How will Indonesia cope with slump in demand for palm oil?

With demand for the environmentally destructive crop falling, the future of Indonesia’s key commodity, palm oil, is under scrutiny

From Focus Asean 2016 Issue 01 – download the complete issue via our app here

Indonesia’s natural resources have been an integral part of the country’s history for centuries. Not long after the first Europeans arrived on the archipelago at the beginning of the 16th century, nutmeg, cloves, cinnamon and pepper were being transported back across the Indian Ocean and sold at European markets. Later, non-indigenous crops such as coffee, rubber, tea, tobacco, rubber, sugar and opium were introduced to the Southeast Asian country’s rich soil.

Today, Indonesia’s top export is palm oil. According to the Observatory of Economic Complexity, the country was the world’s top exporter of the substance in 2014, when 45% of the commodity that entered the global market came from the archipelago.

The thirst for palm oil has largely been driven by biofuel demand in Europe, an increase in use of non-hydrogenated oils in the US, and, increasingly, the need for cooking oils in China and India. However, the price of Indonesia’s top commodity export has been falling.

“Indonesia overplanted palm oil,” said Dave McLaughlin, vice president for agriculture at the World Wildlife Fund, speaking in August. “Supply is greatly outpacing demand, and thus you have prices at a six-year low right now.”

Another strain on the commodity’s place in the global market is said to stem from environmental concerns. “There is increasingly more pressure from environmental groups in sensitive markets [such as the US and Europe], which is pressuring companies,” explained Krystof Obidzinski, a palm oil expert with the Indonesia-based Center for International Forestry Research. “Some of these markets are becoming uncertain for crude palm oil.”

Palm oil in Indonesia
A palm oil mill in April 2015. Photo: Uwe Aranas

According to data from researchers at the University of Maryland, Indonesia lost more than 6 million hectares of natural forest between 2000 and 2012. Commodities have had an impact, including coffee and coal mining, but many environmentalists point to palm oil as a major culprit.

Companies that have made pledges to end deforestation include Unilever, Kellogg’s and even McDonald’s, all of which have stated they will work to ensure their supply chains are free of products that contribute to environmental destruction. In 2017, the European Union will begin implementing carbon standards that require imported palm oil to fall under a certain threshold of carbon emissions.

However, only a small percentage of Indonesian palm oil plantations are certified as being deforestation-free under schemes such as the Roundtable on Sustainable Palm Oil, according to the World Resources Institute. “In Riau, the Ministry of Forestry said 50% of the palm oil was illegal – that is two million hectares out of four million,” said McLaughlin, speaking about the Sumatran province that produces the largest share of Indonesian palm oil.

According to WWF, some illegal planting is blatant, including significant lands within Riau’s Tesso Nilo National Park, home to endangered Sumatran tigers and elephants. Even more worrisome are huge swathes of forested land, mostly on more remote, less developed regions in Papua and Kalimantan, already given to the palm oil industry. “There is a huge land bank that is undeveloped – another several million hectares already allocated to oil palm,” said Obidzinski.

In the midst of such environmental concern and falling global demand, the Indonesian government is beginning an ambitious project to boost domestic consumption of the commodity, particularly in the transportation sector, where palm oil can be used as biofuel. The plan would have the added benefit of reducing Indonesia’s dependence on imported oils.

In July, biofuel subsidies of 4,000 rupiah per litre ($0.31), paid for by a $50 per barrel levy on crude palm oil exports, came into place across the archipelago, substantially increasing incentives for domestic consumption. But will palm oil-based biofuels make a difference in helping the country achieve energy independence? The Ministry of Energy’s plans for biofuels sound ambitious: 3.5 million tonnes produced by next year, double the 1.7 million tonnes produced in 2014. That is until you remember that Indonesia is a country of 240 million with fast-growing energy demands.

Indonesia imported 690,000 barrels of crude oil per day last year, with energy demand estimated to grow at 6.6% per year. Compared to this, biofuels may be little more than a drop in the bucket. That is why – though the stated reason for the subsidies is energy security – many experts believe that biofuels will do little in the short or medium term to affect Indonesia’s energy consumption.

“No single source of energy is going to solve the problem,” said Obidzinski, who does not see biofuels, even under the most rosy projection scenarios, making up a major percentage of Indonesia’s energy mix in the short or medium term.

Instead, the benefits will be mostly economic, aiding big businesses hurting from a drop in demand overseas. “The policy…aims to protect the industry, and reduce it from external decision making,” said Will McFarlane of the London-based Overseas Development Institute. “By bringing more of the demand domestically, this gives Indonesia more control over volume and price.”

Aviva Imhof, of the Sunrise Project, argues that energy independence will only come with a move towards renewables in the archipelago, which boasts numerous sunny islands and volcanic peaks. “There is significant geothermal potential, which needs government support,” said Imhof. “Energy efficiency could be improved, especially in Java. Solar is untouched.”

Currently, however, investment in renewables remains far behind that of palm oil and coal, Indonesia’s other major natural resource export. President Joko Widodo has even been pushing for countries to reduce import restrictions on palm oil during his overseas visits, hoping to spur global demand. And one thing remains clear. In Indonesia, palm oil – exported or consumed domestically as biofuels – is still king.

Keep reading: “Golden palms – As stockpiles of palm oil soar and prices slump, will Indonesia and Malaysia succeed in rejuvenating its most profitable export?