Palm oil stocks as a hedge against a falling currency

It's no secret that palm oil is an international commodity.

From the Edge:

LA LUMPUR (Jan 14): Palm oil output in Malaysia may fall further this month as the aftermath of monsoon flooding takes its toll on yields that are already low for seasonal reasons, while growers in Borneo were now braced for the monsoon, which has shifted to that region.

Malaysia's weather office forecast better conditions over the peninsular region in the coming week, dispelling fears of a fresh wave of flooding in the coastal states of Kelantan, Terengganu and Pahang, which were hardest hit by last month's rain.

Palm oil is generally seen as a boring commodity, but it does have certain desirable properties.  For one, although it is priced in ringgit, Europeans buy the palm oil in US dollars.    The truth is,  it's kind of a running joke to have palm oil priced in ringgit as most of it is sold to foreign countries.

So, the net effect is that Palm oil companies won't be affected much by a weakening currency, with costs in Ringgit, while their revenues are in US dollars.  The majority of palm oil companies will see a bit of tasty profit.

Why crude oil affects Malaysia so much

From the International Energy Agency in the US:

December cut the outlook for 2015 global oil demand growth by 230 000 barrels per day (230 kb/d) to 0.9 million barrels per day (mb/d) on lower expectations for the Former Soviet Union and other oil‐exporting countries.

Crude demand is a commodity unlike any other.

I'll compare it to another commodity well known Malaysian commodity, palm oil.  Palm oil has applications such as food.  It's doubtful that people will stop making fried chicken or oil based foods no matter what the price. Without cooking oil, fried foods aren't possible.  The demand is  long term sticky and technology doesn't change it much.  People can use less oil but it doesn't taste the same.

Crude on the other hand, demand changes a lot due to technology.  Now people are driving hybrid cars, governments are building more public transport (Mass rail transit) and thus the demand for crude now is anemic.  Is it going to change in the future?  undoubtedly, no.  People aren't going to change their newly developed habits for two reasons: it's cheaper to run a hybrid, and a car isn't something that will change hands quickly.

For new public transport projects, it goes without saying governments aren't going to stop with billions invested in their projects for nothing.  They are going to run their lines whether or not oil is at a cheap price.

This is the "new normal" and what oil producing countries have to live with until population growth and vehicle growth overshadow the current demand situation.  This may happen in 5-10 years, but not in the foreseeable future.

With Petronas dividends contributing 40 of the 200 billion ringgit budget, next year's budget revenues will fall heavily.  At an average of  50-60 usd a barrel for next year, I'll be surprised if Petronas contributes more than 20 billion ringgit a year.

Felda Global Ventures, can things get any worse?

The palm oil industry in Malaysia isn't as free a market as one might think.  For instance.  Many producers have an unusual calmness when it comes to their product.  They think it's as good as money.  They won't bother sourcing for buyers because, there will always be one guy to buy it, Felda.

They know no real hardships because sourcing for buyers and refiners is a pricey endeavour.  In the US, sourcing for buyers in commodities is hard, but rewarding.  It teaches the farmers that no one can be relied on except for themselves and the work they do in not only crop production, but customer relationships.  

Sourcing for buyers is hard work, but a reality of a free market product.  Palm oil is a free market product outside of Malaysia.  In Malaysia, it is not.  Too bad, because efficiencies are lost and job opportunities foregone because of this entitlement attitude.  

Because Felda is a government entitiy, it will not use its infrastructure as leverage in negotiating lower prices from the local producers, which is why conflict of interest exists and why investors should be wary.

From Alliance Bank research:

 Upstream plantations’ 3Q14 PBT grew 32% y-o-y to RM146.4m. This was in line with increases in FFB and CPO output, which expanded by 3% and 13% y-o-y to 1,340k MT and 909k MT, respectively.

However, realised ASP eased y-o-y to RM2,317/MT (vs. RM2,341 in 3Q13). This was however offset by a weak downstream segment, which booked pretax loss of RM117.2m for the quarter (including RM52.0m unrealized loss on commodity contracts in Canada and RM50.7m loss due to negative domestic refining margins)

Positive on MISC and even MMHE (long term)

When MISC lists MMHE, it will obviously be good for MISC shareholders, but overall I think both should do well over a long period. One of the most expensive parts of doing business in the natural gas business is the building of huge LNG ports to convert the natural gas to liquid form. This is no small feat and is very costly from a fixed cost point of view.

Recently, there has been a breakthrough converting the Natural Gas to LNG on a ship. The FLNG vessel will then offload the LNG to a tanker for transporting to places around the world. This platform goes from rig to rig converting Nat gas to LNG and offloading it to a tanker.

Some advantages include:

• Smaller fields can be developed, that were previously unfeasible,
• Less red tape
• More share of the Natural gas pie for shipbuilders and rig construction.
• Less fixed cost for ports on land.
  
• More natural gas for everyone.

This is good for both MISC and MMHE. Petronas, MISC, and Mustang has also started a joint venturel on constructing a FLNG vessel. It will be expected to be in operation by 2013.

disclosure: long MISC.

Natural gas supplies, effect on Malaysian companies

From Politics Daily:

But natural gas has suddenly emerged as both a factor in this year's energy debate and a potential game-changer on the political landscape for the long term. A few facts, dramatic new supply projections, and a geological map help explain why.

First, natural gas is up to twice as clean as coal and 30 percent cleaner than oil when it comes to carbon emissions that contribute to global warming. Second, because of new drilling technology and shale gas discoveries in the last few years, America now is estimated to have a 100-year supply of natural gas at current consumption levels (see page 7 of the linked document). And third, check out where that gas is located. It's in Rustbelt states where senators are worried about how the energy bills would affect polluting industries, and in conservative states where they are concerned about how the measures would affect the cost of electricity.

Malaysia is a very large producer of natural gas. The companies that would have problems with the currently over abundant resource are MISC and Petronas. Petronas Gas could see some problems if prices keep falling. MISC is exposed through its large LNG shipping fleet. These tankers basically are made for LNG shipments only. They can't easily be converted to anything else. If countries like the US don't need as much gas shipped to them as indicated by their 100 years supply of gas, then MISC will surely suffer.

This oversupply of natural gas has caught many countries by surprise. For instance, the US is now only incorporating natural gas as a big part of their energy plans. They are in the law-writing stages only and infrastructure will take years to come online to make use of this over supplied resource. In the mean time, exporters of natural gas will have problems on what to do with all the supply.

China Claims Evidence Shows Rio Tinto’s Hu Stole State Secrets

From Bloomberg:

China said it detained Rio Tinto Group’s Stern Hu, head of iron ore operations in the country, after obtaining evidence he stole state secrets.

“Competent authorities have established the evidence before they took action against anyone,” the foreign ministry’s spokesman Qin Gang said in a regular press briefing in Beijing. Hu, an Australian national, and three Rio workers, all Chinese citizens, were arrested by the Shanghai state security authority, the official Xinhua news agency reported earlier today.

Chinese mills and iron-ore producers are continuing the longest-running negotiations in the 40-year history of setting annual prices for the steelmaking material. China, the largest buyer, rejected Rio’s push for a 33 percent price cut, which was agreed to by rivals in South Korea and Japan, and is seeking a steeper discount to counter losses as demand drops.

Hu “is suspected of stealing Chinese state secrets for foreign countries and was detained on criminal charges,” the ministry’s Qin said. The act “caused huge loss to China’s economic interest and security,” Qin said, without elaborating on how Hu stole the secrets.

Rio’s staff stole state secrets by corrupting employees at Chinese steelmakers, the China Business News reported on its Web site, citing the Shanghai state security authority.

This reeks of desperation. Is it coincidence, the Chinese government arrest the long-term negotiator after long term contract talks have failed? Sounds like China is taking these long-term negotiations a bit personally. Who's the big bully now?

Some of the comments claim that iron ore manufacturers should bend to China's will. I doubt they will, seeing how China reacted to the unsuccessful contract negotiations. China will come to them after the smoke has cleared, obviously China still wants the long term contract. Probably the suppliers will demand more due to the risk that China will pull a similar stunt.

US Job Report suggests that Green shoots are mostly Yellow weeds

Some excerpts from RGE Monitor:

The June employment report suggests that the alleged ‘green shoots’ are mostly yellow weeds that may eventually turn into brown manure. The employment report shows that conditions in the labor market continue to be extremely weak, with job losses in June of over 460,000. With the current rate of job losses, it is very clear that the unemployment rate could reach 10 percent by later this summer, around August or September, and will be closer to 10.5 percent if not 11 percent by year-end. I expect the unemployment rate is going to peak at around 11 percent at some point in 2010, well above historical standards for even severe recessions.

The other element of the report that must be considered is that, for the summer, the Bureau of Labor Statistics (BLS) is still adding between 150,000 and 200,000 jobs based on the birth/death model. We know the distortions of the birth/death model – that in a recession jobs created within firms are much smaller than those created by firms that are dying. So that’s distorting downward the number of job losses. Based on the initial claims for unemployment benefits, it’s more likely that the job losses are closer to 600,000 per month rather than the figures officially reported.

The other important aspect of the labor market is that if the unemployment rate is going to peak around 11 percent next year, the expected losses for banks on their loans and securities are going to be much higher than the ones estimated in the recent stress tests. You plug an unemployment rate of 11 percent in any model of loan losses and recovery rates and you get very ugly losses for subprime, near-prime, prime, home equity loan lines, credit cards, auto loans, student loans, leverage loans, and commercial loans – much bigger numbers than what the stress tests projected.

There are also signs that there may be forces leading to a double-dip recession, sometime toward the second half of next year or towards 2011. If oil prices rise too much, too fast, too soon, that’s going to have a negative effect on trade and real disposable income in oil-importing countries (US, Europe, Japan, China, etc.). Also concerns about unsustainable budget deficits are high and are going to remain high, with growth anemic and unemployment rising. These deficits are already pushing long-term interest rates higher as investors worry about medium- to long-term stability. If these budget deficits are going to continue to be monetized, eventually, toward the end of next year, you are going to have a sharp increase in expected inflation - after three years of deflationary pressures - that’s going to push interest rates even higher.

For the time being, of course, there are massive deflationary pressures in the economy: the slack in the goods markets, with demand falling relative to supply-and-excess capacity. The rising slack in labor markets, which are controlling wages and labor costs and pushing them down, implies that deflationary pressures are going to be dominant this year and next year.

But eventually, large budget deficits and their monetization are going to lead – towards the end of next year and in 2011 – to an increase in expected inflation that may lead to a further increase in ten-year treasuries and other long-term government bond yields, and thus mortgage and private-market rates. Together with higher oil prices driven up in part by this wall of liquidity rather than fundamentals alone, this could be a double whammy that could push the economy into a double-dip or W-shaped recession by late 2010 or 2011. So the outlook for the US and global economy remains extremely weak ahead. The recent rally in global equities, commodities and credit may soon fizzle out as an onslaught of worse- than-expected macro, earnings and financial news take a toll on this rally, which has gotten way ahead of improvement in actual macro data.

I pulled some interesting sections from RGE Monitor's article by Nouriel Roubini regarding the current US job numbers.

Last month's job losses were quite decent at 360k compared to the trend of 500k job losses a month. But this blip might be explained by the distortions caused by the birth/death model that the BLS is recently employing. Adjust 360k by 150-200k jobs a month, we are back at 500k job losses a month, about where the trend currently is.

Higher unemployment has a huge effect on the stress tests., so bank losses will get larger. Analysts using the stress test results for their earnings projection will need to adjust for higher unemployment.

Deflationary pressures will be around for this year and next, adding on to the idea that the recent commodity rally looks like a head fake.

And this "W" shaped recovery a lot of economists are talking about seems more like a recovery with ups and downs instead of a double bottom. The recovery will be weak, recessions will now be weak, basically, a stagnant economy. Inflation might rise further into the future.

Roubini comments about China

From Roubini's RGE Monitor:

Roubini had recently been in China and met officials there. We talked about the bind that the world economic slowdown had created for China’s leadership—not despite but because of its huge trade surpluses and foreign-currency holdings. Many Chinese commentators have blamed American overborrowing and excess for dragging them into a recession. But even they realize that the very excess of American demand has created a market for Chinese exports. Chinese leaders would love to be less dependent on American customers; they hate having so many of their nation’s foreign assets tied up in U.S. dollars and subject to the volatility of American stock exchanges. But for the moment, they’re more worried about keeping Chinese exporters in business. To do that, they want to prevent their currency from rising. And for reasons laid out in detail in a previous article (“The $1.4 Trillion Question,” January/February 2008 Atlantic), the mechanics of finance require them to keep buying U.S. dollars and entrusting their savings to the United States. “I don’t think even the Chinese authorities have fully internalized the contradictions of their position,” Roubini said.

I agree. But I can report that for these past six months, virtually every economic conference I’ve heard of in China and every special supplement in a Chinese business publication has been devoted to the changes the country would have to make in order to reduce its vulnerabilities.

This was released on June 25, 2009 coinciding with what I wrote on how I doubt the export model will change. From what I highlighted, it's obvious the Chinese are just huffing and puffing, even Roubini acknowledges. I think China will be all talk until they actually do something substantial which could involve lifting the currency controls and not buying so much US debt.

Lets see if they will be able to take the tough medicine. If not, I see no reason to change my outlook. All this talk about a new super currency may help, but it all comes back to whether China will continue to grow through pushing exports. Nothing wrong with growing through exports, but keeping output artificially higher by manipulation has consequences.

Furthermore, China has not shown signs of trying to stop securing cheap sources of commodities evidenced by their pursuit of large multi-national commodity suppliers such as Rio Tinto. They must think that they can buy entire value chain and keep all the profits for themselves! I think it's not so easy. This is a good thing because the world needs to help keep China in check from overproducing. The world needs sustainable, healthy growth as opposed to the binge-style of growth over the last few years.

Why commodities will do well over a longer horizon (but not now).

Currently, China has been buying up lots of commodities. I believe they think that commodities is one of the most important investments they can make. But likely most of the purchases at this point is speculative and probably unneeded unless they are willing to let the supplies sit their for years.

The major reason commodities will do well over a longer period of 5+ years is mainly because nothing has really changed. China will continue to dump exports and piggy back on the the US and other developed nation's economies. They will find it harder to do so as time goes on as they will have to manage their currencies with other developing nations besides the US.

As you can tell, this is not a really healthy or effecient way of running an economy. By force feeding products to developing nations, we have a problem. The other economies don't really need the exports. By making exports cheaper than they are supposed to be through currency manipulation, quantity of products supplied to the world grossly exceeds what is effecient.

But alas, nothing is perfect. If nations can't play fair with each other, it will show with commodity prices. To keep this oversupply of products gravy train going requires an equally sizable oversupply of commodities. So this is a nice gutcheck against those countries who piggy back through export oriented economies.

The export model has taken a gut check, but there are no indications that countries will change their growth through exports philosophy so the picture for commodities is still strong. Also contritbuting to this is monetary abuses by nations. So once the monetary abuses abate or the world has an oversupply of commodities, we will probably see the commodity prices come back down.

The other way the commodity picture might turn bad is for world nations to start paying down debt. Most nations, though aren't doing the right thing as all they can think about is spending their way out of a recession. Most countries' leadership lack the mettle to take the tough medicine and would rather put it off for later. As long as we have this, the outlook for commodities looks good.

Better times for steel makers?

From the Edge:

Despite the difficult market condition for steelmakers, Malaysia Steel Works (KL) Bhd (Masteel) expects to be profitable this year in anticipation of a recovery in demand for long bar and steel billets in the coming months.

I'm not really holding my breath. China has been buying lots of commodities as of late, but for what? to make stuff that the US doesn't want? I'm a bit skeptical.

Palm Oil may be in trouble

The Edge Malaysia weekly magazine also reported that the EU may have regulation that would effectively stop shipments of palm oil based products. The chances are notably slim, but that just illustrates the dependencies Malaysia has on foreign countries.

Like I said before, we need to have the ability to divert our own palm oil feedstock supply into the local market. Our government hasn't been able to initiate effective biodiesel policy. We need the downstream infrastructure to support the palm oil industry. We need to be able to use our own palm oil.

Politicians need to stop jockeying for votes and lining their pockets and make intelligent economic decisions for Malaysia. Not only that, they should implement it fast as well. The downstream alternatives are lacking and if a demand shock such as the US or EU stops importing biodiesel, Malaysia will be in trouble. Malaysia is such an advanced country, but we lack the foresight compared to a country such as lower ranked Brazil which has their infrastructure in place.