Palm oil prices on roller coaster amid bullish outlook but soft fundamentals

In January 2026, the palm oil market staged a dramatic performance fueled by expectations over global macroeconomic and energy market fluctuations. The Dalian Commodity Exchange's front-month palm oil contract (P2605) climbed throughout the month, reaching a monthly high of Yuan 9,396 per tonne on January 29, marking a near 10% monthly gain. However, upon entering February, as the bullish expectations were digested and the market returned to fundamentals, prices retreated from their highs, falling below Yuan 9,000 per tonne. This price volatility mirrors the market's core contradiction between strong expectations and soft fundamentals.

I. The Drivers of the Rally: The Optimistic Narrative Built in the Previous Month

The bullish expectations centering U.S. biodiesel demand was the primary driver. The market strongly anticipated that the U.S. Environmental Protection Agency would finalize the renewable fuel standard (RFS) blending mandates for 2026-2027 in early March, with policy details potentially favoring vegetable oil feedstocks, including palm oil. This expectation first ignited the U.S. soybean oil market and, through spillover effects, injected significant upward momentum into global vegetable oil prices.

The Indonesian government's ongoing policy actions to "confiscate illegally planted plantations" have sparked market concerns about potential production losses in the world's largest producer in the coming years. Although the confiscated land may be transferred to state-owned enterprises for operation, the incident has provided continuous risk premiums and concerns on the supply side.

In addition, Malaysia entered the traditional low production season. Mysteel's high-frequency data showed Malaysia's palm oil production in January declined by over 14% month-on-month. Combined with expectations of improving export data, this constituted short-term fundamental support, bolstering prices at the place of origin.

Lastly, strengthening international crude oil prices due to geopolitical conflicts boosted the appeal of vegetable oils as biodiesel feedstocks, providing an additional "energy premium" for vegetable oil prices. Meanwhile, a weaker U.S. dollar also made internationally priced palm oil more attractive.

II. Fundamentals Check: Divergence Between Futures and Spot Markets Amid High Inventory Pressure

In stark contrast to the robust futures market was the weakness in the domestic spot market, which led to a quick pullback in palm oil prices.

Throughout January, while DCE palm oil futures prices soared, the spot basis for domestic palm oil faced widespread pressure and continued to decline across the country. Notably, by late January, the basis for 24-degree palm oil against the P05 contract in South and East China dropped to Yuan -100 to -150 per tonne. In Shandong and North China, the basis hovered below Yuan +100 per tonne. This indicated that downstream industries were unwilling to accept the inflated absolute prices driven by expectations, showing extremely low appetite for chasing highs.

Globally, despite strong Malaysian exports in January, part of the exports may have been deferred from December to January due to tax adjustments. Meanwhile, biodiesel constraints in the EU market may lead to reduced soybean imports in the future, implying sustained global supply pressures.

Domestically, commercial palm oil inventories exceeded 740,000 tonnes by late January, remaining in a historically high range. More critically, as import margins improved temporarily in mid-to-late January, domestic buyers concentrated on purchasing February shipments. Ample upcoming arrivals will continue to pressure the spot market and nearby contracts.

To be more specific, the significantly greater price increase in the domestic market compared to international markets (Malaysian palm oil, U.S. soybean oil) suggests the rally was driven more by large-scale speculative fund inflows in the absence of strong supply-demand drivers. The sharp increase in long positions both fueled the rally and posed a potential risk. That is, should speculators' appetites reverse, a sell-off could occur.

III. February Turn: "Expectation Verification" Interrupted by External Turmoil

The nominee for U.S. Federal Reserve Chair (Kevin Warsh) released hawkish signals, intensifying market expectations of monetary tightening. This meant the premium previously supported by liquidity and a weaker dollar needed to be unwound.

Elsewhere, on January 31, international crude oil prices plummeted, with WTI falling over 5% and Shanghai crude oil futures hitting limit-down. The sharp decline in crude prices drastically reduced the imagination around the biodiesel sector, prompting funds to take profits and leading to a retreat in domestic oil markets.

Simultaneously, the funds that previously drove domestic price hikes showed signs of withdrawal. Based on position data, just two institutions shifted from net short to net long by over 100,000 lots in January. Amid shifting macro sentiment and crude oil trends, these highly profitable, purely fund-driven positions chose to exit, exacerbating the downward pressure on the market.

IV. Outlook: Fundamentals Still Unable to Support High-Price Valuation

The current price cut does not confirm a downtrend but rather suggests a transition into a phase of wide-range, high-level volatility. Future market focus will shift to fundamentals and their interplay with expectations.

Regarding the final details of the U.S. RFS policy (early March confirmation), any disappointing details could deliver a heavy blow to the fragile sentiment. In addition, if inventory drawdowns fall short of expectations or sustainability is questionable with regards to official Malaysian supply and demand data for January, which will be released by mid-February, the seasonal production decline narrative alone will be insufficient to sustain high prices. In China, as prices retreat and related hedging pressure eases, whether downstream consumption can sustain is key to repairing the futures-spot divergence.

In the medium to long term, the global palm oil supply-demand structure has not shown signs of tightening. The EU is projected to reduce palm oil imports by 41% compared to the three-year average in the new season, meaning the market needs to find new markets for excess supply. Secondly, the price spread between soybean oil and palm oil has narrowed, with the forward curve indicating soybean oil discounts to palm oil are already emerging. In major importing countries like India, the demand for soybean oil versus palm oil will shift to "spread-driven" competition.

V. Conclusion: Return to Normality

Overall, the January palm oil rally was collectively driven by global macro policy expectations, geopolitical risks, energy prices, and speculative activity. Entering February, the market's focus has returned to the fundamentals with the sudden shift in US Fed's monetary tone, the sharp decline in crude oil, profit-taking, and persistently weak domestic basis,

The current adjustment is no longer a mere technical correction but an inevitable process of the market "splitting the bill" from the shared optimistic narrative. Until the expectations pay off, palm oil prices are likely to experience wide-range, high-level volatility. Traders are advised to focus more on inter-commodity spreads, futures-spot basis repair, and the sustainability of macro trends.