Indonesia s biodiesel mandate, low Brent prices and El Niño: impact on CPO prices Presentation to Bursa Malaysia Price Outlook Conference, 2016 by Dr James Fry, Chairman, LMC International www.lmc-kl,com LMC International, 2016 1 Making sense of an action-packed few months Since we last met, three developments have had a major impact on the state of today s CPO market. 1. The arrival of the most severe El Niño since 1997. 2. The introduction of Indonesia s very ingenious biodiesel mandate, which made producers pay for the subsidies, knowing that taking CPO out of the market would lift prices by more than cost of the export levy to pay the subsidies. 3. The failure of crude oil supplies to fall back in the way many had predicted following months of low crude prices. I will do my best to tie these together in today s forecasts. LMC International, 2016 2 1
Let s start by updating the price band, linking vegetable oil prices to petroleum. LMC International, 2016 3 This updates the EU price band for vegetable oils with Brent crude as the floor. Oils didn t follow Brent all the way down. Let s consider why. 1,600 1,400 EU prices, US$ per tonne 1,200 1,000 800 600 400 200 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Brent Crude Soy oil Rapeseed oil Palm oil LMC International, 2016 4 2
CPO-Brent spreads move in the opposite direction to MPOB stocks; but in 2015 the monthly EU CPO premium never touched zero, unlike 2012/13/14. 600 3,050 EU premium over Brent, US$ per tonne 500 400 300 200 100 0 2,800 2,550 2,300 2,050 1,800 1,550 MPOB Palm Oil Stocks, '000 tonnes -100 1,300 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 CPO Premium over Brent Average CPO Premium MPOB Stocks LMC International, 2016 5 On a daily basis the picture is different. Indonesia s CPO premium over Brent fell to zero during August, but then turned round and moved up in September. 350 Daily premium over Brent, US$ per tonne 300 250 200 150 100 50 0-50 -100-150 -200-250 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Normal behaviour Inside Indonesia LMC International, 2016 6 3
CPO was a competitive fuel in Indonesia in Sept 2012, 2013 & 2014. 2015 was different. In 2015, it looked as though Indonesian CPO was about to become cheaper than crude oil at the end of August, when suddenly the local price moved up. There were two reasons for this rapid about-turn. 1. The first solid evidence that the BPDP (CPO Fund) in Indonesia was subsidising biodiesel. At the end of August, local biodiesel producers started to buy both stearin and CPO to meet orders from Pertamina. 2. The other, which was slower to take effect, was the belief that a serious El Niño was affecting production. LMC International, 2016 7 A brief word about PKO prices LMC International, 2016 8 4
There is a strong negative correlation between the PKO premium over Brent and MPOB PKO stocks. Low palm (and PK) output will support PKO prices. 1,500 550 EU PKO premium over Brent, US $/tonne 1,200 900 600 300 0 500 450 400 350 300 PKO + oil in PK stocks, '000 tonnes -300 Jan-07 Jan-09 Jan-11 Jan-13 Jan-15 250 EU PKO premium over Brent Stocks LMC International, 2016 9 Identifying the impact of the biodiesel mandate in Indonesia LMC International, 2016 10 5
Indonesia s CPO Fund includes a feedback from CPO prices to the amount of biodiesel that can be subsidised under the Public Service Obligation. Assuming $35 Brent; $325 gasoil; and $750 million for biodiesel PSO subsidies. 3.0 2.8 Last Friday Million tonnes, PME 2.6 2.4 2.2 2.0 1.8 1.6 525 545 565 585 605 625 645 665 FOB CPO, US$ per tonne PSO Plus Non-PSO Plus Grandfathered Exports LMC International, 2016 11 Indonesia s mandate creates an interesting stabilisation mechanism for CPO prices Because the Indonesian export levy is a fixed sum per tonne and is unrelated to the CPO price, the revenues from its collection are fairly predictable. In our diagram, we have assumed annual spending of $750 million on subsidies. The subsidy/tonne paid to Indonesian biodiesel producers is linked to the local CPO price. As a result, the wider is the gap between CPO and gasoil prices (I applied January s Singapore gasoil premium over Brent in the diagram), the smaller is the amount of biodiesel that can be subsidised. Thus, Indonesian subsidised biodiesel use moves in the opposite direction to CPO s premium over gasoil, which has the effect of dampening fluctuations in the CPO price. LMC International, 2016 12 6
What can we say about the petroleum market? LMC International, 2016 13 Shale oil supply is the big new factor in the world petroleum market, and the number of US rigs drilling for shale oil follows crude prices closely. 140 1,400 WTI, $ per barrel 120 100 80 60 40 1,200 1,000 800 600 400 Number of rigs 20 200 0 - Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 WTI Rig count LMC International, 2016 14 7
However, the productivity of these shale oil rigs has increased tenfold since 2007. Therefore, total shale oil output has only recently started to fall. 6 600 Million barrels per day 5 4 3 2 500 400 300 200 Barrels/day per rig 1 100 0 0 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Total shale oil output Production per rig LMC International, 2016 15 As a result, shale oil has driven US crude output growth, and now accounts for most US supplies. US oil output, million barrels per day 10 9 8 7 6 5 4 3 2 1 0 2009 2010 2011 2012 2013 2014 2015 Other Shale oil in 7 regions LMC International, 2016 16 8
World crude oil output in 2016 will remain ahead of demand, adding to 2014 and 2015 surpluses. 97 World supply and demand, million bbl/day 96 95 94 93 92 91 90 89 88 2010 2011 2012 2013 2014 2015 2016 2017 Output Demand LMC International, 2016 17 The shale oil revolution is helping to keep world crude oil stocks at record high levels Global stocks of crude oil will rise until late 2017. The world now knows that shale oil technology has advanced rapidly and that, contrary to the expectations of OPEC producers, shale oil companies have not been forced out of the market by the sharp fall in the crude price. This means that it would be foolish to expect any sudden recovery in the Brent crude price during 2016. More important in the long run is the evidence that shale oil will be a growing influence upon the behaviour of the crude price. It will stop it from hitting the heights of $100- plus, but will also help to defend the floor to the price. LMC International, 2016 18 9
The impact of the El Niño, as measured by the Oceanic Niño Index (ONI) LMC International, 2016 19 The ONI tracks ocean warming. The 2015-16 El Niño is as strong as in 1997-98, the last major El Niño, and is much stronger than that in 2009-10. 2.5 2.0 1.5 1.0 ONI 0.5 0.0-0.5-1.0-1.5-2.0 Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov 1997-98 2009-10 2015-16 LMC International, 2016 20 10
These photos, courtesy of A.H. Ling, illustrate the impact of the drought in East and South Kalimantan. Hawaiian skirt effect in August 2015 Sarong Effect in late 2015 This shows the massive male inflorescence cycle in February in Central, East & South Kalimantan Photo: courtesy of A.H. Ling, Ganling, 2016 LMC International, 2016 22 11
This reflects the impact of regional rainfall on CPO yields. This compares S.E. Asian yields in 1996-1999 with estimates for 2014-2017. 3.9 S.E. Asian CPO yield, tonnes/hectare 3.8 3.7 3.6 3.5 3.4 3.3 3.2 3.1 3.0 1997 2015 Year before El Nino Year after Next year Prepared in conjunction with Ganling, 2016 LMC International, 2016 23 Our forecasts of year-on-year CPO output growth by quarter reveal the similarity between 2015-16 growth rates and Malaysia in 2009-10 s El Niño. 30% Year-on-year growth in CPO output, % 25% 20% 15% 10% 5% 0% -5% -10% -15% -20% Q1.09 Q1.10 Q1.11 Q1.12 Q1.13 Q1.14 Q1.15 Q1.16 Q1.17 Malaysia Indonesia LMC International, 2016 24 12
The price outlook in 2016 The El Niño will pull world 2016 CPO output down by over two million tonnes. A Q3-Q4 La Niña, with heavy rains, would reduce 2016 output by a further 0.4 million tonnes. At $35 Brent: FOB CPO will be $700 by June. For BMD, assuming the Malaysian government applies export taxes, CPO futures will stand at RM2,750 (with RM/US$ at 4.175). As output picks up, the Jul-Dec. average price will fall back to $625 FOB, and the price will fall further as 2017 unfolds. PKO will be supported by weak output of both oil palm and coconut oil to average $425-$450 above CPO over the year. At $40 Brent: June FOB CPO will be $735 & BMD RM2,900 LMC International, 2016 25 The role of the other oils in filling the shortfall in supply left by the drop in world palm oil output The reduction in total CPO output in 2016 puts a spotlight on the role of other oils in making up for the lost supplies. Consider what will happen to demand for oils as a whole. As regards biodiesel, the wide gap between its price and that of gasoil will hit its use where there is scope to do so (the EU). Regarding food demand, weak commodity prices are hitting incomes in poorer countries, reducing their import of oils. In oils supply, No. 2 is soy oil, a by-product of crushing for meal, whose sales are merely growing at a normal pace. This makes the current release of China s reserves of oils, notably rapeseed oil, badly needed to balance the market. LMC International, 2016 26 13
Thank you Oxford 4 th Floor, Clarendon House 52 Cornmarket Street Oxford OX1 3HJ UK T +44 1865 791737 F +44 1865 791739 info@lmc.co.uk New York 1841 Broadway New York, NY 10023 USA T +1 (212) 586-2427 F +1 (212) 397-4756 info@lmc-ny.com Kuala Lumpur B-03-19, Empire Soho Empire Subang Jalan SS16/1, SS16 47500 Subang Jaya Selangor Darul Ehsan Malaysia T +603 5611 9337 info@lmc-kl.com Singapore 16 Collyer Quay #21-00 Singapore 049318 Singapore Tel: +65 6818 9231 info@lmc-sg.com LMC International, 2016 All rights reserved This presentation and its contents are to be held confidential by the client, and are not to be disclosed, in whole or in part, in any manner, to a third party without the prior written consent of LMC International. While LMC has endeavoured to ensure the accuracy of the data, estimates and forecasts contained in this presentation, any decisions based on them (including those involving investment and planning) are at the client s own risk. LMC International can accept no liability regarding information analysis and forecasts contained in this presentation. LMC International, 2016 27 For more information, please visit www.lmc.co.uk 14