central to the sector, we believe the CPO market is gearing up for a stepchange in its cost structure, which will push prices higher in 2012, but even more so
in 2013.
The market is enter ing a per iod of
severe demand rat ioning as fal l ing
CPO yields strugg le to cope with
burgeoning demand
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AppendixSEA policy developments and impact on trade
A new CPO fiscal regime went into effect in Indonesia in October 2011
The aim of the new tax structure is to promote downstream activities
The sector can no longer rely only on trade data from Malaysia to gauge industry-wide fundamentals
Palm oil is the key agricultural export in both Indonesia and Malaysia and its
importance in the economic fabric of both countries make the industry susceptible to
frequent reform. However, because of the environmental, social and macroeconomic
implications associated with the use of palm oil, policy changes within the CPO
industry have far-reaching consequences. The key policy change in 2011 was
Indonesias announcement of a change to its CPO export tax grid (see Table 9).
In August 2011, Indonesia announced changes to the export tax structure in its palm
oil sector that would come into effect in October 2011. The key changes in the law
included setting a minimum tax rate for crude palm oil at 7.5% (previously 1.5%) and
capping it at 22.5% (previously 25%). The export tax for palm olein was reduced to
13% from 25%.According to policy makers, changes in the export tax structure willfoster the growth of the refining (downstream) sector in the CPO industry, limit price
volatility and meet its long-term objective of securing adequate supply for domestic
(mainly cooking) purposes.
The new tax regime replaced the previous system in which trade ministry and
industry officials met monthly to decide the tax rate for the coming month, using the
average spot crude palm oil prices in Rotterdam from the preceding 30 days as a
reference price. Now the reference price is derived from the weighted average ofthree marketsRotterdam, Bursa Malaysia and ICDX from the 30 preceding days
and calculated on or around the 20thof each month.
The need to promote the downstream sector is understandable, in our view.
However, the new laws are part of a raft of measures being introduced by policy
makers in Indonesia as the country positions itself to become the dominant regional
and global player in the palm oil trade, particularly after it overtook Malaysia to
become the top producer of palm oil in the 2007/08 season.
Table 9: Indonesia CPO export ratesThe CPO export tax rate is now capped at 22.5%
Chart 44:Maximum tariff under different CPO price scales,USD/t, Importers pay more if the CPO price is between
USD751/t and USD1200/t
USD/t Tax rate, old regime Tax rate, new regime
1,251 25% 22.5%
Sources: Gapki, Standard Chartered Research Sources: Gapki, Standard Chartered Research
Old regime
New regime
0
50
100
150
200
250
300
350
1,251
Indonesia introduced a new fiscal
regime for i ts palm oi l industry with
the aim of promot ing downstream
activ i ty
Changes to Indonesias CPO
tax structure is part of a raft of
measures to overtake Malaysia
Pol icy changes in the CPO industry
have a huge bear ing on the market
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We believe the entire South East Asian CPO industry and its stakeholders will go
through a difficult period of adjustment. Indonesias key export markets of India and
China, both with idle refining capacity, will have to accept the new terms of trade. In
the short term, we expect an inventory build-up in South East Asia as importersassess how best to react to the reform, although we believe that this window will be
limited by a tight edible oil/oilseeds market.
Still, this development has not been well received in India, where CPO imports
declined sharply in Q4-2011 and have yet to recover. The decline in demand is not a
coincidence. Indonesias CPO export tax changes, which effectively increased the
tariff for its CPO exports within a band of USD 751/t to USD 1,150/t (see Chart 44),
triggered an immediate outcry in India, which is the top importer of crude palm oil,
most of which it sources from Indonesia. India traditionally imports around 6mt of
CPO a year (Chart 45), which it refines for use in its domestic market. With a refining
capacity of around 15mt, there is concern that a lot of refining capacity would be idle.Many in Indias edible oil sector, including the influential Solvent Extractors
Association (SEA), requested protectionist measures in favour of the local refining
industry. We are concerned that attempts to increase the base price of refined CPO
imports could backfire and instead stoke inflationary pressures (Chart 46).
Options will be limited for Indian refiners in the short term. While domestic oilseed
output has increased moderately, India will still rely significantly on imports to meet its
edible oil requirements. The initial decision to slow CPO imports in anticipation of
lower prices, was wrong, in our view (see Agricultural Insight, 8 November 2011,
Crude palm oil Finding a floor), as we expected the market to trend higher.
According to industry reports, Indias demand is now likely to rise to 7.5mt in 2011/12,
up 15.4%, with a significant increase in its refined palm imports.
The twin tasks of appeasing refiners a
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