Assessing the implications of implementing European Union countries’ anti-deforestation regulations on Indonesia’s palm oil industry

The European Union Parliament recently issued an anti-deforestation (deforestation-free regulation) policy for several agricultural and livestock commodities, expected to be implemented in 2023. Palm oil considers one of the commodities driving deforestation. Indonesia is the largest supplier of palm oil and its products to European Union countries, so it is not free from the influence of the enactment of this law. This paper discusses the possible effects of implementing these regulations and their implications for the Indonesian palm oil industry and the European Union countries. For Indonesia, this regulation will have affected changing the governance of the palm oil industry for export purposes. Traceability requirements can affect for supply chain separability and the exclusion of smallholders. However, it can also provide the possibility of increasing the position of smallholders in the global market. For the European Union, regulation will impact decreasing supply and incompatibility of the palm oil processing industry and traders in their countries. Indonesia can continue to exist by pursuing several strategies to strengthen export markets outside the European Union countries and deepen the structure of the domestic palm oil industry.


Introduction
The European Union (EU) Parliament approved the EU Regulation on Deforestation-Free Supply Chains law (from now on referred to as the anti-deforestation law) on November 6, 2022, and enacted it to enter the entry-into-force stage in May or June 2023.This anti-deforestation program aims to ensure that every product on the EU market does not contribute to deforestation and forest degradation.The law is aimed at curbing deforestation and degradation of legal and illegal forests that result from EU consumption and production.In contrast to industry voluntary commitments, anti-deforestation laws provide a stronger legal basis for upholding zero-deforestation commitments.
The implementation of these anti-deforestation laws has the potential to impact palm oil supplies to EU and pose legal and reputational risks for operators and traders who violate the new rules.Apart from companies, all relevant stakeholders in the EU market are required to comply with the law in question.This anti-deforestation law contains rules that the area of oil palm plantations that are cleared must be free from deforestation by December 31, 2020.Companies that are referred to as operators (companies that first enter palm oil and products made from it into the EU market) and traders (companies that distribute in the EU market) must comply with several conditions that the products that enter the market and are distributed in EU member countries are under applicable regulations.Apart from palm oil, this law also applies to soybeans, coffee, cocoa, and beef.
IOP Publishing doi:10.1088/1755-1315/1308/1/012066 2 Operators will be required to implement due diligence on their supply chains to ensure they are deforestation and forest-degradation-free, and traders will be responsible for storing and sharing information on their supply chain with operators.Operators will need to provide verifiable evidence of their products being deforestation-free.Operator companies are obliged need to conduct due diligence to ensure only deforestation-free products are allowed into the EU market.
A due diligence system involves three parts: (1) Information Gathering.Data on the supply chain of product collection, including the geo-localization and the time of primary production.(2) Assessment of risk.Assessment of the information collected to determine the risk of deforestation, forest degradation, and illegality associated with the product.(3) Mitigation of risk.Actions to reduce non-negligible risks to negligible levels include requesting further information, independent surveys, scientific product testing, or audits.A benchmarking system operated by the EU Commission will identify countries as presenting a low, standard, or high risk of producing commodities or products that are not deforestation-free or under the legislation of the producer country.Obligations for operators and authorities will vary according to the level of risk of the country or region of production, with simplified due diligence duties for products coming from low-risk and enhanced scrutiny for high-risk areas.Operators will need to provide verifiable evidence of their products being deforestation-free.Supply chain traced to origin with geo-localization information.The comparison between images taken before and after the extraction of raw materials will be applied.Direct reporting maybe will be needed, for example, the farmers take photos of tree re-planting after the extraction of raw material (geotagging or photo metadata enabled to record date and location).
On the global market, there are many producing countries that export their palm oil products to the EU.In addition, the EU is a major importer of palm oil and products made from it with a very significant volume and value.Many producing countries of palm oil have the potential to be affected by the enactment of this anti-deforestation law including Indonesia.As one of the largest suppliers of palm oil and products made from it to EU member countries, this anti-deforestation law has the potential to have a major impact on palm oil imports originating from Indonesia.This paper examines the potential impact of EU legislation on deforestation-free products and their implications for the Indonesian palm oil industry.

Methodology
The assessment of the implications of the EU's anti-deforestation regulations for the Indonesian Palm Oil Industry begins with conducting a review of global and EU palm oil market trends.This is to get an overview of the palm oil market in the period 2002 -2022.Furthermore, a quantitative assessment is carried out using the multimarket model analysis method, to obtain predictions for the period 2022-2032.The structure of the model and the equations were formulated in the General Algebraic Modeling System (GAMS) and available from Hutabarat which was resumed in the model Hutabarat et al. [1,2].This model consisting of six blocks of equations has been used in other studies [3 -6], the analysis in this paper fully follows that model with an assessment focus on export prices, farmer (producer) prices, production, total exports, exports to market countries that are members of the EU in one group (27 countries or EU27), and Indonesia's domestic consumption of palm oil commodities.
The data used in the analysis is based on the model in research [6], but is calibrated to a baseline solution that describes Indonesia's agriculture in 2019.To predict the effects of the implementation of the anti-deforestation law, the calculation was based on and adjusted to predictions in two scenarios, namely Scenario 1 (S-1) and Scenario 2 (S-2).S-1 is a scenario in which the Indonesian palm oil industry fully complies with anti-deforestation regulations, in which the European Union will reduce the use of palm oil for bioenergy by an average of 7.7% per year in the period 2022-2032.Whereas S-2 is a scenario where the Indonesian palm oil industry does not fully comply with anti-deforestation rules, diverts exports to other countries and develops biodiesel from Biodiesel 30% to 35%/40% (B30 to B35/40).The two scenarios are compared to normal conditions, the average values for the 2017-2019 period.
This study has two limitations, namely, although the decline in exports to EU countries and being diverted to other countries is taken into account in the model (contained in Scenario 2), on the current occasion it is not shown in the analysis results.The second limitation is that variations in decisions and intertemporal changes in decision-making between industry players (such as farmers, processing companies and exporters) are not taken into account and government decisions are exogenous, so it is assumed that full government control occurs over the relevant policy instruments.Appendix A.2 shows that in 2022, the world PO export volume will reach 54.14 million tons (50.74 million tons of CPO and 3.41 million tons of PKO).Indonesia is the largest exporter, namely 30.25 million tons or 55.87% of total global exports, of which the export volume of CPO reached 28.50 million tons and PKO 1.75 million tons or 56.17% and 51.36% of the total global export volume of CPO and PKO, respectively.Malaysia ranks second with a share of around 33% of the total global palm oil export volume.In the 2018-2022 period, Indonesia and Malaysia's export volume growth was relatively low, as was the case with Guatemala, Colombia, Papua New Guinea and Costa Rica.The Covid-19 pandemic and climate change are the factors causing the relatively low export growth of these countries.This is different from Thailand, Honduras and Cote dÍvore which are experiencing high growth because as new producing countries they are enjoying increasing production along with the age of the plants.

Global and European Union
The total volume of global palm oil imports is 52.61 million tons in 2022, and increases by an average of 1.49 percent per year in the period 2018-2022 (Appendix A.3). India, China, EU, Pakistan and the USA are the biggest importers of palm oil, respectively having import volumes of 8.45 million tons, 8.10 million tons, 6.60 million tons, 3.60 million tons and 2.11 million tons.The five countries had CPO import volumes of 8.30 million tons, 7.20 million tons, 5.90 million tons, 3.60 million tons and 1.73 million tons respectively.In the 2018-2022 period, among the five countries, a decrease in import volume occurred for the EU due to reducing imports related to achieving the RED II target.In the RED II Policy scheme, the volume of EU palm oil imports estimated will decrease to around 4 million tons in 2030 [7,8].
The global palm oil consumption volume in 2022 is around 85.83 million tons, with a composition of 76.74 million tons of CPO and 9.09 million tons of PKO (Appendix A.4). Indonesia is the largest palm oil consumer, followed by India, China and the EU.In 2022, EU PO consumption reached about 6.39 million tons, experiencing an average decrease of 2.37% per year and 0.33% per year in 2018-2022 and 2013-2017 respectively.The main source of this decline in consumption occurred for CPO, which decreased 0.51% per year in 2013-2017 and decreased 2.71% per year 2018-2022.In contrast to CPO, EU PKO consumption decreased sharply in 2013-2017 by 13.10% per year and increased 3.17% per year in 2018-2022.It is suspected that the decline in CPO and PKO consumption for the 2013-2017 period was due to the implementation of sustainable palm policies, while in 2018-2022 it was related to efforts to reduce the use of CPO as raw material for biodiesel and energy, and to increase the use of PKO for the food industry and others.
The EU vegetable oil market is growing rapidly due to its use for bioenergy.In the 2005-2012 period, consumption of vegetable oil for bioenergy increased by an average of 20.58% per year, in the 2012-2022 period it only increased 2.59% per year.In the next decade, consumption of EU vegetable oil for bioenergy is predicted to decrease by an average of 2.09% per year.Appendix A. 5 shows that in 2022, the volume of vegetable oil consumption for bioenergy consumption will reach 12.28 million tons and for food and other use 12.36 million tons.Palm oil consumption for bioenergy is estimated at 4.17 million tons (34%) and for food and other use 3.61 million tons (30%).It can be said that the EU vegetable oil market is dependent on palm oil by 32%.In 2022, the use of palm oil for biodiesel and energy is still high, namely around 64.57% (Figure 1), however it shows a decrease compared to previous years (2018, 2019, 2020 and 2021).The percentage of using palm oil as an ingredient raw-materials for biodiesel and energy in these years are respectively around 65.44%, 66.54%, 66.18% and 65.27%.Another research shown that approximately 65 percent of the total was used for energy products, including biodiesel and power plants, and the remaining 35 percent is used for the food, feed, and toiletries industries [7].
Source: Author calculation from [11] data The EU market is one of Indonesia's palm oil export markets [12].In 2017, the volume of Indonesian palm oil exports to the EU was around 5.1 million tons, then decreased to 4.5 million tons in 2022, decreased on average 2.25% annually.The share of total palm oil export to EU compared to the total volume of Indonesian palm oil exports was about 17.46% in 2017, decreased become 15.21% in 2022.At the same time the value of Indonesian palm oil export to EU decreased 2.06% annually

The effect of the implications of the European Union's Anti-Deforestation Regulations on Indonesia'
Palm Oil Industry The results of the analysis (Table 1) show that compared to normal conditions (the average value in the 2017-2019 period), in S-1 the export price of Indonesian palm oil will decrease by an average of 0.40 percent per year, producer prices decrease by 1.20% per year, production increases by 0.12% per year, total exports increased by 0.31% per year, exports to the EU decreased by an average of 1.52% per year and Indonesia's domestic consumption decreased by 0.22 percent per year in the 2023-2032 period.However, S-2 shows the results of the analysis that export prices for Indonesian palm oil increased by an average of 3.01% per year, producer prices increased by an average of 1.77% per year, production increased by an average of 0.31% per year, exports to the EU decreased an average of 2.18% per year and domestic consumption will increase by an average of 0.45% per year in 2023-2032.
The results of the S-1 analysis are caused by a decrease in demand for imported palm oil from Indonesia which will depress export prices on the one hand.Meanwhile, on the other hand, there are several problems, namely first, the costs incurred as a result of following all the anti-deforestation regulations, some of them will definitely be borne by farmers so that it will depress prices at the farmer level; secondly, only smallholders who are plasma from the core company or who form partnerships with large oil palm companies that may be able to meet the stipulated requirements; third, in general, oil palm farmers do not sell their produce directly to the main company or partners, but through traders and or cooperatives there are additional costs which will also reduce prices at the farmer level; Fourth, currently the EU market has absorbed more than 85% of certified palm oil production, and of the total certified production and area, only 63% is sold according to certified standard prices.Although initially fulfilling the conditions set for the implementation of the anti-deforestation law was able to stimulate production, in the medium and long term it failed to provide incentives to producers.Production continued to increase even though it was relatively small and also increased due to leaks to countries that have standards, certifications and regulations that are more-lax.In the end, the consequence will be a decrease in domestic consumption.One of the main points of the anti-deforestation law is full supply chain traceability of palm oil commodities with several provisions, namely the mandatory due diligence, analysis and evaluation of risks in the supply chain, as well as proportional mitigation measures including the use of satellite monitoring tools, field audits, improvement supplier capacity or isotope testing to check product origin.EU member states have access to digital systems that provide relevant and transparent information about commodities and products in the form of anonymous data.The search results from the system become a comparison of the deforestation risk of a product for the EU Commission [9,10].To comply with traceability requirements, in addition to requiring additional fees, they must also be implemented within a period of no later than 24 months.The additional costs required to separate the supply chain to comply with EU market conditions may be substantial for palm oil companies.In a relatively short period of time, companies must ascertain which supply chain meets EU market traceability requirements, or which parts do, and which parts do not.In addition, for small-scale oil palm grower traceability requirements including geolocation with the coordinates of the plots of land where the commodity is produced can also incur additional costs for implementing traceability requirements.Even though there are concessions that producer countries in implementing anti-deforestation laws must improve land and forest governance, and create socio-economic opportunities, and sell products according to domestic production rules, and take advantage of EU support and funding, this is not easy to do.S-2 shows better results considering that there is a domestic market for the development of B35/40 where there is at least an additional domestic market of around 3.5 million tons of palm oil.The next driving factor is the EU's plan to completely replace palm oil for bioenergy with other oils and use waste vegetable oil which is very risky.The production of other vegetable oils such as rapeseed and sunflower are highly dependent on climatic conditions.This change pushed up the price of vegetable oil on the global market and pushed up the export price of palm oil.Another thing that is also important is that palm oil is unique in that it cannot be substituted for other vegetable oils such as rapeseed, soybean, and sunflower.It can produce cooking oil and bioenergy, but cannot make other products such as detergents, toothpaste, soap, and cosmetics.A full replacement program of palm oil with other vegetable oils may not be fully successful.Due to its unitary nature, the palm oil downstream program and the deepening of its industrial structure will greatly influence the increasing competitiveness of palm oil against other vegetable oils.The palm oil export market will be more open and the volume of palm oil exports will also increase.This provides more incentives for smallholder oil palm farmers to produce because an increase in export prices will also encourage an increase in producer prices.

Conclusion
Based on the two scenarios used, even though both require changes to the governance of the palm oil industry for export purposes, S-2 namely not fully complying with anti-deforestation rules, diverts exports to other countries and develops biodiesel from Biodiesel 30% to 35%/40% (B30 to B35/40) shows better performance than S-1, which is fully complies with anti-deforestation regulations.The results of traceability requirements can have implications for supply chain separability and the exclusion of smallholders.But it can also provide the possibility of increasing the position of smallholders in the global market, if farmers become part or plasma of large-scale companies and scenario 2 is succeeded by the government in collaboration with all relevant stakeholders.For the European Union, under the S-2 or S-1, regulation will impact decreasing supply and incompatibility of the palm oil processing industry and traders in their countries.

Implication
Indonesia needs to switch the export market of palm oil from the EU to other countries or regions and increase domestic consumption.Expanding the biodiesel program from B30 to B40 is expected to reduce the impact of the EU's anti-deforestation law on the national palm oil industry.In anticipating the impact of implementing anti-deforestation laws, apart from working with all domestic stakeholders, the Indonesian government also needs to immediately make a joint response with other vegetable oil producing countries.Improving the palm oil downstream program and the deepening of its industrial structure and immediately seeking alternative export markets is a must, and must be carried out in a sustainable manner.

Appendices
Palm Oil Market Trend Palm oil production will reach around 88.24 million tons in 2022 (Appendix A.1), with a composition of Crude Palm Oil (CPO) production of around 79.16 million tons and Palm Kernel Oil (PKO) 9.08 million tons.The five largest producing countries are Indonesia (51.75 million tons), Malaysia (22.05 million tons), Thailand (3.66 million tons), Colombia (1.98 million tons) and Nigeria (1.79 million tons).With the exception of Nigeria, the largest palm oil producing countries experienced lower production growth in the 2018-2022 period when compared to the 2013-2017, 2007-2012, 2003-2007 and 1998-2002 periods.It is suspected that the age of the oil palm plantations, climate change and the Covid-19 pandemic is a contributing factor.

Table 1 .
The effect of the implications of the European Union's Anti-Deforestation Regulations on Indonesia' Palm Oil Industry 2023-2032 as Compared to Average Value 2017-2019 Period Global Import of Palm Oil (PO) and Palm Kernel Oil (PKO), 2002-2022 Global Domestic Consumption of Palm Oil (PO) and Palm Kernel Oil (PKO), 2002-2022 Total vegetable oil market balance in the EU, 2005-2032