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Malaysia Plantation: Outlook Remains Challenging For CPO March 19, 2018
In this writeup, we would like to discuss the underlying factors that are likely to affect the CPO price moving forward.
Author : Jerry Lee Chee Yeong


Malaysia Plantation: Outlook Remains Challenging For CPO

After the 3rd strongest El Nino in 2015/16, which pushed the CPO price to as high as about RM 3300 in the beginning of 2017, the crude palm oil posted the biggest single year losses (-24%) over the past 5 years. The weakening CPO price was a result of the strong recovery in CPO production which subsequently led to the rapid build-up in CPO inventory (see figure 2). In this writeup, we would like to discuss the underlying factors that are likely to affect the CPO price moving forward.

Figure 1: CPO price
Figure 2: Malaysia CPO Production and Inventory

Positive Factors

1. Suspension of Exports Taxes & Seasonally Lower Output

Early 2018, our government made a timely suspension on the CPO exports taxes for three months which aims to ease the pressure on the current 2-year high CPO stockpile which might subsequently provide a boost to the CPO price as the suspension of export taxes is likely increase the competitiveness of Malaysia CPO in the global market and boost the demand for the local CPO.

The market participants see this as a timely and effective measure to resolve the issue of high CPO stockpile. In fact, this has resulted in a spike in the January’s CPO exports (+6.0%) (see figure 3).

Figure 3: Malaysia's CPO Exports

On top of that, generally, we will see a seasonally low production during the first quarter of the year. As such, the timely suspension of export taxes coupled with the seasonally lower production has resulted in a lower stockpile in January and this could also explain on the performance of CPO on YTD basis (+5.2%) as of 28th February 2018.

2. Lower Soybean Production

The U.S Department of Agriculture (USDA) during its annual Agricultural Outlook Forum, projected that the soybean production to drop by -1.6% y-o-y in 2018 due to lower planted area (down 100,000 acres from 2017) and lower yield (down 0.6 bus as compared to 2017).

On top of that, as the drought in Argentina persists which is known as the worst in 30 years, we might see a sharp decline in supply of soybean from one of the top producers in the world.

In fact, since palm oil is a close substitute to soybean, the lower soybean production is likely to drive the soybean price higher and leads to a wider price premium of soybean to CPO, hence, improve the demand for CPO against soybean.

 

Negative Factors

1. Demand Side

1.1 India Palm Oil Import Taxes

If one still remembers, during November 2017, the world’s largest edible oil importer – India, raised the import taxes on crude palm oil to 30% from 15% while the duty for refined palm oil has been lifted from 25% to 40%. The hike in import taxes was seen as a measure to protect and support the local refiners, hence, it is likely to dampen the Malaysia’s exports of CPO to India unless there is any revision being done on the high import duties.

1.2 China Stockpile and Import

Besides the possible slowdown in CPO demand from India, the recent data from China showed that the China palm oil inventory is currently at almost two-year high level of close to 700,000 tons (see figure 4). On top of that, the robust demand of soybean by China which sent the soybean import to historical high level of 95.54 MT in 2017, up by about 14.8% y-o-y (see figurer 5), showed sign of waning appetite for palm oil by the world’s second biggest economy.

According to USDA, they projected that the China palm oil import is likely to decline by 4.8 million tonnes and this might cap the upside of the CPO price as a result of slowing demand.

Figure 4: China Palm Oil Inventory
Figure 5: China's imports of soybean and palm oil

2. Supply side – Accelerating CPO Production

Currently, the weak La Nina that has started in late 2017 with moderate rainfall is likely to benefit the production recovery after the worst El Nino in 2015/16. This explained the rather strong production in January as compared to the corresponding quarter last year.

In fact, the Malaysian Palm Oil Board (MPOB) forecasted that the CPO production is likely to climb to 20.5 million tonnes from 19.9 million tonnes produced in 2017. As such, with the better production and recovering yield for palm oil, we see a limited upside for the CPO price.

Our View

At this moment, we do not think that the abovementioned factors could provide sustainable support to the CPO price. Reason being, the suspension of exports taxes and the lower production are considered as short-lived factors unless the government extends the suspension of exports taxes which we do not expect it to materialise in near future.

Whereas for the lower estimated soybean output, we do not expect it to have any significant impact on the CPO price as the current price premium of soybean to CPO is standing at 7.5%, lower than the 5-year average of 16.5% (see figure 6). Hence, we do not foresee any significant shift in demand from Soybean to CPO as long as the price premium stays below the 5-year historical average level.

Figure 6: Soybean and CPO

As such, coupled with the several negative factors mentioned, we believe that the existing and potential downside factors for the CPO price could outweigh the upside of it. For investors who are on the same page as us on the outlook of the Plantation sector while looking to have exposure into the local equity market, they can consider Kenanga Growth Fund which has a minimal exposure into the Plantation sector.


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