Industry Trend Analysis - Malaysia: Palm Oil Output Recovers, Growth To Decelerate Long-Term - OCT 2017

BMI View: Malaysian palm oil production is on a recovery path following theperiod ofsevere El Ninorelated climate disruptionsof recent years. We expect yields to return to trend and output to continue growing, albeit modestly, over our forecast periodthroughto 2021. Over the longer term, we foresee a gradual decelerationin growththat will undermine Malaysia's share in export markets, driven by labour shortages, environmental concerns and a deteriorating outlook for palm oil-based biofuels.

Malaysian palm oil production is recovering after two consecutive years of decline due to El Nino-induced droughts, seeing output fall from 20.2mn tonnes in 2014 to 17.7mn tonnes in 2016. Yields are moving back up to trend and are compensating for an ongoing deceleration in area expansion, in line with industry efforts to reduce deforestation and meet sustainability criteria. We expect the recovery to peter out by 2019/2020, as production growth falls below the 2% level and struggles to regain momentum thereafter, leaving Indonesia as the undisputed leader in global palm oil production.

Yields To Converge Back To Trend After El Nino Episode
Malaysia Palm Oil - Area Harvested ('000 ha, LHS), Production ('000 mt, LHS) And Yields (mt/ha, RHS)
Sources: USDA, BMI

Output is being constrained by a series of bottlenecks that are unlikely to be addressed in the short term:

1. Labour shortages. In June this year, the Malaysian government decided to end the amnesty programme for informal/illegal immigrant workers. Both employers and employees face harsh penalties if discovered engaging in informal or illegal employment practices; a rigorous enforcement campaign has provoked some employers into sending illegal workers home. The situation has been exacerbated by the depreciation in the ringgit, which has made Malaysia a less attractive destination for migrant workers. Many Indonesian workers chose not to return to the palm oil plantations following the end of the traditional Ramadan festivities on June 25. The resulting labour shortages led to a steep drop in palm oil production in June and reports of fresh fruit bunches (FFB) rotting atop trees. A government programme to replace Indonesian workers with Bangladeshis, under a specific temporary migration programme, has reportedly been a failure.

Ringgit Depreciation Discourages Migrant Workers
Malaysia - Exchange Rate, MYR/USD, ave
f = forecast. Sources: Bloomberg, BMI

2. Environmental concerns. The European Union, the second-largest export market for Malaysian palm oil in 2016, is becoming more hostile to palm oil-based foods and biofuels. In March 2017, The European Parliament approved a report on palm oil and deforestation of rainforests - presented by Katerina Konecna at the Committee on the Environment, Public Health and Food Safety - which calls for the EU to introduce minimum sustainability criteria for palm oil and palm oil products, and to consider indirect land use change when assessing biofuels produced from vegetable oils. The report is advisory in nature, but references to trade restrictions have caused consternation among palm oil producing countries. Furthermore, plans are being made to act on its recommendations through amendments to the EU winter energy package, which would carry the weight of the law.

EU Considers More Stringent Palm Oil Import Restrictions
Select Countries - Percentage Share Of Global Palm Oil Imports (USD)
Source: Trade Map, BMI

3. Domestic resistance to B10 biodiesel. Malaysia has, for the third time, postponed the change in the bio-diesel blending mandate. The proposed mandate will phase out the current B7 blend (7% palm methyl ester with 93% regular diesel fuel) in favour of a new B10 blend (10% palm methyl ester with 90% diesel) with a view to hitting a target of B15 by 2020. This delay in mandate reform is due to resistance from car manufacturers, who claim that B10 causes damage to diesel engines. The blending mandate in Indonesia is currently at 20%, suggesting that the new mandate is feasible in principle and could provide a significant boost in demand of palm methyl ester in the long run. However, the latest postponement is indefinite and could prove permanent if opposition from the car manufacturing industry is not overcome.

Returns Diminish Faster In Malaysia
Palm Oil Production Growth (% y-o-y)
Source: Badan Pusat Statistik, MPOB, USDA, BMI