According to IJM Plantation CEO Joseph Tek, Sabah palm oil refiners will start to impose a higher discount on palm oil they purchase from millers from September. The discount, which is at RM40 per tonne compared to West Malaysia price, may increase to RM80 ' RM100 per tonne. (Business Times.)

The move by the refiners reflects market forces at work. Malaysian refiners' margin has been squeezed since late last year when Indonesia introduced a new export tax structure. Under that structure, Indonesia's export tax for refined products becomes lower than that for CPO, which results in its ability to price refined products cheaper in the international market.

Malaysian upstream players have been selling CPO at international prices while its Indonesian counterparts have been selling at a discount (based on export tax for CPO) to international prices. The cheap domestic CPO price is the source of Indonesian refiners' competitive advantage. Hence for Malaysian refiners to be as competitive as the Indonesians, they must be able to buy CPO as cheaply.

We believe the Malaysian government is hesitant to introduce a measure which will lower domestic CPO price, as it will hurt upstream players and will prove to be an unpopular move, especially with the general election around the corner. Without the government's help, Sabah-based refiners are ganging up to create an oligopolistic situation in the refinery space. If refiners are successful in introducing a wider discount in Sabah, we do not dismiss the possibility of them attempting to do the same in West Malaysia, although it will be more difficult to do so with the excess capacity and higher number of smaller refiners.

Wider discount on CPO will hurt upstream players with pure or significant Sabah exposure, such as IJM Plant (BUY, FV RM4.51) and Genting Plantations (BUY, FV RM11.34), and benefit those with refineries in Sabah such as KLK (BUY, FV RM27.20), IOI Corp (NEUTRAL, FV RM5.34) and TSH Resources (BUY, FV RM2.88).

We will not revise our CPO price assumption at this point as average palm oil price YTD is still safely above our assumption of RM3,000 per tonne. Maintain OVERWEIGHT on prospects of stronger CPO price next year, for which we have an average assumption of RM3,500 per tonne.