Why is Palm running ahead an analysis

Paper by Dorab E Mistry Director, GODREJ International Limited At Palm Oil Trade Seminar MPOC On 18 May 2009 The New Otani Hotel, Tokyo Ladies and Gentlemen I am delighted to be speaking once again in Tokyo, this time under the auspices of my friends at the Malaysian Palm Oil Council. Last year I spoke at the Annual Forum of the Japan Oilseed Processors Association and it was a most pleasant experience for me. It is a privilege to address you as processors and consumers of palm oil for the sophisticated and quality conscious Japanese market. It has also been a privilege to meet His Excellency Tan Sri Bernard Dompok, the new Minister for Plantation Industries & Commodities of Malaysia. In my paper today, I shall use the Price Outlook Conference of 10 March 2009 as a starting point and discuss the development of fundamentals and market performance from that date. As you all know, most of the papers on Price Outlook this year in March will today appear to be out-dated and misguided. Some of us were too bearish and even the bullish paper did not foresee or predict such a dramatic change in price behaviour in such a short span of time. My duty today is to firstly accept that my prognosis was wrong and discuss how and why that happened. I believe there are 3 major reasons why prices have risen dramatically in the 2 months since the POC conference. First: The soya crop in Argentina has turned out to be much smaller than expected. In early March most estimates were at 43 million tonnes whereas today the best estimates are almost 10 million tonnes lower. Argentina does not have a sophisticated system of crop estimation like the USDA. Farmers only realised how bad things were when they actually began to harvest. The various actions of the Argentine government have also not helped or encouraged farmers to sell. The result has been much greater export of beans from USA. Even export of bean oil and meal from USA has been much stronger than earlier expected. Second: The USDA report of 31st March 2009 on Planting Intentions for the new crop in 2009 was a watershed. The USDA estimate of soybean plantings at just 76 million acres put an end to ideas of a massive carryover into the next year. Just a few days earlier trade estimates for soya acreage had been as high as 80 to 81 million acres with the possibility of an embarrassingly large carryover. We now know that even if the final planted acreage is higher than the USDA estimate, the carryover could be just about adequate or in the event of a uneven weather, absolutely Tight. We also learnt that US plantings of other oilseeds would be lower. Soon after that USDA Report, we also learnt that Canola acreage in Canada would be reduced. By way of example, it can be seen that CPO BMD futures on 31st March were at exactly 2000 Ringgits. They are now almost 50 percent higher. CBOT Bean oil futures were at 32.34 cents on 30th March. They are now flirting with 40 cents. July cash bean oil on 30th March was US$ 665 FOB, today we are flirting with US$ 900 FOB Argentina. Third: Indian imports and consumption of vegetable oil have witnessed a dramatic Upward Adjustment as a result of low prices. During the first 6 months of the Oil Year, from November 2008 to April 2009, India has already imported 1.7 million tonnes MORE vegetable oil than the previous year. At first many of us thought these massive imports were going into storage and hoarding due to the removal of import duty. The Indian trade may have expected import duty to be re-imposed and could be building up stocks with a view to making a quick profit. We were wrong. Low prices had spurred per capita consumption in this quintessentially Price Elastic market. It is now acknowledged that Indian per capita consumption has undergone a once-in-a lifetime upward adjustment of almost 1.4 kilos per head, as a result of the removal of import duty. It can be said that the Indian vegetable oil market has finally integrated with the world market. Indias low per capita consumption was artificially suppressed by high

import duties and now that the heavy burden had been lifted, it had come into its own. This strong Indian demand came as a God Send to the producers of Sunflower oil, mainly in the Ukraine and also to Palm producers in Malaysia and Indonesia. There were other reasons too for the price action that we witnessed. The stalemate in Argentina has continued and parliamentary elections are due on 28 June. It makes sense for farmers to sell as little as possible prior to the elections so that the unpopular government which they detest is denied export tax revenue. Besides, it is a moot point as to how much tonnage of beans will actually be available for export from Argentina this year and whether the government will try and put disincentives in the path of bean export. In recent weeks we have also learnt that the Ukrainian rapeseed plantings have run into difficulty and that the projection for the 2009 Rapeseed crop in Ukraine has been drastically reduced to just 1.4 million tonnes against last years 2.8 million tonnes. Finally, we have not seen any significant demand destruction except perhaps to some extent in Mexico and in parts of Eastern Europe. It was expected that demand for bio diesel would collapse. That has not happened. As a result of mandates, both existing and new ones, bio diesel production in 2009 will be somewhat higher than in the previous year. Also, despite the abolition of Splash & Dash, Palm Methyl Ester production and exports have held up better than expected. As I mentioned earlier, food demand has actually been energised due to lower prices in the first 6 months of the year. PALM: Slow Production - Specifically in the case of Palm, the recovery in production has taken longer than anticipated. We started a Low Cycle in production around the November 2008 and this Low Cycle is likely to continue atleast until August 2009. There is one other reason why the recovery in palm oil production will take longer than expected. When prices collapsed in August / September 2008, the price of fertiliser did not decline correspondingly. Plantations in many cases cut back on fertiliser application and only restored it around March 2009 when palm oil prices recovered and rose above 2000 Ringgits. Therefore this 6 month gap in normal fertiliser application is making its effect felt in slower production. At the same time, strong exports stimulated by lower prices have led to big drawdown in stocks in the last 3 months in Malaysia. Low Stocks - It is my view that based on annual usage in terms of domestic consumption and exports of almost 19 million tonnes, a stock level of 1.4 million tonnes is a must for the palm oil industry to operate normally. We must remember that for the palm oil processing industry, this stock level of 1.4 million tonnes represents 25 days consumption and includes Raw Material and Finished Goods combined. It is very tight. For 2 consecutive months, Malaysian stocks have been below this threshold and I expect them to remain below this threshold of 1.4 million tonnes until mid August. Replenishment of stocks will be very gradual and will commence only in mid July. Based on information available at present and the outlook for exports, I expect Malaysian palm oil stocks to peak in November at 1.7 to 1.8 million tonnes at best. Having explained the reasons why most analysts were proved wrong in the last 3 months, I shall now proceed to make a prognosis of price behaviour for the next 6 months. Let us first look at the prospects for Supply. In the case of PALM, production of CPO should begin to recover in Malaysia and Indonesia from August onwards. At present, the best estimate of 2009 Malaysian CPO production must be around 17.5 million tonnes, about 250,000 tonnes lower than the previous year. In the case of Indonesia also, I have reduced my estimate of 2009 CPO production from 22 million tonnes to 21.5 million tonnes. Given the fact that production will begin a recovery from August onwards, we must conclude that in the second half of 2009, Palm will be part of the solution and not part of the Supply problem.

The real problem of Supply will be felt in the three soft oils Sun, Rape and Soya. The pressure from Sunflower oil has already begun to abate and as we go into the second half of 2009, sunflower oil will attain a premium over Soya oil and its availability will be curtailed. Rapeseed oil will also remain at a premium for use in its specific markets. The lower overall Rapeseed crop in Ukraine and the expectation of smaller Canadian crop will keep seed prices high and ensure the premium pricing of this oil. The major problem will be the availability of Soya oil. Brazil has announced the enhancement of its bio diesel mandate from 3 percent to 4 percent from July 2009. If this mandate is confirmed and implemented, it will rule out any further exports of soya oil from Brazil in the second half of 2009. Already Brazil has exported beans and products very aggressively in order to make up for the slow pace of disposals in Argentina. There may or may not be a pick-up in exports from Argentina. Many observers of the soya complex believe that exports from Argentina post October will be dramatically reduced. Firstly the crop is small and that will preclude bean exports beyond August. Then between June and August there are likely to be electricity cuts due to the shallow water levels as a result of the drought. That factor will affect export of meal and oil. We are approaching a very tight S&D situation in the soya complex. Soybean oil exports are only a third of the volume of palm exports. However, in winter, certain markets simply will not and cannot switch to palm. Hence soya oil is likely to assume price leadership from September onwards. Let us now look at DEMAND On the DEMAND side, we must expect the phenomenal growth in Indian consumption to mellow a bit. However, Indias imports of vegetable oil will continue to exceed the previous year. At this stage, my prognosis is for vegetable oil imports to continue in the remaining months up to October at a pace of 650,000 to 700,000 tonnes per month, with higher tonnages in the festival months. That would give us a total for imports for the oil year November 2008 to October 2009 of a staggering 8.2 to 8.5 million tonnes. I must caution you that if the newly elected government in India imposes an import duty of 10 to 20 percent on crude oils like CPO and soya oil, it will push up domestic prices and thereby reduce consumption to some extent. As I have said before, India is very much a Price Elastic market. In such an event, imports may reach only 8 million tonnes. My own view is that it is extremely unlikely that a new government, which will be cobbled together under a coalition, will impose or raise import duties. Oilseed farmers have been getting good prices this year as a result of the recovery in world prices. What does this mean in terms of Indian S&Ds? At this stage, I believe vegetable oil production in 2008-09 has been slightly lower than my earlier estimates at POC. My revised S&Ds for India are as follows: Indian Supply &Demand figures ( metric tonnes ) 2007-08 Opening Stock Production Imports Consumption Exports Closing Stocks Per capita consumption 750,000 7145,000 6300,000 12995,000 175,000 1025,000 11.40 kg 2008-09 1025,000 6600,000 8500,000 14825,000 100,000 1200,000 12.78 kg

The break-up of imported oils that will add up to this staggering figure of 8.5 million tonnes is likely to be as follows

000 tonnes Soya oil Palm Sun oil Lauric oils Vanaspati Total

2008-09 1000,000 6750,000 500,000 200,000 50,000 8500,000

2007-08 750,000 5270,000 30,000 200,000 50,000 6300,000

2006-07 1335,000 3665,000 200,000 200,000 215,000 5615,000

INDIA has been the biggest driver of consumption growth in this year. As I said earlier, this is a one off adjustment and growth in future years will never again match this level. It is significant that last year, in 2008 India signed a Free Trade Agreement with ASEAN. I do not think that the ministers of Malaysia and Indonesia ever imagined in their wildest dreams how much they would benefit from their close cooperation with India. CHINA: No discussion on Demand can be complete without a mention of China. I expect consumption in China to expand as normal. Vegetable oil imports into China are running almost 24 percent behind last year. This is to some extent due to import of Rapeseed. To you in Japan, you must have noticed that China is now a strong competitor to you for the purchase of Canadian rapeseed. In the second half of 2009, we must expect Chinese import demand for vegetable oil to grow faster than in the first half of the year. Chinese import demand for oilseeds is running far ahead of last year and is responsible for the tightness in oilseed availability. The stimulus and the recovery of the Chinese economy have undoubtedly helped consumption and import. Where shall we see the much talked about Demand Destruction as a result of the worldwide Recession? We shall see Demand Destruction in Mexico and in some East European and Baltic states where for reasons of currency and the recession, per capita consumption of all items has fallen. Elsewhere, food demand has remained more or less unaffected. Industrial demand is a bit weaker. Before I discuss the Incremental S&Ds of the world, let me caution you that Swine Flu is something that I have not taken into account in this analysis. I pray to God that Swine flu will soon be controlled and will not hurt humanity. I am also cautiously optimistic that the worldwide recession will soon end and that some growth even in the developed world will resume in the second half of 2009. We can see the Global Incremental Supply and Demand as follows : 000 tonnes Soya oil Rape oil Sun oil Palm oil Lauric oils Total Supply Demand _ 2007-08 + 1200 + 1000 + 4500 + 450 + + + 500 _ 2008-09 1500 + + + 1400 1500 1250 200 2850 4500

+ 5650 + 4500

We see clearly that Incremental Demand exceeds Incremental Supply in 2008-09. PRICE OUTLOOK Any discussion on Price Outlook for the next six months must include a mention about the possibility of a new El Nino developing this year. There are enough indications to make us concerned about it. Should an El Nino develop, it will undoubtedly hit palm oil production in 2010 and develop a very bullish momentum in the market. I am neither a meteorologist nor an astrologer but I do have access to an excellent weatherman. We need to watch these developments very closely. I believe the strong increase in consumption and the problems with production have created a powerful bull market which has yet to realise its full potential. As I mentioned previously, the situation in soya is more bullish than in palm and soft oils will soon take price leadership. However, price conscious markets like India will chase palm and therefore I expect BMD CPO futures to exceed 3000 Ringgits very quickly. At this stage it is not wise for me to speculate on how high prices will go because the macro economic picture still causes concern. However, the powerful injection of liquidity in all our economies must create inflation at some stage down the road. Looking at the prospects for additional oilseed production in 2010, we could see higher prices in the second half of 2009 and beyond. What happens if an El Nino develops? In that event, we are likely to re-visit the price levels of early 2008. It could mean that the Cyclical Bull Market in commodities, which many of us talked about in 2006 and 2007, may resume. This Cyclical Bull Market started around 2001 and was said to last for between 12 and 15 years. It is not unusual for such markets to undergo a sharp correction at the half way stage. Perhaps the collapse of 2008 was just that correction. I shall stop at this point from speculating any further on what could be the shape of things to come. Instead I shall draw attention to the lukewarm demand in Europe for Green Palm Oil. It must be a disappointment to all the dozens of plantation companies who undertook the onerous certification process under the Round Table on Sustainable Palm Oil. On the other hand, it is our duty as good citizens of this planet to do the right thing and the RSPO is the right way forward. The problems of drought and the tightness in oilseed supply give us a sense of the importance of palm oil. The productivity of the oil palm is such that its promotion is itself the best way forward to conserve our planets scarce resources and to preserve the environment. Palm oil is winning new friends each day. On that optimistic note, I once again thank the Malaysian Palm Oil Council for inviting me to speak at this POTS conference. I hope you are all well covered for your palm oil needs for the medium term. I wish the Palm Oil and other vegetable oils and oilseed processing industry in Japan good luck, success and prosperity. Good Luck and God Bless