This article first appeared in Forum, The Edge Malaysia Weekly on November 25, 2024 - December 1, 2024

While it is looking increasingly likely that the deadline for the European Union’s Deforestation Regulation (EUDR) will be postponed by a year, this does not solve the inherent problems caused by the regulation. Complying with the EUDR is extremely difficult, costly and damaging to sustainable producers due to a factor that is missing in most discussions: logistics.

The law requires that importers of cattle, cocoa, coffee, oil palm, rubber, soya and wood demonstrate that their products can be traced back to the plot of land on which they were grown and submit extensive data to prove, if required, that there was no deforestation after 2020 and that it was produced in “accordance with the relevant legislation of the country of production”.

Signing that statement is a large commitment: importers could be fined up to 4% of their revenue in the EU for any breach.

Given the high-minded aims of the EUDR, to prevent importing goods that cause deforestation, it may seem tedious to mention something as mundane as the question of how crops are collected, processed and stored. However, it is these aspects that will determine whether the law achieves its goals and at what cost.

The law means that commodities imported or exported from the EU must be stored and processed separately. This is a radical departure from thousands of years of trading, in which the emphasis has always been to aggregate commodities and move them from surplus regions to deficit regions, as efficiently and cheaply as possible.

This is a particular problem for one of the more controversial crops covered by the regulation: the oil palm.

The law is the same for all crops it covers, but each crop has its own peculiarities. For the oil palm, nature provides one single fact that shapes its logistics: it produces fruit. The oil palm’s fruit, in turn, needs to be processed as soon as it ripens.

Just like during the apple harvest, when different orchards combine their crops in one press, the fruit from the oil palm needs to be aggregated and processed together in one mill. Individuals with a few trees, small family farms, large estates, dealers — all of them supply mills within a short radius of their palms.

Can mills buying from many small farmers really be sure that they can demonstrate legal compliance? Small farmers usually don’t read English and they certainly can’t afford their own legal department, human resources team or sustainability adviser. Tribal laws are often still the main source of legitimacy, not those written at the federal capital a thousand kilometres away. The inheritance of land is a particular problem: it follows ancient traditions not modern demands for the correct paperwork.

A company cannot risk a fine of potentially 4% of their revenue in the EU in the hope that the thousands of small farmers who supply millions of fruits to their mills possess all the correct paperwork. The result is that the sustainability team, who joined the sector motivated by a desire to improve the livelihoods of small farmers, now finds that their job is to exclude smallholders, to their immense regret.

This comes at a high cost to the farmers. They used to rely on the local mill but now they are being told that a European law means they cannot accept their fruit. Small farmers will have to transport their crops much further to find a mill that doesn’t sell to Europe. The cost of that transport will be reflected in a lower price for the farmer and less income for their family.

There is also a cost to the mill that doesn’t run as efficiently. As we move away from the mill, the problems multiply. The palm oil and its downstream producers now need an entirely separate supply chain for the EU, with extra storage, dedicated processing plants, additional infrastructure, people, and IT systems, to manage the paperwork. All of this comes at a substantial cost, as well as introducing inefficiencies.

The cost can be estimated by looking at the volume of products imported by the EU, the normal cost of processing and the increase caused by the EUDR. Crucially, while these costs appear small per tonne, they are substantial in aggregate as they reverberate up the value chain. The EU requires around 1.7 million tonnes of palm kernel oil; this is extracted from over four million tonnes of kernels, which in turn requires close to 90 million tonnes of fruit. Even a modest US$1.50 (RM6.70) increase in the cost of processing these fruits, easily caused by reduced efficiencies, will cost producers US$135 million. At the same time, the smallholder crops that can no longer be processed locally will require millions of tonnes of fresh fruit bunches to be trucked further; the oil produced for the EU will need to be stored separately, requiring more storage; and the refineries will run less efficiently, wasting energy and money. We estimate these inefficiencies add a cost for the industry of around US$650 million. Importantly, this is not a one-off cost but a cost that will be paid every single year due to the requirements of the law. Of these costs, US$260 million will come out of the pockets of small farmers.

Are companies willing to make these investments? For most Southeast Asian palm oil producers, the EU is only a minor buyer and they are willing to wait and see what happens. Meanwhile, the European Commission, faced with the complexity of making these laws workable, has been unable to provide updated guidelines or an IT system that can handle the volume of data required. Those who comply will, of course, only do so in the hope that this cost will ultimately be paid by the EU consumer. Large companies understand that the law benefits them by reducing competition. Entire business strategies are being built around having access to what everyone assumes will be a highly priced EU market.

The EUDR may turn out to be very profitable for producers. Yet all those who work on the oil palm — and particularly those in sustainability — view the EUDR as a tragic waste.

EU consumers, who genuinely care about the environment, will want to believe that the sacrifices they are making are worthwhile to pay to prevent deforestation. Europe must face the reality that they will be buying the same palm oil they have always bought but will be paying for it to be delivered in a less efficient manner which excludes small farmers.

Dr Julian McGill is the managing director and founder of Glenauk Economics, a specialist advisory firm focusing on the economics of agricultural commodities. Based in Kuala Lumpur, a major focus of his research is the economics of the oil palm. Prior to becoming a consultant, McGill completed his PhD at the University of Oxford.

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's App Store and Android's Google Play.