ESG Perspective: Palm oil
Through its investments, NN Investment Partners is exposed to palm oil. We believe we can use our influence to improve the standards in the sector. We therefore have developed an engagement strategy with the companies in the industry in order to improve on the environmental and social aspects.
Palm oil is a commodity which is used in many different consumer-related products, and its use has been increasing. This growth has come at a cost to society, however, and it also poses risks to investors. NGO’s, investors and banks have been focusing their attention on palm oil, and the palm oil sector has taken several steps to improve on the sustainability effects. We do believe, however, that much more needs to be done to successfully address the negative environmental and social impacts, especially taking into account the rapid expansion of the industry.
CO2 emissions Indonesia (metric tons per capita)
Source: World bank
What is palm oil?
Palm oil is a vegetable oil which contains a high level of saturated fats, is free of trans fats and contains a high substance of beta-carotene (vitamin A). Palm oil is cultivated from the oil palm tree which mainly grows in a humid tropical climate. It is able to produce high yield when it grows 10 degrees north and south of the equator. The tree contains palm fruits that grow in compressed bunches and they contain more than a thousand individual fruits. The fruits produce two types of oil, palm oil, and palm kernel oil. Palm oil is obtained from the flesh of the fruit, and palm kernel oil is produced by extracting the oil from the internal seed. Oil palm is a productive crop, and it is capable of yielding more oil than any other vegetable oil.
Palm oil is used in many products purchased and used by consumers globally. It is, for instance, an ingredient in pre-packaged food, cosmetics, cleaning products, and personal care products. The oil can also be used as a biofuel and has become the green fuel option for transportation. Palm oil is relatively cheap and has a wide range of applications, which has made it a very popular commodity for manufacturers and retailers. Due to the increasing demand, more production is expected to be realized to sustain the demand.
The controversies around palm oil
Since oil palm trees only grow in the tropics, the clearing of land for plantations has a significant impact on rainforests. Several animal species like elephants, orangutans, rhinos, and tigers have lost their habitat, and some indigenous peoples have also been forced off their land. The chopping and burning of trees have intensified climate change as well, and the sector is exposed to several other sustainability risks, both environmental and social oriented. These controversies have raised the awareness of the issues that the sector is facing, and many NGO’s target the different stakeholders to improve environmental and social standards.
The biggest environmental impact of palm oil production is the large-scale deforestation. Indonesia and Malaysia produce around 90% of the world’s palm oil and it is crucial to their economies. In these countries, there is a direct relationship between the growth of oil palm estates and deforestation. Clearing land for the creation of oil palm plantations wastes forest lands, and the remaining forest areas support fewer animal species. It results in an additional side effect, as the clearing of forests deteriorates the quality of the remaining forests. In addition, where there is a plantation, companies, and governments need to establish infrastructure, including mills, roads, and workers’ housing, leading to even more intense deforestation.
Air, soil and water pollution
Burning is a common method for clearing vegetation within oil palm plantations. The burning releases smoke and carbon dioxide into the atmosphere, polluting the air.
Peat, also known as turf, is an accumulation of partially decomposed vegetation that is unique to natural areas like peatland. The draining and alteration of peatlands is damaging, since peat soils store more carbon per hectare than any other ecosystem in the world. Fires on peatland are also the most difficult to extinguish, and the smoke and haze resulting from these fires have health consequences throughout Southeast Asia.
In addition to the fires, just as within any agriculture activity, fertilizers, pesticides and the waste generated from palm oil production pollute groundwater and soils.
Forest fires used for land clearing for plantations release carbon dioxide into the atmosphere. These fires contribute to climate change, and due to the high deforestation rate in Indonesia for instance, the country is the third-largest emitter of greenhouse gases in the world.
Human rights challenges
Land rights are often unclear in many Asian countries, and indigenous peoples or local communities can claim ownership rights. In the sector, it has occurred that communities have been forced off their land, and the large-scale development of palm oil plantations is often a source of conflict between companies, communities, and governments. The plantation work also exposes the sector to labour issues, and forced, bonded, and child labour are common within the sector.
There is a lot of debate on the health impact of palm oil, but it is in any case clear that there is a difference in the impact of palm oil and palm kernel oil.
Saturated fats are believed to raise cholesterol levels in the blood, increasing the risk of heart disease. Palm kernel oil contains over 80% saturated fat, compared to palm oil which contains only 50%. When palm oil goes through the manufacturing process it becomes oxidized, reducing some of its health benefits. Despite the high level of saturated fats, palm oil is still healthier than other hydrogenated vegetable oils which are often high in trans fats. Trans fats have a more damaging impact on health than saturated fats.
Complexity supply chain
Palm oil is a popular commodity in consumer-related products. The supply chain can be long and complex, and the growers, mills, traders, refiners/processors and the retailers/manufacturers are often different companies. Crude palm oil goes through several stages of processing at different refineries, and due to an overall lack of transparency at the refinery stage, the growers and mills are largely undetectable for the end consumers. It is therefore necessary that all the different participants in the sector engage with each other in order to improve transparency and traceability of the palm oil.
The role of RSPO
The Round Table of Sustainable Palm Oil (RSPO) is a multi-stakeholder forum which aims to modify the global palm oil sector to a more sustainable one. RSPO represents the entire palm oil supply chain, including the plantations, processors and traders, consumer goods manufacturers, retailers, some investors and NGO’s. To ensure that palm oil is both sustainably produced and transparently traded, the RSPO established a certification system for different stakeholders of the palm oil supply chain. Producers, the growers and millers, are certified on the basis of their application of RSPO’s principles. The trade of sustainable palm oil, from the mill to the retailer, is tracked and certified through RSPO’s supply chain certification system. Since certification began in 2008, RSPO has been successful in both certifying the production of sustainable palm oil and in securing commitments from companies to produce, supply, and/or source certified sustainable palm oil.
Sustainable palm oil
The RSPO established four supply chain certification systems, “Identity Preserved”, “Segregated”, “Mass Balance”, and “Book & Claim”. These types of palm oil certificates have been developed in order to facilitate the acceptance and growth of certified sustainable palm oil (CSPO).
This type of palm oil is segregated from all other sources (certified and non-certified) and a batch of certified palm oil can be traced throughout the entire supply chain from plantation to factory to retailer.
Segregated palm oil must be kept separate from non-certified palm oil throughout the supply chain, but can be blended with other types of certified palm oil and therefore it is difficult to trace it back to the plantation.
The mass balance option allows mixing of certified palm oil with non-certified palm oil. All processors in the mass balance supply chain need to be supply chain certified by RSPO.
Book and Claim
The book and claim system makes it possible for manufacturers who are committed to the sustainable production of palm oil but who do not yet have access to a segregated supply chain. However, under this system, manufacturers may still be purchasing oil from unsustainable sources and therefore supporting irresponsible growers.
Through its investments, NN Investment Partners is exposed to palm oil. We believe we can use our influence to improve the standards in the sector. Due to the complexity of the supply chain of palm oil, we do not think that excluding the palm oil producers is beneficial. Engagement is in our view a better approach, and in this engagement we will not focus on the palm oil producers only, but also the traders, processors, food producers, and retailers. All these different companies can influence the supply chain and work towards the overall improvement of the sector and acceptance of higher standards.
For our engagement we have developed several objectives:
- Improve traceability of palm oil, and work towards certification systems for producers, traders, and processors;
- Companies should support and respect human rights, and improve the labour standards within the oil palm plantations and their approach to community involvement;
- Implementation of sustainable agriculture practices including reduced use of hazardous pesticides, and commit to zero-deforestation, zero-peat, and conservation of natural resources and biodiversity;
- Development of small holders to improve their standards and knowledge.
Up till now, we have seen that the biggest companies that we engage with have shown commitment to sustainability and most of them have established a detailed palm oil policy. The challenge for them in fully bringing this into practice, however, is transparency of the sector, the traceability of the commodity, and monitoring progress. Companies like Sime Darby, Wilmar, and GAR (Golden Agri) are leading the efforts when it comes to production, and due to their role and size in the supply chain, they are able to connect with different stakeholders within the supply chain. Wilmar, for instance, has created a dashboard which lists all the mills and suppliers in Indonesia and Malaysia, and initiatives like these are an important development to improve traceability in the sector.
We also see a role for the bigger companies to help with the development of small farmers. According to RSPO, small holders produce 40% of the world’s palm oil. The bigger companies are often targeted due to their size, but access to the small holders is still limited. In our opinion, bigger companies are able to work with these small holders so that no more land is cleared, nor peat is drained, and that they address sustainable agriculture practices. Several initiatives have started to work with small holders directly, but in our view, there is still a lot more work to be done on this front.
Our influence can also be used to monitor the progress of the sector, and in our engagements with food producers and retailers we will push for their commitment to transforming the sector. We support the work of organizations like RSPO, and in our engagements we can use this to move companies to fully certified palm oil. Despite all the progress, we recognize that there is still a long way to go. We have developed a scorecard of the companies we engage with, and through tools like SPOTT (Sustainable Palm Oil Transparency Toolkit) and general ESG research we will continue to monitor these companies, and engage to ensure improvement.
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