The palm oil market has softened by more than 60% since crude palm oil (CPO) reached its apex at RM4,486 per tonne in March. CPO futures are trading at the RM1,700 level on Bursa Malaysia Derivatives.
With widespread recession as the backcloth, it is unlikely that these prices will rebound anytime soon. In fact, they may continue dropping as demand weakens in tandem with deteriorating economic and business conditions. For example, some pundits see oil at US$50 a barrel as a possibility.
It is not hard to see how the depressed prices can hit Malaysia. The two oils dominate the agriculture and mining sectors, and are in fact, the primary fuels of the country’s economy over the last several years, thanks to the commodity boom.
Now that the good times for oil and CPO may well be over, the effect will reverberate throughout the economy.
“The immediate impact (of the lower prices) is in the export earnings,” says RAM Holdings Bhd group chief economist Dr Yeah Kim Leng. “There will be a small dent. About 20% to 22% of our total exports are commodities.”
Much of the value that oil and CPO brings to Malaysia comes from the huge amounts that we sell to other countries. Malaysia has lost the top spot for palm oil production to Indonesia, but we are still the largest exporter, accounting for almost half of world demand last year.
Aseambankers chief economist Suhaimi Ilias agrees that the declining oil and CPO prices will be a concern from the exports growth perspective. He points out that of the 16% exports growth between January and August this year, 75% to 80% of it was driven by commodities and resource-based industries.
Time to tweak?
The Government has projected gross domestic product (GDP) to expand by 5.7% this year and by 5.4% in 2009, supported by growth in exports of goods and services of 4.7% and 4.6%. The problem is, these were worked out based on the scenario that oil and CPO prices would stay at lofty levels.
The Economic Report 2008/2008 adopts RM3,000 per tonne as a guide for CPO prices and US$125 for oil prices. These may not be far off the mark for 2008 because of the commodities’ strong run earlier in the year, but it will probably be a different story next year.
If CPO and oil prices do not plunge further than what they are today, we are looking at a 40% downward adjustment in the forecast export earnings from these commodities in 2009. And this is if we assume that the global financial turmoil will not constrict export demand.
Already, some economists have accepted that their earlier numbers have to be toned down to factor in the recent upheaval in the economic landscape.
Last Thursday, the Malaysian Institute of Economic Research (Mier) announced that it had bumped up its 2008 GDP growth figure from 4.6% to 5.3%, but lowered its projected rate for next year from 5% to 3.4%, largely owing to the bleak prospects for the world economy.
Dr Yeah Kim Leng
In the press conference, Mier executive director Datuk Mohamed Ariff Abdul Kaleem made references to impact of the sagging oil and CPO prices.
He pointed out that Budget 2009 was tabled based on a significantly higher oil price. That means the Government’s forecast budget deficit of 3.7% of GDP for 2009 may have to be tweaked. Mier’s figure for 2009 is more than 4%.
“The government’s revenue will be affected by the decline in crude oil price, which accounts for more than 40% of revenue,” said Ariff.
On the ripples caused by the declining commodities prices, he warned that they may be harsh and that few will be spared.
“Even during the 1998 Asian financial crisis, the rural population was not adversely affected, but instead benefited from the weaken ringgit that increased their commodity exports revenue,” he explained.
“But what we are seeing now is the likelihood of an increase in unemployment in urban areas and sliding commodity prices that would affect income of those in the rural areas as well.”
These two points raised by Ariff are clearly key issues to others as well. Yeah of RAM says the slipping CPO market will eventually result in the shrinkage of consumption spending. In particular, he says, the smallholders will feel the pain.
“It will take some time to filter through, but there will be an income effect,” he says.
According to the Malaysian Palm Oil Board, almost a quarter of the country’s oil palm-planted area are smallholdings, either as part of government schemes or owned by independent smallholders. The Federal Land Development Authority (Felda) alone has some 113,000 settlers in oil palm and rubber schemes.
What makes it worse is that the smallholdings tend to have lower yields and it will be difficult for the growers to raise production to partly offset the reduced prices.
The strengthening of the US dollar against the ringgit and the easing of inflationary pressures will work in favour of the smallholders, but most people feel these will not be enough to completely counter the effect of lower oil palm revenue.
Plantation consultant Mahbob Abdullah believes that plantation workers and smallholders will be badly affected. “Many of the oil palm companies have some fat from the good years and they can rely on that for a while. But they have to batten down the hatches, of course,” he says.
“However, the workers and smallholders will suffer. The cost of living is not likely to go down and they will be forced to cut down on their expenditure.”
But Aseambankers’ Suhaimi expects the smallholders to be somewhat insulated from the CPO carnage. He says it is possible that the Government will come up with an income support programme or measures that will help ease the smallholders’ cost burden.
That relief may come sooner than expected. Some observers think this may be part of the stabilisation plan that Deputy Prime Minister and Finance Minister Datuk Seri Najib Tun Razak will unveil on Monday.
Another area of the economy that is strongly linked to oil prices is the federal budget. On the revenue side, as pointed out by Ariff of Mier, the Government coffers relies a lot on petroleum-related incomes such as taxes and duties. At the same time, the Government also subsidises petrol prices.
As such, when crude oil prices sink, so too will the revenue from the oil and gas sector, although there will also be savings from having to fork out less in fuel subsidies.
Also, the lower CPO prices means that the Government cannot count on collecting windfall tax from the oil palm growers.
According to a sensitivity analysis by Aseambankers, a US$1 per barrel drop in crude oil prices will result in the Government losing RM600mil in petroleum-related income over a year. This will hamper the efforts to trim the budget deficit.
Says Suhaimi: “This year, the average oil price is just over US$100 per barrel. Next year, it’s bound to be lower.”
Malaysia has little sway over the direction of crude oil prices, but there may be some hope on the CPO front. For one thing, the prospects of palm oil as biofuel is brightening. If the CPO prices are low for a sustained period, it will make the commodity a viable biofuel option and this will establish a floor price.
Decline in crude oil and palm oil price will hit Malaysia hard