Why this soft commodity is heading for exponential growth

The world's demand for palm oil is rapidly outstripping supply. And with environmental concerns restricting further expansion in Asia, production is moving to other areas of the world. Tom Bulford looks at where the palm oil industry is heading.

Most of us feel quite good about eating margarine. Compared with slabs of lard or rich butter, margarine seems like a healthy alternative.

But perhaps not. Margarine is made from assorted vegetable oils in a process called hydrogenation. The oils are heated to a high temperature then a nickel catalyst is added along with hydrogen atoms to solidify it. Finally, deodorants and colourings are added to remove margarine's horrible smell and unappetising grey shade.

If you knew all this before you spread the stuff on your loaf, you might not be quite so keen. But what is really bothering margarine producers is that some researchers believe it can even lead to genetic mutation and cancer.

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The state of California and the cities of New York and Philadelphia have already banned restaurants from using cooking oils containing so-called 'trans-fats'. But while that is bad news for producers of soya oil, sunflower oil or rapeseed oil, it is music to the ears of the palm oil industry.

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You see, the crucial difference between palm oil-derived spreads and the other types just mentioned are that those that use palm oil are naturally solid at room temperature - and therefore do not require this hydrogenation process. This is just one of the many factors driving up demand for this soft commodity.

How Asia's taste for palm oil is creating a supply crisis

Although it is used in the manufacture of cosmetics and as a biodiesel, the main use of palm oil is either as cooking oil or as a food ingredient.

The number of hungry mouths in the world is growing inexorably, but on top of that the Chinese are increasingly developing a taste for fried food. Bored of boiled rice and vegetables, they can now afford cooking oil and the global palm oil industry is struggling to keep pace.

In the last four decades the area of Malaysia devoted to the oil palm has increased five-fold. The land used to grow the trees in Indonesia has risen by an astonishing 23 times.

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Today 12 million hectares of land around the world are covered in oil palms. But it is not nearly enough. According to the World Development Report on Agriculture a further 6.2m hectares must be planted by 2020 if global demand growth is to be met.

Herein lies the problem. Eighty-five per cent of the world's supplies of palm oil come from Malaysia and Indonesia, but they are running out of space and into the protests of the environmental lobby. The industry has been accused of being a large-scale contributor to greenhouse gas emissions through deforestation.

Some 70% of Indonesia's palm oil plantations are on land that was previously forested. Now the green lobby is beginning to get its way.

For big business, environmental credentials are becoming more important than shaving a few cents off input costs. That's why, last month, Burger King stopped using palm oil from Indonesian supplier Sinar Mas, following allegations from Greenpeace of rainforest destruction.

The industry is reacting by looking for land elsewhere. As Ahmad Zubir Murshid, chief executive of major plantation owner Sime Darby has explained: "It is increasingly difficult to acquire arable plantation land in Asia and thus it is imperative that new frontiers be sought to meet increasing demand."

The race is on to locate suitable land and growers are looking at opportunities for expansion in South America and Africa. Already Colombia is the largest producer in the Americas, with much of its output exported as a biofuel additive for diesel. Costa Rica, Honduras, Guatemala, Papua New Guinea and Thailand are also producers. But the focus of attention is now turning to Africa.

There is one logical reason for this.

Why the palm oil industry is turning to West Africa

Elaeis Guineensis - the oil palm - originated in the tropical rain forest of West Africa. For centuries local people have been hacking down bunches of its red fruit and squeezing out theoil.

In the nineteenth century the region was the centre of an emerging global trade. It supplied palm oil to lubricate the wheels of the industrial revolution or, as Lever's famous Sunlight Soap, to clean the hands of the workers.

Now the West African industry is being revived and the prospects look good. Although freight costs will probably keep West African palm oil out of the Chinese market, it is closer to Europe and America's east coast.

But for the time being there is the domestic market to satisfy. Amazingly, given its heritage, West Africa is an importer of palm oil to the tune of some 500,000 tonnes per year.

In the October issue of Red Hot Penny Shares I describe one company that has seized this emerging opportunity and could build a multi million-pound palm oil business.

Comparisons with other palm oil producers show that, as this company's oil palms grow, its share price could multiply 25 times over the next few years. That's the sort of opportunity I look for in Red Hot Penny Shares and I reveal this company in my latest issue, available now.

This article was first published on the 5th October in Tom Bulford's twice-weekly small-cap investment email The Penny Sleuth.

Red Hot Penny Shares is a regulated product issued by MoneyWeek Ltd. Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Penny shares can be volatile, relatively illiquid and hard to trade. There can be a large bid/offer spread so if you need to sell soon after you've bought, you might get less back than you paid. This can make them riskier than other investments. Please seek advice if necessary. 0207 633 3780.

Tom worked as a fund manager in the City of London and in Hong Kong for over 20 years. As a director with Schroder Investment Management International he was responsible for £2 billion of foreign clients' money, and launched what became Argentina's largest mutual fund. Now working from his home in Oxfordshire, Tom Bulford helps private investors with his premium tipping newsletter, Red Hot Biotech Alert.

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