Mar 28, 2021
🌴 Your Guide To Investing In Palm Oil, A Controversial Oilseed Commodity Used In Lots Of Consumer & Food Products
Brief Background
First things first, all coconut trees are palm trees, but not all palm trees are coconut trees. The palm tree that produces the red palm fruit shown in the picture above is different to the palm tree that produces coconuts. The flesh and the seed (or kernel) of the fruit can be processed to make crude palm oil (CPO) and palm kernel oil (PKO) respectively. Further processing of these two oils results in the production of the final products — RBD (refined bleached deodorised) palm stearin and RBD palm olein. The versatility in the physical properties of palm oil’s products (in addition to its relatively affordable cost) means it’s pretty much in everything, in both food and non-food uses.
What Can It Do For You
🧺 Portfolio Diversification. As always, adding commodities to your portfolio can help diversify and lower risk. Adding palm oil to your portfolio means owning an asset that tends to act differently to other asset classes, and even to other commodities. Furthermore, palm oil can act as a hedge against inflation & a weak US dollar. This is because although palm oil is used in both food and non-food use cases, most of global palm oil consumption is for food. So, when the economy undergoes inflationary periods, food commodity prices could rise in response to these conditions.
💰 Profit. As you can see from the price chart below, palm oil can certainly provide opportunities for profit. Most of global palm oil production comes from two countries, so any supply disruptions here can definitely impact prices, causing volatility and wild swings, as we’ve seen in the price chart below. In the long-term, there are a number of trends that could support palm oil prices. One such trend is increasing demand, particularly from emerging economies such as China. Due to the versatility of palm oil and its downstream products, palm oil can also be used as a biofuel as well as food. As the population of these emerging economies grow, demand for food and biofuels is also likely to grow. Furthermore, as more and more countries are looking for alternative sources of energy and become less dependent on crude oil (either for economic, political or environmental reasons), palm oil could certainly contribute to this. However, palm oil is a controversial vegetable oil. Not only are there health concerns due to the high saturated fat content in the oil, there are also environmental, animal cruelty and human rights concerns in the way palm oil is planted and harvested. Should public attitude for palm oil worsen, demand for palm oil products could certainly be affected, which would then impact its price.
What Affects Palm Oil Prices
There are several key factors that are involved in moving the price of palm oil:
- 🇮🇩🇲🇾 Indonesian & Malaysian Production. Indonesia is the world’s biggest palm oil producer, accounting for ~58%. Add Malaysia’s output, and together, both countries produce ~85% of the world’s palm oil. Any supply disruptions in these two countries alone can certainly impact supply.
- 🇮🇩🇨🇳 Emerging Market Demand (Especially Indonesia & China). Emerging market demand is likely to increase as an increasing population means increased biofuel and food demands. On top of being the biggest producer, Indonesia is also the world’s biggest consumer, partly due to the government’s effort to support the palm oil industry and to reduce dependency on foreign oil imports. In addition, China has shown a steady increase in palm oil consumption over the years, according to USDA reports.
- 🏛️Government Policy. Policies such as biofuel mandates, import and export taxes can all have an effect on prices. As mentioned above, Indonesia introduced a B30 biodiesel mandate, which meant that it contains 30% palm oil blended with 70% diesel, increasing their consumption. Furthermore, import and export taxes can all impact the supply and demand for palm oil, and therefore, can affect prices.
- 📈 Stock Levels. To an extent, stock levels can also play a part in moving prices as it can provide insight into supply and/or demand levels, which can then lead to speculation in the market. So, if a country dips into their stock levels, it could suggest higher demand and/or lower production, and vice versa.
- ☀️ Weather/Climate Change. As with other oilseed commodities, palm oil production (and therefore its prices) can be affected by adverse weather. In tropical Malaysia and Indonesia, heavy rain and floods (or prolonged periods of drought) can definitely affect crop production.
- 🔄 Substitution. As an oilseed, palm oil also competes with the others, including soybeans, canola, sunflower, and cottonseed. So, if prices of palm oil goes higher than the others, this might lower demand as consumers have a number of alternatives to choose from.
- 🏥 Health Concerns. Even though palm oil contains a number of vitamins and minerals, it also has high levels of saturated fats, which is bad for your cardiovascular health. Should consumers become more health conscious, demand could be impacted.
- 🌱 Sustainability Concerns. Deforestation, greenhouse emissions, human rights abuses and exploitation, and animal cruelty concerns have been raised when it comes to palm oil production. Though there is a push for more sustainable palm oil, it is up to government authorities and the industry players themselves to hold themselves accountable. Otherwise, demand may be impacted, especially from western countries where there is more focus on sustainability.
What Is It Used For?
As mentioned above, the palm fruit and its seed can be further processed into CPO (crude palm oil) & PKO (palm kernel oil) respectively. Further processing of these oils results in other derivative products, such as palm stearin and palm olein. Both serve as a base for a variety of food and non-food products. Here are some of its uses:
- 🍳 Food. Not only is palm oil used as a cooking oil, it’s also in other food products such as candy, margarine, ice cream, condiments, and much more.
🐄 Livestock Feed. The palm kernel/seed can be used as livestock feed, due to its relatively cheap cost and nutritional content. - 💄 Cosmetics & Other Consumer Products. Derivative palm oil products can be used as a base for many cosmetic and consumer products, such as lipsticks, balms, candles, soaps, detergents, and creams.
- 🧪 Oleochemicals. Derivative palm oil products can be further broken down into different chemicals, and can be used to produce a variety of products like grease, lubricants, ink, and more.
- ⛽ Biofuel. Increasingly, palm oil is also used as a biofuel, especially in major palm oil producing regions, serving as a more affordable alternative source of energy, and to decrease dependence on crude oil imports.
The Case Against Palm Oil
There are a couple of risks involved if you want to get involved with palm oil. Firstly, it’s quite a controversial oil, both in terms of the health risks due to the high levels of saturated fats, as well as the environmental, human rights, and animal cruelty concerns related to palm oil production. In fact, because of all the forest fires used to clear wide swathes of land, Indonesia is the third biggest emitter of greenhouse gases. Should importing countries and consumers take a tougher stance on these issues, then demand (& therefore its price) can certainly be impacted. In addition, this could eventually force companies that use palm oil and its derivative products in their supply chain to look for alternatives, dropping demand even lower. This vulnerability will only be solved when there is more regulation and more self-accountability by the palm oil industry players themselves.
The Case For Palm Oil
Palm oil & its downstream products are quite versatile, and has a number of end-use cases. It’s a food commodity for both humans and livestock, a key ingredient in many consumer products, and increasingly, an energy commodity, used as a biofuel. As such, demand for palm oil is expected to continue to grow, especially in emerging economies such as China. This is because as the population and economy grows in these countries, demand for food and energy is certain to increase, needs that palm oil can fill. As a biofuel, palm oil can certainly be an alternative source, and lower dependency on crude oil imports, as we’ve seen with the rapid increase in domestic consumption in Indonesia over the years. Part of this is due to government policy, introducing a mandate that increases demand for palm oil. In the long term, poor weather (such as prolonged droughts and excess rain) conditions due to climate change can certainly impact production, causing supply constraints and pushing upward pressure on prices. Weather plays an especially important role in palm oil prices, since two countries account for most of the world’s palm oil production.
Popular Ways To Invest In Palm Oil — Pros/Cons of Each
Like some of the other agricultural commodities, you can’t really invest in physical palm oil. Here are some of the more popular ways instead. If you’re still confused about how any of these work, refer back to our basics newsletter for a refresher.
- Palm Oil ETFs. Unfortunately, there are no ETFs that focus solely on palm oil, but there are country-focused ETFs (either Malaysia or Indonesia) that invests in a range of prominent companies in that country, including oil palm plantations. Because of this, you won’t have full and direct exposure to palm oil prices. However, palm oil plays an important part in the Indonesian and Malaysian economy, and could boost the economy should palm oil prices rise. Regardless, they’re traded on stock exchanges, so they’re pretty easy to buy and sell. Depending on which broker you go with, you may be charged with trading commissions. ETFs also charge an expense ratio, or management fee that gets taken out of their total holdings and is then reflected on your account. Be sure to read the fine print & understand the risks and costs involved.
- Palm Oil Stocks. There are large public companies with business activities related to palm oil production, whether they’re the plantations themselves, crushers/millers, refiners, further downstream activities, or a mix of these. However, they’re spread out across different exchanges, namely the Malaysian Stock Exchange (Bursa Malaysia), the Indonesian Stock Exchange, the Stock Exchange of Singapore, and the London Stock Exchange. If you choose to Invest in these companies, you aren’t directly following palm oil prices since there are other factors at play. As always, you may want to consider looking at the company’s annual reports (especially operational costs), portfolio of what products & assets they have, what research & development they’re currently conducting, and potential expansion plans.
- Palm Oil Futures Contracts. The Chicago Mercantile Exchange (CME) offers two palm oil futures products: CPO (crude palm oil) & OPF (palm olein). As mentioned above, CPO is the unrefined version of palm oil, whereas OPF is a refined product of palm oil. In both cases, a standard contract deals with 25 metric tons of the stuff! These futures contracts are financially settled after the contracts have expired. As a reminder, futures contracts are binding agreements traded on futures exchanges between two parties where they agree to buy/sell palm oil at a specified time in the future with an agreed-upon price. Because you are using a significant amount of borrowed money, even small price changes in palm oil can either lead to massive profit, or massive losses beyond what you paid for, potentially leaving you in massive debt. They are certainly high-risk and not recommended for beginners. Further, fees associated with futures trading include broker commissions, and exchange/clearing fees.
TL;DR — Is It The Right Investment For You?
As always, it depends on what your aims are. As a versatile oilseed that’s used as food for both humans and livestock, used in various consumer products, and increasingly, used as a biofuel, palm oil can be used as a hedge against inflation & for portfolio diversification. In the long-term, as with other agricultural commodities, climate change can have an impact on production, causing supply constraints and putting upward pressure on prices, especially since two countries produce most of the world’s palm oil. Furthermore, demand for palm oil is expected to increase in emerging economies, such as China. As these countries grow in wealth and population, consumer demand for palm oil as a biofuel, as feed for livestock and humans, and as an ingredient for consumer products, could certainly grow. However, palm oil is a controversial commodity with many concerns related to its production, ranging from environmental, to human rights abuses, to animal cruelty. If consumers, brands and/or importing countries take a tougher stance on these issues with a focus on sustainability, then demand for palm oil could certainly drop as there are a number of alternative oils that are available.
🧺 If you are considering palm oil to your existing portfolio or bundling it with a number of others, you may want to consider doing dollar-cost averaging (regular investments over time) to build your palm oil position so you can take advantage of any volatility in the market.
💰 If you are considering adding palm oil for speculation and profit, you may want to monitor the factors that affect palm oil prices mentioned above. You may also want to keep track of monthly reports of world production, consumption & stock levels released by the USDA, so you can keep track of supply & demand. In addition to monitoring the factors mentioned above, you may also want to consider performing some technical analysis on palm oil’s price chart to help consolidate trends and patterns to help with your decision. That being said, as you can see in its price chart, historically, its prices are volatile and can also swing unexpectedly and dramatically, so be prepared and have an exit plan in place.
As always, if you are unsure, check in with a professional financial advisor before making any moves.
Thank you for reading! Let us know if you found this helpful. You can connect with us @VNewsletters, or check out our website for more information @ vaultcomms.com.
