A CPI, PILAR, GWA Working Paper

Executive Summary

The Central Kalimantan Provincial Government has ambitious goals to deliver inclusive and sustainable regional development. Given the region’s high reliance on agriculture, more efficient management of land and natural resources offers a promising pathway to transform the local economy and achieve development goals.

This working paper provides a first overview of Central Kalimantan’s oil palm value chain and the business actors involved throughout. It aims to identify how business investment can be optimized to support socially inclusive development, delivering productivity, profitability, and sustainability gains

Opportunities to Increase the Economic Value of Central Kalimantan’s Oil Palm Value Chain

Significant economic value is derived from oil palm in Central Kalimantan at all phases of production. In 2013, the value-added upstream was approximately USD 1 billion, with USD 0.95-1.25 billion added midstream, and a further USD 30-31 million added downstream (see Figure 1). Notwithstanding, governments, business and smallholder farmers can derive even greater economic value.

There is potential to increase land productivity upstream, particularly for smallholder farmers, including by applying good agricultural practices (GAP) and technology. Average yields of oil palm plantations in Central Kalimantan were around 13% lower than Indonesia-wide yield averages and 23% lower than those in Malaysia. While this is in part driven by differences in the age of plantations, there remains significant potential to improve average yields, particularly for smallholder farmers. In addition to opportunities to increase palm oil production through productivity gains, there is also potential to expand upstream production into environmentally suitable degraded land.

There are also opportunities to better utilize existing capacity of mid and downstream processing and manufacturing facilities. Further, strengthening organization and the integration of actors within and between phases of production can increase value throughout the value chain.

Midstream mill capacity was under utilized in 2013, with mills generating just 50-65% of potential crude palm oil (CPO) compared to total installed capacity. This is in part driven by a lack of sufficient supply of fresh fruit bunches (FFB) from upstream plantations. Increasing upstream FFB yields to the same level as the Malaysian average would increase the supply of FFB for processing and could reduce the CPO production gap by around 40%. To achieve 100% of current mill capacity, however, a further 300,000 hectares of highly productive plantations will be needed. Given that Central Kalimantan has an estimated additional two million hectares of land designated for oil palm plantations, this under-supply issue may be addressed in the near term. However, in addition to supply challenges, infrastructure, energy access and supply chain integration may pose further barriers for some mills and requires further analysis. Addressing this production gap should be a priority ahead of further midstream capacity development.

Downstream, only 22% of Central Kalimantan’s CPO was refined locally in 2013. This represents a significant reduction in the value-add retained by Central Kalimantan from this key economic sector and presents a potential opportunity for the region. However, further analysis is needed in relation to the costs, barriers and opportunities for such downstream development, as refineries require suitable infrastructure and energy access, among other factors, to become viable investment propositions.

Supporting business to realize productivity, profitability and sustainability gains

Transitioning to more efficient land use and deriving higher productivity, profitability, and sustainability in the Central Kalimantan value chain will impact the different business models in different ways. This is because their risk and investment profiles are substantially different, and as such they will face different costs, challenges, and opportunities in transitioning to more sustainable practices. This means that understanding which business models and actors are willing and able to take on which risks, and at what cost, will be critical to developing appropriate policy and finance instruments to drive the transformation toward a sustainable oil palm sector (Frisari et.al. 2013).

Oil palm business models are the production and manufacturing systems applied by business actors and smallholder farmers to produce FFB and convert them to CPO and crude palm kernel oil (CPKO), as well as other derivative industrial and consumer products.  The models range from being as simple as ‘trees to fresh fruit’ to those incorporating more complex integrated elements that carry from plantations right through to downstream manufacturing, including shipping, logistics, distribution, and financing strategies. Business models also range in size, with smallholder farmers managing between 1-25 hectares of plantation, or 1000+ hectares in the case of farmer cooperatives or groups, and companies managing from 25 – 300,000+ hectares. For the more integrated business models, there is wide variation in the level of reliance on third party suppliers at each phase of production. For smallholder farmers, there are varying levels of independence or company partnerships. Variations can also be found in different regions of Indonesia as a result of both the prevailing local conditions and other business considerations.

Within this context, business models operating at a single point in the oil palm value chain, such as smallholder farmers and smaller scale upstream actors, have the greatest challenge in managing broader financial risks, owing to their more limited collateral and lower ability to use tools to transfer and manage currency and investment risks compared with more integrated business models. Off-take risks are also greatest for single point, upstream operators who need to sell their FFB within short time horizons to minimize yield loss.

Market access risks are highest downstream where consumer product brands directly face restrictions, such as European Union sustainable oil palm standards. Conversely, the ability to mitigate market access risks by effectively managing negative social and environmental risks and impacts is largely contained upstream. Therefore, a more integrated approach to managing risks and associated costs is necessary.

Recommendations and Next Steps

We propose that a landscape management approach offers government, business, and community partners the best opportunity to derive greater value added from the oil palm value chain and collectively achieve productivity, profitability, and sustainability gains. New business tools and targeted enabling policies will be needed to support the complex array of actors operating within the sector to transition to highly productive, sustainable practices at scales that deliver meaningful economic, social, and environmental benefits.

To take forward the findings of this working paper, we will support an ongoing multi-stakeholder dialogue and further analysis to improve understanding of Central Kalimantan’s oil palm value chain and develop implementation-ready options for capitalizing on these above opportunities.

As a consequence of the wide variety of business models, there are large variations in productivity, profitability, and risk exposure for different actors within the sector.

As a next step, we propose a more detailed case study of the value chain within selected districts in Central Kalimantan working alongside government, business and community partners. This could also inform the development of a more comprehensive and comparable database to support ongoing design and implementation of evidence-based policies and business tools to promote increased value-added and sustainability throughout the oil palm sector in Central Kalimantan.

We also suggest that translating Central Kalimantan’s oil palm planted area target into a production-based target could encourage higher productivity and more efficient use of existing lands, including through the adoption of good agricultural practices and good manufacturing practices as a first priority over expansionary measures.