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Palm and crude oil are locked in a serious relationship, the bonds of which may only get stronger as ever-larger volumes of vegetable oil get diverted to producing biodiesel in future.
The Malaysian palm oil market has been tracking crude oil prices and ignoring traditional market-moving factors ever since global biofuel appetites started growing this year. And the marriage could be here to stay as several biodesel plants world-wide move closer to production and companies hurry to lock up supplies of raw material.
"It's just one window on our screen that we keep looking at these days," said the head of trading at a plantation house. "We are just bothered about crude oil prices. There is no concern for stocks, production and demand - unless there is a big change." A new breed of players is invading Bursa Malaysia Derivatives, the country's palm oil futures exchange, and many of them are companies building biofuel units which are taking positions to secure supplies of raw material.
"A lot of biodiesel players don't have crude palm oil of their own," said Ivy Ng, an analyst with CIMB Securities. "The futures market is an avenue for biodiesel producers who are looking to secure some feedstock for their plants."
Biofuel plants are coming on stream as countries from Europe to Asia seek ways to cut dependence on crude oil, reduce greenhouse gas emissions and boost agriculture.
Malaysia, the world's top producer of palm oil, has approved licences for 52 biodiesel plants with a combined annual capacity of more than 5 million tonnes. Biodiesel plants with 1.9 million tonnes of capacity will start up by 2007, the government expects.
Malaysian palm oil futures jumped more than 3 percent on July 20, when Malaysia and Indonesia decided to set aside nearly 40 percent of their joint output, or 6 million tonnes each, of crude palm oil for biodiesel. Since then, palm oil futures on Bursa and crude oil have been moving in lockstep. Reuters data shows the statistical correlation between the two instruments and has sharply improved this year.
During the period from August 1 to October 16, the correlation rose to 0.86 from 0.39 in the period from January to July, and up from 0.26 for all of 2005. By moving closer to 1.0, it demonstrates a relationship that is growing stronger.
Crude palm oil prices jumped as much as 20 percent this year but then retreated as petroleum prices fell, even though the market is still up 10 percent since January. This is despite the fact that exports are stagnating and reserves are hitting record highs, which would have otherwise sunk the market, traders said.
"In a normal scenario, with these kinds of levels of stocks and production, we should have been trading at around 1,100 to 1,200 ringgit a tonne," said Amir Chitta, marketing director with Singapore-based trading firm Agritrade International.
"But thanks to biodiesel, we are still staying above 1,500 ringgit." The benchmark third-month January contract on the Bursa Malaysia Derivatives was up 14 ringgit at 1,612 ringgit ($437) a tonne by midday on Wednesday. Exports of Malaysian palm oil have failed to keep pace with growing production, which resulted in September's all-time high stockpile of 1.799 million tonnes.
Industry officials said worse is yet to come, with stocks expected to rise further towards the end of the year on the back of a seasonal decline in global palm oil demand.
But market players are unfazed. "You could have a massive stock of palm oil but if all of it is going to be turned into biodiesel, it does not matter, the price will still go up," said Mike Coleman, a partner at Singapore hedge fund Aisling Analytics. But some analysts said the relationship would depend on how soon the biodiesel industry developed and started consuming palm oil. "If it is slow, the relationship will not be as close but there would be some sort of relationship," Ng said.
But the new equation spells unhappiness for the food- processing industry - and particularly its biggest clients, India and China - because it relies on stable prices.
"If vegetable oil prices are going to fluctuate like crude oil, it is not going to be easy for the food sector," said M.R. Chandran, former head of the Malaysian Palm Oil Association, who now works as an independent consultant. "Food prices need stability and it will become difficult for developing countries like India and China to adjust."

Copyright Reuters, 2006

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