Oh no! El Niño sets to comeback in August, says Nomura

Asian palm oil industry braces for a drier weather.

Here's from Nomura analyst Muzhafar Mukhtar:

Double trouble: Drought in the US, El Nino more certain

The past few weeks have seen a very sharp worsening of drought conditions in the US, with the % of land area under moderate to exceptional drought conditions spiking to 51% as of 26 June.

Key corn and soy growing regions are amongst the hardest hit areas.

At the same time, the probability of an El Nino event occurring in August 2012 – Mar 2013 has increased further.

This would bring drier weather to Malaysia/Indonesia, as well as potential flooding to parts of South America.

Interestingly, there has been lower-than-normal precipitation in many key oil palm areas for Malaysia and Indonesia in the past 2 weeks.

Why does this matter for palm oil?

The USDA increased its planted area estimates for soy by 3% last Friday, but we think the threat from the weather outweighs this.

Whilst comparisons with the 1988 drought which saw soy yields plummet 20% y/y could be too alarmist (according to the USCPC the 1988 drought was more concentrated in the Midwest), we note that (1) there are still key soy growing areas which are seeing severe to exceptional drought conditions (2) the US soybean crop enters its reproductive phase between mid-July to August.

After germination (mid Apr-June), this is the second moisture-critical part of the plant’s life cycle.

Unfortunately, the USDA expects the existing drought conditions to persist until late September.

The % of the soy crop (as of 24 June) judged to be in very poor or poor conditions is already 15% (prev week: 12%; 2011: 8%).

Previous significant droughts have seen soy yields coming in ~10% below the previous 5-year rolling average.

As such, the USDA’s current yield estimate for the 2012 US soy crop (one of the highest ever), could be too optimistic.

Assuming a similar yield deviation due to the current drought, we estimate total veg oil stock/usage falling to 7% by 2013 (currently USDA estimates indicate 8%).

To put this into perspective: if in 2013 we were to see demand disappointment as drastic as that seen in 2008-
2009, this soybean production shortfall would eliminate half of the impact from that demand evaporation.

As for El Nino, the phenomenon would overlap with the soybean planting season in Brazil and Argentina. Whilst the wet weather it brings to South America would be positive for soybean germination on the surface, there is also a high chance of flooding, which would impact both the crop and planting logistics.

As such, we could be looking at 2013 being the second consecutive year that both North and South American soybean output disappoints.

Equally as important, El Nino would pull down FFB yields in Malaysia and Indonesia, after what increasingly looks to be a year of weaker output in 2012.