KUALA LUMPUR, Dec 4 ― The El Nino-induced dry weather that’s parching fields across Southeast Asia has pushed palm oil’s premium over gasoil to the highest in 10 months, threatening to curb use of the commodity in biofuel production.

Palm oil in Kuala Lumpur cost about US$160 (RM673) a metric tonne more than gasoil on ICE Futures Europe December 3, the most expensive since January and more than double the average of US$60 over the past year, data compiled by Bloomberg show.

Palm oil surged 27 per cent from a six-year low in August on concern the strongest El Nino in almost two decades would reduce output in the top producers and as Indonesia promoted more use for biodiesel. Gasoil touched the lowest since 2009 this month and fell 22 per cent in 2015 amid weak crude oil prices. Indonesia and Malaysia supply about 86 per cent of the world’s palm, the most-consumed cooking oil and a feedstock for biofuel.

“Palm oil has recovered sharply on the back of concern over production next year due to El Nino effects and highly optimistic biodiesel policies by palm producing countries,” said Ali Muhammad Lakdawala who is in charge of edible oils & fats procurement at ITC Ltd. “At the same time, with the glut of supplies in the energy market, gasoil prices are still languishing at lower levels.”

Dorab Mistry, director at Godrej International Ltd, last month cut his 2016 output growth estimate by 60 per cent to 1 million tons, saying El Nino and Indonesia’s biodiesel mandate are a “powerful cocktail” that may drive prices. The biggest palm producer is raising the amount of the edible oil blended with diesel to 20 per cent next year from 15 per cent now.

World palm oil output will be down year on year until the fourth quarter at the earliest, while demand ― unless rationed by price ― will rise, which is bullish for the premium, LMC International Ltd Chairman James Fry said on November 27.

Biodiesel mandate

A widening premium can be a risk to expansion in biodiesel use as subsidies required for each ton of biofuel will rise, said Marcello Cultrera, a dealer at Oriental Pacific Futures Sdn. A rally above RM2,500 or RM2,700 will make it too expensive, putting the viability of the biodiesel mandate into question, he said. Futures were at RM2,373 a tonne by midday break in Kuala Lumpur after earlier reaching a 3-week high.

“As long as there is a spread of US$50, then it is ideal,” said Cultrera. “If the spread goes to US$100, that is still workable, based on the hedging that will be on the market side. If it goes beyond there, we have a problem.”

Falling oil has already impacted palm demand as a fuel, said ITC’s Lakdawala. Indonesia’s biodiesel mandate “can go off track if there is another round of sell-off in commodity markets, especially the energy market,” he said.

Crude oil has dropped 23 per cent this year amid a rout in commodities as a global surplus persisted. Diesel may fall over the next two years as the glut and high stockpiles will limit price gains amid weaker demand in China, BMI Research said in a November 18 report.

“Palm would still have upper hand as, unlike the energy market, the palm oil tap cannot be easily switched on and off,” said Lakdawala. “Any impact on palm production, which is yet to be seen, would help the spread to hover near US$100 levels.” ― Bloomberg