At the just-concluded palm oil Price Outlook Conference in Kuala Lumpur, many analysts presented a bullish forecast for palm oil prices. Without doubt, the market fundamentals are currently tight and set to get tighter in the next three months.
Dry weather conditions in South America are set to reduce soyabean production. So, in the short-term, for the upcoming quarter, the downside to prices is rather limited.
But is there a large upside risk to prices as some analysts have suggested? The situation looks extremely dicey, simply because some of the crucial market making factors have either not been dealt with or glossed over.
It is axiomatic that commodity markets move based not only on demand and supply fundamentals but also on non-fundamental factors such as geopolitics, currency dynamics and role of funds.
The most critical issue, of course, is the less-appreciated and less-articulated advantage that Indonesian refiners enjoy due to the favourable export tax structure; and by implication the tremendous pressure Malaysian refiners will face because of the disadvantage.
Refined palm oil is sure to score over crude palm oil in terms of export and Indonesia is almost certain to garner market share from Malaysia. A trade agreement with a large buyer like Pakistan puts Indonesia on a stronger wicket to snatch market share from Malaysia.
This will result in palm oil stocks rising in Malaysia rather than falling, which in turn will put pressure on Malaysia for competitive price reduction. Already a rising ringgit vis-à-vis the rupiah has been making Malaysian palm oil less competitive. This can potentially squeeze Malaysian companies' margins and force them to lower prices in order to compete.
Surprisingly, analysts have chosen to ignore the large stocks of vegoils that two of the world's largest importers, China and India, are currently holding. According to reports, China's port inventories of palm oil have doubled year-on-year and as at end-February they were said to be close to 850,000 tonnes.
This raises the possibility of a slowdown in Chinese imports in the next 2-3 months. Equally surprisingly, the same holds for India, which has imported excessive quantities of palm oil in February (total imports 8 lakh tonnes) with the hope of a tariff hike in the upcoming Union budget.
Port-based stocks here are estimated at over 10 lakh tonnes. Worse, traders have complained of sluggish domestic off-take for last several weeks. Summer months — April to July — are periods when cooking oil usage drops.
Role of speculative funds is another factor that didn't receive attention. Very clearly, despite its own market fundamentals, for its pricing, palm oil takes a cue from soyabean oil.
At present, speculators have aggressively ramped up their long positions in soyabean and soya oil in the futures exchanges. Palm oil prices have been helped by flow of speculative funds in soya oil resulting in firm prices.
This speculative capital came into the soya market to make profits, and there is reason to believe, the price objective has been more or less achieved. This hot money can exit the market anytime, especially if some other commodity provides a compelling investment option.
So, a combination of competition between Indonesia and Malaysia to garner market share, firming ringgit that makes Malaysian palm oil less-competitive for exports, large port-based stocks in China and India as well as exit of speculative funds can potentially limit any strident rise in palm oil prices in general and Malaysian prices in particular.
South America and Africa together produce about 7 million tonnes of palm oil, which has been rising by about one million tonnes, a fact that received little attention. So, while palm oil prices are most likely to remain firm, there is no case for a bull run suggested by some analysts.
Prices will be steady to firm till June averaging around $1,000 a tonne (plus or minus $100-150) and actually soften in the second half.
There are early signs of a rebound in American soyabean crop in the upcoming season with some experts forecasting 8-10 per cent increase in production.
Generally, the northern hemisphere is almost certain to witness a huge rebound in farm output in the second half of 2012 which in turn will soften prices. The vegoil market cannot escape the pervasive softness.