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Bursa Malaysia palm oil futures updated for sustainability

27 November 2018

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Supply chain documentation helps indicate sourcing 

The production of palm oil, the most popular vegetable oil on the planet, comes with some serious problems. In Malaysia, Indonesia and other parts of Asia, rainforests have been destroyed to create palm oil plantations, displacing endangered species and causing irreparable harm to the environment.

As one of the most active markets for palm oil trading in the world, Bursa Malaysia plays a key role in the global supply chain. Although it is not directly involved in production, the exchange recognizes the demand for change and is working with its customers to help the industry transition to a more sustainable model.

The exchange’s first efforts at reforming palm oil markets took place in 2015, when it launched a futures contract that tracked the price for palm oil produced in accordance with sustainability standards. But the product never took off and liquidity remained concentrated in the exchange’s well-established FCPO contract, the global benchmark for crude palm oil prices.

This year, the exchange took a different approach. Recognizing that the primary need is to track palm oil to its source, the exchange modified the specifications for the FCPO contract by adding a documentation requirement. Sellers planning to deliver palm oil at expiration are required to fill out a document with information on the mill used to produce the oil. That gives buyers who are looking to show a commitment to sustainability some clarity on where and how their palm oil is sourced.

The FCPO futures contract, which has been trading since 1980, reached a record level of volume and open interest in 2017. This year trading activity has been down slightly, but open interest has continued to rise, reaching a record level of 270,000 contracts at the end of September. More than half of trading comes from commercial users and institutions, reflecting its position as a leading reference price for the global edible oils industry.

The contract is based on the price of oil produced in Malaysia, which ranks as the second largest producer in the world. Facing a potential ban on exports to Europe, the Malaysian government recently made it mandatory for all palm oil producers in the country to obtain MPSO certification, which tracks compliance with a national standard for sustainable production. The modification to the FCPO contract, which took effect in March, will help ensure that the physical delivery feature of the contract will remain suited to the needs of buyers.

In the first nine months of this year more than 540 thousand metric tons of palm oil have been delivered to buyers of the FCPO contract, up 27% from the prior year. “The new traceability requirement in the FCPO facilitates self-declaration by sellers of FCPO contracts who wish to be involved in physical delivery, which aligns to the requirements and processes of MPSO,” said Bursa Malaysia’s CEO Datuk Seri Tajuddin Atan in a press release earlier this year. “We have made it an integral part of our strategy to ensure that our initiatives are geared towards the sustainability of palm oil throughout the supply chain.”

While most consumers may not give much thought to palm oil, the substance is a crucial ingredient in many products they buy every day. It lacks the unhealthy trans fats of some alternative edible oils, and it is semi-solid at room temperature, which allows for smooth blending in products like makeup and creams. It’s also cheap and cost-effective compared with many alternatives. All that has added up to booming demand for this agricultural commodity. But that surge in interest has come with serious challenges.

Rainforest deforestation, driven in large part by palm oil farmers, has caused severe damage to the world’s third-largest tropical forest in Indonesia. From 1990 to 2015, deforestation has erased 100,000 square miles of rainforest, an area larger than the United Kingdom, according to the Yale School of Forestry and Environmental Studies. In one particularly grisly incident in 2012, hundreds of endangered Sumatran orangutans died in forest fires deliberately lit by palm oil companies to clear the land.

In the aftermath, environmental and consumer groups have put pressure on corporations to think twice about how they source ingredients for their products. Lawmakers in the European Parliament have debated a ban on the use of palm oil for biofuels, which accounts for roughly a third of the EU’s annual imports. Consumer goods companies are also demanding changes in the palm oil supply chain: Nestle, for example, recently blacklisted 10 companies after learning they destroyed rainforests as part of their production of palm oil.

Cargill, a major supplier of palm oil to companies like Nestle, uses the Bursa Malaysia futures contract to hedge the price risk in its operations. Though it typically does not seek to take delivery on its positions in the palm oil futures market, Robert Horster, Cargill’s global head of trading for edible oils, praised the exchange’s adoption of traceability requirements as “an important step forward” for the industry.

“What Bursa Malaysia has done is that they have added to the flow of traceable oil,” Horster said. “And with that they have made an important step toward traceability and sustainability.”

The exchange may need to go further, however, to keep up with changes in the industry. Bursa Malaysia’s traceability documents specify the mills where the palm kernels are crushed to produce oil. That’s a key step in the supply chain, but the longer term goal is to trace the oil all the way back to the plantations where the trees are grown. Cargill, for example, is aiming for full traceability to the plantation by the year 2020, as are many other suppliers. “The whole marketplace is converging, [from] traceability to sustainable plantations,” Horster said.

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