Palm oil: food and fuel risk is back for investors

In a surprise recent announcement, UK supermarket Iceland pledged to remove palm oil from its own-label food products by the end of 2018. It is taking a capital hit of £5m (€5.73m) to avoid passing on the costs of reformulation to customers. That followed a vote in January by the European Parliament to phase-out palm oil-based biofuels by 2021 on the basis that any potential benefits from reduced emissions would be nullified once the costs of deforestation are factored in. Both developments could be interpreted – in the unusually blunt terms employed by Iceland – as “a direct response to the palm oil industry’s failure to clean up its act”.
For investors exposed to the commodity, making the right call is paramount. If palm oil production is incompatible with sustainability, public sentiment may continue to shift and increased reputational risks could have stark implications. And investors have significant exposure. Many track indices containing palm oil-linked companies.
The de facto standard for sustainability best practices and good management is the high-profile Roundtable on Sustainable Palm Oil (RSPO), which claims to credibly represent the sector with a multi-stakeholder model drawn from NGOs, financiers and producers. The RSPO’s fortunes are inextricable from its ability to deliveron its stated vision to “make sustainable palm oil the norm”. However, the RSPO says only 19% of current global palm oil supply carries its Certified Sustainable Palm Oil (CSPO) label, the flagship RSPO certification. In 2013, The Guardian newspaper reported that nearly half (48.3%) of CSPO badged palm oil had failed to find buyers and had to be sold as conventional palm oil without a price premium. At the time, Darrel Webber, RSPO CEO, said this had lead to “sluggish uptake” for RSPO certification by producers and buyers.
In 2016, a WWF survey of 137 of the world’s largest retailers, food companies and consumer goods producers found that less than half (43%) purchase CSPO, although at the time it said certified stock could meet the collective demand of all the surveyed companies. The weak demand, despite many global buyers having pledged to source responsibly, prevents a convincing economic case being made as responsible growers find that they are not able to offset costs associated with certification by charging price premiums.
Critics of the RSPO have questioned the fundamental integrity of certification. Through an in-house credit trading platform, companies are able to use RSPO packaging on products containing palm oil from any source as long as they purchase credits from
certified producers for every ton of palm oil produced. This raises doubts as to the actual sustainability of RSPO-branded products. Greenpeace has argued that it is akin to “certifying destruction”. RSPO’s multi-stakeholder model has also led to claims that member interests are impeding the pace of change.
But when the RSPO does act, there are severe consequences. The 2016 suspension of IOI Plantations, a Malaysian supplier, due to noncompliance resulted in the loss of one-third of its market cap, a credit score downgrade and the loss of major procurement contracts.
Despite the staggering environmental and social costs of palm oil production and the criticism of the industry’s efforts at self-regulation, environmental interest groups largely advocate for reform not prohibition. This hinges on the consensus that there are few viable alternatives. Substitutes such as rapeseed, sunflower and soya bean oil require hydrogenation to achieve the desired consistency at room temperature, a process which increases the risk of obesity, high blood pressure, and heart disease. When used as a component of biodiesel, palm oil leads to a reduction of 50% in emissions compared with conventional fossil fuels, the only vegetable oil to do so. The palm plant is also around 10 times more productive than these substitutes, the implication being that replacing palm oil will require as many times the amount of land.Prohibition does not mean eradication of the problem. Far from it, warns Madere Olivar, Head of Consumer Goods Research at Sustainalytics, the ESG research provider. The reduction of demand could instead encourage producers to approach consumers in other markets who may be much less stringent in their sustainability requirements. She says: “There is a concern that industry momentum toward sustainable production might stall or even be reversed as a result.” Already, it seems that this warning is coming to pass. Malaysian and Indonesian producers are reportedly eyeing new markets such as Pakistan, Myanmar, Chile and the Middle East in response to the EU ban and other trade hurdles. In 2015, global palm oil production was estimated at 62.6 million tonnes, an increase of 311% over the preceding decade, and it continues to be the highest production volume of all vegetable oil. The commodity is here to stay, and investors are well placed to encourage the continued development of sustainable practices in the industry. Shareholder engagement can help reinforce existing consumer pressure on global brands to increase CSPO uptake with a view to establishing it as an industry standard. Clearing this hurdle would exponentially improve regulation as producers find it in their best interests to maintain certification. Investors would be rewarded with access to developed economies, increased brand loyalty and the promise of improved earnings as a result.