This article first appeared in The Edge Financial Daily on December 31, 2019 - January 6, 2020

KUALA LUMPUR: With palm oil currently trading at its highest level in almost three years — with prices above the RM3,000 per tonne mark — analysts see an earnings boost for the plantation industry in 2020.

The industry’s recovery, they said, will be aided by demand for crude palm oil (CPO) outstripping supply due to factors such as lower production and the mandated biodiesel programmes in Malaysia and Indonesia.

One of the reasons for the lower output, according to some analysts, is the move by many planters to hold back their 2019 fertiliser applications to ride out depressed oil palm prices.

“I am looking at around 2% to 5% drop in fresh fruit bunches (FFB) production for 2020 compared to the market estimates of 20 million tonnes [in inventory] at end-2019, as the market has not factored in the impact of a cut in fertiliser application,” said Public Investment Bank Bhd research analyst Chong Hoe Leong.

“Based on the poor CPO price performance over the last two years, it is tough for smallholders to have the budget to apply fertiliser. Smallholder plantations make up 17% of the Malaysian palm oil industry, and 41% in Indonesia,” he told The Edge Financial Daily.

Chong said the plantation sector’s earnings are expected to improve in 2020 as CPO prices remain healthy on the back of slower global production growth when oil palm trees enter the seasonal low-cycle period.

United Plantations Bhd chief executive director Datuk Carl Bek-Nielsen also sees a brighter outlook for the sector in 2020 amid constrained supplies and greater demand.

“Supplies will be constrained from now and into the first quarter (1Q20) combined with greater demand. This will magnify the tightness situation which we are currently seeing that in return will help sustain the present prices. This could become even more precarious if there are any weather calamities in the first six months of 2020,” said Bek-Nielsen when contacted.

Indeed, CPO futures have been trading at historically weak levels for the most part of 2019 — falling to a near four-year low of RM1,937 in July — before the recent recovery.

The benchmark third-month palm oil contract averaged at RM2,224.50 in 2019, versus RM2,300 in 2018, RM2,703 in 2017, and RM2,628 in 2016 when prices finished the year above the RM3,000 level as prolonged drought capped supplies.

Prices closed RM55 up at RM3,128 a tonne yesterday, near a three-year high.

Chong said prices could remain strong in the first half of next year (1H20), before easing to the RM2,400-2,500 bracket in 2H20 when the market starts seeing signs of a production recovery.

Coming from a low base, he sees an average net profit growth of more than 50% in financial year 2020 for all upstream plantation players in the industry that are under his coverage.

“Our sensitive analysis suggests that for every RM100 per tonne increase in CPO prices, earnings will be boosted by as much as 10% to 20%.

“Upstream producers will be more sensitive to CPO prices as margins are expected to expand on the back of stronger sales as well as a sharp decline in CPO production cost,” he said.

CGS-CIMB Research head of regional agribusiness research Ivy Ng cautioned that the “significantly better earnings” of palm oil players expected in 2020 may be partially offset by higher fertiliser costs, higher CPO export tax, as well as the return of windfall tax at the current CPO price.

“Demand for palm oil will be driven mainly by Indonesia’s and Malaysia’s mandated biodiesel programmes, which are estimated to raise palm oil demand by 2.5 million tonnes in 2020.

“However, this could be partially offset by weaker discretionary biodiesel demand as palm oil is currently not competitive relative to gas oil. On top of this, food demand from price-sensitive countries like India may be negatively impacted by the higher CPO price,” she added.

Meanwhile, Gan Huey Ling of AmInvestment Bank believes there is limited upside to CPO prices going forward, as prices are priced to perfection with bullish factors already taken into account.

Gan sees CPO prices averaging at RM2,300 a tonne in 2020, implying a trading range of RM2,100 to RM2,500 throughout the year.

“We are neutral on the sector as we believe that price-earnings valuations have already priced in the improvement in CPO prices. We reckon that this is an opportune time to take profit on some plantation stocks.

“We have ‘sell’ calls on Sime Darby Plantation Bhd (fair value [FV]: RM4.90), FGV Holdings Bhd (FV: RM1.10) and TH Plantations Bhd (FV: 45 sen),” she added.

Contrary to market expectations, Gan also sees easing demand from China — one of Malaysia’s biggest buyers — in 2020 as the country has aggressively purchased palm oil in 2019.

In the first 11 months of 2019, China bought 2.23 million tonnes of CPO from Malaysia, up 40.4% from the same period in 2018, according to data provided by the Malaysian Palm Oil Board.

“In addition, China renewed its purchases of US soybeans in 2H19, increasing the supply of soybean oil in the country. Hence, there is less need for palm oil,” Gan explained.

TA Securities Research noted in its 2020 outlook for the sector that the provisional Phase One deal between the US and China could lower palm oil demand into the latter’s market. As part of the deal, China would have to buy US$50 billion (RM205.5 billion) worth of agricultural goods annually.

Soybean made up half of China’s agricultural purchases in 2017. This means that if China increases soybean imports, soybean oil supply would increase on account of higher crushing activities in China. As such, palm oil demand may decrease and result in lower CPO prices.

MIDF Research, in its 2020 outlook, forecasts that India will continue to be a top importer of Malaysian palm oil. Under the Malaysia-India Comprehensive Economic Cooperation Agreement, the tariff for Malaysian refined palm oil will be reduced to 37.5% in 2020, thus making palm oil more attractive from a price standpoint. This advantage is also heightened given the close proximity between India and Malaysia in geographic terms, MIDF said.

In addition, India is also seeing lower meal demand, translating into less demand for crushed domestic soybean oils, such as rapeseed, soybean and peanuts, resulting in the country lending support to palm oil demand in 2020.

Dubai-based Hakan Agro DMCC will also import more than a million tonnes of Malaysian CPO into its core Indian markets next year.

Meanwhile, the higher biodiesel mandates could serve to drive consumption of palm oil, MIDF said.

“In Malaysia, the increase in mandate from B20 and B10 for the transport and industrial sectors respectively in [2020], from the prevailing B10 and B7 is expected to mop up more than 1.2 million to 1.5 million tonnes of CPO annually,” the research house noted.

In the case of Indonesia, domestic CPO consumption is expected to rise by 50% to 3.4 million tonnes following the implementation of the B30 mandate for the country’s transportation sector next year.

TA Securities said the Indonesian government expects B30 biodiesel consumption to increase to 9.6 million kilolitres, from 6.6 million kilolitres posted in 2019.

If this happens, stocks will be reduced by 3.1 million tonnes to 2.1 million tonnes, the lowest since June 2017.

The picture is less rosy when it comes to exports to the European Union (EU), as its Renewable Energy Directive II comes into effect next year, where it officially caps biofuel consumption — including products with palm oil — in transport energy to 7% from 2020 to 2030 before implementing a total ban.

Palm oil exports to the EU could come under pressure as 53% of its palm oil imports are for biodiesel consumption.

However, the recent heatwave seen in the EU is expected to shrink rapeseed oil crop supply, which would result in more imports of other vegetable oils such as palm oil in 2020 for the food, animal, heating and electricity segments, while the mandatory Malaysian Sustainable Palm Oil certification on all palm oil production by the end of this year will deal with negative perceptions in the market.

TA Securities said a stronger local note against the greenback would eliminate CPO’s price advantage, making it more expensive in US dollar terms and less competitive for export markets. The ringgit is expected to strengthen to an average of 4.10 against the greenback, from 2019’s 4.15.