EU Deforestation Regulation: Can We Expect a Trade War?

The draft EU Deforestation Regulation was released by the European Commission in late November. Its approach is simple: ban commodities produced from deforested land.

The released version has already caused significant consternation, with arguably the world’s leading trade policy journalist describing the measure as “neocolonialism … for all Brussels’ talk of international partnership and co-operation, unashamedly unilateralist and potentially WTO non-compliant.”

The regulation will have significant implications for palm oil exporting countries, the EU’s trade relations with Indonesia, and for trade law. We go through the key points below. 

Implications for palm exporters

The key point of the law is this: the EU wants to ban the importation of different commodities that have been grown or produced on land that was deforested from January 2021 onwards.

The commodities that are currently within the regulation’s scope are cattle, cocoa, coffee, palm oil, soy and timber.

For palm oil, the regulation specifically targets crude and refined palm oil, palm kernel oil and palm oilcake.

The regulation will benchmark different countries as ‘high’, ‘low’ or ‘standard’ risk for deforestation, based on deforestation rates, governance and international treaties, among other things.  High risk countries will be subjected to greater levels of scrutiny.

Importers will be required to undertake due diligence on their imported goods; this will mean being able to provide information on the source of the goods via traceability, and undertaking a risk assessment and mitigating any risk accordingly.

Will voluntary certification be a significant part of the risk assessment? According to the Commission’s proposal, it will only be secondary. There will be a much greater emphasis on chain-of-custody and traceability. Segregated supply chains will be paramount; mass balance will struggle to satisfy the requirements. All of this will need to be proved, and communicated, to European authorities directly.

Particularly because existing certification systems will not be the lynchpin of any system, this will mean compliance costs will go up for EU importers. But it is also highly likely that these costs won’t be passed on to customers, and will simply be borne by producer countries. This is something that was flagged by the EU in its economic impact assessment. Once again, palm oil producers will feel the economic pain and all the promises about ‘supporting the developing world’ made in European boardrooms and government offices will count for naught.

This regulation is like many others in that it imposes a non-tariff barrier that will disrupt trade and create uncertainty for exporters to European markets.

Beware the EU Parliament

On first look – as outlined above – it may be tempting for palm oil exporters to wonder what the fuss is about. Much of the palm oil being exported from Indonesia and other countries will not fall afoul of the regulation because any deforestation happened before 2021 – so it’s all exempt from the regulation, right?

Wrong.

This is the start of the EU legislative process. The Council (made up of the 27 EU Governments) and the EU Parliament, now have free rein to add, delete and amend the text over the next 12-18 months.

The 2021 cut-off date? That could be changed dramatically, dragging exporters into the net of the regulation. Penalties could be increased; demands added for specific commodities; countries explicitly called out … the EU Parliament is often where common sense goes to die. MEPs have a long history of anti-palm oil sentiment; this regulation is unlikely to be any different.

Trade relations

What is significant in this proposal is that the EU is seeking a prohibition on products from deforested land, whether that deforestation is legal or not. This is a significant departure from existing laws, such as the EU Timber Regulation and the UK Environment Bill.

It is also clear that the laws are specifically targeting two of the world’s largest emerging economies, Indonesia and Brazil.

For Indonesia, this will impact around USD2 billion in exports of palm oil products that go to the EU. This includes palm oilcake, which is generally used for animal feed and has not previously been on the radar of EU-based activists. It will also impact around USD900 million in exports of cocoa and coffee.

These are significant exports for Indonesia that support millions of livelihoods. It’s notable that there is no exception for palm oil smallholders – or any smallholders – in the regulation.

The Commission proposal also comes just weeks after President Jokowi and members of his cabinet made it clear that Indonesia is not prepared to accept regulation that undermines Indonesia’s development and its sovereignty.

The question at this point is how it will play out in terms of the Indonesia-EU trade agreement negotiations, and also trade relations going forward more broadly. Another round of negotiations took place last week; as we have pointed out previously, Indonesian negotiators  have generally been dismayed by the lack of consultation on ‘Green Deal’ measures and have stated that the EU keeps ‘moving the goal posts’.

What is Brussels’ Game?

Trade doublespeak is nothing new for the multiple institutions of the EU. On the international stage it argues for liberal trade and new trade agreements. Its exporters – like Germany – need those agreements to happen, particularly with a large market like Mercosur (i.e. Brazil) or ASEAN. But at the same time, EU farmers won’t accept an influx of imports.

The severity of the situation was highlighted in a report from by the JRC early this year – which we highlighted in February – that showed the EU’s FTAs would increase vegetable oil imports by around USD850 million from Indonesia and Malaysia over the next decade (inflation adjusted). Responses to the report indicated that the greatest concern was over beef imports.

As always, Brussels’ ongoing protecting of competing industries is of paramount importance, but it needs to make new FTAs palatable for member states and farmer groups. The best way for Brussels to do this is to impose a non-tariff barrier that will curb imports without completely banning them.

If anyone has doubts about the EU’s determination on this, it’s worth remembering that the EU effectively ignored a WTO ruling on bans of beef from the US because of hormone use. This resulted in the US being able to levy retaliatory tariffs against the EU of more than USD100 million annually.

It’s also worth noting over the past few years, there has been ongoing and increasing animosity between the EU and Brazil over trade, deforestation and politics more broadly. This is likely a key driver in the scope of the regulation.

But for Indonesia’s EU negotiators, it simply adds to the complications of completing a deal that is being held hostage by EU domestic politics, rather than genuine concerns about deforestation (Indonesia’s deforestation rates are at historic lows). What is the point of getting better market access for some products when Brussels simply blocks the path with new trade barriers?

If Brussels is genuine about cordial relations with Jakarta, it will need to smooth things over – and quickly.

Trade law

None of the above even touches on what will become a significant question in international trade law. There are some clear basic problems that many EU officials are also concerned about.

A memo that was strategically leaked to the Guardian newspaper indicated that trade officials were concerned about three things.

First is the idea that all deforestation – not just illegal deforestation – should be considered. They stated that it would be “a direct challenge to notions of sovereignty over land use decisions, whether in the EU or in third countries” and that this “will be particularly difficult to accept” among trading partners.

Second is that it will impose a significant cost on small farmers, as noted above.

Third is that some non-trade officials are seeking to use a number of the exceptions provided in the GATT including for ‘public morals’ to ensure that it is consistent with WTO rules. Trade officials have described this as ‘a risky avenue’.

Notwithstanding the existing problems of the regulation, if the aim of the regulation is to end deforestation because it is so morally abhorrent to EU citizens, it shouldn’t actually matter which products it applies to – it should apply to all products. The obvious parallel would be, for example, certification of halal/haram products for Muslim countries.  

If the EU proceeds with this measure, it might need to be careful about what it wishes for. And it also needs to be prepared for some raised ire; not just from Indonesia, but also from other ASEAN members.

France has stated that it is now trying to improve its foreign relations with Indonesia – it is notable that Foreign Minister Le Drian recently visited Jakarta. Here is our question for Le Drian: is this the best way to treat a country that you value?

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