Potential supply shock form US Midwest flood 20080616

Cedar River in Iowa, US has burst its banks late last week with a total of 9 Iowa rivers are at or near record levels following heavy rainfalls. Cedar River, which also feeds into the Mississippi River, has already crested 12 ft above flood level. The US National Weather Service predicted crests of 10 ft above flood stage and expects the worst flooding in Missouri and Illinois along the Mississippi River in 15 years. Massive crop destructions in the US could be in the making. We believe the potential supply reduction of soybean oil from the US could amount to 3.6m tonnes, which will need to be met by palm oil. A sharp reduction in palm oil inventory appears inevitable, leading to a spike in CPO prices.

Maintain Overweight.
A repeat of 1993? This appears to be a potential repeat of the 1993 Great Mississippi Flood where massive crop destruction was experienced as the US Midwest is the key soybean and corn planting area in the US. Although rainfalls had slowed down since with flood areas around Cedar River to recede, meteorologists are expecting more rainfall from soon. Already Mississippi River broke its levees (堤岸) in 2 places on Saturday.

Global soybean supply to be negatively impacted. The US is expected to produce 72.4m tonnes of soybean this year or 24.6% of global production
(A: global production should be 72.4/24.6% ,which in turn to 294.31m tonnes)
, according to Oil World. At this point in time, planting progress has been slower than expected for both corn and soybean. The current condition is certainly not promising for planting and if we do experience a repeat of 1993 flood where it stretched all the way to September, both soybean and corn production from the US will be substantially produced this year. Back in 1993, total crop losses due to flooding or saturated fields exceeded 14m hectares. Soybean yield also fell by 17% while corn yield was down by 33%, according to US National Climatic Data Centre.

CPO price spike in the making. Early estimates suggest that crop destruction will be about 25% of total planted area which means an 18m tonne of soybean supply reduction from the US. At 20% crushing yield, this means a shortfall of 3.6m tonnes of soybean oil. Compared to Malaysia’s palm oil inventory of 1.9m tonnes, the shortfall in supply created by the US flood is certainly sizeable. Even if Indonesia has the same inventory level (which we doubt), meeting the soybean oil shortfall will mean palm oil inventory in the two top palm oil producing nations is wiped out. Hence, we should expect to see Malaysia’s palm oil inventory reduced sharply in the coming months, given that in the summer months, palm and soybean oil are near perfect substitutes. Palm oil prices have been extremely resilient despite the high inventory level. We reckon that if inventory level starts to fall, palm oil prices will climb drastically. If the shortfall in soybean oil from the Midwest flood truly amounts to 3.6m tonnes, a spike in CPO prices will be inevitable.

Yield still down in the best case scenario. Even before the Cedar River broke its banks, the USDA (A: United States Department of Agriculture) had already reduced its corn production estimate by 10% to 11.7bn bushels with yield estimate falling to 149 bushels per acre from 154 bushels last month as heavy rain wash away soil nitrogen content. We believe the lower USDA estimates has not taken into consideration a potential crop destruction from flooding.

Rush into corn planting next season. The flooding has pushed up corn prices more than it did for soybean as probability of planting corn has became much lower as corn season ends earlier than soybean. If the profitability spread between the two crops maintains at current level, it will greatly boost corn area next season. This will help to strengthen soybean and indirectly palm oil prices.

Maintain Overweight. The massive crop destruction in the US will be beneficial to palm oil producers. Y-t-d average CPO price stands at RM3,485/t based on West Malaysia MPOB price. We believe our expectation of RM3,500/t for this year could be well exceeded in the event of a price spike. CPO prices do have plenty of room to rise just by closing in on the discount of around $300/t to soybean oil. We continue to recommend to BUY IOI Corp (TP RM8.75), Asiatic Development (TP RM10.90), Kulim (TP RM13.80), IJM Plantations (TP RM5.95), KLK (TP RM18.55) and Golden Agri Resources (TP SG$1.37).

Figure 1: Corn profitability versus soybean suggests a rush into corn planting
next season


filed: Potential supply shock form US Midwest flood _20080616 OSK.pdf