Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
Peter Garnry
Chief Investment Strategist
Summary: Indonesia’s sudden decision to clamp down exports of palm oil has sent inflation shock ripples globally not just for edible oil or food prices but more generally for consumer products. While the ban is unlikely to extend beyond a few weeks, these consequent price increase of consumer goods may be stickier and may especially harm emerging markets. A focus back on palm oil plantation is likely in the medium-to-long term, also as ESG funds turn more accommodative to palm oil products.
Last week, Indonesia made a shocking announcement to ban palm oil exports in the face pf domestic shortages and price pressures that have pushed vegetable prices to multi-year highs. Vegetable oil prices have been on the rise in the last six months, amid a host of factors from labour shortages in Malaysia which have dampened the palm oil supplies to droughts in Argentina and Canada curtailing soybean oil and canola oil exports respectively. Finally, the war in Ukraine has tightened the supplies of sunflower oil, so palm oil has been in key focus.
Indonesia is the world’s largest producer and exporter of palm oil. The US Department of Agriculture estimates that FY21/22 palm oil production volume for Indonesia is 44.5m MT and that Indonesia is responsible for roughly 60% of global production. Malaysia is the second largest producer of palm oil. Palm oil is not just a key source of vegetable oils, but also used in many diverse applications, including other food products such as margarine, instant noodles and snack foods, food packaging and also as an ingredient in cosmetics and toiletries, and as a biofuel. The sector has been running on tight supplies amid the under-investment due to the ESG push.
This clearly means a further push higher to food prices that are already running at record highs, amid sharply higher energy prices, supply constraints as well as the increase in fertilizer prices. We are also concerned about the likely spill over to other industries, especially in the consumer staples space as prices of detergents and toothpaste will be pushed higher. In Asia, India and China will likely see the biggest impact, given the large dependence on palm oil imports from Indonesia and food shortages in China on account of its zero covid policies.
Other emerging markets that are food importers and where food represents a high share of household consumption expenditure such as the Philippines and Africa will also see rising inflationary pressures. Developed markets won’t be spared either, and many European countries have imposed limits on the amount of vegetable oil households can purchase. Malaysia may stand to benefit from substitution demand for palm oil, but this will be with a lag as new contracts are worked out. But it is worth noting that Malaysian supplies still cannot cover up for the lost Indonesian exports.
To be fair, Indonesia is unlikely to sustain this ban into the summer. Palm oil is a key input for Indonesia’s balance of trade and foreign exchange, and there is limited storage capacity for the oil. Meanwhile, Indonesia has excess palm oil supplies, as it consumer only about a third of its production. This means that the surge in palm oil prices may be temporary. But consumer staple companies are facing the perfect storm of rising prices over and above the palm oil price gains, and any move lower in palm oil is unlikely to be followed by a similar move lower in consumer product prices.
Indonesia’s move has brought back a focus on food protectionism and de-globalisation. It will be no surprise if alternatives such as rice bran oil and cottonseed oil see more traction. Still, with ESG funds becoming more acceptable of palm oil products there is scope for higher investment in the sector.