The impact of biodiesel on the vegetable oils price outlook Presentation by Dr. James Fry, Chairman, LMC International, Oxford, UK CIOC, Guangzhou,

Background to my presentation The oilseeds complex is complicated, thanks to the interaction between the oils and meals sectors. Since biofuels only affect oils, I will not discuss meal, but will concentrate on the forces determining vegetable oil prices today, which will highlight the role of biofuels. The 12 months since we last met have been the most remarkable “laboratory” for testing the validity of the price band linking vegetable oil prices to petroleum. A year ago, palm oil stocks were at all-time highs. The world was anticipating record S. American soy crops. No wonder most people were bearish for 2013, but I hope to explain why my belief in the price band in the face of its greatest ever test has been fully vindicated.

How has the price band been behaving?

This is my favourite diagram. It shows how EU oils and petroleum prices have been linked since 2007 in a price band, which has survived its major test.

Because of the price band, we should now focus on EU spreads over Brent crude inside the band.

September was the third time that the premium for CPO fell to zero, i.e., the EU CPO price was equal to the Brent North Sea crude oil price.

The main oils now trade inside a cage that links them to petroleum prices. Brent North Sea crude is the one we use, as it is the price reference for most world trade. Brent crude sets the floor to the price band, while palm is the oil whose price trades the closest to this floor. The CPO price floor, which is where EU palm oil prices equal Brent crude prices, was tested to the extreme just after last year’s CIOC and it has been tested again in the past three months, but once again it held firm. In the rest of my talk, I will explain why the price band has been so resilient and what this means for the future. Since 2007, vegetable oil prices behave as if they are part of the petroleum complex.

What determines the premium for vegetable oils over Brent crude?

Answer for palm oil: its premium vs. Brent moves in the opposite direction to Malaysian stocks.

Brent crude prices lie at the bottom of the price band. Malaysian palm oil stocks are crucial in determining the level of the EU premium for CPO over Brent prices. High stocks have been associated with a low premium; and low MPOB stocks with a high premium. Did you notice that something has changed recently? The market has started to be forward-looking and the premium has started to anticipate stock changes. The premium tumbled before stocks rose, and then in the past month, the premium soared before stocks fell. (To be honest, it is remarkable it has taken so long for the seasonality of CPO output to be recognised.) Since 2007, Brent crude oil has set the floor to EU CPO prices. Malaysian Palm Oil Board data on stocks drive the CPO premium over Brent.

I mentioned seasonality because the monthly pattern of Malaysian CPO output is very regular, with the monthly peak just before the year-end.

How does the CPO price floor hold firm in the face of the pressure of stocks?

At the zero premium floor to the EU price band, CPO in S.E. Asia is cheaper than Brent. See EU (red) and Malaysian (blue) premia over Brent.

In Indonesia export taxes pull local CPO prices (green) down to a bigger discount to Brent than those at a FOB level for exports (in blue).

Indonesian export taxes make local CPO (green) and stearin prices (red) very similar. Therefore biodiesel for local use is often made from stearin.

Freight costs from S.E. Asia translate the floor to the EU price band (where CPO prices equal Brent crude prices) into an FOB CPO discount on crude oil in S.E. Asia. Export taxes in S.E. Asia have reinforced the economics of turning CPO into biofuel for use in the region. There is no doubt that, at the floor to the price band, vegetable oils are competitive liquid fuels in S.E. Asia. However, the big increase just announced in Indonesia’s biodiesel mandate has added $120 to the CPO price. In the first week of October, internal Indonesian CPO prices were $105 below Brent crude. In the first week of November, they had leapt to $15 above Brent. Freight costs and export taxes have defended the floor to the EU price band

If palm oil producers have been the winners, who have been the losers?

The main losers are the seed oils. As EU and US support for biofuels has eased, seed oils look to strong CPO prices to underpin their own prices.

Another group of losers as a result of Indonesian export taxes has been importing refiners. CIF CPO prices are often above those of RBD olein.

This is possible because Indonesian export taxes on olein are lower than those on CPO, pulling olein prices above CPO prices inside Indonesia.

The prices of soy, rapeseed and sunflower oils would all be lower if it had not been for the support they received from lower palm oil stocks, which are a direct result of the stimulus to Asian biofuel demand from export taxes. Without palm oil prices as support, seed oil prices would have started to fall to levels that trigger their own price- sensitive biofuel demand in competition with petroleum. It should be stressed that the boost to palm oil offtake in biofuels has not been at the expense of seed oil sales. The main losers from the differential export taxes in S.E. Asia (higher taxes on CPO than RBD oils) have been the import refiners; hence the lobbying by Indian refiners for an increase in the import tariff on RBD palm olein. Seed oil prices are boosted by CPO export taxes, but destination refiners suffer

How are biofuel policies evolving - US?

The US ran into an ethanol blend wall, making it impossible to meet renewable fuel mandates. As they are cut back, biodiesel will suffer, too. E10 blend wall

How are biofuel policies evolving - EU?

EU political support for biofuels is falling, causing a cutback in EU targets; and the “double counting of waste oils” is hitting its biofuel demand for oils.

Different reasons (technical and political) lie behind the slowdown or fall in biofuel demand in the US and EU. However, this coincides with a sharp rise in S.E. Asian biodiesel demand, led by Indonesia, and the emergence of a new form of demand for biodiesel as a cheap fuel in Asia in imports of biodiesel-diesel blends into China. Therefore, the geographical balance of biofuel demand is shifting, but changing government policies on biofuels will not affect the future relevance of the price band. The scope to use palm oil as a cheap fuel is now well known. That knowledge is just as relevant for the seed oils; therefore, every time prices approach that of crude oil, free market biofuel use should create the price floor. Weakening EU and US enthusiasm for biofuels will not end the price band

Price influences in the next few months

The price band will not go away. Now that the world knows of the ability to turn oils into biofuels when it is profitable to do so, that knowledge will not vanish. However, biofuel policy can play an important role, boosting demand (as in S.E. Asia next year) or slowing it (as in the EU and US), which will affect the position of individual oils inside the price band. As a result, there will be a difference between the prospects for palm oil, whose stocks are peaking far below the level in 2012, and the seed oils, which cannot look to biofuel mandates to take more oil. This all points to a narrower spread between palm oil and seed oils, such as we last saw in The price band, biofuel policies and palm oil stocks will remain the key to oil prices

New crude oil supplies and rising competition from shale gas still convince me that Brent prices will decline; but these forecasts apply today’s Brent prices of $ EU CPO prices will move towards $200 above Brent at $975 in March-April. This implies Malaysian BMD futures at $850 (M$2,700 at M$3.16/US$). 2. CPO would be higher if weak biodiesel demand were not holding back seed oil prices; but markets work, and low EU palm-soy spreads, now only $70, will lead some Chinese and Indian food demand to switch to seed oils. 3. This implies EU soy oil should be at $1,050 in April. 4. FOB Argentina SBO prices will be $990 vs. FOB olein at $900 (pulled down by the impact of export taxes). Implications for future vegetable oil prices

Thank You Acknowledgements: EIA, IMF, Jacobsen, MPOB, Public Ledger, SEA (India), TNS, USDA, World Bank

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