We expect the current flood hitting West Malaysia  to have very short term impact  on  palm oil production.  The delayed impact of  dryness in 1Q14  could  have  contributed  to  the  relative  weakness  in  West Malaysia’s  production  vs  East Malaysia.  Regardless, inventory  should decline  given  the  sharply  lower  Dec  2014  production,  giving  palm  oil price a seasonal lift. Upside is limited by falling energy prices. 

Short-term impact on production.  Floods  typically  have a  very short term  impact  on  production.  Once  the  waters  subside,  production normalises rather quickly.  Nevertheless, there will be some crop loss  in the  interim  as  floods  make  harvesting  difficult,  if  not  impossible.  Oil extraction rate will also suffer due  to  loss of loose fruits.  Also, there are issues  with  crop  evacuation.  Malaysian  Palm  Oil  Association  ( MPOA) interim  production  numbers  suggest  that  Dec  2014  production  will decline  by  20%  MoM,  which,  coupled  with  a  single-digit  decline  in shipment, will result in inventory reduction. 

More  than  just  floods.  We  suspect  the  current  production  weakness could be due to more than just floods. The extreme dryness experienced in 1Q14 could have played a part, which was why the product ion decline in Dec  2014  was significantly worse in West Malaysia (down 27% MoM vs 9-11%  in East Malaysia). In any case, the last time Malaysia was hit by such flooding  was possibly in 2006.

Current price upswing.  We believe the current palm oil price upswing will continue into January. However, upside is probably limited due to the weakness  in  crude  oil  price  reducing  non-mandatory  biodiesel  usage. Indonesia’s mandatory  biodiesel  usage  could  also  be  reduced,  as  it is driven by economic feasibility and not carbon emission reduction. 

2014 average palm oil price  in line.  We exited the year with palm oil prices  averaging  MYR2,413/tonne,  which  was  in  line  with  our  average price assumption of MYR2,400. We expect prices  to average MYR2,500 in 2015, with most of the upside taking place only in 2H.  At this point in time, we believe there is a downside risk of some MYR150/tonne  to our average 2015 price assumption.

Source: RHB