If emissions from tropical deforestation were a country, it would rival the United States
It is hard to overstate the importance of forests, both environmentally and otherwise.
Covering over 30% of the world’s land mass, forests supply food, medicine, building materials and fuel for more than a billion people. Worldwide, they provide more than 86m green jobs and support the livelihoods of many more. In terms of biodiversity, forests are home to an estimated 80% of the world’s plant and animal life, including endangered species such as the orangutan, Borneo pygmy elephant and Sumatran rhino.
Forests are clearly a resource but, as history proves, they have also been used as large, undeveloped swaths of land that can be cleared and converted for other purposes.
According to the UN Food and Agriculture Organization (FAO), the rate of global deforestation has been decelerating over the past three decades. Nevertheless, it continues to endanger local communities, contribute to global warming and result in the loss of biodiversity:
- Today, most deforestation is happening in the tropics where, thanks to newly constructed roads, previously inaccessible areas of forestland are now reachable. This is a concern, not only because tropical forests are one of the greatest biodiversity reservoirs on Earth, but because the World Economic Forum and Swiss Re estimate the value of biodiversity to exceed $40tn, more than half of the world’s GDP. The 15th meeting of the Conference of the Parties (COP 15) to the Convention on Biological Diversity (CBD) ─ which is scheduled to take place this year in China ─ is expected to further emphasise the value of biodiversity and ‘natural capital’.
- Fewer trees also mean a loss of cooling power and carbon capture, which has alarming consequences for global warming. If tropical deforestation were a country, its annual impact would be comparable to the greenhouse gas emissions (GHG) of the United States, the world’s second largest emitter.
Figure 1. Tropical deforestation ranks third in CO2e emissions
Source: Word Resource Institute, citing Seymour & Busch 2016.
- Put differently, the loss of tropical trees is causing more emissions every year than 85m cars would over their entire lifetime.
- In addition to the environmental damages, the loss of tropical forests has dramatic social implications, depriving local communities of their homes and income. The process often goes hand-in-hand with worker exploitation, child labour and/or corruption.
Extensive monocropping for the production of palm oil is one of the main causes of deforestation, together with urbanisation, cattle ranching, soybean production and logging.
So, if palm oil causes deforestation, why can't we just stop using it?
At the heart of palm oil’s success is its versatility. Palm oil is used in 70% of cosmetic products, yet most of us don’t think about its origins when going about our morning routine with soap bars, toothpaste and face creams.
And it’s not just cosmetics; palm oil is in around half of all supermarket products. It is a key ingredient in staple foods such as bread and margarine, as well as delicious treats like chocolate, ice cream, peanut butter, instant noodles, chocolate spreads and biscuits, where it is praised for its texture and taste. It can also be used in the production of biodiesel and biofuel for cars and power plants.
There are many reasons why palm oil is so popular. Firstly, palm trees produce 4-10 times more oil than other crops per unit of cultivated land and consume less water in the process. This makes palm oil the most environmentally friendly vegetable oil in the world: alternative oils (e.g. sunflower or coconut oil) result in greater environmental damage.
Second, palm oil’s high yield makes it the cheapest vegetable oil on the market. The fact that palm oil is an ingredient in so many affordable foods is key here, particularly given our ever-increasing global population size and appetite.
Third, thanks to its natural preservative qualities, palm oil extends the shelf life of food products, thus reducing waste.
Figure 2. Comparison of global oil yields by crop plant in tonnes per hectare (t/ha)
Source: WWF, “You don't have to give up products containing palm oil!”.
With this in mind, environmental activists such as the World Wildlife Fund (WWF) argue that consumers should not boycott products containing palm oil. Avoiding it could, in fact, have far worse environmental and societal consequences.
Take Indonesia, and the role of palm oil in the reduction of poverty, as an example. Together with Malaysia, Indonesia accounts for around 85-90% of all palm oil production globally. The country is the largest producer; around 3m people directly depend on the palm oil industry and a further 16-17m jobs are created by the supply chain. While some NGOs lament that these are not high paying jobs, they have undoubtedly transformed the lives of many people, particularly those in central Java.
In WWF’s words, “palm oil can be produced in a responsible manner that respects the environment and the communities where it is commonly grown”.
The winds of change: advocating to increase palm oil yields, sustainably
With the above data on yields, affordability and job creation, ESG advocates within the investment industry support sustainably produced palm oil.
Indeed, the Investor Working Group on Sustainable Palm Oil, which is coordinated by the United Nations Principles for Responsible Investment (UN PRI), is backed by over 60 global investment organisations, representing approximately $7.9tn in assets under management. Signatories endorse the UN PRI’s statement regarding the expectations of companies operating across the palm oil value chain - including producers, refiners, traders, consumer goods manufacturers, retailers and banks - and advocate that these companies adopt and implement the UN’s publicly available, “No Deforestation, No Peat and No Exploitation” (NDPE) policy.
What’s more, we – at the international business of Federated Hermes – have joined forces with other stakeholders to raise concerns and lobby government authorities in Brazil and Indonesia. For instance, we signed the “Investor Expectations on Deforestation in Cattle Supply Chains” statement, highlighting our expectations of companies with respect to cattle ranching and palm oil production. We are also supporting the “Investor Statement on Deforestation and Forest Fires in the Amazon”, which requests that companies demonstrate a commitment to eliminating deforestation within their operations and supply chains.
Good intentions aside, with the global palm oil market expected to enjoy a compound annual growth rate (CAGR) of 5.6% over the 7-year period from 2018-2025, sustainable palm oil production remains a challenge. How can the industry achieve a greater volume of production ─ by increasing palm trees’ yields ─ and avoid further deforestation?
Currently ill-equipped and undercapitalised smallholders ─ which represent approximately 34% of Indonesian palm oil production – may hold the answer. These smallholders typically produce half the yield achieved by large scale producers; with better resourcing, this could change. If Indonesian smallholders catch up to their large scale counterparts, then the industry could deliver an additional 26m tonnes of palm oil, all without further deforestation.
The certification jungle: reforming standards and encouraging widespread adoption
At the same time, it is important to ensure that existing and additional production is delivered in a sustainable way. Buyers and investors currently use certification to ensure the sustainability of their purchases but navigating this can be tricky. For one, there is no uniform set of standards in use ─ some are designed for local markets, some are internationally recognised.
Then, there is the issue of credibility. In obtaining certification, it is not unheard of for producers to cut corners and pay bribes. Rather than providing assurance, some certificates may not be worth the paper they are written on.
Despite this, we would argue that certification is the way forward, provided the underlying standards are strengthened and the process for obtaining certification is made corruption-free. At present, three reputable bodies cover over 60% of palm oil plantations globally. 19% of palm oil production (or 15m tonnes from plantations extending over four million hectares) is certified under the strictest, internationally accepted set of standards known as the Roundtable on Sustainable Palm Oil Certification (RSPO). In Malaysia, an additional three million hectares of plantations have received local certification under the Malaysian Sustainable Palm Oil (MSPO) standard. Likewise, over four million hectares of Indonesia’s plantations have obtained the Indonesian Sustainable Palm Oil Standard (ISPO). The certification of 100% of palm oil plantations under strict standards should be our next collective push.
To this end, we have been working with the UN PRI to strengthen certification standards, especially as they relate to the ISPO, where very little protection is currently afforded to human rights and community livelihoods.
Equally, we are pushing to improve the process by which certification is granted and remove the risk of malpractice. Here, modern technology ─ from satellite monitoring to geolocation tracking and blockchain ─ could be used to enforce certification standards. Investigations on the ground might also complement a company’s self-disclosure on ESG matters, as could third-party verification checks by the like of Aidenvironment, RSPO and others.
How are the companies we invest in contributing to the sustainable palm oil transition?
It is abundantly clear that the production of palm oil has far-reaching implications.
Palm oil is Indonesia’s second-biggest export earner after coal, bringing in more than $10 billion in 2019 and is key to industries from agriculture to food production and finance. We are mindful of this when it comes to stock selection, considering the specificities of the industries that use palm oil, and related sustainability issues along the value chain. While we have no exposure to growers or distributors, in various emerging markets, we have positions in food and cosmetic companies, local banks, and supermarkets selling products containing palm oil.
Unilever Indonesia, our consumer stock in the country, benefits from Unilever’s group-wide approach to palm oil. The group is one of the largest users of palm oil globally and aims to use only RSPO-certified palm oil. It implements procurement and supply chain management initiatives to improve traceability and enforcement, such as blockchain technology, geolocation data and satellite imagery. It also maintains a public database of suspended suppliers, as it believes transparency to be key in making the industry more trustworthy. The company has set an ambitious target to achieve a deforestation-free supply chain by 2023. Furthermore, it helps independent smallholder farmers to obtain the certification and/or improve their yield and it supports regenerative agriculture overall.
According to the WWF, Unilever’s approach to palm oil sustainability scores very highly, but currently lags the likes of Ferrero, which strengthened its approach (and reached the top of the rankings) after criticism threatened the reputation of its brands.
For Forest 500 ─ an organisation that identifies and ranks the most influential companies and financial institutions in forest risk commodity supply chains ─ Unilever ranks second globally, after PepsiCo Inc.
LG Household & Healthcare (LG H&H), our Korean manufacturer of cosmetics and household cleaning products, has held RSPO certification since 2014. LGH&H’s policy recognises the severity of issues related to workers’ rights and the reckless environmental destruction caused by unsustainable palm oil production. The company will immediately terminate contracts with suppliers that violate human rights in producing palm oil.
92% of the palm oil used by China Mengniu Dairy, our food company in China, is RSPO certified. All materials used in the company’s packaging has also received Forest Stewardship Council (FSC) certification. We will continue to engage with the dairy company to strengthen its commitment and disclosures regarding sustainable palm oil.
Leading Mexican food retailer, Wal-Mart de Mexico S.A.B. de C.V. (Walmex), also has ambitions to eradicate deforestation from its palm oil and paper supply chain, in line with the UN Sustainable Development Goals (UN SDGs). We will soon find out if Walmex achieved its internal target of zero deforestation by 2020; encouragingly, 85% of its suppliers in 2019 held a sustainable palm oil certification. Walmex’s eventual aim is to have all private brand products source their palm oil with zero net deforestation, in accordance with the principles and criteria of the RSPO, or equivalent. According to the WWF, Walmart’s group approach to palm oil sustainability is above average.
We covered PT Bank Rakyat Indonesia (BRI) in a previous issue of ESG Materiality. Loans related to palm oil are not material - accounting for only about 3% of BRI’s loan book, as of December 2019. Still, BRI’s Sustainable Finance Action Plan and sustainability report cover this segment in detail. As a condition for new loan approval, the bank requires clients to follow international labour laws, have RSPO or ISPO certification and complete an environmental impact assessment. We are encouraged by the progress made, and our engagement efforts now look to bolster certification coverage to 100%, with preference for RSPO.
The same is true of Bank Central Asia (BCA). Loans to the edible oil sector represent only 4% of the bank’s total loan book, as of December 2019, and BCA’s financing policy asks corporations to complete an environmental impact analysis assessment. The bank also oversees certification and monitors the compliance of companies with standards such as the ISPO or RSPO. We are engaging to expand the bank’s coverage to 100%, strengthen its due diligence process and either end its exposure to controversial clients or vigorously engage with them to drive change.
Sustainable palm oil: a commitment beyond the financial
The FAO reports that an estimated $200bn p.a. is required to finance cattle, soya bean, palm oil, and pulp/paper production free of deforestation. This figure sounds large, but it is small when compared to current fiscal incentives for agriculture, which amount to over $700bn p.a. and subsidies for fossil fuels, which were estimated at around $5.2tn in 2017.
Nevertheless, the fight against deforestation will require a commitment that is more than financial; advocacy is key to driving sustainable practices at the company and industry level. As a collective, we should encourage the wider adoption of sustainability certification among companies involved in palm oil production, and work with awarding bodies and the UN PRI to improve the standards and processes applied. In terms of enforcement, we support investigations on the ground and the use local sources to complement a company’s self-disclosure on ESG matters. The Forest Peoples Programme (FPP) mentions the need for “ground-truthing” in this regard.
Palm oil can be grown sustainably. To realise this goal, we will need to engage extensively with companies involved in the palm oil supply chain, but our outlook remains positive. With rates of deforestation declining globally, significant progress being made by leading companies, and mounting pressure from investors and other stakeholders alike, it would seem an end to deforestation may come sooner rather than later.
This case study will feature in the Global Emerging Markets: ESG Materiality, Q1 2021 newsletter which will be published in the coming weeks.