The Market Corner: the month in review by Filippo Lecchini
Part of the solution or part of the problem?
In December 2007 the US Government passed a bill with the purpose of increasing dramatically the use of biofuels. The intention of the Lawmakers, at the time, was to address two sets of priorities: energy dependence and environmental concerns. For those who recall the economic environment at the time, the US had started dealing with the subprime mortgage crisis (a warning sign of bigger problems to come) and was in the early phases of an energy rally that eventually reached its peak in summer 2008. Car producers were already feeling the pain of a public concerned with the cost of filling up the tank, with a large share of fossil fuels being imported from abroad. By shifting from fossil to biofuels, the US hoped to achieve more independence from imports and, at the same time, contain environmental damage.
The new plan, however, posed an immediate problem: much like now, there was hardly any land left available for growing new crops in the US. Therefore, increasing production to any degree would require either new imports or land conversion away from edible crops. The intuition was, in fact, correct because the decision for the US to rely increasingly on biofuels, along with the scarcity principle, opened the door to dramatic transformations in far away countries.
The palm tree originates in the West African region, thrives in humid and tropical environments, and can grow as high as 60 feet (roughly 20 meters). According to with the Malaysian Palm Oil Council, within 30 months of planting the palm tree starts bearing fruit; among the oil-bearing crops, it is one of the most efficient plants, requiring only .26 hectares of land to produce a ton of oil. [As a comparison, soybeans require 2.22 hectares.] Palm trees were already popular in the southern part of Asia since the 19th century, frequently planted for ornamental purposes. Palm oil is used in many ways around the world, including in all sorts of foods from pizza to ice cream. As the new US initiative led to growing demand, it should then come as no surprise that somebody was willing to jump at the opportunity. Malaysia and Indonesia became world leaders in the production of palm oil, increasing output dramatically. As a testament to how large the business has become, futures contracts are now listed on multiple exchanges (noticeably Bursa Malaysia) and the industry is booming.
Just over a decade later, the goal of independence seems closer. In part because of differentiating away from fossil fuels, which is not just biofuels but also renewable clean sources like wind and solar. Another contributing factor is a domestic investment in exploration and extraction; the US today is less vulnerable to price and supply shocks. Achieving the environmental goal however, appears a lot more elusive. While there is certainly a benefit from reducing fossil fuels emissions, increasing supply of palm oil came with unintended consequences. Tropical forests and peatlands were burned down extensively to make room for palm trees, producing massive amounts of carbon emissions on the one hand, but also releasing what the native vegetation had retained. As the palm trees grow, they become too tall to harvest with the result of being burned down and replanted again, making emissions an ongoing concern. Other unwanted effects are displacing of local populations, displacing and survival threats for the different animal species, and conversion away from other edible crops, affecting supply and prices of different food on local markets.
In times where various policies seem increasingly controversial, there is a lesson to learn here: innovators need to consider both immediate goals vs unintended consequences and short-term vs long-term environmental effects. Failing to analyze all the different dimensions of any issue might lead to trading a problem today for a problem tomorrow, which is not what policymakers should aim for.
The three big themes for the market in 2018 were the FED’s rate decisions, trade agreements and tariffs, and the Government shutdown toward the end of the year. Fast forward a few weeks and those are still the main catalysts. The FED pretty much announced that they will remain in a holding pattern for now, but tariffs and government funding are still very much in flux. February 15th is the next deadline for the Government to be funded, hopefully through the fiscal year, and March 1st is when the hold for tariffs on Chinese goods expires. President Trump and President Xi will not meet prior to the deadline, even though the rhetoric has been more subdued in recent weeks. Interesting times ahead.
RISK DISCLAIMER: Trading in futures products entails significant risks of loss which must be understood prior to trading and may not be appropriate for all investors. The past performance of actual trades or strategies cited herein is not necessarily indicative of future performance. The information contained herein is provided to you for information only and believed to be drawn from reliable sources but cannot be guaranteed; Phillip Capital Inc. assumes no responsibility for errors or omissions. The views and opinions expressed in this letter are those of the author and do not reflect the views of Phillip Capital Inc. or its staff.