Living in a world with low crude oil prices,

an El Niño and biodiesel subsidies

Presentation to
The First Pakistan Edible Oil Conference 2016
by Dr James Fry, Chairman, LMC International
[Link]

08/02/2016 ©LMC International, 2015 1

The outline of my presentation today

First, I will set the scene by standing back and examining

where we are in the long term commodity price cycle.
Then I turn to a more recent phenomenon, the emergence
of the price band linking vegetable oil and petroleum.
In view of their crucial role, I will take some time to review
the outlook for crude oil prices.
I will end by discussing the impact of the weather, in the
form of droughts and El Niño, and of Indonesia’s change in
its biodiesel policy in mid-2015 on the outlook for the
prices of vegetable oils.

08/02/2016 ©LMC International, 2015 2

There is a long run price cycle, which
applies to most commodities

08/02/2016 ©LMC International, 2015 3

The long run trend in real EU CPO prices is down

2,000 The long run trend line in real prices

fell by 1.6% per annum
1,800
Real (2014) Price US$/tonne

1,600

1,400

1,200

1,000

800

600

400

200
1950 1960 1970 1980 1990 2000 2010
Palm Oil Real Price Trend

08/02/2016 ©LMC International, 2015 4

The trend in all major crop prices is also down.

Robusta Coffee
Palm Oil
Rubber
Cotton
Arabica Coffee
Soybean Oil
Maize
Coconut Oil
Wheat
Cocoa
Soybean
Soybean Meal
Sugar
Rapeseed Oil

0.0% 0.2% 0.4% 0.6% 0.8% 1.0% 1.2% 1.4% 1.6% 1.8% 2.0% 2.2%
% Rate of Long Run Real Price Decline, 1950-2015

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Today CPO prices are above their trend values.

1,400 The price was 11% above trend in February 2016

1,200

1,000
US$ per tonne

800

600

400

200

0
Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13 Jan-15
Palm Oil Trend

08/02/2016 ©LMC International, 2015 6

The same is true of all major crops, except cotton

Coconut Oil
Cocoa
Maize
Soybean Oil
Rapeseed Oil
Wheat
Sugar
Soybean
Palm Oil
Soybean Meal
Rubber
Robusta Coffee
Arabica Coffee
Cotton

-20% -10% 0% 10% 20% 30% 40% 50% 60% 70%

% Price deviation from long run trend February 2016

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Prices influence plantings. Within the Indonesian
oil palm sector there is a clear investment cycle.,

200 1,000

160 800
Millions of germinated seeds

Indonesian CPO price, US$/tonne

120 600

80 400

40 200

0 0
1988 1992 1996 2000 2004 2008 2012
Plantings in Indonesia CPO price

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Long run cycles affect all industries. High prices
cause over-supply and low prices. Low prices hit
new investment and eventually create shortages.
400
1995-2014 = 100

350

300
Real price index, average 1995

250

200

150

100

50

0
1967 1972 1977 1982 1987 1992 1997 2002 2007 2012
Metals Excl Iron ore Fertiliser Food & Feed

08/02/2016 ©LMC International, 2015 9

The commodity cycle

Before the mid-2000s, we experienced a long period of

relatively low prices for commodities across the board. The
world economy was benefiting from all the extra capacity
created by investors during the previous commodity boom.
By 2005, it was evident that new capacity was needed, in
particular to keep up with Chinese demand. So commodity
prices gave the signal for a new investment boom. The
2008 recession came before the new investments had a
big impact on supply, and so prices recovered quickly.
However, the wave of investment is now contributing to
output, and this is putting downward pressure on prices.
In the meantime, something else was changing – biofuels.
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Welcome to the price band, linking the
prices of vegetable oils to petroleum.

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EU vegetable oil and Brent North Sea crude oil
prices went their very separate ways until 2006.
900

750
EU Prices, US$ per tonne

600

450

300

150

0
Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06
Brent Crude Palm Oil Soy Oil Rapeseed Oil

08/02/2016 ©LMC International, 2015 12

Since 2007, there is no doubt that in the EU a
price band has emerged linking vegetable oils to
petroleum, whose price is the floor to the band.
1,600

1,400
EU Prices, US$ per tonne

1,200

1,000

800

600

400

200
Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16
Brent Crude Palm Oil Soy Oil Rapeseed Oil

08/02/2016 ©LMC International, 2015 13

Palm tested the floor (where its price equals
Brent crude) three times since 2012. Biofuel use
was critical in pulling its price up from the floor.
1,600

1,400
EU Prices, US$ per tonne

1,200

1,000

800

600

400

200
Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16
Brent Crude Palm Oil Soy Oil Rapeseed Oil

08/02/2016 ©LMC International, 2015 14

Indonesian palm oil is often a very
competitive fuel vs. petroleum.
Palm oil flows from the EU from South East Asia; the
difference between S.E. Asian export prices and EU
prices is the cost of freight between the two regions.

Indonesia and, to a lesser extent, Malaysia levy export

taxes on palm oil. These pull palm oil prices inside
both these countries below FOB export values.

If EU palm and crude oil prices are equal (i.e., if we

are at the floor to the price band just described), then
South East Asian palm oil is a very competitive fuel.

This is what defends the floor to the price band.

08/02/2016 ©LMC International, 2015 15

Discretionary biodiesel use emerges when it
competes as a fuel. Indonesian biodiesel exports
to price-sensitive markets, e.g., China, prove this.
160 400
Exports from Indonesia ('000 tonnes)

Indonesia CPO premium vs Brent, $/tonne

120 300

80 200

40 100

0 0

-40 -100

-80 -200
Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15
Premium Exports not to US or EU

08/02/2016 ©LMC International, 2015 16

Malaysian stocks are the key to the EU
crude palm oil (CPO)-Brent price spread

08/02/2016 ©LMC International, 2015 17

The EU CPO premium over Brent is negatively
correlated with stocks. High stocks usually imply
a low premium and low stocks a high premium.
600 3,000

500 2,700
EU premium over Brent, $/tonne

MPOB Stocks, '000 tonnes

400 2,400

300 2,100

200 1,800

100 1,500

0 1,200

-100 900
Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16
Premium Average Premium Stocks

08/02/2016 ©LMC International, 2015 18

As palm oil stocks soared, the Indonesian CPO
spread vs. Brent slumped in Q3 as happened in
2012-2014, but then it suddenly turned around.
400
350
Premium over Brent, US$ per tonne

300
250
200
150
100
50
0
-50
-100
-150
-200
-250
Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15
CIF Rotterdam Inside Indonesia

08/02/2016 ©LMC International, 2015 19

Why didn’t palm oil prices fall further?

Malaysian stocks were at an all-time high in November.

So why are EU CPO prices now over $350 above Brent?
The answer is that until 31st August the spread behaved
exactly as one would have predicted, but then it became
apparent that two things were different this time.
One is the awareness that droughts and El Niño were
going to hit palm oil output in 2016 (in fact, world CPO
output will be down in 2016).
More important was the evidence that, for the very first
time, the Indonesian government had come up with a
fully fledged scheme to guarantee that a large biodiesel
mandate will be funded properly.

08/02/2016 ©LMC International, 2015 20

Indonesia’s CPO Fund subsidising biodiesel from
levies faces a trade-off between CPO prices and
how much it can subsidise. This is at $35 Brent.
2.8
Maximum amount subsidised, mn tonnes

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

08/02/2016 ©LMC International, 2015 21

The Indonesian CPO Fund has introduced a new
factor to bear in mind in palm oil price analysis
Because the CPO Fund collects its money from a fixed
US$ per tonne levy on the export of different palm
products, the sum of money it can use for subsidised
biodiesel is determined solely by the volume of exports.
Biodiesel sellers are paid enough to cover their processing
costs, while the buyer pays only the free market price for
gasoil, with the Fund picking up the gap between them.
Right now, the quantity of palm oil that will be taken off the
market for biodiesel in Indonesia is limited both by the high
spread between CPO and gasoil and the impact of 2015
droughts on local palm oil output and hence exports which,
via the levies, generate all the income for the Fund.

08/02/2016 ©LMC International, 2015 22

The petroleum market determines the floor
and the ceiling of the vegetable oil price band

08/02/2016 ©LMC International, 2015 23

A good indication of the tightness in the petroleum
market is the US stock to use ratio. This is now at
an all-time high, and Brent prices have corrected.
140 105

US Stocks of All Products in Days of Use

120 100
Brent Crude, $ per bbl.

100 95

80 90

60 85

40 80

20 75

0 70

Brent Crude Moving average US stocks in days of demand

08/02/2016 ©LMC International, 2015 24

Looking globally, US EIA projections of crude oil
supply outstrip its forecasts of demand till 2017.

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

US Energy Information Administration

08/02/2016 ©LMC International, 2015 25

The long term direction for crude oil prices

Petroleum is much like oil palm, in that there is usually

a long time between decisions to invest, typically made
a times of high prices when finance is readily available,
and the first output from the new project.

The crude oil market is now suffering the indigestion

brought on by the wave of new capacity. This is made
worse by the urge on the part of OPEC members to
maximise their exports to generate foreign exchange.

The big new players are the shale oil producers, whose
cost competitiveness is clearly much greater than the
OPEC producers believed. This is not bullish for prices.

08/02/2016 ©LMC International, 2015 26

Shale oil, the new driver in the crude oil market
The development of shale oil, first in the US due to the
ease of acquiring drilling rights, but soon elsewhere,
will transform the behaviour of crude oil prices.

Shale oil wells can be developed much faster than

traditional oil fields, and fracking technology is still
improving rapidly. This points to the emergence of a
new flexible source of crude oil with an ability to react
quickly, on the upside and downside, to price signals.

Shale oil wells will come onstream when prices rise

sufficiently; but will drop out as prices fall. That will be
crucial in bringing the crude oil market back to balance
in 18 months and a quarterly deficit by end-2017.

08/02/2016 ©LMC International, 2015 27

The price outlook in 2016

Even without a full El Niño, Indonesian output will be static

in 2016, while Malaysian output will fall slightly in 2016, as a
result of recent droughts.
If El Niño droughts return until mid-year, production in S.E.
Asia as a whole would fall 4 million tonnes in 2016.
At Globoil I said that FOB CPO prices will be above $600 by
March. At GAPKI I said that they would be $50-$75 higher
than that by June. These forecasts still sound good.
However, a full new El Niño drought would mean that all
bets are off. CPO prices rise to a point where the world
would have to turn to soy oil to fill some of the lost supplies.
My last slide indicates the potential CPO price upside.

08/02/2016 ©LMC International, 2015 28

Other oils’ spreads vs. CPO have been rising. It is
now $170 for soy oil. That is the minimum rise in
CPO prices if soy is to fill an El Niño CPO shortfall
600
EU Premium over Palm Oil, US$ per tonne

500

400

300

200

100

-100
Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Sep-15
Soybean Oil Rapeseed Oil Sunflower Oil

08/02/2016 ©LMC International, 2015 29

Thank you
Oxford New York Kuala Lumpur Singapore
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© 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.

08/02/2016 ©LMC International, 2015 30

Monthly price developments and forecasts from LMC

Oils Price View – a monthly report in PowerPoint

LMC’s monthly price forecasting service presents:
Price forecasts six months ahead for each of the major vegetable oils,
including the lauric oils, as well as refined palm products and also tallow.
Supporting analysis that includes:
• Key price developments that month
• Insights from key global markets and sectors
What you get:
• The LMC report – this is supplied as a PowerPoint presentation.
• Excel price model –allows you to make your own price forecasts for each of
the next six months as a function of Brent crude prices and other variables.

Please contact Lan Chen at Lchen@[Link] or +44 1865 791737 for more details.

08/02/2016 ©LMC International, 2015 31

LMC International is the leading independent economic and business consultancy for
the agribusiness sector around the world.

From crops and agricultural commodities to oleochemicals, chemicals, fuels and their
downstream end-use markets, we provide global business intelligence and market
analysis on a wide range of issues, including production, demand, prices (including
forecasts), strategy, trade, end-use markets and policy.

Founded in 1980, the company has offices in:

• Oxford • New York • Singapore • Kuala Lumpur • São Paolo (partner)

We are entirely independent: we do not trade, broker, offer finance or produce any
commodity, meaning our analysis and advice is entirely objective.

08/02/2016 ©LMC International, 2015 32