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Palm Oil Frontiers: Lessons Learned from SE Asian Corporate Expansion to Africa – ValueWalk

  • On February 2, 2017

valuewalk.com
Palm Oil Frontiers: Lessons Learned from SE Asian Corporate Expansion to Africa – ValueWalk

Companies analyzed include:

Felda Global Ventures (FGV:MK)
Sime Darby (SIME:MK)
Golden Agri-Resources (GGR:SP)
Kuala Lumpur Kepong (KLK:MK)
Wilmar International (WIL:SP)
Olam International (OLAM:SP)
Golden Veroleum
Equatorial Palm Oil (PAL:LN)

SE Asian corporations – Golden Agri-Resources, Kuala Lumpur Kepong, Sime Darby, Olam International, Wilmar International, and Felda Global Ventures – are seeking to expand their palm oil business in West and Central Africa. Palm oil has been identified as a driver of both tropical deforestation and climate change, and this expansion also often has financial risks due to concerns about negligence of communities’ rights and environmental impacts. At the same time, countries supporting palm oil expansion are often post-conflict, fragile states seeking development and investments, dealing with weak governance and legal systems and lack instruments to stimulate and regulate responsible management practices.

Investments in Africa since 2008 illustrate both systemic and company-specific material financial risks. For example, the experiences of investors and corporations expanding into Liberia illustrate that it is important to absorb lessons from previous SE Asian investments regarding specific social and environmental risks and opportunities.

Key Findings

Operational Risks: Hazards to investments can threaten the economic viability of projects when key risk management lessons are not applied in frontier markets. For example, relying on government assurances has proven to be insufficient in securing title when land banks are contested.
Stranded Assets Risk: Contested land bank reduces future growth and impacts investor value. Key drivers are difficulty in forecasting public policies, governance risk, land-tenure disputes resulting from unclear customary and legal ownership, and international deforestation policy commitments and regulatory changes to halt climate change.
Financial Risks: Failure to obtain free, prior, and informed consent (FPIC) from local communities can result in cash flow disruption. For example, every SE Asian investment in Liberia has been subject to delays, community conflicts, and complaints filed with the Roundtable on Sustainable Palm Oil (RSPO).
Reputational Risk: Violations of procurement policies and ESG criteria imposed by investors, buyers, and certification standards can damage companies’ reputation. This increases revenue-at-risk and earnings volatility, and may increase the cost of capital as lenders price risks more accurately. For example, civil society has had success in monitoring current and proposed corporate actions in Liberia.
Regulatory and Procurement Risks: Companies relying on land conversion for large-scale plantations may no longer be compliant with corporate buyers’ procurement policies regarding environmental and social risks, and international deforestation policy commitments.
Palm Oil in Africa Can Succeed: Effective financial risk management aligned with investors’ expectations and local communities’ requirements and avoiding deforestation and biodiversity impacts can drive long-term financial returns. Large-scale concession models may become obsolete. Schemes that integrate smallholders and respect customary land rights are a precondition to create mutual benefits for both sides and value creation.

SE Asia Palm Oil Social and Environmental Impacts: Lessons Learned

From Africa to the World: Originating from Africa, the oil palm was harvested by subsistence smallholders in West and Central Africa from wild or semi-wild trees for centuries. After full domestication was achieved in the early 1900s, large plantation companies introduced new varieties to colonial Central Africa, first to Cameroon and today’s Democratic Republic of Congo (DRC). In the post-colonial years, as mineral mining and petroleum exploitation generated greater government revenue, interest in palm oil waned.

SE Asia Leads: In the 1960s, Malaysia pioneered large-scale industrial cultivation of oil palm trees. With a comparative advantage from low production costs, high productivity, and palm oil’s versatility of use in food and non-food, global demand caused production to quickly expand to Indonesia. The two countries today are responsible for 85 percent of global palm oil production. Currently, a large share of SE Asian palm oil production is in the hands of private enterprises. A comparatively small share of production is managed by smallholder farmers.

Deforestation and Greenhouse Gas Emissions: Emissions from tropical deforestation and forest degradation are responsible for 7 percent to 14 percent of the total global greenhouse gas emissions from human activities. Indonesia’s plantations have been predominantly established in carbon-rich tropical forests and peatlands, where clearing and draining for palm oil cultivation, often with the illegal but widely practiced slash-and-burn method, releases significant greenhouse gas emissions. Tropical peatlands can burn for many months, which has led to severe regional haze problems. It has been connected to thousands of deaths in SE Asia in recent years.

Indonesia is one of the world’s largest producers of greenhouse gases. 85 percent of the country’s emissions come from forest destruction and degradation. During 2015, Indonesia’s average emissions repeatedly exceeded those of China and the U.S. Indonesia’s primary forest loss totaled more than 6 million ha from 2000-12. In 2012, Indonesia lost 840,000 ha of primary forest, the largest loss globally for any country.

Human Rights Violations: The rapid expansion of palm oil production in SE Asia has also been connected to serious human rights violations, including child and forced labor. Migrant workers, whom are often discriminated against and exploited, are widely involved in palm oil production. Jobs available on palm oil plantations are often casual and seasonal. When compared to smallholder cocoa, rubber, rice and agroforestry, industrial palm oil creates fewer jobs per ha. Smallholders owning and managing their own estates tend to have higher earnings than laborers on corporate palm oil estates.

Value Appropriation vs. Value Creation: The full potential benefits from palm oil production for the economy and livelihoods of people in SE Asia have not been realized. This is due to the lack of a strong regulatory framework and policies that often favor extraction and value appropriation over investment and value creation. At the same time, smallholder cultivation – which currently accounts for one-third of production in SE Asia – has long been prevented from further expansion by disregard of land rights and lack of access to quality inputs and affordable finance.
Persistent Production Rise Despite Volatile Crude Palm Oil Prices

Volatile Markets: As shown below in Figure 1, after a sharp decline during the 2007-09 global credit crises, palm oil prices tripled and then collapsed. Since 2011, crude palm oil (CPO) prices declined about 50 percent caused in part by shifting buyer preference and a decrease in demand for biofuels caused by low petroleum prices.

Continuing Demand for Food and Fuel: In the 2015/16 agriculture season, palm oil and palm kernel oil accounted for 37 percent of world vegetable oil supply, followed by soybean oil at 29 percent and rapeseed oil at 16 percent. Rising global food demand – currently accounting for an estimated 68 percent of global palm oil production – and the expectation of biofuel demand picking up are likely to expand palm oil production in the foreseeable future.

From 2016-25, palm oil production is forecasted to increase 29 percent. Indonesian output is forecast to grow by an additional 2.5 percent annually over the same period. This is lower than Indonesia’ 8.1 percent annual growth over the previous decade. Malaysian growth is forecast to grow over the same period by 2.1 percent annually compared with 2.4 percent annually over the previous decade.

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