On 9 January 2023, both Malaysia and Indonesia’s heads of government agreed to work together to “fight discrimination against palm oil”, in a reference to new European Union anti-deforestation legislation. Tangibly, the Malaysian plantation and commodities minister is threatening a wholesale ban on palm oil exports to the EU. Given that Malaysia and Indonesia combine for more than 80 per cent of the world’s palm oil supply and the EU is their third-largest market, the potential ramifications for any such moves would be significant. 

How has an issue over palm oil trade reached such a point? For years, Malaysia and Indonesia have railed against EU import barriers on their palm oil, which they characterise as protectionist in favour of the EU’s domestic vegetable oil sector. The EU’s new law, which is expected to be implemented late 2024, obligates “companies to ensure that a series of products sold in the EU do not come from deforested land anywhere in the world” and is aimed at reducing the EU’s impact on biodiversity loss and global climate change. Whilst no country or commodity is explicitly banned, the new regulation covers palm oil and a number of its derivatives. Currently, both Malaysia and Indonesia have separate lawsuits at the World Trade Organization (WTO) pending over the EU’s palm oil trade restrictions.

Implications

To date, only Malaysia has explicitly threatened to ban palm oil exports to the EU. Were this issue to escalate and Malaysia to impose the suggested ban, it would have several consequences. First and foremost, Malaysia’s palm oil industry and wider economy would be hit; the industry makes up 5 per cent of Malaysian GDP, of which a non-negligeable 9.4 per cent of its exports are bought by the EU. Additionally, an abrupt ban is likely to harm producers who have contracts to sell in the EU. Alternative export destinations could be found, especially in food-importing markets such as the Middle East and North Africa, but these producers would struggle to pivot in the short-term and likely see financial losses. Even greater disruptions would be experienced by the few Malaysian palm oil companies that have established refineries in Europe, necessitating a reorientation in their supply chains. Yet the outlook is not entirely negative; palm oil’s lower cost as compared to its substitutes such as soybean oil or sunflower oil will sustain global demand. Overall the Malaysian export ban to the EU would cause a limited scope of economic damage in the short-term, and would see gradually less impact as time progresses and firms adjust.

The potential implications for the EU are equally significant. Firstly, if Malaysia were to enact an export ban soon, this would likely be in unison with Indonesia as the larger producer. A unilateral Malaysian palm oil export ban to the EU, with new regulations permitting, would simply lead EU imports to shift to Indonesia along with profits - hence Malaysia is seeking bilateral action. A joint ban on exporting to the EU would cut the EU off from around 70 per cent of its palm oil, meaning significant interruptions in processed food or biofuel production. New import regulations, however, will help the EU’s domestic vegetable oil sector, which is something that Malaysia asserts. Especially in biofuel production, oils such as soy, canola, and rapeseed would fill the palm oil gap and increase their respective market shares. This issue is further complicated by the EU and Indonesia seeking an elusive free-trade agreement, with negotiations routinely stalled by the EU’s palm oil regulations. This could be in the EU’s favour as free-trade negotiations would break Indonesian-Malaysian solidarity on the issue. 

Ironically, the EU’s new regulation could also result in greater amounts of deforestation, instead of less. As the EU reduces its palm oil imports through stricter environmental regulations, Malaysian and Indonesian exports would shift even more to the two larger importers in India and China, with less stringent environmental regulations. The EU’s citizens may not be as directly responsible for deforestation, but worldwide deforestation may in fact increase as a result of this policy. 

Market forecast

The immediate reaction from markets was nonplussed. Traders don’t see the threat of an export ban from Malaysia holding. This is reflected in palm oil futures contracts (FCPO: Bursa Malaysia Derivatives Exchange, the benchmark for palm oil), where prices remained stable since the EU’s law was proposed and Malaysia’s threat issued. This means the ban is currently not taken seriously, with Malaysian threats interpreted as a knee-jerk reaction. In any case, firms are anticipating decreased demand from the EU and have been exploring new markets to offset potential European losses. If this Malaysian export ban to the EU were to happen, this would nonetheless pale in comparison to the supply shocks experienced in 2022. A brief ban on all Indonesian palm oil exports globally in April 2022, amidst fears of food shortages and high domestic prices, resulted in record-high global prices. This is a level we are unlikely to see again, as stability returns.

On the supply-side the Malaysian Palm Oil Council expects production to recover in 2023 with estimates of a 3-5 per cent increase, after three years of decline amidst labour shortages linked to COVID-19. This is likely to have a greater impact on global markets instead of a ban or the threat of one, and both Malaysia and Indonesia’s output will continue to climb in the years to come. 

Forecasting the demand side is more uncertain. Short-term projections suggest lower demand due to China’s surge of COVID-19 infections post-Lunar New Year, but this is more symptomatic of the wider Chinese economic reopening which will, on balance, stimulate demand. In the medium-term, the threat of recession facing the global economy will hurt palm oil demand, with a mild recession expected in the first half of 2023 followed by a gentle recovery. A longer-term positive outlook is observed in relation to biodiesel’s potential. Amidst high crude oil prices, the further development of biodiesel utilising palm oil would incite new demand. 

Looking ahead, projections are uncertain given factors such as the Malaysian migrant worker shortage, the Chinese economy reopening, and potential global recession. This is in addition to Malaysia and Indonesia’s unpredictable regulatory environment, where any policy is subject to rapid change. Palm oil exports to the EU are likely to remain a point of contention between the two south-east Asian countries and their European counterparts. Because palm oil forms a significant part of Malaysia and Indonesia’s economies, their respective governments will continue to intervene.

As the two largest producers in this market potential cooperation between Malaysia and Indonesia over an EU export ban must be monitored- acting together would result in greater consequences for EU imports and worldwide prices. While the Malaysian threat to ban exports to the EU may be an empty one, decreased EU palm oil imports will be observed as it shifts towards more sustainable consumption. Combating climate change is the EU’s underlying aim, but this will necessitate a change in trade patterns.