Kub's Den

Producers of agricultural commodities like it when prices go up. Therefore, there must be some happy producers halfway across the globe in Indonesia and Malaysia, where most of the world's oil palm plantations are located. Benchmark futures prices for Malaysian palm oil have risen 24% since the start of October, surging Wednesday to their highest levels in two years. That has implications for soybean growers here in North America, because edible oil prices are linked across the globe, even when typical trade patterns are disrupted.

Palm oil is a relatively cheap and an extremely useful industrial product, formulated into everything from shampoo to candy bars, so a burst of market movement could eventually trickle into our world when we simply go to the grocery store. More immediately, it's worth investigating how much influence the rally in Malaysian palm oil futures could have on CBOT soybean oil futures and, of course, the prices for soybeans themselves.

First, let's consider the causes of the palm oil rally. If the world were experiencing a sudden shortage of palm oil, we might reasonably expect the high prices to persist and carry over into soybean oil. However, there's not really a lack of inventory, globally speaking. In the current marketing year, the world stocks-to-use ratio is projected by USDA's Economic Research Service to be 15%, right in line with its typical level of the past several years.

Palm oil production always tends to dip in October and November and there had been some dryness in Indonesia and Malaysia last month, but that's expected to affect the yields of palm fruit in 2020 more than the supply available to processors right now. Together, these two countries represent 85% of global palm oil production and private estimates predict their production levels to be essentially flat in 2020.

Last week, the Malaysian Palm Oil Board released monthly data showing the country's palm oil inventory down 4.1% from the previous month, which was indeed an unexpected drop. The culprit behind the sudden disappearance? Exports. Analysts' pre-report export expectations already predicted the country's October exports to be up 13% from the previous month, but ultimately exports were shown to have increased 16.4%.

Perhaps this shouldn't be such a surprise to us in the United States who have keenly noted how many fewer cargoes of soybeans have been going to Asia lately. The Chinese soy crushing industry has quieted over the past year due to the huge losses in that country's swine herd, which is traditionally their biggest customer for soybean meal. Without the soybean meal demand, there is less soybean crushing overall, and without the soybean crushing, there is less soybean oil on the market. Enter more palm oil.

Among consumers in China and India, there has been a growing preference for soybean oil over cheaper palm oil. In Europe and the United States, soybean oil carries less of the emotionally fraught baggage of environmental protests by people concerned about deforestation and the intensive agriculture of palm oil plantations. But these preferences clearly aren't strong enough to prevent a sudden surge of demand for palm oil when the soybean oil becomes less available.

Pricewise, palm oil is also attractive to Chinese and Indian importers, especially now that the Malaysian ringgit has been gently weakening through 2019 (from 4.05 ringgits per 1 U.S. dollar in March, to its current level of 4.16 ringgits per dollar). This means that nearby Malaysian palm oil futures, presently at 2,588 ringgits per metric ton, show a price equivalent to $0.28 USD per pound. Compare that to nearby soybean oil futures in Chicago at $0.31 per pound or soybean oil futures at the Dalian Commodity Exchange in China at the equivalent of $0.41 per pound and palm oil's appeal becomes clear.

These two products -- palm oil and soybean oil -- aren't the only edible oils available to substitute in consumers' shopping baskets, but they are the biggest segments of the market. Annual palm oil consumption, at 71 million metric tons (mmt) globally, is 36% of the market, followed by soybean oil consumption at 56 mmt or 28% of the market. The next-largest segments are canola oil (28 mmt) and sunflowerseed oil (18 mmt) just to namedrop a couple of crops that interest North American farmers; followed by a few more edible oils with much smaller market footprints: palm kernel oil, peanut oil, cottonseed oil, coconut oil and olive oil. The market for canola has its own problems right now with the January futures contract up $10 CAD per metric ton so far this month (a 2% gain) during a cold, challenging harvest season that has left a significant chunk of the 2019 Canadian crop unharvested under snow. Apparently, the loss of those fields' production isn't bullish enough to counteract the loss of the demand for exports to China, because prices remain lower than year-ago levels.

What does any of this mean for soybeans themselves? When a bushel of soybeans is crushed into soybean oil and soybean meal, the oil value from that process represents only about a third of the overall crush equation: 11 pounds of soybean oil at $0.31 per pound is worth $3.41, while forty-eight pounds of soybean meal at $300 per ton is worth $7.20. Therefore, it's uncommon for the prices of soybean oil to lead the overall direction of the soybean market. Also, with soybean oil already higher priced than palm oil, it's unlikely the rally in palm oil prices can really push this premium market too much higher. It can, however, provide supportive underpinning to global edible oil crush margins and ultimately to the demand for the underlying feedstock crops themselves, like soybeans.

Elaine Kub is the author of "Mastering the Grain Markets: How Profits Are Really Made" and can be reached at elaine@masteringthegrainmarkets.com or on Twitter @elainekub.

(BE/CZ)

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