Recent changes in both the supply and demand for palm oil are rapidly changing the face of its world market. The underlying cause of this change is tension between conflicting desires: economic growth and environmental protection, which drive the choices of palm oil producers, consumers, and policy makers. The future of the palm oil industry, both locally and globally, is a yet unknown balance of these forces.
While environmental pressures and regulations are shifting the entire supply curve of palm oil up, making palm oil production more costly, there is a simultaneous increase in the global demand curve for palm oil. The degree of the increase in demand is vast – consumption is expected to triple between 2000 and 2050. Use of palm oil in processed foods and cosmetics is largely driving the increase. The food industry is adjusting to nutritional recommendations that consumption of hydrogenated fats be reduced or eliminated, and palm oil is increasingly used for biodiesel production and cosmetics. Clearly, palm oil is experiencing a moment in the sun.
The palm oil market’s ability to meet increased demand is further complicated by several factors shifting the supply curve. Indonesia and Malaysia are the main producers of palm oil for the entire world, but pressure from environmental groups and governments is changing their ability to continue production. Concerns over deforestation cause governments to place restrictions on logging and the purchase of land for industry, which effectively raises the cost of production in Malaysia and Indonesia.
This change in policy may be explained by the environmental Kuznet’s Curve, which says that environmental quality will become degraded while a country develops, but there exists a level of income at which environmental quality will begin to improve. One hypothesis for this behavior is that at low levels of income the marginal benefit of any increase in income is so high that it dwarfs the marginal benefit of improved environmental amenities. As income rises (and the marginal benefit of additional income falls), this tradeoff reverses. Combining this logic with the behavior of Indonesia and Malaysia suggests that these countries have reached a level of GDP at which the utility of improving the environment through reduced palm oil production exceeds the utility of the wealth they earn by producing palm oil.
In addition, recent efforts to promote “green” production are forcing the environmental impact of palm oil plantations into the international spotlight. Wilmar, an agribusiness group based in Singapore and a major owner of palm oil plantations, was reported by Newsweek to be the least environmentally sound of the world’s 500 largest publicly traded companies. This kind of exposure is affecting firms’ ability to invest in producing palm oil.
All of these constraints on the supply of palm oil are an attempt to get palm oil producers to internalize the negative environmental externality associated with its production. Producers bear no cost of the environmental damages. It is therefore economically efficient to drive the firm’s marginal cost upwards to the point that their cost reflects the true social cost of their productive actions, thereby increasing the price and decreasing the quantity of palm oil. In 2010 the government of Malaysia committed to maintaining half of the country as forested; at the time fifty-eight percent of land was forest (Bloomberg 2010). This drives up the price of the remaining eligible land and forces firms to increase production through input intensification on existing land, leading to increasing marginal cost.
Given the constraints that palm oil plantations face in Southeast Asia, firms have two options: Adopt sustainable methods of production or move to a market where production is not yet hindered by restrictions and environmental concerns. Cargill recently announced their commitment to “sustainable, deforestation-free, socially responsible palm oil;” others, however, have set their eyes on West Africa, which is home to vast palm forests (Cargill 2014, The Economist 2014). The demand for palm plantations in West Africa has increased in the last 10 years, and the trend continues. In the past decade, 1.8m hectares have been leased for palm oil production in West Africa, while another 1.4m hectares is still desired (The Economist 2014).
Local governments are typically the main supplier of this land; one hopes they would act in a way that results in socially optimal outcomes. In this instance, however, profit often comes at the expense of environmental protections. Thus these governments produce the same kinds of externalities we saw from firms in Southeast Asia. Local protests, withdrawal of investment, and heightened oversight by the international community are slowly placing pressure on the governments in West Africa to reduce their offering of palm oil forests for sale.
The question is whether the current pressure placed by environmentalists will be enough to cause the governments to force firms to internalize the environmental externality of palm oil production. The process of bringing the cost of deforestation to the forefront of the production process in Southeast Asia was a long one. Now that the issue has been brought to the international public eye, the time needed to fully incorporate it into the production decisions in West Africa should be shorter than it was in Southeast Asia.
Global demand for palm oil is a significant headwind to the environmental efforts, however, because increasing demand makes palm oil more and more lucrative. While Malaysia and Indonesia have already reached a certain level of development, the West African countries in question remain incredibly poor. Their incomes may still be far from the turning point on the environmental Kuznet’s Curve, in which case we can expect to see environmental quality decrease with increases in income for some time. For policy makers, the promise of increased economic growth and jobs for their people may outweigh the environmental costs. The decision they face boils down to this: food for the people today, or decreased biodiversity on the land down the road?
The future of the palm oil industry will be determined by many market mechanisms, including the popularity of palm oil in food products, the strength of environmental lobbies, and the values of the citizens of West Africa. Whether the forests of West Africa become the next frontier for palm oil producers is yet to be seen, but my instincts point toward yes.
“Cargill pledges to protect forests in all agricultural supply chains.” Cargill, 24 Sep 2014. Web.
“Grow but cherish your environment.” The Economist, 16 Aug 2014. Web.
“Oil Palm Growers May Profit Under Rainforest Accord.” Bloomberg, 24 Nov 2010. Web.