Palm oil correction seen as overdone but lower average prices expected in 2023

In just a month, third-month palm oil futures contracts have given back almost all of its gains for the year. At the time of writing, the price stood at RM4,561 per tonne, already close to RM4,363 at the start of the year.

Palm oil futures prices surpassed RM6,000 earlier in April and many had said it was unsustainable. What no one expected was how quickly prices would fall in a short span of time.

This begs the question of whether the price rally for palm oil has ended.

The fall had been steep enough to cause local palm oil millers to stop purchasing fresh fruit bunches (FFB) as millers buy FFB based on the Malaysian Palm Oil Board’s (MPOB) monthly average crude palm oil (CPO) price, which is still high, but can only sell the extracted oil based on the daily market price, which has fallen.

However, it does not seem like the millers will have a say in the issue, with the government — through MPOB — sending out warning letters stating that action, including the suspension of licences, may be taken against those who ceased to buy FFB from smallholders.

Planters have been able to absorb high fertiliser costs and inefficiencies arising from not having enough hands in the estates while CPO prices remained high, with estimates of production costs per tonne of oil at between RM1,900 and RM2,500. In close to 2½ years, CPO futures have climbed from RM3,057 on Jan 3, 2020, to hit a record of RM6,519 on April 29, 2022.

The supply of edible oil has turned tighter over the last few years, owing, first, to labour shortage as borders closed during the pandemic, followed by supply chain disruptions. These factors were exacerbated by the Russia-Ukraine conflict as the latter is a major sunflower oil producer.

When Indonesia, the world’s largest palm oil producer, declared a ban on palm oil exports from its country in May in a bid to stabilise cooking oil prices in the country, prices shot up further, for fear of shortage.

However, that price gain was short-lived. A month later, the Indonesian government lifted the ban, with excess inventory waiting to be exported. It has put the local palm oil supply chain in a quandary, with prices falling swiftly before their eyes.

Of late, other factors have been contributing to the reversal in price. According to CGS-CIMB Research plantations analyst Ivy Ng, the downtrend in prices is also caused by weaker global growth and expectation of higher palm oil supplies in 2H2022.

In a report dated June 28, Maybank Investment Bank Research says that despite the decline, the price of CPO has remained attractive relative to its peers, given that the price gaps between CPO and other vegetable oils have remained wide.

The research house notes, however, that the sharp decline in CPO prices can nonetheless be disruptive to business as buyers may adopt a wait-and-see attitude, hoping to catch even lower prices, considering Indonesia’s excess supply.

“The situation in Indonesia seems dire, judging from the recent sharp decline in domestic CPO price that hit a record two-year low. Last quoted price of RM2,374 per tonne is 40% below the price at the start of the year in Indonesia, and at a discount of RM2,421 per tonne to the Malaysian CPO price.

“But we reckon this is temporary as domestic prices should recover quickly as soon as Indonesia’s stockpile normalises,” it says.

CGS-CIMB Ng’s guess is that excess inventory from Indonesia could take a month or two to subside, depending on government policy, before the situation in the market normalises.

Many analysts believe the current fall in price is overdone and expect to see a rebound taking place.

Oil World executive director Thomas Mielke said in a palm oil webinar organised by UOB Kay Hian last week that the fall in CPO prices in June was an overreaction. He expects some price rebound to take place in the near future as supply is still relatively tight — exports from Indonesia remain limited despite the excess inventory.

He also sees pent-up demand for CPO from consuming countries, given current low inventory levels and attractive pricing while the widening palm oil-gas oil discount adds to the demand for biofuel. Mielke has forecast CPO at US$1,470 (around RM6,400 at RM4.4 per US dollar) for 2H2022.

Meanwhile, Fitch Ratings said last week that it expected higher global vegetable oil output to drive CPO prices to below US$1,000 (about RM4,399) in 2H2022 after averaging around US$1,500 per tonnes in 1H2022. It sees continued output growth in Indonesia exerting further pressure on prices.

“Prices could recover after stocks are cleared or when crude oil rises, but it is unlikely to reach previous highs in 2022,” says Ng, who is expecting prices to come in around RM5,000 for 2H2022. CGS-CIMB expects a CPO price average of RM3,800 for 2023.

UOB Kay Hian says that while it expects to see a downtrend in CPO prices in 2H2022, it believes that prices will remain high — forecasting it to average at RM5,200 for 2022 — supported by the slow exports from Indonesia and the tight vegetable oil situation in 2022. It sees prices averaging at RM4,000 in 2023.

Maybank Investment Bank expects CPO prices to average RM5,000 this year and RM3,400 in 2023.

As for stock picks, Kuala Lumpur Kepong Bhd is CGS-CIMB’s only “add” call (target price: RM28.64) among the Malaysian plantation companies covered by the research house. Its only other “add” call outside Malaysia is on Wilmar International Ltd (TP: S$5.69).

KLK is also Maybank IB’s choice (TP: RM30.90), in addition to IOI Corp Bhd (TP: RM4.87). Meanwhile, UOB Kay Hian has “buy” calls on Hap Seng Plantations Holdings Bhd (TP: RM2.80) and IOI Corp (TP: RM5.15).

Tags: palm oil, futures, contracts, edible oil, costs, exports, price, MPOB, Crude palm oil, Production