Vegetable oil traders across the world have been watching closely the South American weather developments, which are threatening to shake the market up with its somewhat sedate condition in recent months. It is becoming increasingly clear that the global vegetable oil market balance sheet for 2011-12 (October-September) is likely to stay tight (but not get into serious deficit), assuming that Brazil and Argentina face no major crop disaster. Ample stocks of South American soya bean are sure to retard any possible rally.

But where does all this leave the palm oil market?

Supplies are expanding and for 2011-12, world production of palm oil is an estimated 51 million tonnes, up from 49.2 mt of the previous year.

This low-cost tropical oil with a variety of uses in food, fuel and industrial application is currently running a large price discount vis-à-vis its closest competitor soya bean oil.

Indeed, it is this discounted-price attractiveness that ensures sustained demand for palm oil, especially in price-sensitive markets such as India and its neighbours. It is reasonable to believe that palm oil will increase its market share in 2012. But one must remember that this price-driven incremental demand will occur at a time when palm oil production growth will be 1.8 mt in 2011-12, down from 3.7 mt of the previous year.

So, higher demand growth and lower output growth will result in tightening fundamentals. This will mean the price differential with soya bean oil is set to reduce, which in turn translates to a rather limited downside price risk to palm oil in the coming months.

Expectations of crude oil prices rising in the second half of the year will also be a potentially supportive factor via the biodiesel route.

So, does all these mean, palm oil will have a bull run in 2012 and prices will spurt to Malaysian ringgits 4,000/t as some analysts have been predicting?

It seems most unlikely. Without doubt, the demand conditions will stay robust; and the price differential with soya bean oil will narrow to about $90-100 a tonne versus about $140-150/t at present.

But palm oil prices are unlikely to rise sharply simply because prices are a function not only of fundamental demand and supply but also of factors such as weather, flow of speculative capital and global economic growth outlook. Weather experts are sanguine that global risks are abating. Currently, investors prefer cash to commodities. Lack of risk appetite means funds stay in the sidelines, waiting and watching. Most major economies of the world are slowing down and the situation is expected to remain so in the first half of this year.

Since 2009, annual average price of palm oil has been rising robustly. For instance, from RM 2,300/t in 2009, it spurted to RM 2,700/t the following year and then on to RM 3,250/t in 2011. Given the market fundamentals, weak sentiment resulting from less-confident global growth outlook and dollar strength, the year 2012 is most unlikely to witness price moves comparable to the previous two years. If anything, palm oil prices can potentially come under pressure and actually lose some value on an annual average basis in 2012.

Importantly, Indonesia's recent tariff changes for palm oil export and increasing competition with Malaysia is sure to place a lid on prices. Malaysia will be forced to change its pricing strategy just to retain market share. Major importing countries such as India and Pakistan may also drive special bargains with Indonesia.

Disproportional impact

It is axiomatic in commodity markets that when the market is tightly balanced, even a small change in demand or supply or both will have a disproportionately larger impact on prices. Even a modest level of demand compression can potentially push palm oil prices lower. The probability of such an event is higher than supply-driven price movements.

If anything palm oil exporters should be happy if in 2012, annual average price stays intact as in 2011 at around RM 3,250/t. It should be no surprise if prices move in a broad range of RM 3,000-3,400 a tonne over the coming months barring some transient movement beyond the range. So, forget about a bull run in palm oil.

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