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A developing El Nino weather phenomenon is expected to drive palm oil prices higher as the supply-demand balance tightens, with analysts expecting a decline in yields and an increase in biodiesel use in Indonesia and Malaysia amid higher mandates.
Drought conditions in Southeast Asia will most likely intensify toward the end of this year, with severe production losses expected from Q2 to Q4 2027, following a six- to 12-month lag, according to analysts.
A "very strong" event could reduce regional output by 2% to 9% based on historical data, market intelligence provider MySteel said in a statement shared with.
The last strong El Nino episode, which occurred from early 2015 through mid-2016, curbed palm oil yields by 8.3% in Indonesia and 14.2% in Malaysia, according to S&P Global Energy, despite wider acreage.
This year, the early impacts of dry weather and rising fertilizer costs are projected to cut Indonesian palm oil output by 1 million to 2 million metric tons, the country's palm oil association, Gapki, reportedly said.
The El Nino phenomenon coincides with the implementation of higher palm-based biodiesel blending in Southeast Asia. Indonesia will raise its biodiesel mandate from 40% (B40) to 50% (B50) in July. Malaysia has begun expanding its policy from B10 to B15 this month.
Both policies are projected to redirect a total of 3 mmt to 4 mmt of palm oil from the export market to domestic energy use annually, according to data cited by MySteel.
Stronger demand from key buyers India and China, as the countries grapple with domestic supply shortfalls, may further weigh on declining exportable supplies.
"This 'supply shock meets demand shock' scenario is forecast to keep prices elevated, potentially adding a 5% to 10% weather premium on top of an already strong market," MySteel agricultural editor Stacy Chen told.
Chen expects prices to range between $1,100 and $1,300 per metric ton in H2.
The Palm Oil Strategic Policy Institute, as cited by the Jakarta Globe, projects global prices to surge to $1,500/mt in H2, driven by weather-linked supply disruptions, elevated energy prices, and Indonesia's B50 rollout.
Meanwhile, "the backwardation in Bursa Malaysia Derivatives' palm oil futures from February 2027 onwards suggests that market participants are not yet pricing a supply shortage," said Vasu Tripathi, S&P Global Energy principal analyst for crops.
"The second half of 2026 through 2027 represents a critical window for palm oil prices," Chen said, with investors to monitor "the actual implementation progress of Indonesia's B50 mandate, the evolving intensity of the El Nino event, and the demand elasticity response from India and China."
Despite prospects of lower output, analysts noted that the weather phenomenon is not expected to delay Indonesia's and Malaysia's biofuel mandates.
Malcolm Goh, Argus palm and residue feedstocks specialist, said that limitations in blending terminal infrastructure will likely dictate progress in the countries' biodiesel policies. Indonesia may also face uncertainties due to the recently introduced policy that centralizes palm oil exports under a state-backed entity.
However, Tripathi highlighted that Southeast Asian countries "may need to reconsider their higher biofuel mandates" next year if palm oil yield losses reach the 2015-16 level.
Going forward, to mitigate the potential impact of El Nino on the biofuels market, Goh noted that "consumers most likely need to explore feedstock diversification toward sources that are less prone to weather impacts, such as waste-based feedstocks."
S&P Global analyst Sarah Abu Bakar said that flexible blend mandates can act as economic safety valves, such as those in the Philippines, where blending requirements depend on prices and availability of supplies.
Dinita Setyawati, senior analyst at Ember, emphasized the need to transition to renewable energies "sooner" to insulate countries from fossil fuel supply shocks.