What is palm oil and which companies depend upon it?
Palm oil is a vegetable oil from the fruit of the oil palm tree. It comes in two forms, crude palm oil from the flesh of the fruit, and palm kernel oil from the kernel of the fruit. Palm oil has been reported as a commodity since the 15th century, although it was likely used for centuries before this. It is native to western Africa and was originally traded in tandem with the slave trade. Following the abolition of slavery in Britain in 1807, palm oil became the key replacement commerce for the west African traders. Its demand increased when it became a key component in the industrial revolution – it was an ideal substitute of animal-based fatty wax used in soap and candle making, as well as being used as a key lubricant for machinery. One of the companies most involved in the industrialisation of palm oil was Lever Brothers. They merged with Margarine Unie to form Unilever in 1929.
It wasn’t until 1911 that the first successful plantation of palm oil was set up in Indonesia. Although not native to the area, the oil palm tree was taken to Indonesia by the Dutch colonists and planted in the botanic gardens. Here the botanist Adrien Hallet, observed the yield of the plant in Indonesia being higher than in its native Africa. This led to the first oil palm plantation. By 1936 the Indonesian plantations had surpassed all Nigerian palm exports. The majority of palm oil is now produced in Indonesia followed by Malaysia, Colombia, Nigeria and Guatemala.
Palm oil is predominantly used in cosmetics, but it is also found in 50% of all packaged products in a British supermarket. Therefore, consumer goods companies, whether they are producing face cream or chocolate, are dependent on palm oil. The Evenlode portfolio, across all 5 funds, has a consumer goods exposure of 19%, therefore understanding the nature of this commodity is essential to Evenlode’s investment process.
What makes palm oil so special?
Palm oil is both versatile and efficient. Its versatility has increased the demand over time as new applications have been discovered. It stays firm at room temperature but melts in the mouth, therefore, it has become a key ingredient in margarine, chocolate and many other foods. Palm oil is used to manufacture sodium lauryl sulfate which is used as the foaming agent in body care products and household cleaning products. As a fat, it also makes an ideal emulsifier for moisturises, make-up and candles. Alongside its versatility, it is significantly more efficient than other oil-producing crops. In comparison to rapeseed oil, which has the second highest yield per hectare of land, palm oil yields 2.99 tonnes versus 0.73 tonnes. Palm oil makes up over 35% of vegetable oils and is grown on less than 20% of the land in comparison to rapeseed and soybean production. It also requires less pesticide and fertiliser.
Palm oil has created significant employment opportunities for a large portion of the population in Indonesia and Malaysia, lifting many out of poverty. Following the second world war, Malaysia used palm oil production to promote economic growth by establishing the Federal Land Development Authority (FELDA) to distribute land to farmers for development. This programme gave each farmer four hectares of land to grow palm or rubber, as well as a small house and land to plant food. Malaysia received recognition for this model of alleviating poverty by the World Bank and the United Nations. Indonesia soon followed a similar model with support from the World Bank. Currently more than 7m smallholders globally cultivate oil palm as their main form of livelihood, with an additional 11m people being employed by the sector in Indonesia and Malaysia. Therefore, the industry continues to serve as an effective economic tool to alleviate poverty in a sustainable way.
The price of palm oil has remained relatively stable over the last few years compared to other commodities. It saw a significant increase, reaching its highest price of 7,268.00 MYR/MT in the first half of 2022 due to the Russian invasion of Ukraine and Indonesia’s temporary export ban. The price returned to normal ranges in 2023 and has remained relatively stable since then.
What is the problem with palm oil?
Despite the popularity of the product, concerns began emerging in the early 2000s over the significant environmental damage caused by the industry. Large scale deforestation occurs to create space for palm oil. This has led to a destruction of animal habitats and subsequently a loss of biodiversity. Deforestation driven by the palm oil industry is a major factor in the decline of orangutan populations, pushing them toward extinction. In the name of socio-economic improvement, forests were indiscriminatory cleared to grow palm oil. This removal of forests increases climate change due to excess CO2 no longer being absorbed by the forests. To clear the land, the forest is often burned, generating even more CO2. It is cheaper for smallholder farmers and plantation owners to burn down the ancient forest than to increase the efficiency of their current land.
These issues can be traced back to the cheap price of palm oil. The price of palm oil in the late 1990s and throughout the 2000s meant manufacturers turned to palm oil as a cheap and effective alternative to petroleum-based chemicals and it became a biodiesel feedstock. Making biodiesel from palm grown on newly cleared land increases greenhouse gases when compared to petroleum diesel. In response to this research, the EU is phasing out palm biofuels by 2030. Indonesia, however, still markets palm oil as Green Diesel.
Is there a solution?
The current global demand and usage of palm oil is unsustainable, with increasing demand leading to widespread deforestation, particularly in Indonesia and Malaysia. Some argue that due to this deforestation, palm oil should be boycotted. However, it is not that simple due to the efficiency of the palm oil crop. If palm oil was no longer in demand, alternatives could be found in other vegetable oils such a soybeans and rapeseed, however, they require significantly more land. Soy is primarily grown in the Amazon and is responsible for more than double the deforestation of palm oil. Therefore, we must focus on alternative, more sustainable methods of growing palm oil, forming a sustainable system for its production. The Roundtable on Sustainable Palm Oil (RSPO) was set up in 2004 and aims to promote the growth and use of sustainable palm oil products through global standards and multi-stakeholder governance. Although this has led to some improvements, consumers pay higher prices for responsibly sourced products and historically, producers have not had any incentives to seek certification. For example, only 17% of all palm oil sold is certified.
The European Union Deforestation Regulation (EUDR) is on track to come into effect in January 2026. This will ensure that all palm oil sold must be grown on land that has not been deforested from 2020 onwards. If the product does not comply with this and was grown on deforested land, a fine of up to 4% of revenue will be applied to the company selling the product. This regulation has pushed companies to engage with their supply chains regarding their palm oil mills in more detail, consider the traceability of their products and work with smallholder farmers to ensure than efficiency of the land is maximised. Many companies now report to the ‘Palm Oil Scorecard’, run by the Worldwide Fund for Nature (WWF), which provides clear information about their efforts to improve their sustainability of their palm oil supply chains. Despite the increased efforts from the EU, there has been significant opposition from Indonesia and Malaysia. They have stated it will increase cost to the producers of palm oil, have a disproportionate impact on those from a lower household income and could have a devastating impact to the nation’s economy.
Despite the growing push for traceability regarding deforestation caused by the palm oil industry, the current global political landscape threatens to delay or weaken regulations such as EUDR to accommodate political agendas. This could exacerbate deforestation, putting the people of Indonesia and Malaysia at heightened climate risk, as well as reducing the likelihood of keeping below the 2-degree scenario outlined by the Paris Agreement.
Rebecca Nash, Stewardship Analyst
2024
Please note, these views represent the opinions of the Evenlode Team as of 2024 and do not constitute investment advice. Where opinions are expressed, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice. This document is not intended as a recommendation to invest in any particular asset class, security or strategy. The information provided is for illustrative purposes only and should not be relied upon as a recommendation to buy or sell securities. Every effort is taken to ensure the accuracy of the data in this document, but no warranties are given.