The use of palm oil has become commonplace in packaged food and personal care products. This ubiquity is stimulating the rapid growth of the market. While this growth is creating several opportunities for investors, it is also exposing them to a growing number of ESG risks.
Palm oil’s attractiveness lies in its versatility combined with its relatively cheap production costs. This is helping to support the palm oil market, which is forecast to grow from USD 61 to 88 billion between 2014 and 2022. The industry’s supply chain is, however, highly exposed to environmental and human rights issues. This creates operational challenges and business risks related to customers’ sustainable purchasing requirements. It is in light of these risks that I will examine how recent industry developments may impact the ESG risk profile of issuers active in the production, trading and use of the commodity.
Global Palm Oil and Palm Kernel Oil Production, in Millions of Tons
Source: FAOSTAT, Food and Agriculture Organization of the United Nations
New Developments and ESG Risk in the Palm Oil Industry
The largest palm oil producer, Indonesia, is expected to extend its moratorium on palm oil concessions. This would limit the availability of new land available for production within the country. Consequently, plantation companies are looking elsewhere to meet the growing global demand. This expansion is creating new challenges related to deforestation and human rights. For example, plantation companies are expanding into heavily forested West African countries that harbor significant biodiversity.
The U.S.’ Trade Facilitation and Trade Enforcement Act, signed in February 2016, is creating regulatory risks. The act bars products from entering the country that were produced wholly or in part by forced labor. At this stage, it is not entirely clear how the U.S. will enforce these legal provisions. Considering this uncertainty, it will become even more important for producers and users selling value added goods to the U.S. to ensure human rights compliance.
New biodiesel mandates in producing countries may also affect the sustainability of the industry. Indonesia and Malaysia will likely continue to stimulate domestic biodiesel industries that incorporate locally-produced palm oil. Consequently an increasingly large proportion of production will be channeled to these local industries. The question is whether these mandates will incorporate sustainability standards and to what degree they will measure up to best practices.
Tools for Investors
The palm oil industry and its customers have implemented a range of management initiatives to address sustainability-driven business risks. For example, there is an increased focus on promoting suppliers’ compliance with environmental and social standards. Sustainalytics tracks important elements of these initiatives, as well as the frequency and severity of controversies through which ESG risks manifest. This information can be used by investors to assess companies’ preparedness to manage sources of risk in their value chains, while also revealing the companies that are experiencing palm oil related controversies.
The graph below illustrates palm oil companies’ performance on a composite indicator that aggregates environmental commitments and management systems with their labor management commitments and practices in their own and supplier operations. The data indicates that, while some of the companies we assess are taking steps to address ESG challenges, there are relatively few palm oil companies that we consider to have a strong and comprehensive approach to managing key ESG risks. This suggests a need for investors to carefully consider performance at the company level.
The Strength of Palm Oil Companies' Policies and Programs to Manage Key ESG Risks in Percentages (n=24)
Source: Sustainalytics research