Dr. James Fry

© 2019 LMC International. All rights reserved. www.Lmc.co.uk

Dr. James Fry

Chairman,LMC International, United Kingdom

© 2019 LMC International. All rights reserved. www.Lmc.co.uk

The factors behind today’s marketby Dr. James Fry,

Chairman, LMC International, Oxford, UK

PEOC 2020, Karachi, January 2020

I start with a focus on China and the

US in the soybean complex

© 2020 LMC International. All rights reserved. PEOC 2020

The shock from African Swine Fever is fading. Led by sows (a guide to future piglets), pig and sow numbers are growing again, which is boosting soymeal demand. As a result, the pork price has fallen, helped by releases from State reserves ahead of the Chinese New Year holidays.

China’s pig numbers have started to recover

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Pig Sow Pork price, RMB/kilo


To get them all on the same diagram, pig numbers and soy crushing volumes are plotted as an index, with Jan-19 set at 100. We see that crushing volumes ended 2019 higher than at the start, despite the slump in pig numbers. In parallel, the local crushing margin has risen steadily.

China’s soybean crushing has been surprisingly resilient

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Crush Margin Pig Numbers Index Soybean Crush Index


Trump’s China trade war hit US soy farmers badly. In biofuels, he eased mandates, cutting the price of RINs, which value mandates, as we see here. One bit of good news for farmers comes with the return of a $300/tonne tax credit for biodiesel, but only part of this goes to farmers.

On soybeans , Mr Trump has played an inconsistent role

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It is odd to see Mr Trump hailing as a victory China’s return as a buyer of US soybeans, when the reality is that the Chinese has made no big concession and can merely switch back to the US from Brazil. However, it is remarkable that compensation to US farmers for the losses caused by his trade war with China is calculated to have cost the US budget more than the massive bail-out of the car industry ten years ago.

In terms of fundamentals, it is more important that China’s pig industry is at last starting to recover from African Swine Fever, boosting crushing volumes and thereby increasing the supply of locally crushed soy oil

The US Congress has just given another costly gift to the soy sector. The return of the $300/tonne blending credit for biodiesel adds over $2 billion per year to the budget deficit. Curiously this credit is backdated to 2018 and 2019, too late to be an incentive (a further $4 billion of deficit)!

Logically, this tax gift should lead to a fall in the value of the tradeable biodiesel RIN certificates (whose price is paid by the user, not by the government), but this has not yet happened to a large extent.

Combining these factors, they should give a small boost to bean prices.

Impact of China and the US on the soy sector

Vegetable oil price movements


Crude oil prices set the floor to EU vegetable oil prices. As this reveals, there have been several times since 2012, when CPO has been at the floor of the price range, touching Brent prices. Other oils usually trade at prices that are fairly close to one another and at a premium to CPO.

EU oils still trade in a range with crude oil as the floor

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Soybean Palm Rapeseed Sunflower Brent


The dashed line is drawn at a fixed $420 above Brent. Today we are near the top of this price band. I now expect some countries will ease biodiesel mandates in the short run to limit the cost of government subsidies and stop consumers facing even higher cooking oil and fuel prices.

I hope this explains why I talk of the price band for CPO

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Palm Brent


The EU CPO premium over Brent is determined by Malaysian stocks, in the absence of data from Indonesia. The premium and stocks move in opposite directions. As we just saw, we are at the top of the price band, where the CPO premium is $420/tonne (this was yesterday’s level).

Malaysian palm oil stocks determine the CPO-Brent spread

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EU CPO Premium over Brent Average Premium MPOB Stocks


Another barrier to further CPO price rises is that it has lost its competitive edge. The EU soy oil premium over CPO is the lowest since 2007. The zero sun oil premium is at its lowest for even longer. Palm will lose export markets at these price relativities, especially in the winter period.

Prices of other oils are converging on the CPO prices

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Soy oil Rapeseed oil Sunflower oil


History does not always repeat itself, of course. Nevertheless, there is a logic behind the workings of the price band.

In the biofuel sector, government support for rigid mandates becomes more flexible when biodiesel costs much more than diesel and local prices of cooking oil rise, creating consumer disquiet at festival season.

On a historical basis, we are very near the upper limit of the price band. The CPO premium over Brent is as high as it was when the El Niño crisis was at its height, cutting world CPO output dramatically.

A further factor that is at work is that palm oil’s recent large price advantage over competing oils has plummeted, and its price advantage has very recently actually vanished against sunflower oil.

The market is signalling to price sensitive buyers to switch where they can from palm to other oils. On top of this, we saw that Chinese output of soy oil from imported beans is rising again, reducing its need for palm olein imports. When current export contracts made at low prices expire, there should be a significant drop in palm oil shipments from S.E. Asia.

We bounced from the floor to the top of the price band

The factors affecting palm oil output


Malaysia and Indonesia face similar weather problems; and in both some palm producers cut back on fertiliser use and maintenance, harming yields. Yet, they are now out of step in their year-on-year production growth. It seems likely that they will go in opposite directions in 2020.

Where do we stand in the palm oil production cycle?

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Malaysia Indonesia


The ONI is the usual indicator of El Niño (dry) and La Niña (wet) weather in S.E. Asia. The current cycle is returning more quickly to the El Niño range than the past two cycles. If a fully fledged El Niño reappears in early 2020, the impact will not be felt till year-end at the earliest.

Looking ahead: a possible El Niño?

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Petroleum sets the floor to vegetable oil

prices. Thus, we need to understand it.


US shale oil output is still growing fairly steadily, limited mainly by infrastructure. Mr Trump (him again!) boasted after his latest stand-off with Iran that the US is now the world’s largest crude producer and self-sufficient in oil. All this is due to the wonders of fracking technical progress.

US shale oil output grows, even at fairly low prices

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Total shale oil output, bbl./day WTI, $/bbl


US monthly shale oil output now grows at 60-120,000 bbl/day when WTI trades in a price range of $55-$65/bbl (with Brent trading at $60-$70/bbl). This means that US shale oil can meet all world demand growth of 120,000 bbl/day/month at $65/bbl, and half total growth at $55/bbl.

US shale oil production responds at ever lower prices

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US shale oil output growth WTI, $/bbl

$65/bbl.

$55/bbl.


The surge in oils prices was led by palm oil whose weak output growth (due to the lagged impact of cutbacks in inputs and drought) combined with high biodiesel demand to pull down stocks and lift the CPO premium over Brent.

Other oils have enjoyed a price surge, but the leap in CPO prices has wiped out its EU price advantage vs. sun oil and cut its competitiveness against soy oil, too. These oils will now substitute for CPO in important markets.

There is good evidence for believing short run flexibility in biodiesel demand creates a price band, with a range in which oils trade above crude oil prices.

CPO prices are now near the top of the price band. Without higher crude oil prices, it is difficult to see BMD going above M$ 3,300 in the next 6 months.

Turning to the all-important crude oil floor to the price band, we have moved very rapidly to a world in which US shale oil now sets the price range for crude prices. The only big external change that could cause a big price increase for crude oil and vegetable oils is political. As so often in today’s world, Mr Trump and his unpredictable temperament seem to hold the key.

Conclusions from the discussion today

To contact LMC Oxford

LMC International Ltd

4th Floor, Clarendon House

52 Cornmarket Street

Oxford OX1 3HJ

UK

Tel: +44 1865 791737

Email: [email protected]

To contact LMC New York


1350 Avenue of the Americas,

Floor 2

New York, NY 10019

USA

Tel: +1 212 586-2427


To contact Kuala Lumpur


SO-30-8, Menara 1

No. 3 Jalan Bangsar

KL Eco City

59200 Kuala Lumpur

Malaysia

Tel: +603 2202 1414


Some LMC oils publications

www.lmc.co.uk

Dr. James Fry

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