Plenary 2 - 1 DR James Fry PDF

Politics, supply-demand and petroleum
in today’s world of oil palm

by Dr. James Fry,
Chairman, LMC International, Oxford, UK
Bursa Malaysia Price Outlook Conference, 2019, Kuala Lumpur
© 2019 LMC International. All rights reserved. www.Lmc.co.uk
I start with politics: the Trump effect

See the impact of the Trump anti-biofuel policies
Renewable identification Numbers are traded certificates tied to US mandates. They
reveal what fuel companies will pay not to blend biofuels. The EPA gave “waivers”
to many refiners, cutting their biofuel use and slashing RIN (and soy oil) values.
120 600
RIN value, US$ per tonne of soybean oil

There has been a fall of
100 500
RIN values, US c/gallon biodiesel
$200/tonne since 2017
80 400
60 300
40 200
20 100
0 0
Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 Apr-18 Jul-18 Oct-18 Jan-19
Biodiesel Biodiesel RIN, $/tonne soy oil (RH axis)
© 2019 LMC International. All rights reserved. POC 2019, March 2019 3
By cutting support for biofuels, the US capped oils prices

The EPA’s downward pressure on soy oil prices weighed on CPO, too. Between Jan
2016 and October 2018 gasoil prices rose nearly $500, yet CBoT soy oil fell over $200.
This blocked any possible upside for CPO, which fell to 12 year lows late last year.
900
$743
800
Daily prices, US$ per tonne
700
600
500
400
CPO 12 year low
300
$247
200
100
0
Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Jul-18 Jan-19
CBoT soy oil futures CPO FOB Sumatra London gas oil
The outlook for CPO supply
First, a general point about the oils market

Annual oilseeds differ fundamentally from oil palm. Seeds may be stored before
being crushed for oil and meal. They can be stored for years in the case of
soybeans and for months in the case of rapeseed and sunflower. However, as
you know, oil palm FFB must be processed at once.
For soybean oil, the key to output is the demand for meal, and this is being hit by
African Swine Fever in China which has reduced its feed demand by 5-10%, and
now ASF has spread to Vietnam. You might have thought that less need to crush
beans for meal by reducing the supply of soy oil would raise its price; but we
have just seen how policy can cut demand, and hence pull down oil prices.
For rapeseed and sunflower, which are crushed primarily for their oils, we are
currently in a crop year that saw weak rapeseed output, alongside some record
sunflower harvests. Therefore, today rapeseed oil is the most expensive soft oil
and sunflower the cheapest soft oil, with soy oil not far above sun oil’s price.
The key to the short run global supply-demand balance for all vegetable oils is
always the palm oil balance. Mill tanks fill every day, putting them under pressure
to sell oil, and making those without large tank capacity act like distress sellers.
This is why CPO sets the floor to oils prices; and it makes the palm oil supply-
demand balance absolutely central to the entire world vegetable oil complex.
© 2019 LMC International. All rights reserved. POC 2019, March 2019
Where do we stand in the palm oil production cycle today?
For 18 months Malaysia and Indonesia have been out of step. The 3rd and 4th largest
producers, Thailand and Colombia, followed Malaysia’s output declines, but the
growth in Indonesia helped to lift total 2018 world CPO output by 5 million tonnes.
40%
Year-on-year growth in quarterly output, %
30%
20%
10%
0%
-10%
-20%
-30%
-40%
Q1.11 Q1.12 Q1.13 Q1.14 Q1.15 Q1.16 Q1.17 Q1.18 Q1.19
Malaysia Indonesia
The southern-most areas led the output recovery

Annual production growth by region in Indonesia and Malaysia in 2018 was much
stronger in the southern areas hardest hit by El Niño, while Peninsular and Sabah fell.
Year on Year
Output Growth
20 – 25 %
15 – 20 %
10 – 15 %
5 - 10 %
0-5%
-5 - 0 %
Looking ahead: this El Niño is proving to be weak
The ONI is the usual indicator of El Niño (dry) and La Niña (wet) weather in southern
Asia. This weather cycle returned more quickly to the El Niño range than the past
two El Niños. However, the ONI has turned and fallen slowly since November.
2.5
2.0
El Niño
1.5
Oceanic Niño Index (ONI)
1.0
0.5
0.0
-0.5
-1.0
-1.5
La Niña
-2.0
Jan Jul Jan Jul Jan Jul Jan Jul Jan
1997-2001 2009-13 2015-19
Behind the supply forecasts: the trends in CPO yields

The leap in 2017 official Indonesian palm area data was a big shock; but it does not
affect output; instead, it cut already poor Indonesian yields. I plot here the results
of my colleagues’ analysis of past data, and have included our 2019 yield forecasts.
4.75
4.50
CPO yields (tonnes per hectare)
4.25
4.00
3.75
3.50
3.25
3.00
2.75
2.50
2.25
2000 2003 2006 2009 2012 2015 2018
Indonesia Malaysia
We used several sources to estimate true Indonesian areas
This depicts the results of an initial exercise by my colleagues to make sense of the
new official data from Indonesia about oil palm areas. It is clear that the proportion
of immature areas (which of course include replanted areas) has fallen sharply.
16 32%
14 28%
12 24%
% Immature Area
Million hectares
10 20%
8 16%
6 12%
4 8%
2 4%
0 0%
2000 2003 2006 2009 2012 2015 2018
Mature Immature % Immature
The growth in world palm oil output 2016-2019

I illustrate here total output in the eight largest CPO producers in S.E. Asia and
Latin America, after allowing for the impact of new maturing areas and cuts in
fertiliser applications. Overall growth will slow to 2.8 million tonnes this year.
80
68.1 70.9
70
63.1
55.1
60
Millions of tonnes of CPO
50
40
30
20
8.0 5.0
10
-7.3 2.8
0
-10
2016 2017 2018 2019
Output Growth
The key determinant of CPO demand
Indonesian biofuels are the key to CPO demand growth

Indonesian use of CPO in biofuels and direct burning is crucial. 2019 CPO demand
will grow 1.5 million tonnes due to higher biofuel mandates and power generation,
with possible upside if the mandate rises to B30 after the presidential elections.
550
500
450
Biodiesel sales, '000 tonnes
400
350
300
250
200
150
100
50
0
Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19 Jul-19 Oct-19
Local mandate Exports Possible upside
Vegetable oil prices and the price band
I think you all know now about the price band for oils
Updating the relationship between Brent crude oil and EU vegetable oil prices, we
can see that EU CPO has been at the floor of the price band (where it touches the
Brent crude price) four times since 2012, the most recent time being late last year.
2,100
1,800
EU prtices (US$ per tonne)
1,500
1,200
900
600
Floors to the band
300
0
Jan-06 Jan-08 Jan-10 Jan-12 Jan-14 Jan-16 Jan-18
Soy Oil Palm oil Rapeseed Oil Sun Oil Brent
This adds the upper ceiling to the price band diagram
Vegetable oil prices approach the price band ceiling when output is low, such as
after an El Niño drought. Then vegetable oils become so expensive as a source of
fuel that biofuel users cut back their demand, releasing supplies for food use.
2,100
1,800
Ceilings to the band
EU prtices (US$ per tonne)
1,500
1,200
900
600
Floors to the band

300
0
Soy Oil Palm oil Rapeseed Oil Sun Oil Brent
Daily CPO-Brent premia show how a price band is defended

This plots Indonesian and EU CPO premia over Brent. They differ due to freight and
export taxes. When EU CPO is briefly cheaper than crude oil, Indonesian CPO sells
at a very large discount, stimulating the use of palm oil as an unsubsidised fuel.
500
Daily premium over Brent, US$ per tonne
400
300
200
100
-100
-200
Floors to the band
-300
Sep-12 Sep-13 Sep-14 Sep-15 Sep-16 Sep-17 Sep-18
CIF Rotterdam Inside Indonesia
Malaysian palm oil stocks determine the CPO-Brent spread
MPOB stocks are a key determinant of EU CPO premia over Brent. The premium and
stocks move in opposite directions; rising stocks => falling premia, and vice versa.
600 3,300
MPOB Palm Oil Stocks, '000 tonnes

EU premium over Brent , US$ per tonne
500 3,000
400 2,700
300 2,400
200 2,100
100 1,800
0 1,500
-100 1,200
Jan-08 Jan-10 Jan-12 Jan-14 Jan-16 Jan-18
CPO-Brent spread Average Premium MPOB Stocks
We shouldn’t focus solely upon Malaysian stocks

In practice, Indonesian stocks are much larger and, in the background, play a major
role in sentiment. We estimate its stocks from its monthly supply-demand balance.
It is clear that its combination of strong exports (at Malaysia’s expense) and high
biodiesel demand caused Indonesian stocks to peak five months ago in October,
two months before the peak in MPOB stocks. This meant that combined Malaysian
and Indonesian stocks peaked in November, just as in earlier years of high stocks.
If you want an explanation for the turnaround in the CPO-Brent spread that began in
October, you need look no further than Indonesia whose stocks started to fall after
that have continued to decline until today and will do so for the next three months.
Peak stock month

2012 2015 2017 2018
Malaysia December November October December
Indonesia October November November October
Combined November November November November
MPOB PKO stocks determine the EU CPKO-Brent spread
To my surprise, MPOB PKO stocks (which I define to be PKO stocks plus stocks of
oil in uncrushed PK) are also a key determinant of EU CPKO premia over Brent. I say
“to my surprise” because I cannot really see why Brent prices play such a big role.
1,750 600
EU PKO premium over Brent, US $/tonne
1,500 550
PKO + oil in PK stocks, '000 tonnes

1,250 500
1,000 450
750 400
500 350
250 300
0 250
-250 200
EU PKO premium over Brent Stocks
What can we say about future price behaviour?

In the past, palm oil prices used to be determined by factors such as its supply-
demand balance, production costs, and competition with other vegetable oils.
The emergence of the price band adds a new factor, namely the link with crude
oil which sets the floor to all vegetable oil prices. Therefore, before presenting
my price forecasts for this year, I must discuss the key influences upon the
petroleum supply-demand balance and crude oil prices today.
There is also another influence, which only emerged in the past five years. This
is the success of environmentalists in slowing new plantings of oil palm. We
can see today in the recent official upgrading of total Indonesian oil palm areas
the lagged effect of the past planting boom in Indonesia, but it is inevitable that
growth rates in worldwide oil palm areas and CPO output over the next 10 and
20 years will be significantly slower than they were in the past.
If palm cannot meet rising demand for oils, soybeans are the main alternative,
but their oil yield is far below that of palm; and much larger supplies of beans
will hit meal prices (as well as the environment, as soybean farms move into
new areas). To offset lower meal prices, and yet lift soybean prices to promote
more planting, soy oil prices must increase, and lift CPO at the same time. This
is the new “law of unintended consequences”, as NGO success in slowing
future CPO output growth raises the long term price prospects for CPO.
Returning to the outlook for 2019 and
the need to understand crude oil prices
OPEC is cutting output, while others are expanding

In the past two years, US shale oil has led the way by supplying nearly all the
growth in non-OPEC output of petroleum, much of it in conjunction with natural
gas production. OPEC has to decide whether to go on conceding market share.
64 47
Output, millions of barrels per day
62 45
60 43
58 41
56 39
54 37
2014 2015 2016 2017 2018 2019 2020
Others (LH axis) OPEC (RH axis)
The key US area is Permian (nearly half of all shale oil)
Some Permian fields claim to produce oil at $25/bbl, and now one constraint on their
output, limited pipeline capacity to take oil to distribution centres, is being solved.
US shale oil output grows, even at fairly low prices

The revolution in fracking techniques has enabled US shale oil output to grow from
under 2 million barrels/day just 8 years ago to approach 9 million bbl/day today.
9 160
Output from main oil fields, mn bbl./day
8 140
7
120
6
WTI, $ per barrel
100
5
80
4
60
3
40
2
1 20
0 0
Total shale oil output, bbl./day WTI, $/bbl (RH axis)
US shale oil production responds at ever lower prices
New technology means that US monthly shale oil output now grows by over 50,000
bbl/day at a WTI price of $50/bbl and by 150,000 bbl/day at $70. Therefore the US can
meet all world demand growth at $70 WTI (Brent $80), and new pipelines will help.
160 150
Monthly growth in output, '000 bbl/day
120 130
80 110
WTI, $ per barrel

40 90
0 70
-40 50
-80 30
WTI price, $/bbl US shale oil output

Note that the US shale output growth that is plotted here is a lagged moving average of monthly growth rates in order to smooth the groweth curve.
Conclusions
© 2019 LMC International. All rights reserved. www.lmc.co.uk

Conclusions from my analysis today
• The US EPA’s actions have cut soy oil prices, and this has capped CPO prices.
• Indonesian CPO output growth is now out of phase with other major producers.
• Production growth rates will slow significantly in Indonesia, but will resume in
Malaysia and other major producing countries.
• After 5.0 million tonnes of world CPO output growth in 2018, global production
will rise 2.8 million tonnes this year, little affected by the current weak El Niño.
• Indonesia will lift biofuel demand for CPO in 2019 by at least 1.5 million tonnes,
and weak Chinese soy crushing means palm will need to fill its soy oil shortfall.
• The price band is as strong as ever. Crude oil sets the floor to CPO prices and
palm oil stock levels determine the CPO premium over Brent crude.
• US fracking has transformed the crude oil balance. OPEC no longer rules
• Crude oil has an equilibrium today at $60 WTI/$70 Brent, which would allow the
US and OPEC to share in meeting the growth in world crude oil demand.
• If OPEC tries to push up prices, and crude goes to $70 WTI/$80 Brent, the US
will be able to supply all demand growth, leaving nothing for OPEC.
Implications for prices

• I believe that the stand-off between US producers and OPEC will leave crude oil
trading in a range near $60/bbl for WTI and $70 for Brent.
• $70 for Brent implies that the floor to the EU CPO price band will be $510, which
would be $480 FOB S.E. Asia or 1,950 Ringgits at current exchange rates.
• As long as Indonesia sticks to a B20 mandate and Malaysia implements the B10
mandate, world palm oil stocks should fall by 1-1.5 million tonnes during 2019.
This will be on top of the usual seasonal stock drawdown until June.
• The inverse relationship between CPO stocks and the EU CPO premium over
Brent means that the lower stocks should raise the premium, whose recent
value has been $70, as against a long run average level of $225.
• Since we start with very high stock levels, we do not expect the premium to
regain its long run average, but do expect lower stocks to lift it by $100 to $170
by mid-year, taking the EU price at $70 Brent to $650 and FOB SE Asia to $620
(M$2,525). How this translates to BMD and Indonesian prices depends on
official export tax decisions. If Brent settles at $65, the FOB price will be $580
(M$2,360); and at $60/bbl, it would be $550 (M2 2,240).
• PKO does not benefit from biodiesel. Therefore, we expect it to average $75
over CPO in the EU, just below recent differentials, i.e., $725 at $70 Brent.
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info@lmc.co.uk info@lmc-ny.com info@lmc-kl.com
www.Lmc.co.uk
© LMC International, 2019

All rights reserved
This presentation and its contents are to be held confidential by the client, and are not to be disclosed, in whole or in part, in
any manner, to a third party without the prior written consent of LMC International.
While LMC has endeavoured to ensure the accuracy of the data, estimates and forecasts contained in this presentation,
any decisions based on them (including those involving investment and planning) are at the client’s own risk.
LMC International can accept no liability regarding information analysis and forecasts contained in this presentation.

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Politics, supply-demand and petroleum

in today’s world of oil palm

I start with politics: the Trump effect

RIN value, US$ per tonne of soybean oil

$200/tonne since 2017

By cutting support for biofuels, the US capped oils prices

First, a general point about the oils market

The southern-most areas led the output recovery

Behind the supply forecasts: the trends in CPO yields

The growth in world palm oil output 2016-2019

Indonesian biofuels are the key to CPO demand growth

Floors to the band

Daily CPO-Brent premia show how a price band is defended

MPOB Palm Oil Stocks, '000 tonnes

We shouldn’t focus solely upon Malaysian stocks

Peak stock month

PKO + oil in PK stocks, '000 tonnes

What can we say about future price behaviour?

OPEC is cutting output, while others are expanding

US shale oil output grows, even at fairly low prices

WTI, $ per barrel

WTI price, $/bbl US shale oil output

© 2019 LMC International. All rights reserved. www.lmc.co.uk

Implications for prices

© LMC International, 2019

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