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Asia Insight

Palm oil: Indonesia and Malaysia push back as EU clamps down

Producers threaten legal action while rushing to shore up industry

ERWIDA MAULIA and P PREM KUMAR, Nikkei staff writers | Indonesia

JAKARTA/KUALA LUMPUR -- Asia's two dominant palm oil producers, Indonesia and Malaysia, may be heading for a clash with the European Union in international court over an EU clampdown on the fuel. Indonesian President Joko Widodo, however, is not waiting around for someone else to decide the fate of the industry.

On Aug. 12, the president led a cabinet meeting on an urgent topic: biodiesel.

Widodo told his ministers that he wants all diesel sold in Indonesia to contain 30% palm oil by next January, versus the current ratio of 20%. "And then later, at the end of 2020, I want it to jump to B50," he said, meaning 50%. In a speech to parliament that week, the president said the ultimate goal is 100%.

Raising domestic consumption is more crucial than ever. The European Commission decided last year to completely phase out imports of palm oil for transport fuels by 2030, citing widespread deforestation. Not only is the EU one of the top export markets for both Indonesia and Malaysia, but officials in Jakarta and Kuala Lumpur fear relentless campaigning against palm oil could trigger a broader global backlash that would threaten the industry's survival.

With global trade upheaval also throwing the market into flux, producers are scurrying to adjust and attempting to rehabilitate palm oil's image.

Palm oil is used in everything from margarine, chips, peanut butter and chocolate to shampoo, cosmetics, cleaning products and biofuels. For decades, critics have claimed it is hazardous to health, while conservationists blame expanding plantations and slash-and-burn farming for endangering orangutan populations and the climate. Greenpeace says over 74 million hectares of Indonesian rainforest have been "logged, burned or degraded" in the last half century.

Yet Indonesia, which accounted for 56% of global palm oil supply in 2018, and Malaysia, which contributed 28%, claim the EU's real concern is protecting its own rapeseed and sunflower oils.

A forest fire burns next to a palm plantation in Indonesia in July. Widespread deforestation has made palm oil a major target for conservationists.   © Reuters

The Indonesian cabinet meeting -- where Widodo also instructed his ministers to study using palm oil in jet fuel and developing biogasoline -- came a few days after the president visited Malaysia for a summit with Prime Minister Mahathir Mohamad. In an interview with the Nikkei Asian Review after the summit, Mahathir said Malaysia and Indonesia are "thinking about" taking the issue to the International Court of Justice in The Hague.

"We are very disappointed and we feel that this [anti-palm oil campaign] is not so much because palm oil is dangerous to health, but more because of the competition in the edible oil business," Mahathir said. "This is about world trade, and we have to look into trading practices first. If it breaches any international law, of course, we will go to the international court."

The two big Southeast Asian producers had previously signaled their intention to file a formal complaint with the World Trade Organization.

Europe, on the other hand, argues the playing field is tilted against its farmers. The spat escalated on Aug. 13, when the EC imposed countervailing duties of 8% to 18% on imports of subsidized biodiesel from Indonesia. An "in-depth investigation found that Indonesian biodiesel producers benefit from grants, tax benefits and access to raw materials below market prices," the commission said in a statement. "This inflicts a threat of economic damage to EU producers."

The industry turbulence is especially alarming for Indonesia, which relies on palm oil more than its neighbor. The commodity was Indonesia's No. 2 export in 2018, after coal, and brought in $20.54 billion -- about one-tenth of its total export income. Palm oil was Malaysia's seventh-biggest export, accounting for around 3.9% of its total.

This year, Indonesian production is expected to total 43 million tons, compared with 20 million tons for Malaysia.

Indonesia has been hit not only by pressure from the EU but also from India, its No. 1 customer until last year. New Delhi imposed higher tariffs in March 2018, causing Indonesia's India-bound exports to fall 12% last year and a further 17% in the first half of 2019, according to the Indonesian Palm Oil Association. Malaysian palm oil became more competitive thanks to an economic cooperation deal it signed with India over a decade ago.

China, which has turned to palm oil to offset a decline in soybean oil imports from the U.S. amid the trade war, has become Indonesia's top buyer and somewhat cushioned the blows. But other growing markets, such as Pakistan and Africa, are not big enough to offset the losses from India and Europe.

Indonesia's overall palm oil exports in the January-June period rose 10% to 16.84 million tons -- figures that could have been higher considering the dramatic growth of plantations and production capacity over the past 15 years. Plantations now occupy 12.4 million hectares, up from 5 million in 2004.

More concerning for producers is spreading anti-palm oil sentiment. Indonesian food conglomerate Indofood Sukses Makmur said Citibank decided to cut off a credit facility this year after a subsidiary withdrew from the Roundtable on Sustainable Palm Oil, or RSPO, the world's largest palm oil certification scheme.

Indofood insisted it was complying with the Indonesia Sustainable Palm Oil standard, or ISPO, which is compulsory unlike the voluntary RSPO. The Indonesian standard, however, is considered less strict.

To an extent, these battles are not new. The industry has gone through its share of ups and downs since a Belgian agronomist opened the first commercial plantation in Indonesia's Sumatra in 1911 and a Frenchman planted oil palms at the Tennamaram Estate near Kuala Lumpur in 1917.

The tribulations of war and independence movements gave way to investment and advances in cultivation. In the 1980s, the American Soybean Association leveled accusations that palm oil raises the risk of heart disease. Many in Malaysia and Indonesia still see criticism of the industry as a smear campaign meant to support soybeans and rapeseed, which cannot compete on price.

"The EU is well-aware that palm oil is the most competitive and sustainable vegetable oil," said Ahmad Parveez Ghulam Kadir, acting director general of the Malaysia Palm Oil Board, branding "efforts to demonize palm oil" as "protectionism."

But while the challenge may be familiar, the stakes are rising.

In Indonesia, the export struggles and slumping palm oil prices have widened the current-account deficit, after last year's U.S. monetary tightening and the simmering China trade war triggered capital outflows and rupiah depreciation. The industry's growth has also made it one of Indonesia's most labor-intensive sectors, employing 4.2 million workers. The government says it provides another 12 million jobs indirectly.

Jakarta hopes the biodiesel upgrades will reduce the need for exports while maintaining employment and curbing demand for imported oil that has become more costly due to the rupiah's fall. Darmin Nasution, Widodo's chief economic minister, recently said Indonesia will save an estimated $3.4 billion in foreign exchange reserves this year thanks to reduced oil imports.

"We continue to see signs that the government's import substitution policies have been increasingly effective in reducing the current-account deficit," Nomura analyst Euben Paracuelles said in a note last week. The brokerage observed that monthly oil and gas imports have fallen by an average of 12% on the year since the 20% biodiesel policy was instituted last September, versus a 29.6% monthly increase in January-August 2018. Monthly domestic palm oil usage has risen by an average of 42.2%, from 14.9%.

Nomura expects the current-account deficit to "narrow modestly to 2.8% of GDP in 2019 from 3% in 2018."

Local companies are cheering the upgrade program. "Surely this is good news for the industry, including for us," Indofood director Thomas Tjhie said recently. "We are studying this biodiesel to capture existing opportunities."

Widodo's insistence on biodiesel may also stem from the long odds of winning a fight with the EU -- be it a joint battle with Malaysia, a broader offensive involving the Association of Southeast Asian Nations, or threats of tit-for-tat trade moves targeting European dairy products. Analysts said Indonesia would suffer more from a trade war, as it exports more to the EU than the bloc does to Indonesia.

Both Malaysia and Indonesia are attempting to improve palm oil's reputation as well.

Widodo this month made a moratorium on forest clearing permanent, protecting around 66 million hectares, though activists say it does not go far enough. Mahathir's government is pushing the Malaysian Sustainable Palm Oil (MSPO) certification system, which emulates the RSPO. Malaysia's goal is to certify all plantations by the end of the year, though only 42% have been covered so far.

It remains to be seen how much weight the MSPO will hold in Europe.

"Without palm oil" -- the label on this package of bread in France assures consumers that it does not contain the controversial ingredient.   © Reuters

Although Europe will prohibit palm oil as a biofuel, EU foreign policy chief Federica Mogherini told Nikkei in July that the bloc "is not banning palm oil" altogether. "What we are doing is taking the climate emergency that our world faces seriously," she said, calling for energy that is "truly renewable and sustainable."

Kalyana Sundaram, head of the Malaysian Palm Oil Council, explained that by January 2020 "all palm oil going into the EU must be certified sustainable." Noting the EU has yet to specify what standards it will accept, he added that Malaysia will work with Europe "to look into MSPO as an accredited palm oil certification system."

The council chief conceded that the EU's biofuel policy could impact Malaysia's exports. Of the 2 million tons of palm oil the country ships to Europe, 750,000 are for fuels. Still, he said, "We have strategies to find alternate markets."

The CEO of Malaysia's FGV Holdings, one of the world's largest plantation operators, suggested palm oil alternatives might be worse for the planet.

"FGV is also conscious of the potential negative environmental impact of moving away from palm oil to any other less productive sources of oil," said Haris Fadzilah Hassan. "In the interest of responsible and sustainable development, FGV is of the view that the EU ought to work with" palm oil producers, "instead of against us."

Nikkei staff writer Ismi Damayanti in Jakarta contributed to this story.

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