Published October 13, 2008

ANALYSIS
Focus on replanting may spell end to palm price plunge

Crisis may push prices to find floor at RM1,500

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(KUALA LUMPUR) The dramatic slide in palm oil prices could soon be drawing to an end as growers consider shifting their focus from expansion to renewing older crops, curbing supplies in the medium term.

A level of RM1,500 (S$632.6) a tonne - 15 per cent below current levels - represents the breakeven point for plantations, which face a margin squeeze as prices have halved since July while fertiliser and other farm costs stay strong.

'The most efficient producers would be able to ride out the current downturn and the financial turmoil,' said Martin Bek-Nielson, executive director at Malaysia's United Plantations.

'But less efficient palm plantations, just starting out, would have an economic floor of RM1,500, not very far from current prices.' Palm was trading at RM1,770 per tonne on Friday, more than 60 per cent below the record high of RM4,486 a tonne hit in March, when surging crude prices and buoyant demand from India, China and hedge funds triggered a rush for shipments.

The market has been caught up in the financial panic that has sent world wheat, corn and other food prices tumbling, relieving worries over future food supplies but also threatening to stymie new production growth.



'Palm oil falling below RM1,500 is very possible in the mid-term as the global recession will see big buyers like India and China tightening purse strings,' said a head trader at a foreign commodities broker. 'Once oil goes below US$70, there will be a further free-fall.'

M&A activities in the sector reached a fever pitch in 2007 when three listed Malaysian firms merged to form Sime Darby, the world's largest plantation firm by planted area. But the Malaysian plantation index has slumped since March, with sector bellwethers such as Sime Darby, IOI Corp and Kuala Lumpur Kepong Bhd losing almost half of their value.

If palm oil prices stay below RM1,500 for a prolonged period, Moody's Investors Service may consider a rating change for a string of palm oil companies in South-east Asia as lacklustre earnings might hamper financing muscle for expansions, said Hong Kong-based Moody's analyst Wonnie Chu.

Still, planters can weather negative margins for some time because of sky-high land values and record prices over the past two years. Prices of palm oil, used in cosmetics and biscuits to biofuels, have been pummelled by expectations of bumper harvests in Malaysia and Indonesia, increasing availability, and good oilseed crops in importers India and China, reducing their need for imports.

In addition, global financial turmoil has squeezed hedge funds, who were once avid buyers, out of the market.

'The prospect of a global recession means that the risks to our already low forecasts for commodities are probably still on the downside,' said London-based Capital Economics in a note, adding that farm commodities could drop by as much as a third.

Analysts said producers would also feel the pinch from hefty fertiliser bills, which are likely to double to a total RM5 billion in Malaysia this year. Fertiliser accounts for more than half of the total cost of producing palm oil.

Replanting existing estates will be a priority in Malaysia, helping the country meet its annual target of replacing 200,000 hectares of oil palm trees aged 25 years and above.

Previously this target, which would yield 600,000 tonnes of crude palm oil, could barely be met as producers were more keen to acquire greenfield land in Malaysian and Indonesian territories on Borneo island and buy out smaller firms.

'In this downward cycle, it is best to plant now in order to tap higher prices later on,' said Velayuthan Tan, chief executive of IJM Plantations .

Replanting means that production will initially taper off, helping to cut stock levels, which are expected to hit a record 5 million tonnes in Malaysia and Indonesia by December. But once oil palms mature after three years from replanting, analysts say a supply build-up could emerge again.

'We are looking at a 5-8 per cent reduction in production if replanting targets are met but in the longer run, supply will jump as younger trees would have better yields,' said S Paramalingam, executive director at broker Pelindung Bestari.

Biodiesel could take up more palm oil.Malaysia has an annual biodiesel production capacity of 1 million tonnes. The palm price plunge has tilted the equation slightly in favour of the green fuel, with 25 per cent of the capacity now in use, up from less than 5 per cent six months ago. - Reuters