The Impact of Biodiesel on the Vegetable Oil Price Outlook By Dr James Fry, LMC International, CIOC, Guangzhou, November

I will start today by reminding you that the price band, created by the demand for biofuels, linking vegetable oil prices to those of petroleum products, is still alive. Therefore, supply-demand and stocks come second to the petroleum market in determining oils prices. The most important stocks of all in terms of setting oils prices are those of palm oil, as I will explain. In the biodiesel sector, EU policy is crucial, as it is the world’s largest biodiesel user with its own special rules. I will end my presentation by combining the impact of the petroleum outlook and palm oil stock forecasts to arrive at forecasts of oils prices in the next few months. Outline of my presentation today

The vegetable oil price band

Until 2006, there was no link between vegetable oil and petroleum prices. (In our diagrams, Brent North Sea crude oil is the petroleum we plot.)

Since 2007, a price band has linked vegetable oil prices to petroleum prices, with EU oils prices at a premium to Brent crude.

In case you don’t believe me, here I have drawn lines to show the price band, with oils always at a premium to Brent crude.

Note that the price band extends to other crops, e.g., grains, thanks to the influence of biofuels.

The price band means our analysis should start from the premium for oils over Brent crude (or even better vs. diesel, as biodiesel’s competitor).

Reviewing EU palm and soy oil premia vs. Brent since 2007, we see that last month both were far below their average levels over this period.

We see that EU CPO daily prices very briefly fell below Brent crude, but they have now bounced back. SE Asia FOB prices remain at a discount.

Another interesting example of markets working to defend price floors is in the premium of the two laurics, PKO and CNO, over CPO

Once we understand that the price band exists, we should focus our attention upon the differentials between vegetable oil and crude oil prices in the development of price forecasts. This requires a change in the way we analyse the impact of stocks upon the level of vegetable oil prices. When vegetable oil prices approach that of crude oil (as happened very recently), biodiesel production and direct burning of vegetable oils become increasingly attractive options. This creates the floor to the price band. When vegetable oil prices move too far above crude oil, biofuel demand drops, creating the ceiling to the band. Implications of the price band

The last month has seen the floor to the price band tested, just as it was in 2008, and, just as happened in 2008, the floor to the price band in the EU was with CPO prices equal to Brent North Sea crude prices. If this is the situation in the EU, it means that in South East Asia, CPO is at a discount to crude oil, by virtue of the freight from SE Asia to Europe. The discount in Indonesia is even bigger than that caused by sea freight alone, as a result of Indonesia’s export taxes, which hold down local palm oil prices. In SE Asia palm oil has been used for burning and as transport fuel. This is now pulling up CPO’s premium over Brent in the EU, as we have started to observe. The experience of the past month

The impact of stocks on prices

Palm oil plays a crucial role in the determination of prices in the vegetable oil complex, and not only because it is the world’s largest source of oils. Unlike the oils produced by crushing soybeans and rapeseed, for which crushers only decide to produce oil and meal if there is a demand for the end-product, palm oil has to be produced every day, since oil palm fresh fruit bunches cannot be stored. As a result, mill tanks fill every day (oil palm is a year-round crop) and palm oil producers with high stocks act as “distress” sellers. This explains its permanent discount on other oils and the recent sharp drop in palm oil prices after a surge in S.E. Asian output. The significance of vegetable oil stocks

There is no nice relationship between total palm oil stocks and prices. High prices are found at times of both high and low palm oil stocks.

With the price band in place, we should now be studying the relationship between the palm oil premium over Brent crude and palm oil stocks.

We surely all agree that high stocks should be linked in some way to low prices and vice versa. However, now that we have price bands, the evidence is that high stocks are linked to a low CPO premium over petroleum and vice versa. When stocks of oils are low, food users compete with biofuel for these supplies and this pulls up the premium. When stocks are high, the premium falls back and this boosts biofuel demand for oils. The monthly stocks that the market follows are those released by the MPOB, which are very accurate. We must incorporate the price band into the analysis of the relationship between palm oil stocks and CPO prices

The petroleum market is the key to the floor underpinning the price band

Petroleum now drives vegetable oil prices. In terms of output, we see how the effort to find new supplies reacts strongly to price signals.

Here you can see very clearly the impact of high Brent crude prices on demand growth in by far the largest consuming areas, the US and EU.

The impact of good supplies and weak demand may be seen in US petroleum product stocks. In days of use, they remain near their all-time peak. 1 st Iraq War 2nd Iraq War

It is sometimes said that high crude oil prices today are the result of tension in the Middle East. Yet, the two Iraq Wars resulted in Brent prices in the region of $25-$30 per barrel, not over $100. In terms of petroleum supply, the evidence of the rigs drilling for oil is that supply should rise soon. Meanwhile, cheap substitutes (notably cheap natural gas and biofuels) and energy saving investments are slowing petroleum demand. This is not a recipe for high crude oil prices. That is why I believe crude prices will fall, once today’s commodity bubble bursts. In terms of fundamentals, it is impossible to justify today’s very high crude prices

The EU biodiesel market today

EU double counting of biofuels made from “waste products” has changed the relativities between different methyl ester prices in the EU

The EU policy of allowing one tonne of biodiesel made from “waste” products, like animal fats and used cooking oil, to count as two tonnes when meeting biofuel mandates has had the effect of making biodiesel from these feedstocks more expensive than biodiesel from, say, rapeseed oil. Another distortion is created by EU and US policies that erect barriers against the use of palm oil in biodiesel on environmental grounds. These policies have tended to reinforce the palm oil price discounts on other oils, as a signal to users (in Asia in particular) to switch demand towards palm oil. Policies favouring one kind of feedstock over another are creating price distortions

Short run prospects for palm oil

Forecasts of Malaysian CPO output imply that year- on-year declines will now be followed by recovery, as the tree’s biological cycle unfolds.

2011 was a remarkably good year for CPO output all over the world from S.E. Asia to Latin America output is now benefiting from the good rains in most regions in 2011 and early this year, but there is still a legacy of dry conditions in a couple of Indonesian regions. Most important is the growing confirmation that, regardless of pressures to slow the development of new oil palm estates, high prices have done their job of promoting investment in new capacity. Since oil palms take three years to start producing and eight years to reach peak output, we can expect a rising wave of Indonesian palm oil output. The prospects for palm oil output growth

Implications for prices

1.The basic supply-demand data on petroleum imply that today’s high prices are unjustified and are doing their job of boosting supply and slowing demand. 2.However, I will hedge my bets by showing you, first, a petroleum price forecast that I believe; then one that assumes that Brent prices remain at around $ In the first, Brent prices fall steadily to a less crazy level of $90 (above the average price in Q4.2010); 4.The second holds Brent at $ In both, Malaysian palm oil stocks rise until December and then fall back in the first half of We must start with petroleum

This summarises the implications of alternative Brent crude price forecasts until mid Forecasts of BMD CPO prices in 2013 in M$ and US$/tonne

The soy oil premium vs. CPO is now high, but not as high as in It will fall back as palm oil stocks fall and S. American soy crops arrive.

Prospects for Malaysian stocks are inextricably linked to events in Indonesia, where production is surging and the 2011 export tax reform is promoting exports of refined oils, traditionally Malaysia’s domain. After over a year of hesitating, Malaysian government has finally reacted with its own export tax reform. This, together with the emergence of price-sensitive biofuel demand, should stop stocks rising from December, pulling up the premium for palm oil over Brent crude. At that time, as S. American soybean crops approach, the soy-palm oil premium should shrink; but more important than all these influences is knowing when Brent crude finally falls back to more sustainable levels. Export taxes and vegetable oil prices

Thank You Acknowledgements: EIA, IMF, Jacobsen, MPOB, OPEC, Public Ledger, TNS, USDA, World Bank

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