Agribusiness - CGS-CIMB Research 2020-03-09: Falling Support From Crude Oil


Agribusiness - Falling Support From Crude Oil

  • Most active CPO futures fell by 5%, following the plunge in crude oil price. This is due to concerns that the biodiesel mandate progress may be affected due to funding issues, on top of slower global growth due to Covid-19.
  • Pure upstream planters will be the most impacted by declining CPO prices while integrated planters and Wilmar (SGX:F34) are more resilient during low prices.

Crude oil plunges by about 30% after Saudi slashes prices

  • Brent crude oil futures fell by as much as US$14.25 a barrel, or 31.5%, to US$31.02 a barrel. That was the biggest percentage drop since 17 Jan 1991, at the start of the first Gulf War. Saudi Arabia, the world’s biggest oil exporter, is attempting to punish Russia, the world’s second-largest producer, for balking on Friday at production cuts proposed by the Organization of the Petroleum Exporting Countries (OPEC).
  • Saudi Arabia plans to boost crude output above 10m barrels per day (bpd) in April after the current supply deal between OPEC and Russia – known as OPEC+ - expires at the end of March, Reuters reported on Sunday citing two unnamed sources.

Why is this negative for CPO prices?

  • CPO futures prices fell by as much as 10% before recovering to close down 5% today. We believe that CPO prices fell in tandem with the crude oil price due mainly to its rising dependency on biodiesel usage via mandates over the years to support incremental demand for palm oil. In 2016-19, we estimate 18% to 122% of the incremental demand for palm oil was for biodiesel usage. Also, we estimate that around 23% of palm oil was used for biodiesel purposes in 2019 against only 4% in 2007.
  • On top of this, one of the key drivers behind the expectations of rising CPO prices in 2020 had been the rising biodiesel mandates in Indonesia and Malaysia to B30 and B20 respectively. The key concern is that the funding required to sustain the biodiesel mandate programme in Indonesia (one of the major drivers for CPO price) may be at risk due to the widening palm oil and gas oil (POGO) spread, which currently stands at US$188/tonne.

Potential impact on CPO biodiesel support price

  • In 2020, the market is expecting Indonesia’s B30 mandate to draw down an additional 2.6m tonnes in palm-based biodiesel demand. However, this is subject to availability of CPO fund (collected via export levy when CPO price rises above US$570/tonne) to fund the difference between the gas oil and biodiesel price in Indonesia.
  • We estimate the amount of funding available for B30 mandate is around US$120/tonne, assuming the CPO fund available to fund the entire biodiesel mandate of 8.3m tonnes for 2020 is around US$1bn, and 100% of the funding is used for biodiesel funding. This is much lower than the current POGO spread.
  • At the current Brent crude oil price of US$35/barrel, we estimate the CPO-biodiesel breakeven price (assuming US$120/tonne biodiesel subsidy from Indonesia CPO fund) to be US$353/tonne (RM1,483/tonne). (See Figure3 in attached PDF report)

Upstream planters most sensitive to falling CPO price

  • Upstream palm oil producers’ (FGV, Ta Ann, Hap Seng Plantations, Genting Plantations) earnings are most impacted by falling CPO prices as estate costs are mostly fixed. Integrated palm oil producers (those with majority-owned refineries or downstream assets), like IOI Corp, Kuala Lumpur Kepong (KLK), First Resources (SGX:EB5), Golden Agri Resources (SGX:E5H) will be partially cushioned by the declining CPO prices through potentially stable/better downstream profits due to lower raw material costs.
  • Wilmar (SGX:F34), which has integrated and diversified agribusiness operations, has over the past ten years reported a relatively stable average profit of US$1.2bn even during volatile commodity prices due to its integrated operations and exposure to consumer products business which offers more stable profit margin and tends to benefit from lower raw material prices during low commodity prices.
  • Our average CPO price forecast of RM2,300 per tonne for 2020 appears achievable for now as the average CPO price in 2M20 was RM2,846 per tonne.
  • Reiterate Neutral rating and top three picks which are Wilmar (SGX:F34), Genting Plantations and First Resources (SGX:EB5).

Ivy NG Lee Fang CFA CGS-CIMB Research | https://www.cgs-cimb.com 2020-03-09
SGX Stock Analyst Report ADD MAINTAIN ADD 1.910 SAME 1.910