In pole position: Expanding land under cultivation for the palm oil industry

Malaysia is a world leader in the production of crude palm oil (CPO) – and in its development not only as a food product, but as an alternative energy source, too. The commodity looks set for a year of higher prices and demand in 2014-15, with Malaysia plantation companies looking to spread acreage ever further afield. The palm oil industry is going through some profound changes, with the demands of consumers for more sustainably sourced products leading to heightened controls on production and supply.

Facts & Figures

According to figures from the Malaysian Palm Oil Board (MPOB), 2013 saw total planted area for oil palm in the country reach 5.23m ha – 3% up on total of 5.08m ha in 2012.

Eastern Malaysia has become the centre of the industry, as available land has diminished on the peninsula. Sabah is now the state with the largest coverage, at 1.48m ha, or 28% of the total, followed by Sarawak, with 1.16m ha, or 22% of the total.

Production from the oil palm tree follows a life-cycle, with one of the tree’s attractions to growers being that it begins to produce very early, in contrast to rubber. In 2013 some 65% of Sabah’s oil palms hit their peak production age, of between 10-24 years, a factor shown in a 2.4% increase in yield. Yield is generally measured in fresh fruit bunches (FFBs) – the clusters of reddish oil palm fruit that are harvested then processed to make the oil. The fruit’s flesh is usually used to make vegetable oil, while the kernels in the fruit, which also make oil, are usually more suited for food additive and soap production. FFB yield in Malaysia in 2013 was up 0.7% on 2012, to an average 19.02 tonnes per hectare, from 18.89 tonnes the year before.

Whether The Weather

Aside from the maturity of the trees, another factor affecting output is the weather. This can have a delayed effect, typically affecting the harvest six months after a period of climatic irregularity. In 2013 there was both a period of excessive rainfall early on and very dry weather in June and July. Both weather events negatively affected the oil extraction ratio (OER), which measures the proportion of CPO taken from the FFBs. The OER for Malaysia overall was down 0.5% to 20.25% in 2013. The boost in FBB yields, along with increased acreage in production, more than overcame the decline in OER, however, with CPO production up 2.3% by volume to 19.2m tonnes.

Prices & Incomes

This boosted output added to an already high level of CPO in stock – with the volume held in the warehouses a key factor in determining the overall price of the commodity. In January and February 2013 some 2.56m-2.43m tonnes of CPO was in stock, leading to strong downwards pressure in prices.

Another major factor affecting CPO price is the price of its competitors – and substitutes – in the vegetable oil market. These are chiefly rapeseed and soya bean, both of which were less costly during most of 2013 than they had been in 2012, the former $169 per tonne cheaper and the latter $158 per tonne.

Historically, a third factor influencing CPO price has been the price of crude oil. This link emerged most strongly after CPO was established as a workable variety of biofuel. Indeed, in many countries, particularly Indonesia, governments have introduced compulsory ratios of CPO biodiesel to crude oil products. Crude oil prices fell in 2013, with benchmark Brent crude down to $109.56 a barrel from $112.51 in 2012.

The fourth factor then is, of course, the level of global demand. Malaysia exports the vast majority of its output, with 2013 seeing total exports of palm oil, palm oil kernels, palm kernel cake, oleochemicals derived from palm oil, biodiesel and other finished palm oil products up 4.4%, to 25.66m tonnes. China is the largest export market, taking 20.4% of total palm oil exports in 2013, and 23.1% of palm oil kernel exports. Other key markets are the EU, which takes 12.9% of palm oil, 23.1% of oleochemicals and 31.1% of palm kernel cake exports; India taking 12.9% of palm oil exports; the US taking 18.8% of palm kernel oil exports; and Pakistan, which takes 7.9% of total palm oil exports. Yet overall, global economic growth uncertainties continued to plague international demand for palm oil in 2013. As a result, in combination with the other factors, CPO prices fell over the 12 months from RM2764 ($863) per tonne in 2012 to RM2371 ($740) in 2013.

Only Way Is Up

Expectations for 2014 are somewhat rosier for both prices and production. Some of this expectation is the result of fears of a return of El Niño, heightened by a lack of rainfall in the first few months of the year. This is already likely to curb supply, a factor evidenced in the spike in CPO futures, which hit RM2916 ($910) per tonne in March, their highest level since September 2012. An El Niño event would also hit South America, a major source of vegetable alternatives to palm oil. At the same time, Malaysia’s CPO stocks have been falling, as high levels from 2013 are wound down, removing buffers in supply.

On the demand side, Indonesia – which with Malaysia accounts for 85% of global palm oil production – is hiking its domestic requirements for biodiesel in 2014, diverting more production internally. While most analysts are doubtful that Jakarta will be able to achieve a government target of 3.4m tonnes of palm oil used for biodiesel by the end of 2014, Indonesia will still likely emerge as the world’s biggest consumer of palm oil in 2014 with over 9m tonnes expected to be used.

These factors will likely tighten global supply and boost prices. This may present a difficulty in that too high a price might make CPO less competitive against ordinary diesel in the biofuel stakes – particularly, if crude oil prices drift downwards – while substitutes such as rapeseed in Europe are unaffected by El Niño.

Sustainability Concers

A more longer-term concern in the industry is that production costs are likely to trend upwards in the coming years. This is largely to do with increased demands for sustainability. These were writ large in late 2013-early 2014 when the Singapore-based Wilmar International, which supplies 45% of all the world’s palm oil, announced that from the start of 2016 it would no longer source supply from plantations built on peat and forest land. This would affect plantation firms in Sarawak in particular, where much new planting is on coastal peat lands – the state’s mountainous territory means this is some of the only suitable land. Wilmar says it will work with small growers to ameliorate the effects of this ban, while being determined to carry it through. The firm is responding to increased consumer pressure, particularly from Europe, and to the logic of securing a longer-term future for the industry. The move, particularly if followed by other global giants, will likely increase CPO quality and prices by tightening land supply and boosting costs.

Impact

There are fears that two markets could emerge if the sustainability bar is raised too high, with a cheaper, differently certified supply for less discerning consumers. The move also increased pressure on existing bodies committed to sustainable palm oil, such as the Round Table on Sustainable Palm Oil (RSPO). Set up by governments, plantation firms and other stakeholders to implement a system of certification and sustainable standards, Malaysia is the largest producer of RSPO-certified palm oil in the world at 4.3m tonnes.

The Malaysian Palm Oil Association, which represents the largest plantation companies, has recommended a Malaysian exit from the RSPO due to disagreements with criteria and costs. This would be followed by the launch of the Malaysian Sustainable Palm Oil certification. The future may therefore see several competing certification programmes, with increased international market share the goal. In any case, palm oil industry will likely continue to be one of Malaysia’s main export earners – and a major focus for global investors.