Several matters explain the recently rising palm oil prices:

Firstly, the El Nino weather phenomenon brought a severe dry spell to Southeast Asia (Indonesia and Malaysia being the world's top palm oil producers and exporters) in the second half of 2015 and the start of 2016. Dry weather causes the quality and quantity of palm oil harvests to drop. As a result, palm oil reserves in Indonesia and Malaysia have slid. Indonesia's production of crude palm oil is estimated to fall to 31.5 million tons in full-year 2016, whereas the nation is estimated to have produced some 36 millions tons of CPO if there would not have occurred an El Nino in 2015/2016.

Besides the negative impact on palm oil production caused by the El Nino weather phenomenon, markets are now speculating that there will arrive a strong La Nina weather phenomenon before the year-end. Contrary to El Nino, La Nina brings wetter-than-usual weather to Southeast Asia. Although palm oil trees need plenty of water to be productive, an overdose of water will have negative consequences for harvests.

Although Indonesian President Joko Widodo is eager to impose a five-year moratorium on new palm oil plantation concessions through a presidential instruction (that may include existing concessions that are not being used), it may not lead to a drop in supply as the government is eager to encourage the optimization of production at existing plantations. However, the Indonesian Palm Oil Association (Gapki) says the moratorium seriously threatens growth of the nation's palm oil output as well as investment in this sector because - if the moratorium indeed also covers existing concessions - it confirms the lack of legal certainty in the country.

Secondly, the economies of key palm oil importing countries - including China, India, Europe and the USA - seem to show signs of improvement and therefore their CPO demand increase. In the case of China, palm oil demand has been growing supported by the nation's major Mid-Autumn festival, while the USA is demanding more palm oil for the development of its biodiesel program. Meanwhile, palm oil has become more attractive due to gains in rival vegetable oils.

Earlier this week data from the Malaysian Palm Oil Board showed that Malaysia's palm oil stock piles declined 0.2 percent to 1.77 million tons in July 2016, while exports surged 21 percent to 1.38 million tons, the highest level so far this year.

Overview of Indonesia's Palm Oil Industry

Thirdly, the accelerating economy of Indonesia supports rising domestic palm oil demand. According to Statistics Indonesia (BPS), Indonesia's economic growth accelerated by 5.18 percent (y/y) in the second quarter of 2016. This should boost people's purchasing power and therefore household consumption is expected to increase (palm oil is used for the manufacturing of a wide variety of products ranging from food items to personal care products such as soap and shampoo).

Fourthly, Indonesia's mandatory biodiesel program is being implemented consistently and therefore boosts domestic palm oil demand. In 2016 Indonesia introduced its B20 biodiesel program (one notch up from the B15 program), implying the requirement to blend a mandatory 20 percent of fatty acid methyl ester (FAME, derived from palm oil) with 80 percent of diesel. This program should also manage to curb diesel imports into Indonesia.

Indonesian Palm Oil Production and Export Statistics:

  2008 2009 2010 2011 2012 2013 2014 2015  2016
(million tons)
 19.2  19.4  21.8  23.5 26.5  30.0  31.5  32.5  31.5¹
(million tons)
 15.1  17.1  17.1  17.6 18.2  22.4  21.7  26.4  25.0¹
(in USD billion)
 15.6  10.0  16.4  20.2 21.6  20.6  21.1  18.6  17.0¹

¹ indicates forecast
Sources: Indonesian Palm Oil Producers Association (Gapki) & Indonesian Ministry of Agriculture