Commodities heat up

This year is shaping up to be the hottest year on record for the world. Unusual weather patterns are creating havoc for global agriculture production, damaging crops and sending agricultural commodity prices soaring.

Yesterday, crude palm oil (CPO) prices surged RM62 or 2.5% to a two-month high of RM2,519 per tonne.

According to a Reuters report, a US national weather analysis shows the world is enduring the hottest year on record with a hike of 0.03 degree Fahrenheit from the previous high in 1998.

Sweltering heat in the US, especially in the Midwest agriculture belt, is affecting crop production, sending the prices of wheat, soybean and corn sharply higher to multi-month highs late last month.

The problems are not confined to the US. In Russia, sweltering temperatures have reportedly destroyed some nine million hectares of crops, prompting a state of emergency to be declared in 23 regions. The country is facing its worst drought in 130 years, and estimates 20% of its grain crops may have been destroyed.

Europe has also yet to see cooler weather while Canada, on the other hand, is experiencing flooding in key farming regions. India, which depends on its annual monsoon for agriculture, saw annual rains that were 17% below normal in the week to July 21, a slight improvement from a 24% deficit in the previous week.

Wheat prices have jumped over 25% in the last month alone, and is now trading at its year high on supply worries over lower output in the US, Russia and Australia. September delivery of the grain gained 2% to US$6 a bushel at 6pm yesterday.

The prices of corn and soybean are up 6.4% and 8% month-to-date.

At press time, soybeans for November delivery rose four cents to US$9.82 (RM31.62) a bushel on the Chicago Board of Trade while corn for December delivery gained 3.5 cents to US$3.97 a bushel. Meanwhile, December-delivery soybean oil in Chicago also picked up to 39.55 cents a pound.

While adverse global weather conditions are leaving farmers and investors worried, it is also producing high levels of commodity price volatility.

For instance, commodity prices dipped in the early part of this week, due to some showers in the US Midwest that cooled temperatures slightly. However, later forecasts of a return of the hot spell caused commodity prices to resume their upward trend in the middle of the week.

What about the impact on palm oil?
The price of crude palm oil (CPO), which tracks soybean oil, has risen in tandem with its substitute.

CPO for October delivery added RM62 or 2.5% to RM2,519 per tonne yesterday. The commodity has risen some 8% in the past one month, compared with 6.4%% for soyoil.
Year-to-date (YTD), palm oil has outperformed soybean oil by 9%, according to Goldman Sachs in a report dated July 21.

The tropical oil, which is still down some 7% year-to-date, may get a boost should there be a turn in the weather.

Goldman said on a year-to-date basis, CPO production had been weaker than expected, due to a combination of biological yield stress, adverse weather and the lagged impact or reduced fertiliser inputs in 2008 (when CPO prices were low).

For Peninsular Malaysia, in particular, it said yields had started turning down, which it believed was due to biological yield stress.

The US investment house sees more downside risk to production in 2H10, due to the lagged impact of the 1Q10 drought, which was particularly severe in Johor and Sabah (which contributed about 50% of Malaysia’s CPO production in 2009). It noted that dry weather typically impacted CPO yields six to 10 months after the event.

CIMB Research noted that La Nina could occur in the third quarter following the El Nino weather pattern that was currently blamed for the hot temperatures globally.

“Should La Nina materialise in 3Q, we would be most concerned about its impact on US soybean and corn crops which will be entering their critical growing period in July to August.

“It could result in below-average rainfall in the US and crimp soybean yield, which would be positive for CPO price, especially in 3Q,” CIMB Research said in a recent report. However, it is too early to assess the impact of the recent weather on crop prospects.

“In the medium term, the higher-than-expected rainfall may boost palm oil yields, leading to higher palm oil output and lower CPO price. Overall, due to the potential supply risk, we are sticking to our view that CPO price will remain firm in 2H10 with a potential spike if supply risk heightens,” CIMB added.

CPO fundamentals improving
Notwithstanding the weather problems, the fundamentals for palm oil appear to be improving.

In June 2010, Malaysia’s palm oil stocks fell more than expected, by 7.1% month-on-month to 1.45 million tonnes, a 10-month low as exports exceeded local production. This marked the sixth straight month of declining palm oil stocks in Malaysia, CIMB said.

This would be positive for CPO price in the short term as it suggested tighter-than-expected supply, the research house noted. Additionally, there could be a potential CPO price rally in 3Q on weather risk, CIMB said.

There have been concerns over the narrowing discount of CPO prices to soybean oil at about only 10%, which is lower than the historical average 20% discount.

However, Goldman said CPO discount to soybean oil should narrow structurally in the longer run.

“In our view, the key reason for this narrow discount is that CPO supplies are tight, while soybean supplies are ample due to the bumper South America crop, and so it is not unjustified for CPO to trade close to parity, or even at a premium to soybean oil,” it said in a recent report.

If the weather problems and commodity rally continue, rising CPO prices may provide a major re-rating catalyst for the plantation sector and the local bourse.


This article appeared in The Edge Financial Daily, July 23, 2010.