--Clyde Russell is a Reuters market analyst. The views
expressed are his own.--
By Clyde Russell
LAUNCESTON, Australia, July 12 The curve for
Malaysian palm oil futures has moved into a rare contango as the
market frets over the possible re-emergence of the El Nino
weather pattern and lower soy oil supplies in the United States.
But the curve may have steepened too quickly and appears to
be factoring in a worse El Nino than the last major occurrence
in 1997-98 and a fairly disastrous soybean harvest in the
Palm oil futures traded in Kuala Lumpur now have a
steeper curve than soy oil contracts in Chicago.
However, the steepening of the curve doesn't necessarily
mean that prices for palm oil won't rise, with the benchmark
3-month contract at its widest discount to its soy oil
equivalent since October last year.
Given that palm oil has a fairly close correlation to soy
oil, it's possible that the prompt month contract could still
gain even as the curve flattens out.
To justify the curve steepening in palm oil, there will have
to be a significant reduction in future supplies, but this means
the threat of El Nino has to become reality, and it has to be a
The El Nino phenomenon is a warming of sea-surface
temperatures in the Pacific that typically leads to wetter
weather in the Americas but brings drought to Australia,
Southeast Asia and India.
Japan's weather bureau said this week its climate models
indicate El Nino will emerge in the northern hemisphere summer,
while the U.S. Climate Prediction Center said last week El Nino
may strike as early as the third quarter of 2012.
However, the severity of a possible El Nino has yet to be
determined. A mild event will have minimal impact on
agricultural output and if this turns out to be the case, the
curve steepening in palm oil will have been overdone.
The palm oil futures curve was in backwardation, where
front-month contracts are more expensive than those for later
delivery, as recently as three months ago, when the nine-month
future was 3 percent cheaper than the three-month, while the
six-month was at a discount of 1.6 percent.
By Wednesday, the curve was in contango with the six-month
future at 3,099 ringgit ($973) a tonne, 0.6 percent premium to
the three-month, and the nine-month at a 1.2 percent premium.
Given that these futures, which are quite liquid with an
open interest of more than 35,000 contracts in the three-month
and 5,000 in the nine-month, rarely trade in contango, the
switch from backwardation is significant.
If you go back to the last severe El Nino, the nine-month
contract traded at a premium of 2.5 percent to the three-month
in July 1996, before the event, but by the time it was
full-blown in January 1997, it was back to a discount of 3.9
The curve reverted to contango by July 1997, but returned to
backwardation by January 1998.
It is also worth noting that the three-month contract gained
24 percent between July 1996 and January 1997, and then rose a
further 97 percent up to July 1998.
This indicates that a severe El Nino will boost the prices
of the futures, but that moves into contango along the curve are
infrequent and not long-lasting.
There are reasons to be bullish on palm oil, given a slowing
in output in major producer Malaysia coupled with strong demand
from top buyer India.
Malaysia's production dropped almost 18 percent in the
second quarter from the same period last year, while exports
rose in June.
This has reduced inventories by 5 percent at the end of June
from a month earlier, thereby tightening the market.
Palm oil is also being boosted by soy oil, with the U.S.
Department of Agriculture lowering its yield and production
estimates in its latest report on the outlook for the world's
largest soy bean producer.
But while outright prices may rise in the next few months,
it will take confirmation of a strong El Nino to justify the
current steepness of the palm oil futures curve.
(Editing by Clarence Fernandez)