Palm oil supplies are to tighten in Malaysia, and prices close their discount with rival vegetable oil soyoil, Rabobank said, despite official data showing a smaller-than-expected drop in inventories, which sent prices lower.

The Malaysian Palm Oil Board said on Wednesday said the country's palm oil inventories ended last month at 2.58m tonnes, a drop of 1.9% month on month, but half the decline that investors had expected.

Exports from Malaysia, the second-ranked palm oil producer and shipper after Indonesia, had exceeded expectations, in falling only 1.6% from December.

But output had beaten forecasts too, in showing a relatively small seasonal decline to 1.60m tonnes, a record for January.

Yield hits

The data fuelled a decline of 2.2% in Kuala Lumpur's benchmark April palm oil contract to 2,504 ringgit a tonne, representing a close below its 10-day moving average for the first time in nearly a month.

However, prices should "rise into the April-to-June quarter" nonetheless as the trend of tighter Malaysian palm oil inventories continues, reflecting in part by a drop in seasonal production amplified by late-2012 dryness, which saw rainfall in the October-to-December period fall 30% below typical levels.

"The reduced precipitation pattern suggests that yields will trend below average in the February-to-June period, compounding the usual seasonal declines in yield over that time," Rabobank said.

"Lower farmgate prices may result in lower input use, further reducing yield potential."

China's growing appetite

Stocks would also be sapped by stronger exports than being factored in by analysts including the US Department of Agriculture, whose agricultural commodity forecasts are viewed as market benchmarks.

China had in the October-to-December period, the first three months of 2012-13, imported, at 3.22m tonnes, 36% of the volumes the USDA had forecast for the whole marketing year, ahead of a normal rate of 26%.

"Although it is unlikely this pace of import continues, given the large stockpiles at ports, we do believe it indicates import demand will end up above the USDA's forecast," a factor "supportive of palm oil prices," Rabobank said.

Indeed, initial analysis suggested that China's imports in January hit a record for the month.

India's imports also look set to "remain strong in the short term", while shipments to second-ranked buyers "has surged, adding further support to palm oil demand."

Market ideas

The market dynamics will be reflected in a flattening of the futures curve in Kuala Lumpur, where near-term lots late in 2012 sank to a huge discount against further-ahead contracts, and a declining discount to rival soyoil too.

A record large South American soybean harvest "will put downward pressure on soyoil prices as exports rebound" from Argentina, the top producer of the vegetable oil.