209-1602-002

November, 2009

DEWI TAMARA

Crude Palm Oil After Crisis 2008

The Crisis as Momentum

On Asian crisis 1998, the palm owner and businessman still could face the crisis
smugly. The base price of crude palm oil (CPO) for one fresh stem of oil palm (tandan
buah segar) was USD 600 per ton, but will the exchange rate of Rp 16.000 per 1 USD,
the producers were quite blessed from the crisis condition. With the penguasaan
lahan on average was at minimal 2,5 hectare each farmers with the output of 2 tons
per hectare crude palm oil, the farmers gained at least USD 12.000 (2,5 x 2 tons x
USD 600).

The reason was the demand of CPO was still high. Even in China, although it was in
Asian region, its economic was growing. It happened also in India. In Europe,
countries like Germany and Netherlands were consumers of crude palm oil originated
from Indonesia and Malaysia. It was very much affected positively the farmers and
the local economic.

A very different story came up on crisis on September 2008. The price of CPO
declined and so was the demand. The producers were on the edge of the egg. A lot of
TBS were left unharvested by the farmers because the price went down to Rp 300
per kg from Rp 1.200-1.400. Big players in Indonesia and Malaysia were
oversupplied. The firms were to hold on their expansion or to hold the planting.

The crude palm oil was now a disaster. If before it was a green gold, now it was a
dead card. Victims were tumbling down. Now, could the price shine again on the next
year ? a lot of people depended on biofuel programs in most countries as a anchor
price. It that was the case, the CPO price would be better. The problem was the oil
price was on the bullish and made the biofuel was more expensive than the fuel.

Now the case questions were what the producers should do? What government
should do? What were the real threats on this business? How could we control the
prices? How could we adjust with macroeconomics environment? If Indonesia had a
comparative advantage for area of plantation, would it be still comparative
advantage or became big liabilities? Why Indonesia did not start to develop the
downstream crude palm oil industry?

Industry Players
The crude palm oil industy had long been a primadona. On February 2007, BPS
(Indonesian Statistic Bureau) recorded the non-migas growth for 15,51% to USD
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Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective
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209-1602-002 Crude Palm Oil After Crisis 2008

91,94 milyar, where fat and nabati oil were the main contributor for USD 975,3
million. The industry structure was oligopolist consisted of Astra Agro, Sinar Mas, PP
London Sumatera, Gozco Plantation, Tunas Baru Lampung, Bakrie Plantations, and
PTPN.

Astra Agro Lestari (AALI)

Established as PT Astra International Agribusiness Division in 1983, its first assets
was the 2.000 hectares of cassava plantation which later being converted into a
rubber plantation. The cultivication of oil palm started in 1984 with the acquisition of
PT Manunggal Perkasa Plantations, where at the time runs 15.000 hectares of oil
palm plantation located in Riau, Sumatra.

On October 3rd 1988, PT Suryaraya Cakrawala was established and was then changed
to PT Astra Agro Niaga in 1989. In 1997 PT Astra Agro Niaga merged with PT
Suryaraya Bahtera and the company's name was changed to PT Astra Agro Lestari.

Currently PT Astra Agro Lestari Tbk managed more than 250.000 hectares of oil palm
plantations, spreading in Sumatra, Kalimantan and Sulawesi with the average age of
its plantations were 14 years, the peak productive age period. In 2004, PT Astra Agro
Lestari Tbk divested its non-oil palm plantations in South Kalimantan. Up until the
end of 2008, PT Astra Agro Lestari Tbk permanent employees were 22.105 people1.

Planning and Reaction

A very high demand from biofuel industry using CPO and other biofuel sources
pushed the CPO price in the world. Astra Agro planned to acquire the empty (lahan)
200.000 hectare in Kalimantan and Sulawesi. The value of acquisition was worth Rp 5
trillion with assumption 1 hectare equal to Rp 25 million.

When the price of TBS went down from Rp 1.800 per kg to Rp 200 per kg, the
company must change the plan. According to Bisnis Indonesia on November 26,
2008, Astra Agro would have to reduce its working capital from expansion plan to
maintain the plant’s plan. The working capital was allocated to acquire new
plantation, maintaining the plantation, and infrastructure projects. The land price was
increased significantly that the company must change its focus to another three
activities. First to continue the planting program. On the year 2009, the company
planted 22.000 hectare of plantation area and the area planted in the last 3 years
reached 55.000 hectare. On the end of October 2008, Astra Agro was recorded to
have planted area of 252.721 hectare, increased from 2007 was 235.210 hectare.
Second, the company would intesify the plant maintenance. Third, to prepare the
plantation and infrastructure, and at the same time to mitigate the disaster of the
production. According to Astra Agro, the CPO production on 2009 would not be much
different from 2008, at about 900.000 tons – 1 million tons.

The movement of the price in the last 6 months on 2008 made Astra Agro postponed
to build four plants out of five crude palm oil for 2009. The funds needed to build one
plant reached Rp 120 billion of each unit, to build 4 plants it needed Rp 480 billion.
Hence, the company had to keep the liquidity to anticipate the worst scenario for the
next year. The plants of Astra Agro were 20 units in total, with total capacity was 940
tons TBS per hour. One plant was able to produce 45 ton TBS per hour. With the area

1
http://www.astra-agro.co.id/index.php?option=com_content&view=article&id=73&Itemid=63,
downloaded on 15 september 2009

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of 252.000 hectare which spread in 3 region, in Kalimantan, Sulawesi and Sumatra,

the ideal numbers of plants should be 25 units. Apart from CPO, Astra Agro also
produced rubber, kernel, palm kernel oil (PKO), and plam kernel extract (PKE).
From the total production, 90% was sold from local tender, and the remaining 10%
was sold from export tender. The destination country for export was India, Europe,
China, and Malaysia. Until the end of September, the sales reached Rp 6,69 trillion,
operating income was Rp 3,10 trillion and net income was Rp 2,12 trillion.

Table 1. CPO Production of Astra Agro Lestari per Oktober 2008 (ton)
2008 2007 Growth Rate (%)
Sumatra 433.230 370.131 17%
Kalimantan 240.706 218.050 10,4%
Sulawesi 143.844 142.116 1.2%
Total 817.780 730.297 12%
Source: Astra Agro Lestari, 2008

Sinar Mas (SMAR): Golden Agri Resources

Golden Agri Resource’s was the world's second largest oil palm plantation, by planted
hectarage, with the largest total land bank, has a substantial landbank of 1.3 million
ha and 383,000 ha of planted area. The Company operates a total planted area of
396,000 hectares, as well as 33 palm oil processing mills, three refineries and five
kernel crushing plants.

Its primary activities include cultivating and harvesting of oil palm trees; processing
of fresh fruit bunches into CPO and palm kernel oil; and refining CPO into value-added
products such as cooking oils, margarine and shortening.

Palm products production increased about 9% between the second and third quarter
of 2007. Golden Agri is also one of the most cost-efficient producers, spending less
than US$250 a tonne of CPO. As such, any increase in CPO prices would boost the
company’s earnings. Also, the easing of fertiliser prices, as crude oil prices have
come off their US$147 peak, “should help reduce operating costs at its estates from
2Q2009 onwards”, writes CIMB analyst Ivy Ng. The Group has vertically integrated
operations that capture returns from all levels of the value chain. The Group's
revenue in 2008 was US$3 billion, with total assets of US$6.8 billion

“Even if CPO prices stagnate [our assumption is US$500 a tonne], Golden Agri’s
revenue should still get a boost from the expected 7% to 10% increase in
production,” writes OCBC’s Wong in a report last week2.

The declining CPO price and the exemption of Export Tax (PE) were reacted positively
by the coompany. Golden Agri said that the government was reponsive to the
declining price by changing the floor price of the Export Tax. It was said because the
cost of production was very high and could be reduced. When solar price was Rp
11.000 per litre, the cost of production was USD 425 – 450 per ton. When the price
went down to USD 380 per ton on October 2008, Golden Agri could not cut down its
production cost. Then the export tax was 0%, it made the company was able to have
slight gain for Rp 300-400 per kg.

The problem of TBS’ price in the level of affiliate farmers with the company was much
more in control comparing to non-affiliate farmers. The non-affiliate farmers was very

2
http://www.theedgesingapore.com/component/content/3472.html?task=view

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much depend on (pedagang pengumpul). Pedagang pengumpul would bring the price
down to 40% below the affiliate farmer’s price.

Golden Agri believed that the CPO price would also still fluctuative because the
supply was good but it was not followed by increasing of demand, because the world
demand was still low influenced by the world crisis. Meanwhile, the high cost of
production especially the fertilizier would be the reason of the declining national CPO
production in the next 2 years. The yield of the palm plant would decrease because
less fertilizer. It would affect the production on 2010. Then the new equilibrium price
would be reached on the beginning of 20103.

Table 2. The Trend of CPO and TBS price

August September October
Price of CPO CIF Rotterdam 975 800 650
(USD/ton)
Price of CPO local (Rp/kg) 6.900 6.000 4.500
Price of TBS kemitraan (Rp/kg) 1.400 1.200 980
Price of TBS non kemitraan 850 600 500
(Rp/kg)
Source: PT SMART TbK, recalculated

PP London Sumatera (LSIP)

Although the declining CPO price was also hit PT London Sumatera Indonesia Tbk
(Lonsum), the company gave best reaction by acquiring three plantation plants worth
of Rp 48.04 billion4. The three acquiree were PT Tani Musi Persada, PT Tani Andalas
Sejahtera, and PT Sumatra Agri Sejahtera. The acquisition was targeted to be done
on 22 December. At that time, Lonsum would hold 99,92% ownership of Tani Musi
and Sumatra Agri, and 90% ownership of Tani Andalas.

This subordinate of Indofood then also would acquire the plantation area in Sumatera
Selatan because of the acquisition. Lonsum would take over land from Tani Musi of
20.000 hectare, Tani Andalas 10.000 hectare, and Sumatra Agri 16.000 hectare. The
three companies were located in Musi Banyuasin, South Sumatra.

On the year 2008 London Sumatra allocated working capital for USD 100 million to
finance the expansion, included building palm plants in some areas and opened new
plantation to 46.000 hectare. The company expected to increase growth rate to 10%
in 2009 from 2008’s production5. This production was inline with strategic objective
to minimize fixed cost production and to maximize sustainable plant output with
Principles and Criteria from Roundtable for Sustainable Palm Oil, the world standard
for sustainable agroforestry.

To face the challenge, Lonsum had prepared the policy and strategy to make sure
that all plantation and its facilities was along with the Principles and Criteria from
Roundtable for Sustainable Palm Oil. These P&C covered the technical, social
environment, law and safety that supported the production and utilization of palm oil
in sustainable way. This would be value added for Lonsum in the market instead the
price fluctuation.

Gozco Plantation (GZCO)

3
Bisnis Indonesia, 4 November 2008, “Harga Sawit Diprediksi Naik Rp 100 Per kg”
4
Bisnis Indonesia, 21 November 2008,”London Sumatera Akuisisi 3 Perusahaan.”
5
Bisnis Indonesia, 22 Desember 2008, “Produksi CPO Lonsum Akan Naik.”

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Facing the declining price of CPO, PT Gozco Plantation also planned to acquire the
palm plantation for 10.000 hectare worth of Rp 800 billion to Rp 1 trillion. The
company was considering having bank loan for Rp 500 billion to finance the
acquisition.

At this time Gozce had a plantation for 60.000 hectare, with 15.000 hectare was a
planted area, and the rest remained undeveloped. Especially for palm plantation in
South Sumatra, the company had a plantation area of 13.050 hectare with the
provision land of 5.417 hectare and permit status for 10.815 hectare. The company
hoped with another additional plantation for 10.000 hectare, made it possible for the
company to increase the CPO production to 80.000 tons per year, from 50.000 tons
per year1.

Bakrie Sumatra Plantations Tbk (UNSP)

Having faced the fluctuation of the CPO price was signalled for PT Bakrie Sumatera
Plantations Tbk (BSP) to cooperate with AES AgriVerde, the world energy company, to
realize the first cooperation on clean development mechanism on crude palm oil in
Jambi6.

Clean development mechanism (CDM) which was dealt since May 2008 covered three
working plantation owned by Bakrie Plantations in Kisaran, Pasaman, and Jambi. It
was targeted to reduce carbon dioxide emission to 30 million ton per year until year
2012. The commitment of Bakrie Plantations was clear to reduce the emission on
carbon dioxide and methane gas which increased green house effect and global
warming. It would be applied in plantation of PT Sumbertama Nusa Pertiwi.

Sampoerna Agro Tbk (SGRO)

The company owned by Sampoerna family targeted to increase the planted area
from 12.000 hectare to 15.000 hectare (ha). The current planted area was only 9.000
ha7. In this case, the company would use the idle area. From the total plantation area
of 198.849 hectare, 103.499 were not planted and the rest 87.319 was already
planted. From that plantation area, 69.414 ha were in Sumatra and 17.904 ha in
Kalimantan.

Sampoerna Agro was allocated the capital expenditure for Rp 600 billion in 2008. But
until September, the allocation reached Rp 217 billion, and the remained was
dedicated for the next year. On September Sampoerna Agro was succeded to reach
net sales of Rp. 1,85 trillion, or increased for 117,1% from the same period last year
Rp 856,20 billion. Net profit was Rp 388,53 billion or increased 399,1% from the
same period last year Rp 80.06 billion. The increasing sales and net income was
pushed by the high selling price and the increasing volume output. Sampoerna
marketed 95% of crude palm oil to domestic market and exported the remained 5%.

Nowadays the company was finishing the development of crude palm oil in Sumatra.
It was targeted to finish on the second semester next year, with the production
capacity reached 60 tons per hour. Sampoerna Agro owned 5 crude palm oil plants
with total capacity reached 395 tons per hour. Four of the multiplants were in
Sumatra and one unit in Kalimantan.

6
Bisnis Indonesia, November 25, 2008,”BSP & AES Realisasikan Produksi Sawit Bersih.”
7
Bisnis Indonesia, 21 November 2008, “Sampoerna Agro Bertekad Perluas Lahan Sawit.”

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PTPN
In the middle of November 2008, Minister of Agriculture Anton Apriyantono and
Minister of Trading and Commodity Malaysia Datuk Peter Chin Fak Kui met and
decided to decrease CPO production and to accelerate the plantation revitalization. In
the note of agreement Malaysia agreed to cut out 200.000 ha of the palm oil
plantation and Indonesia 50.000 ha starting in 2009. The Department of Agriculture
focused the revitalization program to old areas owned by petani rakyat (plasma) in
North Sumatra collaborated with PT Perkebunan Nusantara (PTPN), with area of
50.000 ha8.

The decresing rate of CPO production was expected to reach 75.000 tons in 2009
with investment estimation to Rp 2 trillion on 2009. The revitalization itself would
need funds of Rp 30 – 40 million per ha depended on location. The needs of
investment funds would be included to the revitalization credit of plantation to the
third settlement next year. But the government seemed to accelerate the program.
The production correction would happen on 2009, because the government planned
to hold the crude palm oil stock, but not with the new planting. The reason of holding
the stock was to stabilize the price of CPO. The Table 3 showed the plantation
capacity in each area of PTPN. The Table 4 showed the production and export CPO
from Malaysian and Indonesia from 2005-2007.

Table 3. Plantation of Palm Oil PTPN in Sumatra

Perusahaan Lokasi Kebun inti (ha) Kebun plasma (ha)
PTPN I Aceh 46.377 6.714
PTPN II Sumut 61.577 25.250
PTPN III Sumut 88.287 10.403,14
PTPN IV Sumut 119.585,71 8.996,56
PTPN V Riau 57.979,69 56.665
PTPN VI Jambi 19.090 26.826
PTPN VII Lampung 31.874 23.868
Source: Collective Marketing Office PTPN

Table 4. Production and Export on CPO (million ton)

2005 2006 2007
Indonesi Malays Indonesi Malays Indonesi Malaysi
a ia a ia a a
Producti 14.1 14.96 16.08 15.88 17.18 15.95
on
Export 10.3 13.58 11.82 14.43 12.44 14.48
Domesti 3.8 1.43 4.26 1.45 4.74 1.74
c

Source: Gapki, 2008.

CPO’s Consumer
Indonesian’s CPO was consumed by Cargill (US), Gardner Smith (Australia), Britania
Food Ingredients (UK), Angila Oils (now Aarhus United) (UK), Cadbury Schwappes
(UK), Archer Daniels Midland (UK), Nabisco (US), Procter & Gambler (US), Safic Alcan
(France), Unilever (Dutch / UK).

8
Bisnis Indonesia, November 21, 2008, “

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Structure of Crude Palm Oil Industry

More than 75% palm production in Indonesia was exported in the form of crude palm
oil (CPO). It was very different with Malaysia, where 80% of its production was
exported in more advance value added downstream products. In one hand, exporting
CPO was very much simple for Indonesian producer. In other hand, exporting CPO
made Indonesian producer became dependent to foreign buyers. If buyer’s financial
situation was favorable, they would buy all CPO output. In reverse, if they were in
financially distressed, they would decline their demand for raw CPO.

Exporting CPO had a very little value added. The exportation was also subject to
export tax with rate reached to 60%. It was not a very favorable situation for the
exporter because export tax would reduce their income.

The price of CPO was determined from fundamental and non-fundamental factors.
Fundamental factors were demand and supply law. Non-fundamental factors were
commodity market price, such as world fuel price.

Hence, the needs of CPO for domestic was also high. The domestic used CPO as raw
material for fried oil and the needs was on average 4 million tons per year. Other
utilization of CPO was for biofuel (Bahan Bakar Nabati).

The downstream industry for CPO did not exist in Indonesia. The downstream product
from CPO was divided into two kinds, food and non-food based. Food based included
fried oil and margarine, and non-food was (oleokimia) which consisted of esther,
asam lemak, surfaktan, gliserin and its derivative.

Until now, some chemical product CPO-based was mostly imported, like isopropyl
palmitat, isopropyl miristat, asam palmitat and asam oleat. The prospect of chemical
industry using CPO was good, because there was about 600 companies from
cosmetics and pharmacy that would absorb the output. Moreover, the world
oleokimia was still in excess demand in the next few years. According to FAO, the
growth of the industry was 3% per year. The most growing producer was Asia region.
On 1960 the production of fat and oil was 7,5 million ton (24,12% from world
production), in 1980 was already 8,4 million ton or 20,95% and in 2000 became 39,3
million ton or 37,43% from world production. The growth rate from 1960-2000
reached 53,63% per year.

Short-Run Determinants of Macroeconomic Variables

The short-run output is principally driven by fluctuation in demand. Therefore any
decision affecting expenditure will impact upon output.

Inflation
In the short-run inflation is determined by inflation momentum. Inflationary
momentum is deflected by two remaining factors: price shocks and business cycle
effects. The most obvious example of price shocks is world oil increases, a rise in
government indirect taxes, exchange rate devaluation, changes in demand. The

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examples of business cycle effects upon inflation are business slowdown and a
booming economy9.

Monetary Policy
Changes in monetary policy work mainly through demand/supply effect on inflation.
The initial effect of a reduction in money supply is the increasing interest rates. The
rise in interest rates slows expenditures and output growth which in turn, puts
downward pressure on inflation. The net result is that while it is certain that reduced
money supply growth will result in lower inflation, the timing of this effect is more
difficult to predict.

Interest Rates
In the short-run interest rates are determined largely as a result of the demand and
supply of liquidity. High demand in money supply will tend to have the short-run
effect of creating a fall in interest rates, even though a sustained higher money
supply growth in the long run will cause a rise in interest rates.

A final factor to be considered is the influence of international capital markets. A rise

in world interest rates will tend to create an outflow of capital, placing upward
pressure on domestic interest rate and downward pressure on the exchange rates.

Exchange Rates
In the short-run exchange rate will affect foreign exchange demand and supply
conditions. For example, a business cycle expansion caused by rising domestic
demand will tend to raise import purchases, which places downward pressure on the
exchange rate. But it will also tend to force up interest rates, causing capital inflows
and upwards pressure on the exchange rate. The net result will depend on whether
the current account or the capital account influence is stronger.

Long-Run Determinants of Macroeconomics Behavior

Output Growth
A long-run determinant of output growth is measured by gross domestic product
(GDP), an economy’s aggregate output. GDP is simply the estimated sum of the
market valur of all final goods and services produced within the country’s boundaries
during a specified time period. The real output depends upon interactions of two
factors, the capacity or potential to supply output and the market demand for this
output.

Inflation
A long-run determinant of inflation depends on money supply. The long-run demand
for money, in turn, is dictated by its nature. An important further complication occurs
when a country is developing from a traditional to a modern, industrialized economy.
The demand for money will grow somewhat faster than the real economic growth
rate. In the short-run the demand for liquidity is affected not just by output growth,

9
Why Managers Need to Have Some Sort of Understanding in Macroeconomics; An Indonesian Economy-
based Empirical Perpectives by Deddy Herdiansjah, PhD, 2006.

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but also by changes in the level of interest rates. A rise in interest rates raises the
opportunity cost of holding money and hence decreases the demand for money.
Therefore, when a central bank tightens the money supply, popularly called as
“monetary policy”, the cost of liquidity (the interest rate) is forced up. Long-run
equilibrium occurs when long-run policy objectives accord with both actual money
supply growth rates accord and with actual inflation rates. If these conditions were
not met, then it would become disequilibrium situation.

Interest Rate
The nominal interest rate represents the percentage monetary compensation that
the borrower is willing too pay the lender in order to have access to funds now, rather
than in the future. The real interest rate accounts for this effect for it represents
the future compensation in terms of the value or real goods and services, paid by
borrower to lender. A significant movement in the average level of real rates should
only occur if there is a shift in the underlying determinants of the private sector
balance between savings and investment balance or if there is an un-reversed shift in
the goverment sector demand for funds. The real interest rate may be volatile in the
short run, but should be relatively constant in the long run unless there is some shift
in the underlying savings and investment relationship. The expected inflation
component, can very from time to time and from country to country. Ultimately,
expected inflation will reflect actual inflation experiences and since actual inflation
depends on the long-run on money supply growth rates, expected inflation in the lon-
run is determined by monetary policy.

Exchange Rate
The exchange rate is really a relative price. The nominal or quoted exchange rate is
the current price of one currency against another. Inflation is the single most
important determinant of long-run movements in exchange rate. Accordingly, exports
should rise and imports should fall. An appreciation of the real exchange rate will
have exactly the opposite direction.

Closing Remarks
As long as the fuel price for the mid term was still low, then commodity prices would
also be low. The fuel price was still in USD 50 or even USD 40. According to analyst
PT Valbury Asia, Nico O.J., when the resession was worldwide, there was no
opportunity that the fuel price would take a rebound significantly. Another important
factor was the US dollar would still be strong enough that the commodity prices
included crude palm oil price would also be low.

The analysis of crude palm oil should be based on short term and long term
determinants of macroeconomics behavior. The factors included were inflation,
exchange rate, interest rate, monetary policy and output growth that would depend
on area of plantation, technology and downstream industry.

---END OF CASE---

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