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The Malaysian Palm Oil Industry Is on Fire in More Ways Than One

Concerns about environmental sustainability clash with Malaysia’s growth needs in the market for this vital agricultural commodity.

Malaysia sees palm oil as a way to power the country’s economy through its recent sluggishness. But international criticism of the environmental impact of oil palm plantations has put some of the country’s leading producers on the defensive and could curtail the industry’s growth potential.

Palm oil is big business for Malaysia. The country produces about 39 percent of global supply, and the commodity accounts for more than 10 percent of the nation’s economy. Much of the rest of the world’s supply— some 44 percent — is controlled by neighboring Indonesia, where Malaysian-owned companies run many of the plantations. Felda Global Ventures, the world’s largest producer of crude palm oil, went public in a $3.12 billion initial public offering in 2012, the largest IPO in the world that year after Facebook’s.

In many respects, the industry’s outlook is bright. Demand for Malaysian palm oil will rise to 66.8 million tons in 2014 from 57.6 million tons last year, according to the Malaysian Palm Oil Board, a government entity. And prices have been rising lately, hitting an 18-month high on March 10 of 2,910 ringgit ($885) per metric ton.

The rise largely reflects low inventories. The effects of a drought in Malaysia during May and June 2013 are still working their way through the supply chain. Some countries, like Indonesia, are retaining more of their production for conversion into biofuels, further squeezing global supply. Expanding production is thus a key goal of policymakers seeking to combat an economic slowdown — growth eased to 4.7 percent last year from 5.6 percent in 2012 — and propel Malaysia into the ranks of the world’s high-income countries.

Increased production has sparked something of an environmental backlash, however, as planters have expanded from traditional growing areas in Peninsular Malaysia into more sensitive territory like Sarawak, a Malaysian state on the island of Borneo.

A 2013 survey published in Science magazine, developed in partnership with Google and its satellite mapping facility, showed that between 2002 and 2012 Malaysia had the highest deforestation rate in the world, largely because of land being cleared for oil palm plantations. Much of the activity in East Malaysia , of which Sarawak is part, has taken place in peat swamp forests, which accentuates the environmental concerns. Such forest land needs to be drained in order to plant oil palms. “When you do that, the peat starts to degrade and rot, creating far higher carbon emissions than any other oil palm–related activity,” says Eric Wakker, a senior consultant on Southeast Asia at Amsterdam–headquartered environmental organization Aidenvironment. Draining peat soil can also release sulfuric acid into the air, given the soil’s high levels of acidic sulfates.

In a 2012 green ranking of corporate environmental impact by Newsweek, Singapore-based Wilmar International, the world’s largest palm oil–refining and –processing company, came in last place out of the world’s 500 largest publicly traded companies, behind Monsanto and mining company Coal India.

Investors have begun to take notice. In 2012 Norway’s Government Pension Fund Global, the world’s largest sovereign wealth fund — and biggest equity investor — with $829 billion in assets under management, pulled out of palm oil companies deemed not to have sustainable production. They included Wilmar; Singapore-based Golden Agri-Resources (GAR), the world’s second-largest oil palm plantation company; and Malaysia-based Ta Ann Holdings, which has extensive holdings in Sarawak.

The palm oil industry has moved into damage-control mode. In late February Wilmar announced that as of January 2016 it would no longer buy oil from plantations built on newly cleared peat and forest land. Explaining the move, a Wilmar spokesperson told Institutional Investor that “big corporates have to lead in the drive towards sustainability.” The spokesperson emphasized that the move would not apply retroactively to land cleared before 2016 and said the company has “already begun to engage our suppliers and advised them not to conduct any new peat land clearance.”

Many nongovernmental organizations applauded the move, but it caused outrage in the local industry.

“If we are not allowed to plant on [peat and forest land], then there will be no oil palm planted in Sarawak,” Tan Sri Dr James Masing, land development minister in the state of Sarawak, told reporters. “If you want to plant palm oil where there is no forest, you will have to go to the Sahara.”

Share prices for plantation companies with heavy commitments in Sarawak, including Ta Ann Holdings and Sarawak Oil Palms, fell after the Wilmar announcement, but both stocks have since recovered sharply. Shares in Felda Global Ventures have traded in a narrow range over the past year, closing at 4.59 ringgit on March 13, just above the June 2012 IPO price of 4.55 ringgit.

Wilmar’s move did not come out of the blue. In 2004 planters, suppliers and governments from many palm oil–producing countries joined to form the Roundtable on Sustainable Palm Oil. Since 2008 the RSPO has been certifying products according to a baseline of sustainability standards. Some big palm oil buyers, including the Anglo-Dutch consumer goods company Unilever and Kellogg’s, the Battle Creek, Michigan–based cereal producer, have announced plans to use only sustainable palm oil.

“Most major players will eventually be pressured to have a sustainability policy,” says Alvin Tai, plantations sector analyst with RHB Research Institute, a financial services provider in Kuala Lumpur. “In the future, practice will get much tighter on sourcing.”

GAR has also adopted a no-deforestation policy and is working closely with Greenpeace to implement a sustainability strategy. Felda Global Ventures is unlikely to suffer direct effects from Wilmar’s decision since the bulk of its estates are in Peninsular, or West, Malaysia.

There is also sentiment among some Malaysian oil palm growers that the larger producers are using sustainability as a way to push the smaller landholders out of business, effectively violating local antitrust laws. “The vertical arrangement between Unilever and Wilmar upon palm oil growers in the peat land areas in Sarawak is preemptive and unilateral,” said an unnamed RSPO member who was quoted by Malaysian newspaper the Star. “This trade overture might either compromise or infringe” our antitrust laws.

The Malaysian Palm Oil Association (MPOA), a trade association that counts among its members some of the world’s largest palm oil companies, including Felda, has been sparring for some time with the RSPO over various issues, including effluents from palm oil mills and greenhouse gas emissions.

If the group leaves the RSPO, it would follow its Indonesian counterpart, Gapki, which left the group in September 2011. The Indonesians said the country’s crude palm oil exports did not fetch a high enough a price to justify the extra costs of RSPO compliance.

“RSPO may become too difficult for certain players,” says Ivy Ng, an analyst with CIMB Investment Bank in Kuala Lumpur. “There is a growing need for palm oil in the world, so you don’t want to stifle growth by making the rules too strict.” If the Malaysian industry group decides to do away with its RSPO designation, individual palm oil producers could remain members independently.

With big buyers like Wilmar committing not to source from newly cleared peat and forest land, the industry’s ability to expand in Southeast Asia appears constrained. There isn’t much nonpeat, nonforest land left to develop in Malaysia or Indonesia. During a 2008 press conference in Kuala Lumpur, Malaysian plantation industries and commodities minister Peter Chin Fah Kui suggested that Malaysian growers expand elsewhere, such as in Africa or South America. Shortly before Chin made these remarks, Felda announced plans to develop a 100,000-hectare (386 square mile) oil palm plantation in Brazil’s Amazon region. Sime Darby, another major Malaysia-headquartered producer of palm oil, has established operations in Liberia during the past few years.

In the short term, however, the environmental factor driving the palm oil market is not land but rain or, rather, the lack of it. Dry weather has depressed production to its lowest levels since April 2012, and Malaysia’s palm oil exports dropped 5 percent in the first 10 days of March from a month earlier, to 293,879 tons. Should the dry spell persist, yields are likely to continue to decline ­— pushing up prices — regardless of the sustainability debate.

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