Palm oil plantations, particularly those with vertically integrated operations and land ownership versus land concessions, are interesting investments from the perspective of several themes:
- rising food demands (due to population increases and rising standards of living)
- future inflation (where land ownership may provide some hedge against inflation)
- rapidly rising Asian economies (because palm oil is an important food for Asia, particularly India and China)
- global fresh water shortage (because the exporting foods grown in wet tropical areas where oil palm is produced is like exporting the water used to grow them)
- increase use of bio-fuels (because palm oil is used as feedstock for bio-diesel production)
Palm oil is used in cooking, as an ingredient in foods, cosmetics, and soaps, and can be refined into various useful chemicals (“oleo-chemicalas” from vegetable oils or animal fats), including bio-diesel. Oleo-chemicals are to palm oil what petro-chemicals are to crude oil.
Oil palm is the most productive vegetable oil crop, yielding several times more oil per hectare than any other major vegetable oil source, although it is more labor intensive. It is also produced in greater quantity than any other vegetable oil. Soybean oil is the second highest volume vegetable oil. For July 2012/2013, the USDA reports palm oil to be 33.3% of world vegetable oil production, and soybean oil to be 27.6% of world production (combined 60.9%). Tbe other 7 vegetable oils share the remaining 30.1%. Indonesia is the world’s largest producer and Malaysia is the second largest producer. Together, they account for the vast majority of total world production of palm oil.
To some degree, the oils are potential substitutes for each other, but not for all purposes. The price of palm oil in recent years has tended to correlate highly with the price of soybean meal and petroleum as these two indexed percentage price change charts show.
data by YCharts
data by YCharts
Farther back in history, the correlation was not tight, as this 30-year history of the ratio of the price of palm oil to soybean oil shows. The current ratio is 0.84. The current 0.86 is the 5-year ratio, and the 10-year ratio is 0.83.
Palm oil prices are down from recent highs, as increased supply and a sluggish world economy puts downward pressure on prices. The price for Malaysian palm oil now is about $922 per metric ton, The futures market for July 2014 is priced at about $936 (up 1.5% from now). That compares to a high of $1,249 in February 2011 (about 35% higher than the current price).
The World Bank forecasts a long-term decline in the price of both soybean oil and palm oil out through 2025. They see soybean oil in 2013 priced at 1200 declining to 1000; and for palm oil at 970 in 2013 declining to 800 by 2025. Their price ratio is 2013 is 0.833 and for 2025 it is 0.825 — approximately the same as the current 10-year historical price ratio.
The question, of course, is the correctness of the forecast direction. The World Bank forecast is a fairly straight line 12 year projection. Commodities don’t move in straight lines, and there are so many variables that will intervene, that the direction and magnitude may be just a wild shot in the dark.
Palm oil prices have been quite volatile, and we see no reason to expect differently in the future. This chart shows the 30-year price history of palm oil, along with its 10-year, 5-year and 3-year moving averages. The June 2012 price was $928. The 10-year average price in June was $649. The 5-year average price was $872, and the 3-year average price was $924. The price today is $923.
click image to enlarge
We tend to think that the World Bank is merely extrapolating the current world malaise out as far as their projections go. They did not provide alternative scenarios in the documents we saw, but there certainly are alternative economic directions over the next 12 years.
Thinking through whether you want to own a plantation stock that is leveraged with debt or one essentially debt free is important, and is a function of your palm oil price direction assumptions.
Determining if you want a plantation that is a pure producer of raw product for wholesale distribution, or one that also packages and/or formulates for consumer products, is another decision to make.
And, whether you want vertical integration into oleo-chemicals, where the company operates its own palm plantations and then “cracks” the oil for its component chemicals for various industrial uses, is another key decision. Your choices would be scenario specific.
We will contrast the scope of business of several leading, publicly traded palm oil plantation companies in an upcoming article.