7/5/07 (The Jakarta Post) - Seen from the point of view of supply and demand, the steep rise in domestic cooking oil prices over the last few weeks seems rather strange, as it has nothing to do with supply shortages or a sudden surge in demand.

Indonesia's crude palm oil (CPO) production is forecast to hit an all-time high of almost 17.5 million tons this year, compared to about 16 million tons last year. This would move Indonesia past Malaysia, the world's largest producer, which has an estimated production of 16.5 million tons.

The quick decision by the government and CPO and cooking oil producers to conduct joint operations to supply the market with low-price cooking oil was nonetheless appropriate in curbing further price increases. Without such a coordinated effort, domestic cooking oil prices could continue surging because the main reason behind the rise is the hike in international prices, which has prompted producers to raise their domestic prices.

Cooking oil price rises have been set off by the large increase in the international prices of CPO caused by surging demand in India and China, the world's two largest consumers of cooking oil and other CPO derivatives.

International CPO prices have climbed steadily to more than US$720/ton, the highest level since 1998, and major traders of CPO-based products such as Godrej International Ltd. predicted last week a $730/ton price level later this year. And this trend will likely continue.

Certainly, without some market intervention, domestic CPO producers would have automatically adjusted their domestic sales prices to international quotations or, if not allowed to do so, they would have preferred selling all their output on the international market.

We are glad to observe that without too much urging by the government, domestic producers have been expanding their market operations in major cities to stabilize cooking oil prices to the government-set range of Rp 6,500 to 6,800/kilo ($0.70) from more than Rp 7,500-8,000/kg at present.

These operations should not require major sacrifices on the part of producers but only a slight reduction in their profit margin. CPO producers, which have thus far exported most of their output -- as domestic consumption took up only about one third of the national output -- have instead been enjoying a windfall profit as a result of surging international prices.

Without good cooperation on the part of producers, the government may be tempted to erect punitively high tariff barriers against exports to force producers to sell a greater portion of their production to the domestic market. After all, the government should always be alert against inflationary pressures.

But the government should be commended because it did not immediately resort to slapping export quotas or very high tax rates on CPO exports, as it did in the mid-1990s. The Trade Ministry has threatened to increase the export tax on CPO, the main basic material for cooking oil, soap, margarine and many other food derivatives, from 1.5 percent now only to 10 percent if domestic cooking oil prices could not be brought down to within the target price range by next month.

Resorting to non-tariff barriers such as export quotas would create uncertainty in the palm oil industry at a time when the government has been aggressively promoting the development of this crop to support its massive bio-fuel production program.

Such a measure also would not be effective given the country's vast coastal areas, which offer many opportunities for smuggling. Riau province, currently the country's second largest CPO producer after North Sumatra, is less than a one-hour boat ride to Singapore or Malaysia. Likewise, slapping punitively high export tax rates on CPO would be highly vulnerable to corruption due to the inadequate institutional capacity at the customs service.

But the government should continue keeping itself well apprised of the latest developments in the international CPO market. The current intervention through joint market operations could run smoothly, and domestic producers have voluntarily joined the market operations because the difference in domestic and international prices is not yet too large.

However, if international prices continue to rise steeply and the price difference becomes very wide the government, for the sake of policy consistency, should allow for a higher target range for domestic sales prices to discourage export smuggling. Imposing export quotas or high export taxes would only scare away new potential investors in the palm oil industry, and the country could simply kiss good-bye its ambitious bio-fuel program.