Reassessing CPO

Supply Side
a) CPO stocks in Malaysia for January 2008 was 1.88m tonnes compared to December's 1.68m tonnes. However, it was interesting to note that some of it was due to Indonesian exporters keeping their CPO in Malaysia owing to the recent hike in export tax in Indonesia.
b) CPO production for first half 2008 relative to second half of 2008 is expected to be 48:52 compared to last year's figure of 44:56. That loosely translated meant that supply in 1H2008 will be a bit stronger. The weaker second half of 2008 may also indicate that current strong CPO prices may be sustainable right till the end of 2008.
c) The inventory levels for corn and soybean in the US is unlikely to increase thus resulting in a prolonged mismatch between demand and supply, favouring CPO. The demand and supply there should take at least 4 years to adjust.
d) The Indonesian Government said that it would increase export tax on CPO to 15% if CPO price exceeds US$1,100/tonne or RM3,553/tonne. Current tax rate on CPO exports is 10%. This again favours Malaysian exporters.The increased export tax rate would affect Wilmar International Ltd and Indofood Agri-Resources, which are among the largest plantation companies in Indonesia. Sime Darby and KLK would be affected. There is minimal impact on IOI Corporation as the group is only starting to develop palm oil on its newly acquired landbank this year.

Demand Side
a) European governments may be revising down their target of using 5.75% biofuel in the transportation sector by 2010. Even now, the utilisation rate of biodiesel plants in Germany is less than 30% owing to the high feedstock cost. However, that is similar for all biodiesel operators and does not represent a genuine demand factor in the long term. Biodiesel demand acts as a support only when CPO prices goes lower.
b) There is a shortage in edible oils still in China, exacerbated by heavy snowstorms which have affected 3.26m hectares or almost 50% of the winter rapeseed acreage. China should be stepping up its demand for palm oilowing to the shortage of vegetable oils.
c) For oleochemical industry which uses palm kernel oil (which has also risen in tandem with CPO prices), there is resistance in demand with fatty acids at current high prices. However, recent IOI Corp's results still showed better margins and higherdemand from sales of fatty acids.
d) Palm oil exports to USA are also expected to climb on the back of a potential change in the chocolate production standards and health benefits of palm oil.Growing biofuel usage in USA supported by legislation and subsidies would also exacerbate the shortage of corn and soybean oil, which would benefit palm oil.China and USA accounted for 25% and 7% of Malaysia's palm oil exports in January 2008 respectively.

The outlook is clear and the current CPO price above RM4,000 is not likely to be the high for 2008. Investors seem to be anticipating a drop back to RM3,500 very soon, which is not likely. It is also easy to leave out those with "issues" (denoted in green). There has been a disconnect in plantations share prices, maybe affected somewhat by sluggish market sentiment. Best for exposure besides IOI Corp should be IJM Plantations (RM4.10) and TH Plantations (RM3.26).