The Palm Oil Saga

What's going on?

Indonesia temporarily removes its export levy for all palm oil products until 31 August 2022.

What does it mean?

Palm oil comes from the fruit of the oil palm tree. Fresh fruit from oil palm plantation are processed in a manufacturing facility and then voila, you get crude palm oil (CPO) and refined palm oil. (This is oversimplified, I know)

It's used primarily as cooking oil, but can also be found in cosmetic ingredients, cleaning products, and biodiesel fuel. Indonesia is one of the world's largest producer of palm oil, producing 51 million tonnes of this product in 2021 alone.

How much is that worth? USD 47 billion (that's billion with a B!), about 4% of our GDP.

Out of the 51 million tonnes produced, 65% is exported while the rest is for domestic consumption. Back in March, the war in Ukraine has pushed up the prices of cooking oil globally, including palm oil. To combat rising prices, in late April President Jokowi decided to ban the export of palm oil with the hope of securing domestic supply and stabilizing local price.

That causes all sorts of consequences.

One, countries who normally buy this stuff from us are angry as they are forced to buy from other sources at higher price. Two, local producers are even angrier as they can't sell their product at a higher price to the international market. After a few weeks of uproar and protest, the ban was lifted.

Instead of a ban, the government impose a $200/tonne export levy and a requirement for producers to set aside at least 25% of volume for domestic supply (also called Domestic Market Obligation).

How do these policies work? Excellent question.

Let's say you're a palm oil producer and you produce 1 million tonne during the month and you want to export at a market price of $1,000/tonne. (Congrats you're rich 😎).

Before you can export, you have to reserve 250 thousand tonne for local supply. Then, when you export the remaining 750 thousand tonne, you will need to pay $150 million in export levy ($200 x 750 thousand) to the government. The government will then use proceeds from this levy to subsidize local production of biofuel and replanting of oil palm trees for smallholder farmers.

On Friday, Finance Minister Sri Mulyani announced a temporary removal of this export levy until end of August.

The reason?

Due to the month-long export ban back in May, export volume has slowed. Inventories of crude palm oil are piling up, with more harvest expected to come in July - August. What happen to price when supply is overloaded? You guessed it, price has dropped to a one-year low. Not to mention the risk of fruits going to waste with storage tanks at processing facilities at full capacity.

Removing the export levy is intended to help boost export and reduce inventory.

What can we learn?

Look, managing a country's economy is hard, especially one as big as Indonesia. This story is a perfect example of how complex it is to juggle between keeping low prices, maximizing export income, and maintaining international relations.

Sometimes (in fact, most of the time) in business and economics, choosing to make one group happy means angering another. When prices of cooking oil kept increasing in early 2022, the government chose to make lowering price a priority by banning export.

But this choice came with the consequence of lower prices received by farmers, lower export income for local producers, and unhappy international trading partners.

Economics is all about trade-off. Making a choice means giving up something else, what we call opportunity cost. We can't make everyone happy, and if we try, no one will be.

There's always a trade-off.

Until next time...

- Jason