The Perils of Palm Oil

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While you cannot find a gallon of palm oil at the grocery store next to Crisco and vinegar, you can expect that many of the groceries within your refrigerator and pantry contain this valuable oil.  More persons across the globe use palm oil as a cooking oil than any other substance -- including olive oil, which provides the Italian mafia with billions in slush funds thanks to aggressively diluting the product -- and it's commonly found as an ingredient in everything from shampoo to ice cream.  With such a profound market of demand, you could reasonably expect that palm oil represents a strong commodity to invest in for the near future.  The monkey wrench thrown into the mix, however, is that of profound over-supply.  While palm oil has a long way to go before it matches the over-supply of corn (with some fifteen billion bushels grown annually), the oil has followed a profoundly steep downhill path over the past decade, to the point where April marked a six-year low for the commodity.  Does palm oil represent a growth market, or will it continue to put the squeeze on investors?

Growing Strong

Humans have used palm oil in some capacity for around five thousand years, making it one of the very first true ingredients used to cook meals.  Since palm trees grow throughout every tropical zone in the world, it's not clear whether the production and distribution of palm oil first developed in Africa, South America, India, or Oceania.  What's certain is that as each of these regions became colonized throughout the 16th to 19th centuries, the cultivation of palm oil quickly became a cash cow that provided most or all of the income in the region.  While palm oil lost its spot at the top of the profitability hill to cocoa by the 1900s, it enjoyed modest growth as a commodity until exploding in the early years of the new millennium thanks to its capability as both food and biofuel, quadrupling in price between 2000 and 2008.  While palm oil took a hit in the 2008 global financial crisis, it came back strong (unlike gold and crude oil) to peak at $1200 per metric ton in 2011.  That number has dropped significantly to today, where palm oil trades for half the figure and has lost value in three of the past four years.

Competing Commodities

No other factor has hit palm oil post-2011 quite like the bumper crop of soybeans produced in the United States.  The 2014 harvest of soybeans proved to be the largest in U.S. history, dropping soybeans down by a full two percent for their first negative-value year since 2011.  Since soy oil has a variety of advantages over palm oil, most notably the fact that you need not slash and burn rainforests full of endangered species to grow soybeans, palm oil took a major beating on the markets and in the courts of public opinion.  Soybean oil production overtook palm oil production to become the world's largest source of vegetable oil for the first time in history, with the world consuming 40 million metric tons of both commodities.  As rapeseed grows in popularity as a livestock feed, now the second-most common animal feed after only corn, this dual-use plant also has put the pressure on palm oil, whose by-products cannot be used as efficiently.  The lowered costs of petroleum, furthermore, make palm oil's biofuel capability less urgent.  The total loss of 18% value in 2014 made palm oil a worse performer than any other foodstuff commodity (although it still wasn't as bad as petroleum's 30% loss).  Rather than re-plant more profitable crops, some farmers are doubling down on palm oil, leading to government intervention in order to stabilize prices.  

Palm Producers

The majority of the world's palm oil comes from Indonesia, Malaysia, and Thailand, where farmers who enjoyed the boom five years ago today face an uncertain future.  Malaysian palm oil in particular represents concern for the island nation, as palm oil accounts for a full six percent of Malaysia's exports, more than any other single export besides microcircuits.  The Malaysian government announced in August of 2014 that they would ease the export taxation on palm oil for a full two months in order to facilitate better price certainty.  The move came at a particularly weak time: palm oil dropped $50 per metric ton from September to November.  Indonesia wouldn't follow suit and waive their own 9% export tax, putting Malaysia at a further disadvantage.  Thailand announced an inquiry into the importation of about 50,000 tons of palm oil from the National Committee, with the accusation that the move led to a depreciation of domestic palm oil prices.  The constraints on the oil aren't limited to national governments, either.  Palm oil companies like Royal Golden Eagle (SLUXY on the NYSE, trading at $1.48) announced at the close of 2014 they would seek no new growth outlets for palm oil despite planting over a quarter of a million acres of new palm groves in the past decade. 

Going Forward

With palm oil solidly lodged in a bear market, what factors will affect any potential price gains in the future?  Perhaps the largest factor will be the ongoing recovery of petroleum, which hit 2015 high marks with the onset of May.  Some investors believe that a resurgence of petroleum will provide palm oil with a much-needed boost: the price of futures for delivery in June has grown steadily in the past two weeks, although it has only gained a mere .25%.  Prices need to fall below the cost of production in order for global supply to dwindle, but due to the low cost of growth in developing nations, that benchmark will likely not be passed any time in the near future.  Instead, the outlook on palm oil is decidedly narrow.  Investors can buy at bargain prices today and watch it grow over a very long course of time, or they can try to ride a short-term boost with futures.  In either case, palm oil represents a commodity that doesn't offer very much growth potential.

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