THE recent rally on crude palm oil (CPO) has been spectacular, to say the least.
After peaking on Nov 3, 2021, at RM5,071 per tonne, the benchmark third-month CPO contract fell to a low of RM4,295 on Dec 20, 2021, and closed the year 2021 at RM4,697 per tonne.
Still, it was a good rally for CPO as price jumped more than 30% last year.
Not many traders thought that CPO will see another leg up in 2022 and for planters, the high prices were more of a bane than a boon as extremely high prices in the industry are rather unusual and unsustainable.
At the same time, it also makes palm oil less competitive compared with other vegetable oil.
A year ago, when prices were just above RM4,000 per tonne, industry experts were already bearish with their predictions as the market imbalance, due to shortfall in production, will sooner or later reach equilibrium and bring prices down.
Fast forward to 2022 and the front-month contract surpassed the psychological RM7,000 while the benchmark third-month CPO futures hit a new record high of RM6,458 per tonne as at Thursday’s close on the back of multiple factors that sent prices to dizzying heights.
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Planters’ time to shine
Despite the rally in CPO, the Bursa Malaysia Plantation Index fell by 10.3% in 2021, as investors were concerned about several issues impacting the sector and the key was of course the issue related to environment, social and governance (ESG).
However, the sector came to life over the past three weeks as the index gained some 22.7% on the back of a rally in CPO.
Many plantation stocks were well sought after by investors, resulting in share prices rallying to either multi-year highs or all-time highs.
The question on everyone’s mind is whether this rally still has the legs to move higher and where is the market price of CPO headed?
In addition, investors seems to have forgotten about their main concern on the plantation sector, especially with respect to deforestation and human rights issues, the major thrust of the ESG theme that these institutional investors live by.
After all, other than the rally this month, the plantation sector was in slumberland for the past two years as seen in Table 1.
Commodities are rallying globally
A confluence of factors is the main reason why we are seeing a rally among commodities globally.
This can be observed from the Bloomberg Commodity Index, an index that tracks 23 commodity futures contracts in six different sectors that include the energy sector, grains, industrial metal, precious metals, soft commodities and livestock.
This index has seen a spectacular rally over the past year as it is up almost 32%, higher by 16.2% since the start of 2022, and almost double from the low in April 2020, which was right at the height of the pandemic outbreak.
The elephant in the room is, of course, none other than the global inflationary pressure that we are seeing today.
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This is mainly caused by five main factors. They are the supply disruption issues related to the pandemic as well as the logistical nightmare of moving goods from one part of the world to another.
Inflationary pressure is also caused by pent-up demand globally as economies opened up and as more nations move towards the endemic stage.
The tension in Ukraine is another factor that has pushed commodity prices higher, as Ukraine is rich in natural resources, in particular oil, coal, natural gas and iron ore as well as agricultural commodities like corn and wheat.
Other factors include the liquidity that has been created by central bankers, which has resulted in too much money chasing after goods and services as well as different asset classes across the spectrum of choices, including cryptocurrencies and non-fungible tokens.
The rise in oil prices, which is again caused by demand and supply dynamics, has a significant impact on global inflation print as pump prices are rising in every corner of the globe.
Last but not least, due to the tight labour market, employers are forced to pay higher wages (United States hourly earnings rose by 5.6% year-on-year in January), which in turn leads to higher consumer demand due to improved disposable income.
Taking the factors together, Table 2 explains that it was the rise in commodity prices that has caused not only higher inflation print but at manufacturers’ level, higher input price has resulted in higher Producer Price Index (PPI) too.
The rally in commodity this month itself may push inflation even further north.
CPO benefits from a confluence of factors
Being an international commodity and as one of the 17 vegetable oils that is produced globally, palm oil production has a significant impact on the global supply chain as CPO is ranked number one in terms of production, followed by soybean oil.
For CPO, where Malaysia and Indonesia command 85% of the global market supply, there are domestic as well as international factors that determine the market demand and supply factors.
The weather and climate change issues, which not only impact production in this part of the world but for other competing oil, mainly out of the US and Latin America, is one of the biggest factors impacting supply.
For example, in a recent publication by Oil World on Feb 18, 2022, it was reported that some 27 million tonnes of soybean were lost in South America over the past two months, which will likely lead to a lower stock level, hence pushing prices higher.
For Malaysia, the recent flooding in several key states is an example of curtailed supplies.
For end-users, government policies too play a role in the form of higher or lower import duties, which in turn impacts demand.
In the case of CPO, the recent move by Indonesia to ensure sufficient domestic supply with planters expected to set aside 20% of their supplies to the local market is an example of how a government rule can impact prices as global supplies are curtailed.
Change in import duties by India and export duties by Indonesia has a significant impact on demand from end-users as well.
Another key factor in terms of supply which was rather evident in 2021 and into this year is the availability of plantation workers which were curtailed by the pandemic.
In fact, it was rather rare to see Malaysia’s CPO production fall by 5.4% to 18.12 million tonnes last year from 19.14 million tonnes in 2020. This too had added to supply factors and hence higher CPO prices.
Last but not least is the rise in input cost and in particular fertilisers, which are said to have increased between 50% and 80% globally since mid-2021.
Higher input cost suggests that the breakeven point for planters too is rising as total production cost has increased by about 15% to 20% last year and is bound to rise by another 15% to 20% this year.
Supply Imbalance will be addressed
With foreign workers set to make their presence felt this year as the government has allowed critical sectors to import the much-needed workforce, CPO output is expected to rise by 3.9% this year to hit 18.8 million tonnes, according to a poll done by Reuters last month.
Over in Indonesia, CPO output is expected to rise by 3.4% to reach 48.5 million tonnes this year but for our neighbours, the rise is lesser than expected as production is expected to be impacted by high fertiliser cost and the unusual weather condition early this year.
The same poll by Reuters pegged the average price for this year at RM4,000 per tonne, which is 9.4% lower than last year’s average of RM4,417 per tonne.
This is within the range of what the Malaysian Palm Oil Board expects prices to average this year, which is at RM3,800 and as high as RM4,300, as forecast by some plantation sector equity analysts recently.
Hence, with the third-month benchmark price last seen at RM6,458 per tonne, it is of no surprise that the futures contract is in backwardation – a situation whereby future prices are lower than the current month contract.
For example, the front-month CPO contract closed at RM7,093 per tonne on Thursday, but the benchmark third-month May 2022 contract was at RM6,458 per tonne, almost 9% lower, while the December 22 contract closed at just RM5,408 per tonne, or 23.8% lower than the front-month and 16.3% below the benchmark third-month contract.
In essence, traders and producers are expecting prices to ease, going forward, similar to what was predicted a year ago. The question is whether CPO prices have peaked or are there more legs for this rally? Only time will tell.
For investors, this is not the time to be chasing plantation stocks as analysts are likely to begin pricing in higher and higher CPO prices going forward, as their current assumed average prices are much lower.
However, as explained earlier, CPO price will ease off going forward and those hoping to ride on the rising tide or to catch a boat may end up being disappointed.
Pankaj C. Kumar is a long-time investment analyst.
The views expressed here are the writer’s own.