Oils and fats market

Overview

A brief analysis of the palm oil market within the context of the world oils and fats market is provided as follows:

• Palm Oil Production
• Uses of Palm Oil
• The World Market for Palm Oil
• World Consumption of Oils and Fats
• World Production of Oils and Fats
• World Palm Oil Prices
• Future Prospects for Palm Oil

Palm Oil Production

The production characteristics of the oil palm have been significantly improved over the years through the introduction of improved cultivars, resulting in greater yields in maturity and higher production earlier in the oil palm's life cycle. Modern plantings can, with the benefit of the best agricultural practices, demonstrate annual yields at maturity in the range of 20 to 30 tonnes of fresh fruit bunches per hectare, compared with 2.5 to 5 tonnes for semi-wild croppings. Seed hybridisation programmes have also increased the oil and kernel content of the fresh fruit bunch from 20% to 24% and from 4.0% to 5.0%, respectively.

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Uses of Palm Oil

In the food industry, palm oil is used as a cooking oil and shortening and in the manufacture of margarine, non-dairy creamers and ice cream. It is also used in products where animal fats are unacceptable on religious grounds.

Palm oil has a high resistance to oxidation and therefore a long shelf life. These properties make it particularly suitable for use in hot climates and as a frying fat in the snack and fast food industry.

Traditionally, the main non-food uses for palm oil have been in the manufacture of soaps and detergents and in the production of greases, lubricants and candles. More recently, the biofuels market has provided a significant new non-food use for palm oil where it is used as the feedstock for the production of biodiesel and as an alternative to mineral oils for use in power stations. The fatty acid derivatives of palm oil are used in the production of bactericides, cosmetics, pharmaceuticals and water-treatment products.

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The World Market for Palm Oil

Palm oil competes directly with other oils and fats in most of its applications and demand is therefore determined by its competitive position within the overall world market for these products. There are three main categories of oils and fats: vegetable oils, marine oils and animal fats.

Although, technically, most oils and fats are interchangeable, processing costs and specific end-use requirements limit the range within which oils and fats are actually substituted. This leads to price premiums and discounts within the market. In general, oils derived from coconut, palm kernel, groundnut and cottonseed tend to be the most highly priced.

Palm oil, together with soybean, rape and sunflower oils, falls into the medium-priced category, and sells at a premium over marine oils, generally the cheapest of the oils. Palm oil, soybean oil, rapeseed oil and sunflower oil together form the most important constituents by volume within the overall market with palm oil normally being priced at a discount to the other three oils.

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World Consumption of Oils and Fats

World consumption of oils and fats has grown steadily during the last twenty five years. 'Oil World' statistics indicate that consumption in the last five years has increased from a level of some 121 million tonnes in calendar 2002 to 153 million tonnes in calendar 2007. The average growth rate over this five-year period to 2007 has been 5.8% per annum. This annual growth rate exceeds that of the previous 10 year period, some 3.7%, due to the additional consumption that has resulted from new demand from the biofuels market. In the period from 1998 to 2005, annual increases in consumption were typically in the range of 4 to 5 million tonnes and arose from the growth in demand for oils and fats as a food. Annual increases in consumption during the three yeari period thereafter were markedly higher and reflected the additional use of oils and fats as biofuel feedstock.

Consumption in each country tends to favour locally produced oils and fats. In North America, Europe and the Soviet Union, annual seed crops are the main sources of oil; in tropical countries, coconut oil and palm oil, together with groundnut oil, are the main types produced and consumed.

World average per capita consumption of all oils and fats has also grown progressively each year during the last decade from a level of 17.5 kg in 1998 to 23.2 kg in 2007. Consumption per capita is closely related to income. In 2007, per capita consumption was some 54 kg and 57 kg in the US and the EU respectively, compared to levels of 12 kg and 22kg for India and China respectively. At low income levels, elasticity of demand is high, whereas at high income levels, elasticity is reduced to values close to zero. It may be expected, therefore, that the highest increases in consumption will be exhibited in those low to middle income countries, where increasing per capita income can combine with relatively high rates of population growth. These high growth countries will tend to be in the developing world where palm oil has traditionally been strong.

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World Production of Oils and Fats

Over the last decade total production of oils and fats has grown by 57%. Production of the major oils, derived from palm, soybean, rapeseed and sunflowerseed, grew by 76% and accounted for 90% of the increase in world output of all oils and fats. Over this period, the production growth rates for the 17 major oils and fats varied considerably. Within the major vegetable oils, palm oil and palm kernel oil expanded by 113% and 100%, respectively, soybean oil by 75%, rapeseed by 61% and sunflower by 23%. Production of animal fats showed significantly lower growth at 21%, primarily due to their being by-products from processes serving other, slower-growing markets and marine oil production contracted by 17%. The combined share of world production held by palm oil and palm kernel oil increased from 19.1% in 1998 to 27.5% in 2007.

Production of oils and fats totalled 154.0 million tonnes in calendar 2007 of which palm oil and soybean production were respectively 38.3 million tonnes and 37.5 tonnes, thus accounting for almost 50% of the total. Production of palm oil has grown faster than that of any other oil or fat and overtook soybean as the most produced oil in 2005.

Oil palm, oilseed rape and sunflower are the vegetable oil crops grown for their oil content and production of these has responded more directly to the changes in world demand for oils and fats. For the other major vegetable oil crop, soybean, the oil is produced as a by-product to soybean meal, a product that is directed at the world protein market.

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World Palm Oil Prices

In calendar 2007, a total of some 57 million tonnes of oils and fats was exported worldwide. Within this total, palm oil and palm kernel oil accounted for the largest individual export total at 32.4 million tonnes, significantly ahead of soybean oil, the second largest at 10.8 million tonnes. Palm and palm kernel oil also had the highest ratio of export to production at 78%, again materially higher than for any of the other oils or fats.

There have been significant price movements during the past decade for the leading oils and fats traded on world markets. As can be seen from the graph below, monthly average palm oil prices reached a high of $705 per tonne in 1998, then falling to a low of $234 per tonne in 2001 before recovering to trade at more normal levels until starting a steep rise in the second half of 2006 to levels of US$1,200 and above in the early start of 2008. The average CPO price for the ten year period from 1998 to 2007 was $469 per tonne.

The 1997/98 El Niño drought had a detrimental effect on the 1998 FFB crop and thus CPO output; this, coupled with the reduction in export supplies from Indonesia, following the imposition by the Indonesian Government of an export ban that was subsequently replaced by an export tax on CPO, lead to a marked decrease in world supply and resulted in downward pressure on worldwide palm oil stocks. As a result, international export prices for palm oil were at historically high levels during 1998.

Starting in 1999, however, prices fell significantly, reflecting a surge in the production of CPO in both Malaysia and Indonesia as post El Niño production recovered to more normal levels. The market also reflected the increasing prospect of Indonesian producers returning to the export markets as the Indonesian government progressively reduced export tax.

Following El Niño, the world stocks of oils and fats fell to a low of 12.0 million tonnes in September 1998 (1.40 months consumption). Stock levels then increased through the three year period to September 2001, reaching 14.8 million tonnes (1.53 months consumption) at that date before falling to 12.7 million tonnes (1.22 months consumption) at September 2003. Stock levels then rose again to levels of 17.1 million tonnes at September 2006 (1.40 months consumption) and 16.2 million tonnes at September 2007 (1.26 months consumption).

Prices for the oils and fats complex have tracked closely the movements in world stocks during this 10 year period. It is notable that although stock levels have been at historically high levels in absolute terms during the three years to September 2007, the levels relative to consumption have been low, reflecting the significant additional demand from the biofuels industry.

Palm oil has followed the general trend of prices within the oils and fats complex as a consequence of its interchangeablility with other members of the complex.

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Future Prospects for Palm Oil

Consumption of oils and fats has grown each year for the last ten years. For the first six years of this period, the annual increase in consumption ranged from 4.1 million tonnes to 5.2 million tonnes, reflecting the steady growth in demand for oils and fats for food. For the final three years of the decade, the year on year growth increased dramatically recording increases of between 6.9 million tonnes and 8.7 million tonnes, reflecting the new demand from the biofuels market.

The main drivers for the remarkably steady growth over the years in demand for oils and fats for food use has been the increase in world population and the increase in per capita incomes, particularly in developing countries. Prior to the new demand for biofuels, consumption grew steadily at some 3.8% per annum and there is little to suggest that this growth rate for food use should change materially in the immediate future.

Less predictable is the volume of demand for oils and fats as a feedstock for biofuels and, in particular, for biodiesel. The commercial viability of biodiesel depends critically on the cost of the vegetable oil used as a feedstock relative to the price of fossil diesel. The recent spike in the price of vegetable oils has rendered biodiesel production uneconomic for most markets and government intervention, in the form either of a preferential fuel tax treatment for biodiesel or of mandatory blending of biodiesel with fossil diesel, has been a necessary condition for biodiesel to be produced and sold. It remains to be seen to what extent governments around the world will be prepared to subsidise the production of biodiesel and, absent such subsidies, vegetable oil feedstocks will need to be price competitive with fossil oil for biodiesel plants to be operated profitably.

The potential for the biodiesel industry to become a very significant source of demand that is separate from and incremental to the more predictable levels of consumption of oils and fats as a food is expected to change fundamentally the future characteristics of the oils and fats market. As with any commodity, prices are likely to remain cyclical as they continue to reflect the surpluses and shortfalls in supply that will inevitably occur over time. In the past, there was little or no opportunity in times of surplus supply to find alternative demand for oils and fats outside its traditional use as a food and the resultant distressed selling lead to a severe fall in prices. In future, it is expected that the biodiesel industry will be able comfortably to absorb any surpluses in supply provided that the pricing of vegetable oils viz a viz fossil oil supports the economics of production. This will effectively place a floor under prices in the oils and fats market that has not heretofore existed and, accordingly, the future average of prices over a cycle is expected to be materially higher than in the past.

In considering the position of palm oil within the oils and fats complex, it is clear that the principal competitors of palm oil are the vegetable oils from the annual oilseed crops, of which the most significant are soybean, oil seed rape and sunflower. As these are annually planted crops, oil from these sources generally has a higher cost of production than that of palm oil and the production of these three annual crops can be adjusted much more rapidly to movements in prevailing market prices than the production of palm oil. Although the economics of growing oil seeds can be distorted by agricultural and other subsidies in some parts of the world, fundamental market factors still drive the overall levels of annual oil seed production. The ability to reduce such production in response to market surpluses and low prices has consistently served to correct surpluses within a relatively short time frame and this is expected to continue in the future.

The high degree of interchangeability within the oils and fats complex gives palm oil a strong position, given that it has typically been the lowest priced vegetable oil and has the lowest cost of production. In more recent times, palm oil has also benefitted from health concerns in relation to trans fatty acids. Such acids are formed when vegetable oils are artificially hardened by hydrogenation. Poly-unsaturated oils, such as soybean oil rape oil, and sunflower oil, require hydrogenation before they can be used for shortening or other solid fat applications but palm oil does not.

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