KUALA LUMPUR, Malaysia–Weak palm oil output in Southeast Asia is likely to push Malaysia’s stocks below 1.6 million metric tons at the end of the second quarter, although lackluster demand for biodiesel and rising production will likely help inventories rebound by the end of the year, an influential palm oil analyst said Wednesday.

London-based LMC International Chairman James Fry said at an industry event in Kuala Lumpur that Malaysia’s stockpile of palm oil will likely fall in the second quarter before rising to more than 2.5 million tons in the fourth quarter.

However, palm oil stockpiles could fail to rise if discretionary sales of biodiesel becomes viable with lower crude palm oil prices or a dramatic policy switch to boost local biodiesel production, he said. According to the Malaysian Palm Oil Board, end-January palm oil stocks totaled 1.77 million tons.

Palm oil production and stockpiles fell in January and December due to heavy rains in Malaysia, which reduced production. Indonesia and Malaysia account for 85% of the world’s total palm oil supply.

The year-over-year decline in palm oil output in the first quarter of this year is set to be greater than the decline in the fourth quarter of 2014, Mr. Fry said. However, output growth is likely to return by the second half of the year.

The development could add further pressure to the market amid the slump in crude oil prices, which has made fossil fuels cheaper than biodiesel. Also, the biofuel sector no longer has support from biodiesel production in Indonesia, where the tax structure has changed, said Mr. Fry.

“Until October 2014, if free-on-board crude palm-oil prices equalled Brent oil prices, Indonesian biodiesel makers bought their feedstocks at well below Brent. Now, the support they enjoyed from export taxes has gone,” he said.

The favorable export-tax structure was crucial in taking surplus crude palm oil off the market, as it made biodiesel exports profitable on many occasions from 2012 to 2014, he added.

When CPO falls below $750 a ton on a free-on-board basis, demand from discretionary biodiesel demand is hit. Crude palm oil from Malaysia on a free-on-board basis is now around $660/ton.

Mr. Fry said that with Brent oil at $60 a barrel, the average price of crude palm oil is likely to be 2,260 ringgit ($623) a ton in the first half, and the average price will likely fall to MYR1,770/ton in the second half.

For discretionary biodiesel production to be viable when Brent oil is at $60 a barrel, CPO needs to be at MYR1,540-MYR1,630/ton on a free-on-board basis. If Brent falls to $50 a barrel, CPO needs to be at MYR1,270-MYR1,360/ton a free-on-board basis for biodiesel production to be viable, he said.