You can contact the author (Teguh Hidayat) by email, The author live in Jakarta, Indonesia.

See my activities in Instagram, @teguhidx.

Outlook of Palm Oil: Between the Price of CPO and Biodiesel Project

After slightly dropped in May - June, in the last two months the Jakarta Composite Index (JCI) continue to rise until closed at 5,199. If the uptrend continues, it is only a matter of time before the JCI would break a new high (the highest position of JCI is 5,251, which was reached in May 2013). In a bullish period like today, almost all of the stocks gained significantly. However, shares in the oil palm plantation sector declined about 10% (in average) in the last two months, while their financial performance in the second quarter of 2014 was fairly good with growing net income. What's wrong?

If you are already familiar with commodity stocks, then you will easily find out that the cause of the decline in stocks of oil palm plantations is due to a decrease in the price of crude palm oil, or CPO. Based on data from Bursa Malaysia (Malaysian Exchange), the latest price of CPO is RM1,987 per ton, and interestingly, this is the lowest price since 2009. In mid-July 2014, the price was still at RM2,400 per ton, before then suddenly dropped all the way to its current position, or fell more than 15% in just a month. If drawn from its peak position during the year 2014, namely RM2,910 per ton (recorded in March), the CPO price has dropped more than 30%, and continues.

So what caused the decline? Some analysts and the media mention the increase in CPO production volume, which might caused oversupply, while on the other hand, the CPO sales volume, in this case the volume of exports of CPO from Indonesia and Malaysia (as the world's major palm oil producers) to the rest of the world, went down, which probably was due to declining demand. And indeed if we use the data from PT Astra Agro Lestari (AALI), one of the largest palm oil companies in Indonesia, they produced 973 thousand tons of CPO during January to July 2014, an increase of 16.6% compared to the same period in 2013. While based on data from the Association of Indonesian Palm Oil Entrepreneurs (Gabungan Pengusaha Kelapa Sawit Indonesia/GAPKI), the total volume of Indonesian CPO exports during January to June 2014 was 9.8 million tons, down 7.7% compared to the same period in 2013.

However, because the increase in CPO production was actually not too significant (less than 20%), while the decrease in the volume of exports was also not significant, then it cannot justify the ‘crash’ in CPO price which reached more than 15% in the last month. And in fact, if we look at the pattern of CPO price movements in the long run, the price of CPO (and maybe other commodities too) tends to move wildly without a definite pattern, and with extreme fluctuations. The following picture will shows you the movements of CPO price in the last ten years (July 2004 - July 2014), taken from Click on the image to enlarge:

Okay, take a look. During the two-year period between July 2004 - July 2006, CPO prices are likely to move sideways in the range RM1,300 - 1,500 per tonne. Entering the second half of 2006, the prices started to rise.. and continue to rise until it reaches RM3,700 as its peak in February 2008, or jumped about 150% within a year and a half, whereas in two years earlier it was almost stagnant at all. Then, in June 2008, CPO prices suddenly plummeted to return to RM1,500 per tonne in November, still in the same year!

So if there is someone who analyzes the CPO price movements for four and a half years between July 2004 until early 2009, he would find the fact that the price of CPO, throughout the long period of time, in the end did not change at RM1,500’s per ton. But he had to notice that the price was once rose to RM3,700 per tonne, before then turning back to RM1,500’s per ton. Does it make you remembering the movement of penny stocks, does not it?

Entering the year 2009, CPO prices once again rallied until reach RM3,800 in early 2011, and I can see for myself that in the two-year period (coz I have entered the stock market in 2009), many of oil palm plantation companies in the country reap tremendous profits. But entering the year 2011, CPO prices fell back to as low as RM2,200 per ton at the beginning of 2013, before then rise until RM2,900 in March 2014, and again fell to its present price, that is already below RM2,000 per ton.

Looking at the above facts, it is difficult to say that the price of CPO can be simply influenced by the increase in production volume, or a decrease in the volume of exports. Because of course, over the last 10 years, the volume of production and exports of CPO could go up and down all the time, but how could it cause the CPO price to skyrocketted of more than 150% from 2009 to 2011? Or conversely, caused the price to slashed almost 50% from 2011 until today? In the end, there are lots of factors that cause an increase/decrease in CPO prices beyond a matter of supply and demand, like the news about El Nino, the development of biodiesel projects, rise and fall of the price of substitute commodities (soybean oil, sunflower oil, etc.), the policy of import duties by the Government of India and China as the main destination of Indonesian CPO exports, tax developments in the country, the length of wet and dry seasons, and so on.

Because of sooo many factors that influence the price, you will eventually come to the conclusion that the movement of CPO price can not be predicted, because it has no pattern, so it can not be analyzed using technical analysis (by looking at the charts) moreover the fundamentals (supply and demand factors). In the above I mentioned that CPO prices may still be down, but who knows that at the end of 2014, the price may return to RM3,000 per ton instead?

That's why, as you already know, Warren Buffett does not like commodity stocks, because the price may easily ups and downs depending on the price of the commodity itself, while the price of these commodities can go up and down at any time, often with extreme fluctuations. But the question, if I had already buy some oil palm plantation stocks, then what should I do? Well, in this case there are a few things you should consider.

The Industry of Palm Oil in Indonesia, at This Moment

First, I’m not so sure with the other palm oil companies, but the three palm oil companies with the best fundamentals in the Indonesia Stock Exchange (IDX), ie Astra Agro Lestari (AALI), PP London Sumatra (LSIP), and Sampoerna Agro (SGRO), they, in this year, obtained all of their income from domestic market, ie did not export at all. So the prices of CPO produced by these companies are no longer influenced by the international price of CPO in Malaysia. Take a look: The average price of CPO of AALI in January - June 2014 was Rp8,700 per kg, up 31.5% compared to the same period in 2013, and still higher than the average CPO price throughout the year 2013, ie Rp7,322 per kg. And currently, based on data from the Office for Joint Marketing of PT Perkebunan Nusantara (KPBPTPN), the price of CPO for auction on August 22, 2014, was settled at Rp7,940 per kg, or once again, still higher than the average price in 2013.

While in fact, as already mentioned above, the current CPO price on Bursa Malaysia is already lower than in 2009. In 2009, precisely in March when the price of CPO on the Bursa Malaysia was around RM2,000 per ton, the price of CPO of AALI is Rp7,000 per kg (based on the auction data at the time). But today, when the price of CPO on the Bursa Malaysia back to RM2,000 per ton, the price of CPO in Indonesia is still in the range of Rp8,000 per kg.

So, if you notice, on the First Half of 2014, the CPO sales volume of AALI was actually dropped 10.3% compared to the same period in 2013, because they eliminate the export, but the company's revenue still rose significantly due to the increase in CPO selling price which reached more than 30%, and because of the additional revenue from the sale of olein. AALI dared to stop exports because they have started to process the CPO into value-added/downstream products, in this case olein and stearin. While another palm oil company, LSIP, also did not need to export its CPO because they can sell it to its parent, Salim Ivomas Pratama (SIMP), to be processed into downstream products, in this case margarine. Then, SGRO, in 2013 the company had to sell some of its CPO to Cargill in Singapore (aka export). But this year, SGRO could sell its entire production of CPO to local customers, which may also processed into downstream products. This condition had not occurred in 3 – 5 years ago, where almost the entire Indonesian oil palm plantation companies sell their CPO directly without any processing, because they did not yet have the ability to process CPO into olein or margarine.

In conclusion, I believe that the decline in CPO prices on Bursa Malaysia will not significantly affect the financial performance of the palm oil companies in Indonesia, especially the ones that mentioned above, because the current condition is different from the condition in the last few years, where the palm oil industry in the country is now more independent.

CPO prices on Bursa Malaysia could Rebound at Anytime

It was the first. Secondly, although the price of CPO on the Bursa Malaysia (or at Rotterdam Port) may not have too much influence on the financial performance of oil palm plantation companies in the country, but it must be admitted that the influence is still there, because the palm oil companies keep looking at the CPO price in Malaysia in determining the selling price of their own CPO. You can see that the CPO price in the local auction market is down when the price of CPO in Malaysia fell (though not as significant as in Malaysia). So if the price of CPO in Malaysia continues to decline, then the revenue of AALI et al would inevitably be affected as well. In addition, for foreign investors/traders who hold the shares of oil palm plantation companies on the Stock Exchange, they only see the international price of CPO in Malaysia in determining their positions, because they do not know about KPBPTPN (or maybe you did not know too?).

Therefore, the decline of shares of palm oil companies that occurred in the past month may continue if the price of CPO on Bursa Malaysia continues to down. But on the other hand, what if the price later rebound? Well, of course the stocks will rise back. If we look again at the chart above, each time the price went down, then the decline is usually extreme, like 30% from its peak position (just like today). However, about when the decline will stop and then rebound, it is no one knows.

And interestingly, once again if we look at the chart above, when CPO price is dropped, the decline will occur continuously without any pause (the CPO price continues to fall every day in the last month, without ever stop even for one day). Conversely, when the price was rising, the increase will also continuously without pause! Hence, I said that who knows, if at the end of 2014 the CPO price can rise back to RM3,000 per ton? CPO is a commodity that, no matter what, is still needed by the entire population of the world, including Indonesia (can you live without cooking oil that made from CPO? I don’t think so). So no matter how deep the decline, but in the end the price will rebound and rise.

In conclusion, taking into account that the palm oil industry in the country is no longer too dependent on CPO price in the international market, and that the price of CPO (in Bursa Malaysia) could go up at any time, then the decision to sell your palm oil shares may be a wrong decision (I received a lot of emails asking about this). In the end, in this year of 2014, oil palm plantation companies recorded good performance. If their financial performance in the upcoming third quarter is slightly depressed due to the drop in CPO prices, but the net income of AALI et al should be still higher than the year of 2013.

New Project: Biodiesel!

But indeed, because on the other hand we also do not know when the decline of CPO price will stop, then you might sell a part of your holdings, but do not forget to keep looking for opportunities to buy it back. I still think that the palm oil sector is very interesting because, in addition to the fact that the performance of the palm oil companies began to improve in 2014, the election of Jokowi - Jusuf Kalla as President and Vice President of Republic of Indonesia for the next five years gave positive sentiment that the project of CPO conversion into biodiesel to substitute the fuel, which have been proposed by the government since long ago but its realization was too slow (which may because Sir SBY has been too busy working on many other projects, while Mr. Boediono and the ministers, with all due respect, can not do anything), will be accelerated. As we all know, Mr. Jusuf Kalla has a convincing track record when he was able to quickly execute the grand-project of conversion from kerosene to gas for household needs. So with his return to his position as the Vice President, there is a great expectation that this biodiesel project can also be done quickly (still remember the motto 'the faster, the better'?).

Because on the other side, the project has been very urgent to make the Government have an alternative source to fulfil the needs of fuel for population, rather than continuous importing the fuel, which in turn can reduce the burden of the state budget because of the fuel subsidy. Mr. Jokowi himself, in one of the presidential debate some time ago, had stated that one of his focus (if elected as President) is to develop renewable energy sources, in this case ordered the Pertamina (state oil company) to open the market for biofuels/biodiesel, and give incentives to companies that have the willing to develop the biodiesel industry. If you look at the fact that AALI et al were already able to develop olein and margarine, then the palm oil industry in the country only requires a little more support from the Government, whether in the form of tax incentives or the like, to then begin developing biodiesel projects.

And if this biodiesel project can be fully realized (there are already several biodiesel producer companies in Indonesia, but the number was small), then the price of fuel does not need to be raised, the state budget was saved, while the oil companies in the country can continue to boost the production volume without worrying that the price of CPO in the international market will go down due to oversupply, because the whole CPO production will be absorbed to the needs of domestic biodiesel production. And last: Indonesian economic growth can rising significantly. Everybody’s happy, everbody’s win! Then when all of this will be realized? Well, hopefully, as soon as possible.

No comments: