Price and Supply-Demand Outlook in

the Vegetable Oil Market Today

by Dr James Fry, LMC International
to PALMEX Thailand, September, 2011
www.LMC.co.uk

Outline of my presentation today

I will start by describing one of the most surprising
changes in the behaviour of the world vegetable oil
market, which has occurred within the past five years.
This is the way in which vegetable oils have become
part of the petroleum complex, as regards pricing. I will
explain why and how this has happened.
This has far-reaching consequences for the future
behaviour of vegetable oil prices. In particular, while
supply-demand balances do matter, they are less
important than they used to be in setting oils prices.
Palm oil stocks are still the main driver of price
differentials within the oils complex, and so I will
examine the recent trends in global palm oil output.

The revolution in vegetable oil price

behaviour

Before 2007 there was no link evident between

petroleum and vegetable oil prices. CPO was
often cheaper than crude oil per tonne.

Since 2007, a price band has appeared, linking

vegetable oil prices to crude oil prices, within a
price band with vegetable oils at a premium.

The two lauric oils are not so strongly tied to the

new price band, but their premium over crude
petroleum has shrunk sharply in recent weeks.

Examining differentials vs. diesel for oils, we can

see that, after a sharp correction after January,
the CPO premium has settled near its average.

The emergence of a price band is the

major revolution in vegetable oil pricing
We can now see very clearly that there is a price band
in place, which became established in 2007.
When vegetable oil prices get too far above crude oil,
a correction occurs, and typically quite fast. We saw
such a correction in 2008 and again this year.
Since the floor of the band is set by crude oil prices, it
seems likely that biofuels are the key to the link.
This view is reinforced by the evidence that lauric oils,
which are distinct from the other oils and are not used
in biofuels, are less closely tied to the new price band.
However, I suppose the link could be caused by basic
commodity speculation, and so I now turn to examine
whether there is a good reason for the band to exist.

Biodiesel demand has changed the

balance within the oil and meal sectors

Biofuels have pulled demand growth rates for

oil ahead of those for protein meal. This boosts
the reliance upon high oil-content crops.

Until ten years ago, the growth rates in the

demand for oils and meals were similar
If we look back 40 years, we see that, by coincidence,
global demand for oils and meals grew in step with
one another.
The feedback from income growth to oil demand (for
food) and meal demand (for meat) meant that the
global consumption of oils and meals rose in parallel.
Since 2000, world vegetable oil demand has grown
faster than meal demand, with the divergence
between the two curves widening steadily.
The best reason for the change has to be biofuels.
They generate a demand for oils, but without any
corresponding demand for protein meal.

Among oil-bearing crops, oil palms oil yield/ha.

averages five times that of rapeseed, six times
that of sunflower and seven times soybeans.

In contrast, oil palm has by far the lowest meal

content of leading oilseeds. Hence, oil palm is
the oil crop best placed for the new biofuel era.

Palm oil has captured market share thanks to

rapid output growth. It has overtaken soybean
oil to become the worlds most important oil.

The new global balance of consumption

growth plays to oil palms strengths
Now that we are in a world that craves more and
more vegetable oil, and is doing so at a faster rate
than its demand for meal, it wants more of the world
oilseed output to come from a crop that gives us a lot
of oil and relatively little meal.
The crop that best meets this need is called oil
palm!
As a result, it is not simply because oil palm is a
highly productive and cost-competitive crop that it
has captured a greater share of world supply.
In reality, the world needs more palm oil, rather than
other oils, if it is to avoid the problems of large
surpluses of unwanted oilseed meal to dispose of.

Biodiesel demand is very sensitive to

the biodiesel premium over diesel

Biodiesel use in Germany and the US, reacts

quickly to swings in the biodiesel premium over
diesel. This links biodiesel to diesel prices.

The same is true of biodiesel demand in the UK

where biofuel users can pay the government
money not to use biofuels if they get too costly.

Biodiesel demand has been affected by

high price differentials earlier this year.
Around the world, biodiesel users cut back demand
when biodiesel became very expensive vs. diesel.
Some of the cutbacks were temporary, as blenders
waited until biodiesel became cheaper. Some were
caused by users buying out their mandates
In a few cases, governments responded to high food
prices by reducing their legal mandate targets.
In Thailand, your government reacted to low palm oil
output by cutting the mandate for a while.
The effect of all these changes was to pull biodiesel
prices (and hence vegetable oil prices) closer to the
price of diesel, narrowing the spread in the market.

Understanding vegetable oil prices

The main factors behind vegetable oil

price levels today now include biofuels
1.

I hope that I have persuaded you that you have to take

account of biofuels today. In English, we talk about a
tail wagging the dog. In oils today, the tail of
biofuels, with only one eighth of world oil demand is
waging the dog of the global vegetable oil market
(with the other seven eighths of demand).

2.

Because of the price band, petroleum prices are

undoubtedly a major factor behind oils pricing today.

3.

Vegetable oil stocks also influence prices. The recent

period of low palm oil output has passed, and I will next
study how the upturn is affecting stocks.

4.

Finally, vegetable oils compete. I will illustrate this with

evidence from price-sensitive Indian imports.

Stocks and oil supply-demand balances

Strong palm oil output this year will be crucial in

lifting growth in output of the main vegetable
oils to 6 million tonnes worldwide in 2011/12.

High prices will slow 2011/12 world demand

growth and cause it to lag behind output growth,
after two years when demand exceeded output.

Oil output will be sustained in 2011 by cutting

oilseed stocks. Biofuel price sensitivity will be
crucial to balancing world oil supply vs. demand.

Seed stocks provide a cushion for oil output

Oilseed stocks are big enough to ensure high growth

in world oil output, while high prices slow demand.
Within the world oil total, palm oil will make a bigger
contribution to global production growth in 2011/12
than it did in 2010/11, rising 3.0-3.5 million tonnes.
This increase will be crucial in keeping world supply
expanding in line with the rise in global oils demand.
The key looking further ahead will be the speed of
the revival in palm oil output growth. Newly mature
areas and good rains in the past year should keep
world year-on-year CPO production growth strong for
a few more months, as I will now demonstrate.

In palm oil, it is clear that the unusually slow

Malaysian CPO output growth in 2010 was a
temporary aberration and that growth is back.

Here we can see both how much more wildly

Thai CPO output fluctuates than Malaysias,
and we can also see the poor upturn in 2010.

It is interesting to see that the recent production

cycle has been spread throughout the world of
oil palm all the way from SE Asia to S America.

Here we see the scale of the problems in palm

kernel output in 2010 and early 2011, which
explains the recent wild swings in PKO prices.

We are near the peak of the current palm

oil and palm kernel growth cycles.

2010 was undoubtedly an unusual year, in that the

year-on-year increases in both CPO and PK output
were very modest by historical standards (which may
have been a result of low fertiliser use in 2008-09 in
reaction to high costs), and it ended with sharp yearon-year declines in Q4 production of CPO and PK.
Palm kernel output was hit harder than CPO in the
downturn, but was displaying very strong growth
again by the second quarter of 2011.
Looking at the growth patterns, we must be close to
the peaks. Malaysias and Indonesias year-on-year
growth rates peaked in May-June, while the Thai rate
of growth almost certainly touched its peak in July.

What is the role of palm oil stocks?

Until 2006, the year-on-year changes in CPO

prices used to be fairly easily explained in terms
of changes in Malaysian stock levels.

Since 2007 stock and price changes have tended

to move together. Prices are still growing year-onyear despite the big increase in Malaysian stocks.

If stocks no longer determine CPO prices,

we must look instead inside the price band

It is clear that palm oil stocks (we use Malaysian

stocks as the reference) no longer drive CPO prices.
Instead, our theories must adjust to reflect the band.
Logic suggests that, with a price band, a floor exists
to CPO prices when high stocks have driven prices
down so far that it becomes profitable to make and
use biodiesel without any government subsidy.
However, when stocks are low, food demand for oils
should pull CPO far enough above the price floor for
food use to compete oil away from biodiesel output.
So, we expect the CPO premium over diesel to be
inversely related to the stock level, i.e., the premium
should be high when stocks are low and vice versa.

Here we plot stocks against the CPO premium

over diesel. Early in 2011, the premium was too
high, but it is now back down near its average .

Looking ahead to falling palm oil stocks, the

premium over diesel should rise a little, but
not back to the peaks of early this year.

In the background, competition between palm

and soy oil in vital markets such as India keeps
soy oil prices from moving too far above CPO.

This is why, with CPOs premium now close to

normal, the soy oil premium, which is already
high, is not expected to rise much further.

The new world is different from the old one.

We have to analyse the petroleum market as
well as supply-demand in vegetable oils.

The picture I have described is quite different from

that you may have expected.
We are now in a new world in which vegetable oils
trade in price band, created by biofuels, which links
vegetable oils inextricably to the petroleum price.
The old fashioned drivers of oils prices, i.e., supplydemand and stocks, are still a factor in setting prices,
but the supply-demand balance only influences
prices within limits that are set by petroleum.
Therefore, I will end with a few remarks about the
outlook for the petroleum market.

What is the petroleum market doing?

Looking at short term oil supply, high prices are

encouraging lots of drilling. This should boost
output, especially when Libyan supplies return.

On the demand side, petroleum use in the US,

still by far the biggest consumer, has stabilised,
but high prices have pushed it below its peak.

Meanwhile, US stocks are still high in terms of

its demand; yet, prices were much lower in the
past, when stocks were also much lower.

It is hard to see why petroleum prices

should remain at current high levels

The cure for high prices is high prices.

This is as true for petroleum as it is for other markets.
High crude oil prices are stimulating new discoveries
and output, including from deep offshore fields and
from unconventional sources such as tar sands.
High crude oil prices are also hitting demand, both as
users save energy and turn to cheaper alternatives,
led by natural gas, but also by making a double dip
recession much more likely.
This is why I believe the petroleum prices must fall,
and this will have a direct and negative impact on all
vegetable oil prices, as a result of the price band.

www.LMC.co.uk

Acknowledgements: EIA, IMF, Jacobsen, MPOB,

National Biodiesel Board, Oil World, OPEC, Public Ledger,
SEA, TNS, UFOP, US Commerce Dept., USDA, World Bank

Thank You

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