Wednesday, June 20, 2012

I am bullish on Palm Oil-----By Shan Saeed
Agriculture is the best investment for the next 5-10 years. I am bullish on agriculture because of 3 reasons
1.    Weather patterns are changing
2.    Huge gap between demand and supply
3.    Under-investment in agriculture in the last 25-30 years.
This lesser-known commodity could be one of best investments in emerging markets now.  I wrote this piece on April 6, 2012.
With the world’s need for both edible fats and oils rising at a nearly unsustainable rate, palm oil represents a massive opportunity to fill that growing demand.  Emerging markets are in an explosive growth phase in caloric needs.  As they rise in wealth, so will their demand for calories and as such so will the demand for meat and dairy, the primary sources of saturated fats, which, despite propaganda to the contrary are absolutely essential for proper growth, development and maintenance of human beings. 
Tropical countries have an advantage in that they can produce both palm and coconuts whose oils are rich in saturated fats; providing a relatively cheap source for them as well as high caloric density.  Palm and coconut oils alleviate that creating a low cost entry point into a higher calorie dietary cycle.  In essence, palm and coconut farming can be seen as a substitution effect for animal husbandry to some extent.
The reason as to why palm oil is the disruptive technology of food production is simply because it is more than ten times more efficient per acre than soybean oil and seven to eight times more efficient than rapeseed oil.  Every acre of palm planted yields nearly 11 times the volume of soybean oil and seven times the rapeseed oil.  Total land under cultivation is somewhere around 15 million hectares, which is less than 2% of that which is dedicated to soybean production.   
Indonesia and Malaysia produce 87% of the world’s palm oil or 38 million tonnes.  Thailand and Nigeria are next, producing 2.2 million.  Nigeria has put 2.5 million hectares under cultivation that has yet to begin producing in quantity.   It is estimated that Indonesia has the ability to triple its output while Malaysia is  going through some constraints. Thailand’s industry is struggling with low yields, 60% of the world average, but the industry there is still very immature. 
The global demand for palm oil has risen by a CAGR of 7% for the past 10 years, doubling in demand and tripling in price.  The economics of palm oil are so strong that that have driven production beyond that of soybean oil in less than 10 years.  Oil seeds in general represent less than 5% of the total land under agricultural use.  Palm trees, which produce economically for 25-30 years without replanting account for less than 0.1%.   Countries like Benin and Kenya have ideal conditions for growing palm as does the northern portion of Brazil.  Colombia’s production is rising. 
At this point part of the palm oil market is being siphoned off into the biodiesel industry, with a number of counties using a 5% biodiesel mandate to support the price similar to the corn/ethanol subsidies in the U.S. and Europe.  But, regardless of that, and the sustainability of it which is suspect at best, the world is trying to figure out how it is going to feed all of these people being lifted out of poverty in the world’s emerging markets. 
While Nokia is trying to figure out how to connect the next billion people to the internet and Facebook wants to give them a platform to express themselves, there is still the looming problem of how they are all going to get fed.  Malthusians of every stripe have been wrong since Malthus himself wrote; misunderstanding the impact of price on supply and demand, so there is little doubt that all of these people will get fed.  The key to affecting this outcome is increasing energy per acre and no crop comes close to palm.  The question is at what price in who is going to benefit the most from it? 

Outlook in Malaysia.
The iShares Mayalsia Index ETF (AMEX:EWM) has significant exposure to their palm oil industry directly, and since it represents a significant portion of their export market, even more so indirectly.   Genting Plantations is a rising Malaysian player with a young acreage profile that should see yields expand at a CAGR of 14%, according to a recent report by HSBC, for the next 3-5 years.  It is widely held by a number of agricultural ETFs, including EWM and the PowerShares Global Agricultural ETF (AMEX:PAGG), which also holds Singapore’s Wilmar Industries as its top holding
Palm oil trades in sympathy with soybean oil and crude oil.  This is due to substitution effects with both soybean oil and diesel fuel.  So, it is vulnerable to large swings in the price of crude oil, but only large swings.  With Malaysia announcing that their palm oil stockpiles are at 13 month lows the recent 15% move down in price to $924 per metric tonne is a normal reaction when the price of palm oil nears parity with soybean oil (black line in the chart).  So much of the verbiage surrounding palm oil has to do with its use as a sustainable biofuel and its carbon neutrality, or lack thereof.  While it is the best choice for making biodiesel due to its insanely high yields and sunlight conversion rate its need as a food source will be far greater.  
If one believes in the long term peak oil story or simply believes that demand will far outstrip supply at the current prices regardless of the politics, then that would also support the thesis for a massive expansion of palm plantations around the world over the next decade.  An acre of land can create enough fuel to power a Volkswagen (NYSE:VW) Polo 60,000 miles, or the average usage by five Americans. 
Doing a little math, current land under cultivation is approximately 38 million acres which produce 350 million barrels of biodiesel per year, 0.9 million barrels per day.  Since diesel constitutes approximately 24% of total oil consumption that means at 90 million barrels of crude used per day, current palm oil production could support between 4-5% of the world’s current diesel needs.  That would constitute the upper limit on biodiesel production in the world, regardless of the price. Happy investing in Palm Oil.
The energy production per acre from palm oil is disruptively large compared to other edible oils and represents a great long-term investment opportunity, regardless of the short-term softness in price.

Disclaimer: This is just a research piece and not an investment advice. All financial transactions carry a RISK. 

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