Palm Oil’s Due Diligence Battle Is About to Heat Up

Last week, the UK confirmed that its due diligence regime for deforestation in imported commodities – including palm oil – would be based on legality, rather than sustainability criteria.

This was particularly significant for palm oil exporting countries, as they have faced an onslaught of trade restrictions from Brussels. As London sought to diversify its trade partners around the world, it has also sought to step away from heavy-handed EU regulation.

But this week, Brussels is set to release its own due diligence proposals, contained within its Anti-Deforestation regulation. It is expected that these will be supplemented later in the year by a second proposal focused on labor rights.

As for this week’s deforestation-focused due diligence, here’s what we know so far from what we’re hearing in the EU, and from a number of leaked documents on the proposal.

There are three critical parts to the legislation that are worth calling out.

The first is the general prohibition:

Relevant commodities and products as set out in Annex I shall not be placed or made available on the Union market unless: a) they are deforestation-free; and b) they have been produced in accordance with the laws and regulations of the country of production.

Deforestation-free in this instance is further qualified:

‘deforestation’ means the conversion of forest to other land use, including conversion to plantations, independently whether human-induced or not, (3) ‘forest degradation’ means changes within a forest which negatively affect its species composition, structure, and/or function and reduce the capacity to supply products, support biodiversity, and/or deliver services, (4) ‘deforestation-free’ commodity or product means a relevant commodity or product which was produced in a way that has neither caused nor contributed to deforestation or forest degradation after 31 December 2020, [TBC]

These are reasonably clear and at this point, it would not appear that there is a move to retrospectively apply the rules to existing commodity groups.

The second is the establishment of a due diligence system by operators. There are two forms of due diligence, those for ‘high risk’ and those for ‘low risk’ countries. Low risk countries will have simplified due diligence; high risk will have ‘enhanced scrutiny’.

So, what determines risk? The EU will undertake a benchmarking exercise:

This list of countries shall be published by the means of a delegated/implementing act in accordance with Articles XX. That list shall be updated where necessary in light of new scientific evidence… the Commission shall compile and analyse information related to deforestation and forest degradation caused by the production of relevant commodities and related trade.

In other words, it will be handed over to the Commission via a delegated or implementing act, decided away from the scrutiny of the political process. This is where many commodity exporters will find the real problems start.

If this sounds like the Renewable Energy Directive (RED II) process that banned palm oil, it’s because it is. The key difference here is that the EU is seeking to apply different criteria to different countries.

This is a potentially a WTO minefield – which is grounds for a longer discussion —  but that hasn’t stopped the EU from acting in this way before.

The third aspect is the different commodities that are being singled out. These are beef, cocoa, coffee, palm oil, soy and wood products. The classification for palm oil is HS1511, which is basically crude or refined palm oil.

Generally, the products are in their less refined forms, with the exception of wood products, which goes well into paper and pulp products.

The big outstanding questions are less about what constitutes deforestation, and more about how the benchmarking process will take place, and which products will be included. And there are significant political implications for both.

For example, it is more than likely that Indonesia and Brazil, for example, will be considered ‘high risk’ countries. But this won’t give anti palm oil campaigners or industry protectionists what they are seeking.

Consider, for example, that Malaysia and Argentina have low deforestation levels. But both are significant exporters of palm and soy respectively. In both cases, if supply is disrupted from other countries, those countries will be able to fill in. Trade will be interrupted, but it will also be diverted.

It’s not surprising, then, that some campaign groups are seeking to have the criteria expanded significantly to include, say, human rights. But if the criteria become too broad, then the whole bill becomes problematic – which is arguably why the EU is also introducing human rights due diligence separately. The case of corn, for example, which causes significant global deforestation could enter the picture, and a large import source for the EU is Ukraine. Ukraine may have low deforestation, but its record on human rights and land tenure is questionable.

On products, the EU is facing pressure from both directions. Many companies use imported inputs – cocoa, palm, soy – for manufactured goods and animal feed. If the product and compliance costs go up significantly, this is very bad for the European manufacturing sector. It will become cheaper to manufacture those products outside of the EU. This is something EU farmers, for example, have made Brussels very aware of.

On the other hand, the narrow product focus has caused much consternation with NGOs and there will be pressure to broaden the range of products that are hit by the regulation.

Brussels is walking a tightrope here. This isn’t like steel, which can be manufactured anywhere with enough investment. Palm oil and cocoa don’t grow in Europe.

The final big question is what will satisfy due diligence requirements from high-risk countries. Brussels will be leaning towards RSPO, but they have fallen short of calling for endorsement of particular certification systems meeting particular criteria as they did with RED.

RSPO as a due diligence system would satisfy the EU manufacturing lobby. Nutella, anyone?

Would ISPO and other national systems meet those requirements? Possibly, but in all cases, the EU is not going to make the process easy for importers, nor for exporting countries.

The EUTR’s Due Diligence requirements for timber are very similar to those presented here. They have been trade disruptive and imposed costs on importers, even those using certification systems such as PEFC and FSC.

It’s at this point that President Jokowi’s speech at Glasgow becomes significant. He stated a number of things, but his points on certification stood out:

“Certifications, methodologies, and standards should be based on multilaterally recognized parameters, not unilaterally imposed and capricious. Certification must be fair, so that it has an impact on welfare, especially small farmers. Certification must also take into account all aspects of the SDGs, so that forest management is in line with poverty alleviation and community empowerment.”

This, in our view, is a shot across the bow of the EU, in relation to palm oil, but also in relation to timber and cocoa, which are both big parts of the Indonesian agriculture sector.

The EU will be wary of making the same mistake they did on RED, and the diplomatic furore it caused. This time Brussels will not only have Indonesia to deal with, but also Brazil and a number of African countries. It’s worth remembering that the EU-Mercosur and Indonesia-EU trade agreements still have some way to go.

If Brussels wants to get this right internationally, the first thing they should do is listen to Jakarta. As has been well noted globally, Indonesia has a new confidence in its global role. The days of being pushed around by powers in Amsterdam, London or Brussels are well behind it.