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Palm oil industry needs to invest more in downstream activities

Updated: Saturday June 21, 2014 MYT 7:08:59 AM

Palm oil industry needs to invest more in downstream activities

BY DANIEL KHOO

Money to be made: Pemandu is pushing for the palm oil industry to capture the full potential of downstream activities, especially in the finished segments that generate high value income such as oleo-derivatives.

THE local palm oil sector which has been driven by the upstream segment in the past decades is set to change its course through increased contribution from the downstream segment in the coming years, according to the Performance Management and Delivery Unit (Pemandu), and Malaysian Palm Oil Board (MPOB).

Ku Kok Peng, director of Pemandu’s palm oil and rubber national key economic areas (NKEA), points out that the future of the palm oil industry in the country lies in downstream activities, thus reducing its dependency on the fluctuation of crude palm oil (CPO) prices and increased margins.

Last year, palm oil export was highly biased toward the upstream and midstream segments, with total contribution to the overall industry at 74%, while downstream contribution came in low at 17%, says Ku.

Pemandu sees big potential in the downstream segment where production provides a more lucrative per unit revenue stream at about 41% higher than the output from the upstream sector.

“It is clear that future revenue from the palm oil sector must come from the downstream side and we cannot be too dependent on the upstream portion.

“If the industry continues to rely on the upstream revenue then we will face a lot of challenges and we cannot get the high-income target as the value-added content is not there,” Ku tells StarBizWeek in a recent interview.

The industry trends today indicate that margins for certain palm oil downstream projects such as agro-chemicals and bio-lubricants can go up to as high as 35%.

Government incentives

A venture in downstream is often capital intensive especially if it involves acquiring new technologies.

To encourage further downstream investments, the Government has disbursed capital expenditure incentive grants (under the Entry Point Project 6, or EPP6) since 2011 to companies that are interested to embark further on palm oil downstream ventures.

The grants also help to alleviate the risk, and boost investors’ confidence, and so far have been disbursed for production of higher value-added palm oil derivatives such as surfactants, agro-chemicals, bio-polyols, bio-lubricants, glycerol derivatives and bio-based chemicals.

The same incentive is also given to investments in the production of palm phytonutrients such as tocotrienols and carotenes.

Director of MPOB’s advanced oleo-chemical technology division Dr Hazimah Abu Hassan says oleo-chemicals are mainly derived from palm kernel oil and are used very frequently in our lives daily.

“We start our day with surfactants such as toothpaste and shampoo. Derivatives such as surfactants are a major portion of the oleo-chemicals industry and they are also used in various products such as emulsifiers, personal care and also to improve the performance of some insecticides and herbicides.

“Bio-lubricants can also be used to make greases or hydraulic oils and so on, while bio-polyols can be used in sitting foams, bedding materials, furnitures and non-foam products such as coatings,” she adds.

Payment first

The key industries that depend on palm oil derivatives as important raw materials indicate the urgency for the country to produce them in a sustainable manner. The grants by the Government and further investments from the private sector would facilitate this.

The grants are structured in a way where the private sector commits a certain amount of investment. This is given on a reimbursable basis where companies need to invest first before making claims on the grant.

A total of RM492mil have been allocated between 2011 and 2014 while the aggregate grant disbursed to-date is approximately 42% of total grants which have been committed. Investments from the private sector since 2011 amounted to RM1.786bil, with about RM1.331bil anticipated for this year.

“We still have not seen any commercial production from these projects, except for one which has started production. So it is not reflected in our export figures (for 2013).

“In spite of this, the growth of oleo-derivatives (higher value added) is already outpacing the growth in basic oleo-chemicals because of higher private investments,” Ku says.

Growth expected

Between 2008 and 2013, the compounded annual growth rate (CAGR) for total export revenue in oleo-derivatives grew by 7.14%, while basic oleo-chemicals shrunk by 0.09%.

The CAGR’s export revenue per metric tonne growth rate for oleo-derivatives declined 0.49% while basic oleo-chemicals saw growth declining at a higher rate of 4.92%.

“When production from the EPP6 investments kicks in, we will likely see growth for oleo-derivatives (per metric tonne) move into positive territory. Next will be the export revenue being in positive territory (for growth) as well,” Ku says.

“When you are vertically integrated, you are able to benefit from CPO market dynamics in both ways. Right now, if you are only in upstream and if CPO prices go down then you have no way out of it.

“But if you are in downstream then you will also benefit from the low feedstock prices as well as cheaper input costs,” he adds.

Pemandu, the agency tasked with implementing the Government’s transformation plans, notes that Indonesia as the world’s largest palm oil producer had also actively embarked on developing their intermediate downstream industries.

“Indonesia has a lot of refineries coming up in the last two years as it has imposed a significantly heavier export tax structure than Malaysia.

“This move has created an incentive for refineries in the republic to process CPO into fatty esters and alcohols, which in turn has brought in a lot of investments in palm oil refining activities there,” says Ku.

Ku points out that Malaysia is still ahead of Indonesia in terms of higher value-added production of more refined oleochemical products down the value chain, and needs to continue leading the industry for competitiveness purposes.

 

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KB Kee is the Managing Editor of the Moat Report Asia (www.moatreport.com), a research service focused exclusively on highlighting undervalued wide-moat businesses in Asia; subscribers from North America, Europe, the Oceania and Asia include professional value investors with over $20 billion in asset under management in equities, some of the world’s biggest secretive global hedge fund giants, and savvy private individual investors who are lifelong learners in the art of value investing. KB has been rooted in the principles of value investing for over a decade as an analyst in Asian capital markets. He was head of research and fund manager at a Singapore-based value investment firm. As a member of the investment committee, he helped the firm’s Asia-focused equity funds significantly outperform the benchmark index. He was previously the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. KB has trained CEOs, entrepreneurs, CFOs, management executives in business strategy, value investing, macroeconomic and industry trends, and detecting accounting frauds in Singapore, HK and China. KB was a faculty (accounting) at SMU teaching accounting courses. KB is currently the Chief Investment Officer at an ASX-listed investment holdings company since September 2015, helping to manage the listed Asian equities investments in the Hidden Champions Fund. Disclaimer: This article is for discussion purposes only and does not constitute an offer, recommendation or solicitation to buy or sell any investments, securities, futures or options. All articles in the website reflect the personal opinions of the writer.

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