Crude_palm_oil_–_A_price_storm_is_brewing_28_04_12_11_31

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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 [email protected]

Koun-Ken Lee, +65 6596 [email protected]

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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30 April 2012 2

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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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




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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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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30 April 2012 5

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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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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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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30 April 2012 10

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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30 April 2012 11

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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30 April 2012 12

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%


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%



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30 April 2012 13

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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30 April 2012 14

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)


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)


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


15/36


30 April 2012 15

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


16/36


30 April 2012 16

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


17/36


18/36


30 April 2012 18

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


19/36


30 April 2012 19

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


20/36


30 April 2012 20

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


21/36


30 April 2012 21

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


22/36


30 April 2012 22

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


23/36


30 April 2012 23

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


24/36


30 April 2012 24

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


25/36


30 April 2012 25

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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30 April 2012 26

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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30 April 2012 27

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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30 April 2012 28

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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30 April 2012 29

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


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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30 April 2012 30

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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30 April 2012 31

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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30 April 2012 32

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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30 April 2012 33

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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