Saturday May 1, 2004 - BASED on land area alone, it looks inevitable thatIndonesia will one day overtake Malaysia in the palm oil business. As itis, Indonesia has long been a strong No. 2, and together, the twocountries account for more than 80 per cent of the world's palm oilproduction.

But should this be something that our oil palm players should fret about?Rating Agency Malaysia Bhd (RAM) seems to think so.

The competition from Indonesia may be a dim concern at a time when thecrude palm oil (CPO) market is buoyant, but when the price crunch comes,the players will have to outdo each other just to survive.

In a recent article, RAM says it believes that Indonesia could soon turninto a serious contender for Malaysia's crown as the leader in palm oilproduction and supply. It even predicts that in five years' time,Indonesia will produce more palm oil than Malaysia.

The impending threat from Indonesian CPO should serve as a wake-up call toMalaysian plantation companies, it warns.

Then again, it is not as if these companies, particularly the larger onesamong the listed players, are slumbering. Several already have estates inIndonesia. These include Kumpulan Guthrie Bhd, Kuala Lumpur Kepong Bhd,Golden Hope Plantations Bhd and PPB Oil Palms Bhd.

An analyst who tracks the plantation sector at a foreign research outfitsays a lot of the local companies already hold the view that they have tobe in Indonesia to remain competitive over the long term. The ones whohave not gone in yet are probably more risk-averse than the others, butthey are definitely looking around she adds.

A veteran planter confirms this: Well, if you can't beat them, join them.Quite a number of local plantations companies are working hard at gettingland in Indonesia.

Lots of land

There is no doubt that Indonesia has the capacity to be the world'slargest oil palm producer. To start with, it has plenty more land for newplantations.

Although its total land area of 1.9 million sq km is spread over manyislands, it still has tracts of potential plantation land in places suchas Kalimantan and Sumatra.

In comparison, Malaysia's plantation land bank is depleting. Most of thenew estates are in Sabah, while a lot of the palm oil land in PeninsularMalaysia are becoming increasingly valuable, more for their developmentpromise than for their crops.

At one time, it was widely believed that the oil palm planted area inMalaysia would peak at about 3.9 million ha sometime next year. Thattarget may have since shifted, but considering that we are already at 3.8million ha, it should not be long before we reach the ceiling.

RAM points out that Malaysia's oil palm hectarage increased at acompounded annual growth rate of 5 per cent between 1998 and 2002, whileIndonesia's planted area expanded by 9 per cent in the same period.

Says the rating agency: The abundance of fertile land in Indonesia willpromote new plantings in the future, whereas Malaysia will be constrainedby the increasing scarcity of suitable agricultural land.

That is not all. With a population of over 200 million, Indonesia does notsuffer a labour shortage.

Indonesia has these two great advantages in the plantation business landand labour. It's a matter of time before it takes over the top spot, saysthe veteran planter.

RAM argues that the expected increase in Indonesia's CPO output will havea significant impact on the world's edible oil market. The agency hascalculated that Indonesia may boost the global stocks of oils and fats byas much as 90 per cent by end-2008.

“If the much anticipated surge in consumption in China and India does notmaterialise, there will be immense pressure on the global prices of oiland fats when the Indonesian plantations improve their operatingefficiency, says RAM.

Although some industry observers believe that five years is too soon forIndonesia to surpass Malaysia, very few will rule it out.

Says the analyst with the foreign research house: I don't think it willhappen within five years. But if Indonesia sorts out its politicalproblems and becomes far more stable, its plantation industry willcertainly pick up at a faster rate.

Narrowing the gap

Still, there is some way to go before Malaysia can be knocked off itsperch. Its estimated share of the global palm oil production last year was49 per cent. Indonesia's piece of the action was 36 per cent.

The difference between the two is more apparent when it comes to sellingCPO to the rest of the world. In 2003, Malaysia accounted for 57 per centof the global palm oil exports, while Indonesia contributed 33 per cent.

This is partly because a larger proportion Indonesia's palm oil productionis consumed domestically. Furthermore, the Malaysian palm oil industry hasa superior marketing machinery.

The 1997 Asian financial crisis was a decisive factor in keeping Malaysiaahead. In the few bleak years following the crisis, the Indonesianplantation industry took a far harder hit as investments dried up andcompanies floundered. Few companies could afford new plantings and thecosts of keeping up the yields of their plantations.

Yet, it is this near collapse that has paved the way for Indonesia to makea big comeback. RAM points out that the restructuring of severalIndonesian plantation companies have resulted in the emergence of foreignowners who have the resources and expertise to squeeze more out theestates.

Furthermore, the banks are now more willing to lend to these rehabilitatedcompanies. With more money, the companies can then spend more on newplantings, fertilisers and infrastructure.

These expeditures will ultimately translate into higher CPO production forthe country in the longer term, thereby lowering its average cost permetric tonne, says RAM.

It is perhaps a mistake to underestimate the competitiveness ofIndonesia's plantation companies. RAM compared the profitability and FFB(fresh fruit bunch) yields of some listed Indonesian and Malaysianplantation players, and came up with rather surprising results.

The numbers show that although the Indonesian companies' yields wereinferior to those of their Malaysian counterparts, their profit marginswere not that far off.

And the yields are bound to improve. Most of the palm trees are young andwill bear more fruit as they mature. In addition, the plantations are onvirgin land, which means having to spend less on fertilisers.

Clearly, there is some urgency for Malaysian plantation companies to lookfor ways to enhance their competitiveness and profitability.

What Malaysia must do

Of course, one way to respond to Indonesia's rise in the palm oil businessis to invest there. However, it is a tough business decision to make,chiefly because the country still has major political and social issues toaddress.

The veteran planter says it is possible to duplicate in Indonesia the kindof success planters have enjoyed in Malaysia. But he has a caveat: Itdepends on the location.

That is indeed a major consideration when venturing into a country thathas four time zones and over a hundred languages and dialects. Commoncomplaints about running plantations in Indonesia are land ownershipissues, pilferage, logistical challenges and regulatory obstacles.

RAM notes that some Malaysian plantation companies have gone intodownstream activities such as refining and manufacturing specialty oilsand fats locally and abroad. It says, Investing in downstream activitieswould not only help boost profits, but would also provide a natural hedgefor their plantation businesses.

Another plantation analyst offers an alternative way of viewing the threatfrom Indonesia. We ought to look at the demand side as well. It ispossible that the palm oil market will soon see substantial growth, shesays.

She is referring to the prospect of palm oil benefiting from the transfatty acids (TFA) issue. In recent times, there have been reports linkingTFA to cardiovascular diseases.

(According to literature from the Malaysian Palm Oil Promotion Council,TFA are formed when liquid vegetable oils are chemically processed toimprove the stability and texture of shortenings and margarine. Becausepalm oil is naturally semi-solid, it does not need hydrogenation.)

This has led to a growing backlash against food that contains TFA. LastJuly, the US Food and Drug Administration announced that all food labelsmust state TFA levels by Jan 1, 2006. There are similar moves in Canadaand Europe.

The challenge now is to ensure that when the food manufacturers look foralternatives, they will switch to palm oil. If this happened, even ifMalaysia was no longer No.1, it would probably have a large slice of afast-expanding pie.