Why is Palm Oil Valuable?
Palm oil is an edible vegetable oil derived from the reddish pulp of the palm fruit. The fruit grows on the oil palm tree, which is native to West Africa.
The history of the oil palm plant spans more than 5,000 years. Evidence shows that early West Africans consumed the fruit as a food staple, while the ancient Egyptians buried their dead with casks of palm oil.
However, it wasn’t until the 1700s that palm oil became an important international commodity. The use of palm oil in industrial lubricants, candle-making and other industries fueled the British Industrial Revolution and ushered in the modern era.
Today, palm oil is used in everything from food products to detergents to cosmetics. It is even increasingly being used as a biofuel. The size of the global market for palm oil is expected to reach more than $90 billion by 2021. As a result, the commodity plays an important role in world markets.
How Is Palm Oil Produced?
Oil palm trees are tropical plants that grow in climates with warm temperatures, sunlight and plenty of rainfall. The crops do not produce fruit until three to four years after planting, so establishing a profitable plantation requires advanced planning.
Oil palm production begins by clearing the site of the palm grove and removing tree stumps. However, the crops do not get planted in the grove for another 19 to 20 months. Growers must first nurture the seeds in other environments.
The process begins by germinating the oil palm seeds in very hot rooms. The high temperatures help facilitate faster growth. Typically after about 90 to 100 days, a seed germinates and produce a seedling with a young stem and root.
The seedlings are then planted in small plastic containers to mature. They remain in the containers for four to five months, where they grow a new leaf about every month. When a plant grows a two-pointed (bifid) leaf, it is removed from the container and transplanted into a nursery.
The seedlings stay in the nursery for about a year. When the plant has 15 green leaves, it is planted in the palm grove.
For the next several months, the plant begins to produce first male flowers, which are grouped in spikes, and then female flowers, which form their own clusters. The male flowers fertilize the female flowers and produce clusters of fruit.
Oil palm trees have trunks and leaves, but no branches. The trunk, called the stipe, contains one bud, which is the growing point. If this dies, the tree dies as well. The growing point produces 20 to 25 leaves each year, and each leaf produces a flower that eventually yields fruit.
Each fruit of the oil palm contains pulp, which is crushed to yield palm oil, and a single seed, which is crushed to yield palm kernel oil.
Oil palms generally produce fruit 30 months after planting in the fields and harvesting begins six months later. Plants between 7 and 18 years old yield the most fruit. Once harvested, the fruits must be processed within 24 hours to prevent a buildup of fatty acids.
Fresh fruit bunches are transferred to palm oil mills where they are sterilized with high-pressure steam. After steaming, pressing machines crush the fruit to extract crude palm oil. The palm seed (or kernel) is crushed to produce palm kernel oil.
Palm oil is cultivated in 43 countries in Asia, Africa, and South America. However, 85% of production takes place in Indonesia and Malaysia.
Top 5 Palm Oil Producing Countries
|Rank||Flag||Country||Annual Production (Thousand Metric Tons)|
The top importers of palm oil are India, European Union, China, Pakistan and Bangladesh.
The versatility of palm oil makes it popular in a variety of products. An estimated 50% of food and non-food items on supermarket shelves contain palm oil.
4 Main Uses of Palm Oil
|Use of Palm Oil||Description|
|Food||Palm oil is rich in carotenoids and vitamins D, E and K. It has a high resistance to oxidization, which gives it a long shelf life. In addition to its use as a frying oil, palm oil is found in many foods including the following:|
|Consumer Items||Many everyday consumer items contain palm oil:|
|Animal Feed||Palm kernel expeller is used in some animal feed.|
|Biofuels||Palm oil is often the feedstock for the production of biodiesel.|
What Drives the Price of Palm Oil?
The price of palm oil is driven mostly by these five factors:
- Competing Oils
- Environmental Concerns
- Biofuel Demand
Most of the supply of palm oil comes from two countries – Indonesia and Malaysia. As a result, the price of the commodity can be heavily influenced by government policies and news from these countries.
The expanding population in Indonesia and the government’s push to support biodiesel has resulted in higher domestic consumption. If these trends continue, Indonesian exports of palm oil could decline in the years ahead. This could lead to higher prices. Indonesia also levies export taxes on palm oil, which have varied throughout the years. Changes to this tax could also have an effect on palm oil prices.
The concentration of palm oil supply in a small handful of countries also magnifies the role that weather plays in determining prices.
The tropical climates of Indonesia and Malaysia make them susceptible to heavy rains and flooding. These conditions could delay the harvesting and processing of crops and create supply shortages.
Extreme dry weather could also impact prices. Oil palm plants depend on ample rain to grow and flower. Drought conditions might not only limit fruit yields on plants, but they also have the potential to kill entire plants.
Oil produced from palm fruit and kernels competes with many other oils including sunflower, soybean, rapeseed, corn, canola and cottonseed. The demand for these oils will fluctuate mostly based on price and availability. Political and weather events in regions that produce these other grains could impact their price and availability.
Perception about health benefits and risks could also play a big role in determining demand for competing oils. Palm oil is high in saturated fats, and consumption of this type of fat is a source of controversy.
Palm oil has received a great deal of bad publicity because its production has led to deforestation in large parts of Indonesia. Producing the crop requires clearing large plots of land, and these actions impact the biodiversity and ecosystems of the growing regions.
Critics say that production of oil palm has a devastating environmental impact. Habitat degradation, climate change, animal cruelty and indigenous rights abuses are among the potential consequences of growing the crop. Some organizations, including SPOTT, are promoting sustainable oil palm practices. However, if the public mood about palm oil production sours, prices could suffer.
Biofuels currently represent a small but growing use for palm oil. Factors such as the price of corn and other sources of feedstock could impact this demand.
3 Reasons You Might Invest in Palm Oil
Traders purchase agricultural commodities such as palm oil for many reasons, but the best ones include:
- Inflation Hedge
- Bet on Demand Growth
- Portfolio Diversification
Investing in palm oil might be a way to hedge against the loss of purchasing power from inflation.
Global central banks have kept interest rates low for an extended period of time. This has led to speculation in many asset classes including equities, bonds and real estate. At some point, the low rate environment could produce serious inflation.
Some commodities have been strong in recent years, but on average they have not kept pace with gains in other asset classes. In periods of inflation, food prices are almost certain to rise. Investing in palm oil may be a way to profit from asset inflation.
Bet on Demand Growth
Three of the top five importers of palm oil are the fast-growing countries of India, China and Pakistan.
As the populations of these countries increase, their demand for food is certain to grow. The presence of palm oil in so many items means it is likely to see higher prices.
As many emerging countries grow wealthier, their consumption of meat should rise. Since palm kernel is used in animal feed, demand for this product may grow as well.
Most traders have the vast majority of their assets in stocks and bonds. Commodities such as palm oil provide a way to diversify and reduce overall portfolio risk.
Should I Invest in Palm Oil?
Investors that want exposure to palm oil prices might consider buying a basket of commodities that includes other agricultural staples such as wheat, corn, barley, soybeans, and canola.
For additional diversification, they may want to invest in other commodities including metals and energy. Purchasing a basket of commodities helps protect traders from the volatility of any individual commodity. It also adds overall diversification to an investment portfolio.
There are two specific trends that could boost palm oil prices in the years ahead:
Emerging market demand: China, India and Pakistan could all play critical roles in driving palm oil prices higher in the years ahead. The countries have enormous populations to feed.
Biofuel demand: Almost all countries are focused on sustainable sources of energy, and biofuels may play an important role in this endeavor. Buying palm oil is a way to bet on this trend.
However, traders should consider these risks of investing in palm oil:
Health concerns may sour consumers on palm oil consumption. The high saturated fat content in palm oil makes it a controversial dietary choice. If more studies show detrimental health effects from palm oil consumption, demand could suffer.
Environmental concerns about palm oil production have the potential to lessen demand. In particular, Indonesia is now the third largest greenhouse gas emitter after China and the United States. If concerns about global warming intensify, demand for palm oil could suffer.
What Do the Experts Think About Palm Oil?
One of the leading experts on palm oil is bullish about the prospects for prices. He cites the tightness of supply and weakness in production from the two main suppliers – Indonesia and Malaysia – as sources for his optimism:
Peak stocks in Malaysia will not exceed 2.3 million tonnes by January 2018. After that stocks will decline … all the way to July 2018 and we shall have a period of the tightest ever stocks in history.
– Dorab Mistry, leading edible oils analyst
How Can I Invest in Palm Oil?
Investors have a limited number of options for investing in palm oil:
Palm Oil Trading Methods Compared
|Method of Investing||Complexity Rating (1 = easy, 5 = hard)||Storage Costs?||Security Costs?||Expiration Dates?||Management Costs?|
|Palm Oil Futures||5||N||N||Y||N||Y||Y|
|Palm Oil Options||5||N||N||Y||N||Y||Y|
|Palm Oil CFDs||3||N||N||N||N||Y||Y|
Palm Oil Futures
The Chicago Mercantile Exchange (CME) offers two contracts that track the price of palm oil:
- USD-denominated Malaysian Crude Palm Oil Calendar Futures (CPO)
- USD-denominated Malaysian Palm Olein Calendar Futures (OPF)
The crude palm oil future tracks the price of unrefined palm oil, while the palm olein tracks the price of refined oil.
Futures are a derivative instrument through which traders make leveraged bets on commodity prices. If prices decline, traders must deposit additional margin in order to maintain their positions. Both contracts are financially settled.
Palm Oil Options on Futures
The CME offers an average price options contract on USD Malaysian Crude Palm Oil.
Options are also a derivative instrument that employs leverage to invest in commodities. As with futures, options have an expiration date. However, options also have a strike price, which is the price above which the option finishes in the money.
Options buyers pay a price known as a premium to purchase contracts. An options bet succeeds only if the price of the crude palm oil futures rises above the strike price by an amount greater than the premium paid for the contract. Therefore, options traders must be right about the size and timing of the move in crude palm oil futures to profit from their trades.
Palm Oil ETFs
These financial instruments trade as shares on exchanges in the same way that stocks do.
There is no ETF that specifically invests in palm oil. Investors looking for exposure could buy country funds in Indonesia and Malaysia. The following two funds have some exposure to plantations that grow oil palm:
Top 2 Palm Oil ETFs
|iShares MSCI Malaysia Index Fund||iShares MSCI Indonesia ETF|
Shares of Palm Oil Companies
It is impossible to get pure-play exposure to palm oil prices through the equity market. However, these three diversified, publicly traded agribusinesses offer some exposure to the oilseed sectors:
Top 3 Public Agribusiness Companies
|Company||Current Price||Overview||Exchange||Founded||No. of Employees||Interesting Fact|
|Archer Daniels Midland||Operates facilities that convert agricultural commodities into food, animal feed and energy||New York (NYSE)||1902||32,000||Serves 160 countries|
|Bunge Limited ||Processes oilseeds, wheat, corn and sugarcane||New York (NYSE)||1818||32,000||Company was founded in the Netherlands|
|Glencore plc||International commodity trading and mining company||London (LSE)||1974||Over 200,000||Company began as a metals and oil company|
A popular way to invest in palm oil is through the use of a contract for difference (CFD) derivative instrument. CFDs allow traders to speculate on the price of palm oil. The value of a CFD is the difference between the price of palm oil at the time of purchase and its current price.
Some regulated brokers worldwide offer CFDs on palm oil. Customers deposit funds with the broker, which serve as margin. The advantage of CFDs is that trader can have exposure to palm oil prices without having to purchase shares, ETFs, futures or options.
One of the leading brokers for trading agricultural commodity CFDs is Plus 500. Here’s why:
- No commission on trades (other charges may apply)
- Free demo account
- Easy to use (mobile-friendly) platform
- Industry-leading risk management tools
- Trade hundreds of CFDs
- Your funds are safe – publicly listed company regulated by the UK’s Financial Conduct Authority and Cyprus’ Securities and Exchange Commission
Important: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Between 74-89% of retail trader accounts lose money when trading CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.