Monday, September 24, 2012
CPO prices may remain depresssed for a long while
One of the basic principles of economic model is that the market functions well in determining price by matching supply and demand for any good or service so that the supply of and the demand for the good or service will be in equilibrium. This is illustrated by a simple chart (Chart 1), where the demand curve is red while the supply curve is green. The logic behind the demand curve is simply this: as the price increases, the demand drops. At the same time that the price increases, the supply increases. However, there is a limit to the increase or decline in demand or supply. No matter how high is the price of rice, we still need to consume rice as it is a staple diet. No matter how high is the shipping rate, we still have to charter a ship to transport our export. Conversely, no matter how high is the price of rice, the farmer cannot increase that supply significantly until next year when he would plant more paddy. The same goes for the shipping companies as the number of ships available is limited at that moment in time. They could order more ships to fill the demand but there will be a time lag.
Chart 1: Supply & demand curve in equilibrium
In 2007, the demand curve for CPO shifted to the right [see Chart 2] due to increased demand for CPO for use in biodiesel fuel and also from increased demand by consumers in China & India (a result of improved living standard). As supply curve remained stationary, CPO prices shot up and broke above the USD600 (or equivalent to RM2000) per tonne [see Chart 3].
Chart 2: Demand curve shifted to the right
Chart 3: CPO Prices, in USD per tonne (Source: Mongabay)
The period of super-normal profit induced many plantation companies to open up new land for cultivation of palm oil. Due to time lag, where oil palm trees can only start to produce FFB after 3-4 years (while the more productive age is above 7 years old), the increase in oil palm estate land did not make a dent in the price of CPO for the past few years.
However, as the tree begins to reach the age of 7th year, the FFB output should increase significantly in the next few years. This increase will result in the supply curve shifting to the right. This shifting of the supply curve will result in a new price equilibrium with prices dropping back.
Chart 3: Supply curve shifted to the right
Some may argue that the demand by consumers in China & India are still strong. And, so is the demand for use in biodiesel. However, this additional demand has been factored into the demand curve and the increase (if any) will be marginal and this would not represent a shift in the demand curve. As such, I do not foresee CPO going back to the heyday of RM4000 per tonne. In fact, I believe there is greater likelihood of CPO dropping further to possibly RM2000 per tonne.
In fact, if you read analysts' reports, one of the argument made to buy a plantation stock is that more oil palm estate will be reaching maturity or reaching the more productive phase over the next few years. When this event happens- and there are many companies that are poised to enjoy increased output- wouldn't the increased supply of CPO result in lower prices. My experience in rubber glove sector in late 2010 (here) and the shipping sector in late 2007 (here) taught me something- when everybody increased their capacity to benefit from super-normal profit, that sector will eventually suffer a sharp drop in prices and abysmal profit. I believe that we will see this in plantation sector. The best way to profit from this peak price scenario is to sell off the productive assets. Maybulk sold off most its ship in 2007-2008. CBIP sold off its plantation assets or investment in early part of the year.