As we move closer to the world's largest gathering of the vegetable industry and trade at Kuala Lumpur for the annual palm oil price outlook conference, prices have begun to firm up as they usually do at this time of the year in order to create a positive atmosphere during the mega event.

While experts will debate early next week the outlook for the global vegetable oil market in general and palm oil in particular, the signs on the horizon are ominous.

Adverse impact of the dry conditions in South America has certainly boosted palm oil market in recent days as the shortfall in soya oil is sure to be filled by palm oil. Additionally, even by itself the demand-supply balance for palm oil (mainly Malaysian and Indonesian) is getting tighter this year (2011-12) as production and disappearance are expected to match evenly at about 51 million tonnes.

Prospects for palm oil look constructive on current reckoning as demand for palm oil is sure to remain robust over the coming months because of tightening soya oil availability. However, the 6-8 month period beginning April coincides with seasonal rise in palm oil production, while consumption demand in the world's largest palm oil market – India – will be depressed during May-July because of summer.

The next crop of cultivated oilseeds will be available in the northern hemisphere by September. So, when the market transits from the second to the third quarter, firm palm prices could give way to marked softness, assuming weather stays benign. Also, it is axiomatic that in a delicately balanced commodity market even a small change in either demand or supply will have a disproportionately large impact on market prices.

However, the orbit of palm prices will be influenced not only by its own market fundamentals — admittedly tight — but also that of global vegetable oil market, crude oil market and currency dynamics. Flow of speculative capital will also be an important factor. The world is more likely to see a rebound in agricultural crops in the second half of 2012 resulting from supply response to high prices in the last two years, abating weather risks and less speculative interest. As a result, grains and oilseeds prices would weaken.

Palm has the potential to outperform other oil bearing crops given its tight fundamentals. However, as for price performance of palm oil per se, two critical factors deserve attention. One is the currency. The possibility of the dollar weakening in the wake of Fed statement to continue its ‘easy money policy' till 2014, does exist. If the Malaysian currency, the ringgit, firms up, export competitiveness could be somewhat blunted and palm oil price rise may be muted.

But a more important factor could be the intensifying competition between Malaysia and Indonesia to capture market share. Indonesia looks set to wrest a larger market share this year because of the new Indonesian tax structure.

Additionally, the signing of a preferential trade agreement between Indonesia and Pakistan would mean the former eating into Malaysia's share. Pakistan imports as much as two million tonnes. Malaysia will have to compete on price and nothing else. There could be competitive price reduction.

Given these non-fundamental factors, the potential for palm oil prices to rise sharply is rather limited. If anything, over the next four months, crude palm oil is most likely to trade at an average of around ringgit 3,100 a tonne with a ringgit 200 movement on either side. In dollar terms, it is likely to be around $1,000 a tonne plus or minus $100. Prices will weaken as we move towards the second half. While higher crude oil prices and weather aberrations can disturb the outlook and push prices higher, a major commodity sell-off or global economic growth concerns can pull prices down.

gchandra@thehindu.co.in

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