The Search Is On For Sustainable Palm Oil
Monday, October 30th, 2017
Demand for sustainable palm oil is growing, presenting multiple opportunities and challenges for the food industry. By Rabobank
The food and beverage industry of today is moving towards sustainability. Not only this sector, but the entire manufacturing industry as a whole is moving in that direction. Driving this is not only for better business profitability and efficiency, but especially with the food sector, it is meeting demands of consumers who are becoming more aware of where their food comes from, and is also companies’ commitments to reduce environmental impact, preserve human rights, and sustain natural resources.
Palm oil is one example of an ingredient where sustainable sourcing is becoming more prevalent. This growing demand for sustainable palm oil is bringing ongoing opportunities and challenges to the industry, but one thing is clear: sustainable palm oil is definitely here to stay.
Demand For Sustainable Palm Oil Will Grow
Today’s food manufacturers are launching more and more products that advertise the presence of sustainable palm oil. However, interest in sustainable palm oil is much greater than can be seen in supermarkets, as only a small fraction of companies sourcing this actually mention it on their packaging.
Many buyers of palm oil have adopted the sourcing criteria developed by the Roundtable on Sustainable Palm Oil (RSPO). These aim to guarantee conservation of natural resources and biodiversity, and to support local communities. The RSPO is the most used certification programme in the palm oil industry, and demand for RSPO-certified palm oil is only growing.
However, demand is showing strong growth. Based on current published company commitments, Rabobank forecasts demand for RSPO-certified palm oil to grow to over 7.5 million tonnes by 2020, or to 10-11 percent of expected global palm oil demand. This is without taking into account possible future company commitments.
This demand will be seen all over the world including Asia; the demand for RSPO-certified palm oil in the region will reach more than two million tonnes by 2020. This is still small, compared to expected global palm oil supplies of between 70-75 million tonnes and expected certified supply in 2020. However, demand for RSPO-certified palm oil will likely be greater, as more companies outside of the EU and the US can be expected to publish commitments by 2020.
Sustainability Interests Drive Diversification Of Sourcing Requirements
Food manufacturers and traders are becoming more ambitious in growing their use of sustainable palm oil. However, they have different levels of ambition and different interpretations of what sustainable sourcing entails, which is adding considerable new complexity to the market. Furthermore, the market can expect even more diversity in sourcing criteria in the coming years, as the public debate regarding minimal requirements for sustainable palm oil is not over.
Already, companies are sharpening their sourcing criteria with regard to both sustainability and transparency of their purchases. Criteria for sourcing palm oil are therefore expected to continue to evolve to tighter levels, which will create a wider diversity in the sourcing criteria.
RSPO’s Sourcing Criteria
Palm oil suppliers selling to food manufacturers that have adopted the RSPO criteria still need to consider their customers’ diverse sourcing criteria. The RSPO gives manufacturers the opportunity to buy certified palm oil (CPO) via four different sourcing models, depending on the level of transparency and traceability required: book & claim (B&C), mass balance (MB), Segregated (SG), and Identity Preserved (IP). These purchasing models are also found in other commodity programmes.
B&C and MB are used most often today, but as a consequence of the growing demand for transparency and more CPO entering the market, the market is progressing towards the SG and IP models. In fact, many manufacturers regard these as ‘higher level’ certificates and want to reduce sourcing through B&C. However, SG and IP palm oil require suppliers to keep palm oil volumes separated during transport, storage and processing, making these products relatively costly to suppliers as they cannot consolidate volumes and benefit from economies of scale.
The question is how desirable it is to strive for SG and IP CPO, as the additional costs add little in the transformation to sustainability; sustainability can be equally achieved through the uptake of B&C and MB, as area for these products also needs to be certified.
The main takeaway for palm oil suppliers is that although the RSPO is one system with one standard for sustainable palm oil production, sourcing criteria will differ among manufacturers, and the appetite for the different criteria is subject to change.
Branded Manufacturers Are Setting Stricter Palm Oil Sourcing Criteria
In August 2015, Consumer Goods Forum announced guidelines for retailers and consumer goods manufacturers to achieve zero deforestation by 2020, assisting them in designing their own policies for sourcing more sustainably. Beyond the RSPO criteria, last year, several larger branded food manufacturers, retailers and consumer goods companies voluntarily adopted more stringent sourcing criteria for palm oil.
Often these criteria come on top of RSPO criteria. For instance, Mondeléz announced it would source palm oil that meets the RSPO criteria as well as additional criteria specifically on the protection of peat land and high conservation value area. Danone announced similar sourcing criteria, but also requires palm oil to be traceable to the plantation level. Other brands have added criteria such as demonstrated efforts in greenhouse gas emission reduction or community support.
With branded manufacturers announcing their own standards, demand for sustainable palm oil is expected to grow further in terms of both volume and diversity. Suppliers can already expect buyers to push for meeting the additional criteria.
By 2020, half of all palm oil used by manufacturers who purchase RSPO-certified palm oil is expected to be sourced with criteria additional to the current RSPO criteria. This growing demand for more stringent criteria could potentially undermine the relevance of RSPO-certified palm oil to buyers, negatively affecting demand. Therefore, it is crucial for RSPO-certified suppliers to keep criteria attractive to branded manufacturers, for instance by expanding the criteria.
Suppliers Add On With Their Own Criteria
Without a doubt, growers produce sufficient RSPO-certified palm oil to match forecast demand, and this will continue towards 2020. RSPO-certified production capacity has grown phenomenally since 2008, from 619,000 tonnes to 12.1 million tonnes in 2016, at a CAGR of 45 percent.
On average, CPO production capacity sees annual growth of 1.6 million tonnes since 2009, driven by the growth in certified palm area. Even if certification of new area slows down, the production capacity of CPO is expected to reach more than 15 million tonnes by 2020—twice the expected demand based on current commitments.
Segregated And Identity Preserved CPO Likely To Command Premiums
The questions remains as to how much of the increase in production can be delivered with high traceability levels (e.g. up to mill level or up to plantation level), or through segregated supply chains.
To a large extent, this depends on the capabilities and ambitions of the traders, who need to manage inventories, invest in segregated logistics, and share sourcing information, which will take some time.
Traders are currently taking a three-step approach: 1) mapping the mills they have in their supply base; 2) prioritising mills where action is needed and visiting them; and 3) initiating projects to make mills compliant with the trader’s new standards.
Rabobank believes that the availability of MB-certified palm oil will not be an issue and would therefore command little premium. However, availability of IP or SG-certified palm oil could remain constrained, despite many industry players’ committing to traceable palm oil. If the gap between demand and supply grows, premiums for IP and SG may rise, provided buyers are willing to pay extra to comply with their own sourcing requirements. This could provide stimulus for additional certified IP and SG production capacity.
Key Palm Traders Take Action Outside Of RSPO
Although traders may not be able to supply the market with sufficient palm oil that is both RSPO certified and traceable, they have made announcements to substantially improve the sustainability and traceability of their supplies. Traders such as Cargill, Wilmar, and IOI pledged to have all of their palm oil traceable to the mill level for example, and have set their own criteria in addition to the current RSPO criteria, similar to the companies on the demand side (e.g. food manufacturers, consumer good companies and retailers).
They have also set commitments and guarantee no deforestation, no development on peat, and no exploitation of people. They were joined by several other large traders and because of their large share in global trade, these trader initiatives have great potential to improve the sustainability and traceability of the palm oil industry.
The key challenge that remains for traders is complying with their customers’ criteria for sustainability. They have to convince buyers that their standards match the criteria on the demand side and that RSPO certification should not be the most important criterion.
These parallel developments at traders, outside of an industry-wide programme such as the RSPO, can create uncertainty in the market, as more options increase complexity. Some companies will stick to the current RSPO criteria and some will adjust to the additional sourcing criteria traders are able to offer.
In the meantime, opportunities and challenges emerge for companies that know exactly what buyers of palm oil want.
Opportunities And Challenges For Suppliers
From a supplier’s perspective, the diversity in customers’ sourcing criteria leaves them with an inventory challenge. Suppliers (e.g. growers, traders, refiners and distributors) need to match the demands of their customers with palm oil the right sustainability standard and level of traceability.
In practice, this could mean some palm oil needs to come with specific information on origin (e.g. mills or plantation), some needs to be shipped and stored in separated tanks (i.e. SG palm oil), and some needs to be certified by specific certification programmes.
In addition, customers may require this only for the mainstream palm oil products they source (e.g. palm olein, palm stearin), or for all palm oil derivatives they purchase, including very specific palm fractions such as hydrogenated palm fats, palm kernel oil derivatives, or palm stearin with a certain solid fat content. Niche or small volume fractions will pose bigger challenges to suppliers on the inventory front and offtakers might find scarcity of these in the market.
Beyond this, customers may have different palm oil criteria for products produced under their own brands and through private label, which would pose additional challenges to the suppliers.
Opportunities Arise For Dedicated Suppliers
Suppliers who have built their supply chains around palm oil of the highest standards with respect to sustainability and transparency will undoubtedly see demand for their products increase. These are often suppliers that have built integrated supply chains or have a captive supplier’s model, where farmers deliver high-standard palm oil. They are best positioned to comply with high and diverse purchasing standards or make adjustments to palm oil cultivation practices if offtakers so wish.
However, their limited size can be an issue for larger offtakers that wish to source from a limited number of suppliers at a constant quality. Scaling up will be necessary and as a result, these niche players are expected to be looking to expand. For larger suppliers or buyers of palm oil, these companies can be interesting investment opportunities to expand their own palm oil capabilities.
Economies Of Scale Become More Difficult To Play Out
Larger scale traders and suppliers who have multiple customers may be challenged by the diversity in their sourcing requirements. Currently, they benefit from aggregating demand from different customers to standardise procedures and combine logistical efforts.
However, customers with high traceability requirements will require different procedures, different suppliers and segregation of palm oil flows and logistics. This brings additional costs, which can only be recovered from customers with this requirement.
Interest In Suppliers Deepens
Food manufacturers will be reviewing their suppliers to better understand what volumes and palm oil products are available and whether there are associated price premiums. Which of their suppliers is capable of supplying what certificates or evidence and what level of traceability? If palm products are not available, single-source purchasing strategies may not be sufficient anymore.
However, adding or switching suppliers can be costly as it takes time to develop the right specifications and negotiate prices. Manufacturers can potentially reduce sourcing costs by partnering with other offtakers to build sufficient volume for their supplier to change its sourcing strategy.
Sustainable Palm Will Drive Specialisation And Efficiency Efforts
The sustainability discussion is clearly increasing complexity in the palm oil industry, and this trend is expected to continue as new sourcing requirements will keep being developed. Meanwhile, as new supply and demand balances emerge, changes to prices and premiums can be expected. Premiums can have a positive effect on sustainability, as they stimulate suppliers to get their palm oil from certified area.
For instance, demand for SG RSPO-certified palm oil will push suppliers and ultimately growers to also get the more challenging palm acreage in their supply base certified (i.e. smallholder producers). Therefore, besides the additional costs, the interest in SG palm oil can be a positive development for the RSPO.
Suppliers who specialise in highly sustainable or traceable palm oil can attract new clients, potentially by entering into derivatives to expand their product portfolio and thus customer base. They have to seize the opportunity before larger scale suppliers become capable of improving their supplier base in terms of sustainability and traceability.
For many suppliers, creating, maintaining and controlling different certified and traceable supply chains remains an inventory challenge, and the focus will therefore be on efficiency: making sure all purchased palm oil matches client interests.
Suppliers will benefit from mapping the sustainable palm oil criteria of their customers and understanding for which of them palm oil is a key ingredient and premiums can likely be collected. They can then determine which clients are worth additional procurement resources.
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