Fitch: Palm Oil Producers Adapting to Push For Sustainability

Palm oil producers will continue to face gradually rising pressure from consumers, regulators, investors and environmental groups to adopt sustainable operations, which is likely to drive a further increase in the share of certified sustainable palm oil (CSPO) in global output, says Fitch Ratings. Most producers are already making efforts towards sustainability, but the incentives are stronger for large producers that have the scale to spread compliance costs and product diversity to tap premiums.

Global palm oil production increased to over 60 million tonnes in 2017, from 22 million tonnes in 2000, and palm oil now accounts for around 30% of global vegetable oil consumption. The rising importance of palm oil has increased scrutiny on its impact on biodiversity and tropical forest cover, as well as its social consequences, particularly in the two countries that dominate production - Indonesia and Malaysia.

The push for sustainable palm oil operations mainly comes from the EU, which consumes around 11% of the world's palm oil. High consumer awareness and non-government organisation activism has led many corporates to commit to sustainability and put pressure on EU lawmakers to enact legislation. End-users are less environmentally aware and more price-sensitive in the main Asian markets - India, Indonesia and China - and it is unlikely they will demand sustainable palm oil sourcing in the medium term. In any case, multi-national corporations that operate in these countries are likely to adopt more sustainable practices due to their global commitments for responsible sourcing.

The rising emphasis on sustainability is reflected in the increasing share of CSPO in global output, which reached around 20% in 2016 (see chart), and this trend should continue.

Sustainability compliance adds to producers' costs but also brings benefits. Costs include initial outlays for environmental and social impact studies, corrective action expenses, annual audits and handling and storage costs for the segregation of CSPO from non-certified volumes. On the positive side, compliant producers receive better access to developed markets, and can earn premiums for certified products. Premiums earned are likely to exceed compliance costs, particularly for larger companies that have the infrastructure to segregate and process crude palm oil further to earn higher premiums.

The direct incentives for certification are weaker for smaller producers, especially those focused on the Asian market, and some have indicated a reluctance to pay the extra costs. Nevertheless, sustainability credentials are likely to provide a net benefit to all producers if the broader positives beyond premiums are included. Social engagement processes embedded in sustainability standards can limit losses from disputes with local communities and workers, while prescribed plantation and management practices can support operational efficiency. Several global lenders and investors also emphasise sustainability for funding provision.

Moreover, CSPO producers that have robust sustainable operations are likely to be in a better position for long-term growth as demand for certified crude palm oil continues to rise.

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