Palm oil prices have been under pressure for nearly three months now despite forecasts of a price spike by some analysts. The market has actually dropped 5 per cent to the current level of Malaysian ringgit 2,500 a tonne. Where’s the market headed?

In the near term, palm oil fundamentals are turning weak. Rising production at the origins (mainly Indonesia and Malaysia) with the onset of peak season, weak demand at destination markets and expanding inventory at the origins have combined to weaken the outlook in the near-term. Additionally, abundant supply of soft oils – soya, rape and sun oils – compete for market share and putting pressure on palm oil.

In Malaysia and Indonesia many plantation companies are reporting an increase in production to the extent of 10-12 per cent as the palm oil trees move to the peak of biological up-cycle which is likely to continue till October. This is despite dry conditions prevailing early this year.

Soya poses a risk

Additional risk factor for palm oil market is the anticipated surge in soyabean production in the northern hemisphere, especially in the US, in the coming months. The US is forecast to harvest 99 million tonnes soyabean this year, up from 89 million tonnes last year. At the same time, demand outlook is weak because China has built huge stocks and Brazil is holding inventories beyond what is normal in the export season beginning March. Abundant supply of canola oil in Canada is also creating supply pressure. The discount between palm and other oils has narrowed to about $80 a tonne from the historical average of $150 a tonne, triggering demand substitution. At the expense of palm oil, demand is moving to other oils. If further loss of market share in crude palm oil has to be avoided, its prices have to drop to more attractive levels. On current reckoning, a further 5 per cent fall from current levels to less than ringgit 2,400 a tonne is foreseeable for the next quarter beginning July.

El Nino effect

Edible oil consumption demand during summer months – May to August – is traditionally weak. This year Ramadan starts in July, yet, hot weather will retard consumption growth. The biggest upside risk to palm oil prices is the El Nino. But to be sure, at this point in time, it is unclear when exactly and with what intensity El Nino will strike.

In any case, the adverse effect of El Nino, if any, on palm oil production will be felt only from mid-2015. No wonder, in the near-term, there is no weather premium.

At the same time, if inventories build rapidly at the origins, there may be panic selling later, especially if soft oil supplies continue strongly.

In the event of a mild El Nino, the impact on crude palm oil production will be less. Given the abundant current and potential supplies of soft oils, crude palm oil prices may fall.

However, if the El Nino impact is severe, crude palm oil supplies will be affected and prices will outperform other oils. So, it would take no less than three quarters before palm oil market can rally, provided El Nino curtails supply growth.

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