Highlights

We organised a half-day forum, titled  “El Nino  –  Impact on the Plantation  Sector”,  and  we  invited  En  Jailan  Bin  Simon (Director  of  National  Climate  Centre,  Malaysian Meteorological  Department)  and  Dr  Mohd  Haniff  Harun  (Head of  Peat  Research  Unit,  MPOB)  to  share  their  insi ghts  on  El Nino and its impact on the oil palm sector.  The forum was well attended  by ~30 fund managers  and buy -side  analysts.

Malaysian  Meteorological  Dept’s  view   on  El  Nino… According  to  Mr  Jailan,  there  are  50%  and  70-73%  chances that  a  weak  El  Nino  will  occur  in  Sep-Nov  and  Nov -Feb respectively   (and  it  could  last  until  1Q15).  However,  the occurrence  of  a  weak  El  Nino  will  not  have  a  significant impact  on  rainfall  and  temperature  throughout  Malaysia  (only Sabah  and  the  northern  part  of  Sarawak  may  feel  the  impact between  end-14  and mid-2015).

MPOB’s  view…  According  to  Dr  Haniff,  there  have  been  10 documented El Nino episodes since 1980. An El Nino  episode (which  leads  to  drought )  will  affect  oil  palm  development  and production.  He  noted  that  each  episode  is  unique  in  the degree  to  which  they  influence  rainfall  patterns  and agricultural  production  (see  Figure  1),  possibly  due  to  several reasons  including the timing, duration,  and  severity of El Nino. While  weather  uncertainties  (including  El  Nino)  is unav oidable,  he  noted  that  several  action  plans  could  be taken  to  moderate  the  effect  of  El  Nino  on oil palm, including water  conservation  in  field,  delaying  replanting  during  drought season,  and  the  use  of  mulching  to  protect  the  palms  from expected severe  drought  season.

Catalysts

• Earlier-than-expected  recovery  in  the  world’s  major economies, resulting in higher  edible oil demand  and prices;
• Timely  implementation  of  higher  biodiesel  mandate  in Indonesia  and Malaysia. Weather  uncertainties revisit.

Risks

• Higher-than-expected  soybean  yield  and  soybean  planting, resulting in lower  soybean prices, hence prices of CPO.

Rating

UNDERWEIGHT

Negatives  –  (1)  Weak  demand  and  price  outlook;  and  (2) Pricey valuations.

Positives  –  (1)  Long  term  sector  outlook  remains  favourable; (2) Weather uncertainties  –  the wild card.

Sector View

While there is still possibility that an El Nino episode will likely develop  by  end-14,  we  believe  this  will  unlikely  bring  palm  oil prices  significantly  higher  in  the  near  term,  gi ven  that  the potential El Nino episode will likely be a weak one  with limited impact   on  rainfall  and  temperature.  More  importantly,  several other  bearish  factors  (including  high  production  for  other competitive  crops,  falling  crude  oil  prices  and  the  absence  of seasonal  demand)  will  likely  cap  further  near  term  significant upside of palm oil prices.

Maintain Underweight stance on the sector.

Source: Hong Leong Investment Bank Research - 17 Sep 2014