According to the latest NOAA forecast from August, there is a greater than 90% chance that the El Ni帽o event in the fourth quarter of 2026 will reach super-strong intensity, surpassing the previous cycle of 2023-2024 and gradually aligning with the strength seen in 2015-2016. Meanwhile, the ongoing conflict between the US and Iran has raised concerns about elevated fertilizer and material costs, potentially impacting new crop planting. Combined with a strengthening El Ni帽o, expectations of lower crop yields have led some institutions to adopt a bullish stance on agricultural commodity prices.

Looking at historical data, Malaysia experienced unusually high temperatures and record-low soil moisture levels across many regions in 2016. The situation in 2015 was comparatively better, yet the following year still saw a production drop of nearly 2.6 million tonnes due to both the direct impact of extreme weather and the lingering effects from the prior year. In contrast, Indonesia faced its worst soil moisture conditions in 2015 with higher temperatures in the latter half of the year, but conditions improved in 2016. During that period, Indonesia's palm oil sector was still in a rapid expansion phase, which offset the direct impact of drought. However, a presidential moratorium on new oil palm plantations and permits in 2016, along with delayed effects from the 2015 weather, ultimately led to a 1-million-tonne production decline in Indonesia that year.

During the 2018-2019 El Ni帽o, soil moisture levels in Malaysia's Sabah and Sarawak regions did not significantly fall below historical averages, and any deficits were short-lived. From 2020 to 2021, soil moisture in these regions was actually more favorable. In Peninsular Malaysia, Pahang and Johor experienced poorer soil moisture during 2018-2019, with conditions worsening in 2019 and deficits concentrated in the second half of the year. In 2020-2021, Malaysia's overall soil moisture remained relatively high. Malaysia's production fell by 400,000 tonnes in 2018, largely attributed to Pahang and Johor. The 700,000 and 1-million-tonne declines in 2020 and 2021, respectively, were driven partly by poor soil moisture in Pahang and Johor from 2019, and significantly by pandemic-related labor shortages on plantations. Indonesia, with a larger share of younger trees before 2020, saw only a few hundred thousand tonnes of production loss in 2020 despite poor soil moisture across several regions in 2019. The country also faced COVID-19 impacts in 2021 and 2022.

The 2023-2024 El Ni帽o did not severely affect Malaysian growing regions, which recorded two consecutive years of increased production, supported by labor recovery and the positive effects of fertilizer application. In Indonesia, Kalimantan experienced poor soil moisture in the first half of 2023, followed by Sumatra in the second half, with temperatures notably above normal. However, Riau and Jambi provinces maintained favorable conditions. Although soil moisture improved in 2024, the delayed impact of drought still resulted in an Indonesian production decline of over 2 million tonnes. For 2026, Malaysia saw only localized and brief rainfall deficits from January to July, with no prolonged three-month dry spell. In August, however, rainfall decreased across both Malaysia and Indonesia, causing Malaysian soil moisture to decline rapidly, particularly in Sarawak and Sabah. Among the four key regions, only Pahang remained relatively stable. Soil moisture in Sabah and Sarawak is now approaching historical lows last seen in 2016, 2019, and 2023. In Indonesia, some regions have been dry since July, with soil moisture dropping sharply and most areas now at historically low levels.

During the first half of 2026, South, West, and Central Kalimantan experienced periods of below-normal rainfall. While first-quarter rainfall was even lower than in 2023, the second quarter saw a recovery to near-normal levels, avoiding the consecutive months of deficits seen in 2023. Sumatra's rainfall pattern was better than Kalimantan's. However, in the second half of 2026, many Indonesian regions, especially West, South, and Central Kalimantan and South Sumatra, have seen scarce rainfall. Monthly totals in these areas are close to the dry years of 2015 and 2023, with some regions experiencing consecutive dry months in July and August. According to NOAA forecasts, Indonesia is expected to remain dry through September 1, while Malaysia's rainfall may improve, potentially resulting in a three-month consecutive drought in parts of Indonesia.

Fire incidents in Indonesian production areas follow a seasonal pattern, though the frequency varies annually. Recently, the number of high-risk fires in Kalimantan has declined compared to earlier periods. On a monthly basis, fire counts are higher than in 2023 but lower than in 2015 and 2019. Sumatra has seen significantly fewer fires compared to historical norms. These fires are largely seasonal rather than unique to this year, with some occurring outside oil palm plantation areas. Given that Indonesia still recorded production increases during severe fire months in 2023 and 2019, fires are unlikely to be the primary driver of production declines this time.

The current El Ni帽o has indeed reduced rainfall and rapidly depleted soil moisture in Malaysian and Indonesian growing regions. Weather forecasts suggest Malaysian areas will see improved rainfall by early September, while Indonesia remains dry, with some regions facing three consecutive dry months. As El Ni帽o strengthens, the market is increasingly concerned about the possibility of prolonged droughts similar to 2015 and the second half of 2023. Attention must also remain on future rainfall patterns in Malaysia. Reviewing past El Ni帽o events, Indonesia's palm oil sector has moved past its rapid expansion phase. Earlier events saw production impacts mitigated by aggressive planting, but since 2020, the negative effects have been increasingly pronounced. For Malaysia, with relatively stable planted area and aging trees, sensitivity to El Ni帽o is heightened after the full labor recovery effect was realized in 2025. This makes Malaysia more vulnerable to El Ni帽o compared to Indonesia, a pattern evident before 2020. Consequently, the current El Ni帽o is expected to have a more significant impact on production in both Malaysia and Indonesia than previous events.

The recent rebound in palm oil prices appears to be driven more by speculative capital pre-emptively trading on El Ni帽o-driven production cut expectations. Institutions are also boosting bullish sentiment by forecasting higher agricultural prices due to elevated crude oil and fertilizer costs. Position data suggests the influx is largely from quantitative funds. However, the persistent high inventories in both Malaysian producing regions and domestically remain a challenge. Resolving this either requires palm oil to become more competitive through a wider soybean oil-palm oil spread, or through adjustments in the term structure. The reality is that spot supplies are difficult to move, and long positions are hesitant to take delivery. Palm oil has not opted to reduce inventories through price cuts but has instead moved ahead on expectations. Looking back at 2023, if crude oil fails to rally or begins to decline, palm oil's strength relative to crude is unlikely to be sustainable. The current rally is being sustained more by macro conditions and speculative capital than by hedging from the industry, especially since import bookings continue and producing regions are not short of supply. For now, the momentum rests with the speculative forces.