The world is facing a shortage of edible oils and the situation will get worse unless we shift our thinking on palm oil expansion, productivity and sustainability, warns Sebastian Sharp the head of Investor Relations at PT Eagle High Plantations Tbk.
It is late in October, and an early dusk was settling over a moribund equatorial outpost in Central Kalimantan. I looked through the locked fence at a young palm oil plantation and stood chatting with its much older, kretek-chainsmoking owner. ‘We haven’t fertilized in 2 years’, his voice crackled.
One month later, in Bali, the sky was blue and the sun glinted outside. Inside the Nusa Dua Convention Centre, however, it was as if lightning bolts were striking delegates as speaker after speaker at the 13th Indonesian Palm Oil Conference and 2018 Price Outlook, warned about the dire state of the palm oil industry.
By the end of the 2017 conference, organized by the Indonesian Association of Palm Oil Producers (Gapki) and held under the theme of Growth Through Productivity: Partnerships with Smallholders,” it appeared clear to all that the industry may actually be plunging headlong into a crisis.
Precipitating the crisis is a combination of the disappointing palm oil production growth of the past few years and the contrasting steady rise of world demand for edible oils.
The tight supply in palm oil and its equally tight outlook came despite the sharp rebound in palm oil production from the extreme low levels of a year ago. Analyst Dorab Mistry from one of India’s leading industrial groups, Godrej International Limited, espoused the most extreme outlook, telling the conference that by next June, palm oil supply will reach the tightest level ever.
Palm oil remains, to date, the most efficient edible oil producing crop in terms of planting area and productioncosts. It produces the most oil per hectare and can be harvested all year round.
Production, however, has barely matched demand. Palm oil production in Indonesia, which is now the world’s largest producer as well as consumer of palm oil, has been hampered by low productivity and increasingly limited expansion of planting area.
Stocks are also currently at a low level.
Fadhil Hasan, a Gapki Board member, told the conference that palm oil output from Indonesia is expected to rise to 38.5 million tonnes in 2018, from 36.5 million tons this year. or a growth of just 5.5 percent. In addition to the low growth level in palm oil output, the harvest in soybean, another main edible oil source, was also facing a challenge after having gone through seven consecutive years of bumper crops.
A limited global supply of edible oils will lead to a price increase, that could be quite sharp, putting pressure on consumer prices and disposable incomes.
But the prospects of such a crisis also presents a wonderful growth opportunity for the industry. After many years of no meaningful growth, an opportunity to resume growth should be grabbed.
Growth could come in two ways.
The first is through increased productivity, but it was pointed out during the conference that palm oil productivity has not increased in over ten years. To boost productivity now would require significant commitment, effort and financial Investment. Even then an increase in productivity, based on the productivity increase of other edible oil crops, would result only on an additional single percentage point increase to annual supplies.
The second is through expansion of palm oil planting area, to plant more land with palm oil.
With the limited contribution of higher productivity and the significant financial investment needed, there is really no other practical choice but to expand the area under palm oil cultivation so long as the world will continue to need edible oils.
Palm oil expansion in Indonesia, however, faces a serious problem. The country’s palm oil industry cannot grow and one of the reasons is sustainability. The industry is now extremely regulated by government and sustainability groups whose requirements prevent almost any growth.
The lack of growth and decline of the industry can be seen in the net new plantings. While 600,000 hectares is coming to maturity, there’s only 150,000 hectares of new plantings while another 150,000 hectares need replanting. That’s a net zero addition and replanting will rise to over 600,000 hectares over the next four years.
Emblematic of the ongoing decay is the palm oil industry’s current fascination with higher oil extraction ratios (OER). This measures the ratio of oil to bunch weight, which is water, and is seen as a key measure of oil production. It’s not. It’s a measure of decay. When bunches stop growing they die, water evaporates, and as a result OER increases.
Three solutions present themselves to if we are to revive the palm oil sector and boost production.
The first is that we need to shift the notion of sustainability. Sustainability means growth and anything that is not growing is thus not sustainable, it is dying. Sustainability has to find ways to get comfortable with palm oil planting and growth again. Otherwise, the world will see prices jump in the near the future as production stagnates and demand continues to rise.
The second solution is to mechanize. Productivity has to increase through mechanization. This is a mind shift because it would mean more machines — and thus less workers. For many, anything that involves machines taking away jobs from people is anathema but this is dated thinking.
An alternative way to look at mechanization is that even though it may result in less workers, these workers will be better paid and the net effect is that it would create job opportunities elsewhere.
The third solution is to focus on quality. The opposite of OER decay is Free Fatty Acid (FFA) quality. The lower the FFA, the fresher the bunch and the higher its quality. When bunches are fresher OER may be lower, but quality is higher (with low FFA).
This is like shifting the focus to life instead of death and will bring vibrancy back by increasing activity as low FFA requires faster processing and will please consumers. Better and faster harvesting, transportation and handling of bunches will cause less damage to the fruit and thus maintain the FFA level low. Although increased FFA does not represent a quality issue for those who consume the crude oil directly, oil refiners have a problem with neutralization of high FFA content palm oil.
When everything around you is in decay and in decline, there is an opportunity to make something new and expand, not only to gain a tremendous market share, but also to create new markets. We’ve seen this happening in retail, transport, travel and most recently, in money. Whoever grabs this opportunity in palm oil will win big. Blue Oceans are there for the taking.
Sebastian Sharp, Head-Investor Relations at PT Eagle High Plantations Tbk.