____ uF 3sS POLICY RESEARCH WORKING PAPER 1654 Indonesia's Palm Oil A recommendation Indonesie should repeal its export tax on Subsector crude palm oil and discontinue buffer stock Donald F. Larson operations and directed sales from public estates. it is time for Indonesia to complete the evolution from public interventions in the palm oil market to private sector initiative in response to international price signals. The World Bank International Economics Department Commodity Policy and Analysis Unit September 1996 | POLICY RESEARCH WORKING PAPER 1654 Summary findings Debate on Indonesia's palm oil policy was stimulated by The structure of the tax discourages local processing a sharp increase in cooking oil prices in 1994-95 and a by squeezing margins for processing. And determining resulting increase in the export tax rate on crude palm tax rates on palm oil products independent from the oil. Palm oil has been one of the fastest growing underlying crude palm oil price creates uncertainty about subsectors in Indonesia. In two decades, annual output marketing margins for processors, inhibiting effective grew from less than 400,000 tons to more than 4 risk management. million. Using a quantitative model, Larson analyzes the Larson recommends repealing the tax. He also effect of government policies, including the export tax, recommends discontinuing buffer stock operations and buffer stock operations by the BULOG (the national directed sales from public estates because they are logistics agency), and directed sales from public estates. ineffective at lowering domestic prices and affect Larson acknowledges the export tax's effectiveness in investment by creating needless uncertainty. lowering domestic prices, but observes that its impact on Larson concludes with recommendations on inflation and consumer welfare is minimal. Cooking oil investment policy. Direct incentives (in the form of accounts for only 1.4 percent of the consumer price subsidized loans) to private investors have been an index and welfare gains to consumers are small (less than indirect instrument for overcoming investment risks and $1 per capita annually) because the importance of uncertainties, but investors should no longer need those cooking oil has declined in the household budget of even incentives. the poorest households. (It is 4 percent of the household Instead, Indonesia's government should focus more on budget of the poorest 20 percent of the rural alleviating obstacles to private investment, such as lack of population.) rural infrastructure, land titles, and sovereign risk. The The tax has also had the unintended effect of Bank might be of assistance in this area. transferring income (up to US$99 million a year) from oil palm growers - 22 percent of them smallholders - located primarily off Java. The review for this paper - a product of the Commodity Policy and Analysis Unit, International Economics Department, and the Agriculture Operations Division, East Asia and Pacific, Country Department III - was conducted to help the debate on Indonesia's palm oil policy. Copies of this paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Pauline Kokila, room N5-030, telephone 202-473-3716, fax 202-522-3564, Internet address pkokila@worldbank.org. September 1996. (47 pages) The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be used and cited accordingly. The findings, interpretations, and conclusions are the authors' own and should not be attributed to the World Bank, its Executive Board of Directors, or any of its member countries. Produced by the Policy Research Dissemination Center Indonesia's Palm Oil Subsector Donald F. Larson International Economics Department Commodity Policy and Analysis Unit I would like to thank Takamasa Akiyama, Timothy Condon, Joseph Baah-Dwomoh, Jorge Garcia- Garcia, and Akihiko Nishio for their comments on earlier drafts. I would also like to thank Nawir Messi for his help in putting together much of the data. This report was prepared at the request of EA3AG. CONTENTS I. Sununary .................... I II. The Structure of Production ...................... . . ; . 4 Production History and Investment Policies .4 Cost of Crude Palm Oil Production .................................... ;. 7 Market Concentration in the Refining Industry .....................................8 III. Market Interventions ............................... ...9 Background ............................... ...9 Current Policy Issues ................................. ... 10 A. Export Tax .................................... 11 B. Directed Domestic Sales .................................... 15 C. Bulog Operations .................................... 17 IV. Long-term Development Issues .................................... 19 Land procurement and titles .................................... 19 Direct Investment and a Potential Role for the World Bank .20 Conclusions .21 Bibliography .23 Annexes .24 Tables ...3............................................................................................... 32 Figures ............................... 41 A Review of the Palm Oil Subsector in Indonesia Summary During the last twenty years, the history of the palm oil industry in Indonesia is one of evolution from government sponsorship and market interventions to private sector initiative in response to international price signals. The evolution of the market from public to private sector, while substantial, is incomplete. Investments in new oil palm estates receive preferential financing terms. Further, marketing interventions aimed at reducing inflation and assisting consumers remain but with unintended consequences. Production of palm oil in Indonesia has increased dramatically, from less than 400,000 tons in 1975 to more than 4.4 million tons in 1995. Until 1992, most palm oil was produced on publicly-owned estates, although the mix will change rapidly during the next decade as existing plants mature. Indonesia is one of the lowest-cost producers of vegetable oil in the world. Comparative studies on production costs, based on engineering techniques, generally estimate average costs at around $200/ton. However, a recent study on the field costs at nine Socfindo estates puts the cost of production -- including depreciation of capital investments -- at $127/ton. With palm oil prices currently above $600 tons and projected to remain above $400 for the foreseeable future, prospects for new investments are bright. Since 1991, the government has intervened infrequently in the marketing of palm oil. However, with the price boom in palm oil, inflation fears and concern for consumers has motivated recent market interventions. Still, growth in incomes over the past decade has resulted in a diversified household budget with less importance given to cooking oil-- even among the poor. Cooking oil comprises 1.4 percent of the CPI and 4 percent of the household budget of the poorest 20 percent of the rural population. As a result, the 21 percent increase in the prices of cooking oil in 1994 only contributed 0.3 points to the inflation rate. Further, the costs to the poorest consumers of the increase in palm oil was equivalent to a 0.4 percent decrease in their household income. It is unlikely, with average incomes growing at more than 6 percent, that the price increase created a burden for most consumers. The government currently uses three policy tools to affect domestic prices: 1) an export tax; 2) buffer stock operations; and 3) directed sales from public estates. The export tax is triggered when FOB prices reach $435/ton and targets only above-average profits. The tax has been effective in lowering domestic prices, but does so by transferring income from the oil palm growers who are primarily off-Java, to the government and to consumers who are primarily on-Java. Analysis suggests that the welfare gains to consumers are small -- less than one dollar per capita per year. Further, twenty-two percent of the growers are smallholders. As a result, the tax runs counter to the government's development priorities. Since the advantages to consumers are limited, the government should repeal the tax. The way in which the tax is implemented creates a burden for the processing industry. Generally, the tax has discouraged local processing by heavily taxing processing margins. Further, since the tax rates for palm oil products are not directly linked to the tax on crude palm oil, processing margins are unpredictable and the policy inhibits common risk management practices such as forward sales. This is an unintended consequence of the mechanics of the tax. If the tax is not repealed, it should be modified to address this short-coming by basing the tax on palm oil products on their crude oil content. Since the reforms, restrictions on imports and exports have been lifted and domestic prices of crude palm oil and refined products, including cooking oil, have followed international prices. As a result, crude oil and olein stock pile operations and directed domestic sales cannot have a substantial enduring effect on domestic prices. These interventions transfer income but do not accomplish the intended purpose of the interventions-- improving the welfare of consumers. Further, the interventions create needless uncertainty in the investment community. Regardless of the government's decision regarding its policy of lowering domestic prices during boom periods, these interventions should be abandoned. 2 Although profitable, investing in plantation crops is a risky business characterized by a number of substantial hurdles. The Government of Indonesia has successfully encouraged new investments by investing directly through public plantations and by offering loans at below-market rates of interest. Because of improved domestic capital markets and interest by foreign investors, the industry may no longer require direct incentives. Rather, the GOI might consider addressing the obstacles to private investment directly. The World Bank could play a role as well, by developing programs jointly with the GOI to address 1) rural infrastructure needs; 2) land titlement; and 3) issues of policy risk. 1. Overview As incomes have grown and levels of human and physical capital have accumulated in Indonesia, the economy has become increasingly diversified. Agriculture provides an increasingly smaller portion of national income, declining from 56 percent of GDP in 1965 to 19 percent in 1993. This is not to suggest that agriculture has not grown or that future investments in agriculture are not profitable. Exactly the opposite is true. Further, the association of rapid growth in agriculture along with growth in other sectors has been a common characteristic of growth in developing countries. Such growth is usually associated with the rapid development of new crops and new technologies. In Indonesia, the palm oil industry has been one such source of growth in a dynamic agricultural sector. In twenty years, production has grown from less than 400,000 tons of crude palm oil (CPO) to over 4 million tons. In addition, with production costs among the lowest in the world, investment levels are expected to remain high. As noted in Indonesia: Agricultural Transfornation Challenges and Opportunities (1992), the tree crops sector occupies a strategic niche in Indonesian agriculture and development, providing a valuable source of foreign exchange earnings and generating incomes for millions of smallholder families. Since tree crop production is concentrated off-Java where poor soils limit food production, growth in the tree crop sector has also contributed greatly to poverty alleviation off-Java. 3 During the last twenty years, the role of the industry as both a vehicle of development in off-Java and as a supplier of inexpensive cooking oils throughout Indonesia has been explicitly directed through government ownership of estates and varying degrees of market interventions. Increasingly, the production capacity has become more concentrated in private estates and smallholders and govemment interventions have been reduced. In fact, the history of the palm oil industry in Indonesia is one of evolution from government-sponsorship and marketing interventions to private- sector initiative responsive to international prices signals. The evolution of the market from public to private sector, while substantial, is incomplete. Interventions which still remain in the subsector are designed primarily to limit the negative effects of rising international prices on domestic consumers. The primary policy instrument is a variable export levy which targets profits and appears to have successfully lowered consumer prices. Still, with growing incomes and the diversification of diets, the effects of cooking oil prices on family welfare has become increasingly small. At the same time, the costs of the policies to off-Java income and to potential foreign direct investment remain real and consequential. The remainder of this report is composed as follows. Following this overview, Section II describes the structure of palm oil production in Indonesia, including investment policies, production costs, and concentration in the refining sector. Section III discuses the government's past and current market interventions. Section IV briefly discusses three important long-term development issues related to the subsector -- 1) land titlement; 2) infrastructure; and 3) non-commercial risks as a barrier to private investment. Section V concludes. 11 The Structure of Production Production History and Investment Policies Although considered a new crop in Indonesia palm oil was cultivated and used for soap production in Central Java by the mid-nineteenth century and oil palm plantations 4 producing edible oil appeared in Sumatra by 1911. In 1938 about 90,000 hectares were planted in oil palm, but during World War II and the following years of early independence, little growth occurred. In 1968, all nationalized former-Dutch estates were reorganized into 28 independent management units: Perseroan Terbatas Perkebunan (PTPs) and Perusahann Negasa Perkebunan (PNPs) and all other nationalized estates were returned to their previous owners. Since that time, investment policies have been characterized by three distinct periods. From 1968 to 1988 growth in the subsector came through direct government investments via the PTPs. From 1988 to 1994, most expansion occurred via a joint government-private sector development scheme known as Pir-trans. More recently, the government has initiated a program of government supported private sector and cooperative investment known as Prime Co-operative Credit for Members (KKPA). Following the reorganization of the PTPs, expansion and rehabilitation plans were launched and new plantings begun. Oil palm was considered more profitable than alternative estate crops, and area devoted to oil palm expanded rapidly. Area planted in oil palm on government estates grew from 84,000 hectares in 1969 to 176,000 hectares in 1979 to 343,000 hectares in 1987. In the late 1970s, palm oil became a vehicle for rural development as the government sponsored smallholder development in oil palm. Lands were cleared and planted near existing PTPs where smallholder on 2-4 hectares cared for and harvest the trees, delivering the fresh fruit bunches to the PTP plants for crushing. 'Ion-existent in 1978, smallholder production grew to almost 184,000 tons by the end of Replita V in 1989. (See Table 1 for statistics on CPO production in Indonesia.) During the next five years, greater emphasis was placed on the private sector under the Pir-trans program. Under Pir-trans, the government assumed responsibility for infrastructure development and facilitated the acquisition of property rights. Land- clearing was handled by contractors, frequently in exchange for logging rights. Private investors were granted access to credit at concessionary rates to be used for estate development, new crop planting and crushing facilities. Around the estate nucleus, the government sponsored smallholder development. The standard plan called for a 20 5 percent/80 percent mix between estate area and smallholder area. The government provided financing for smallholder plantings, initial living expenses and housing; the nucleus estate was responsible for extension services, for collecting and for processing the fruit bunches. The Pir-trans program resulted in a significant shift in production from public to private estates and smallholder production. Further, the full effects of the program will not be felt until the turn of the century. Some projects approved under Pir-trans have yet to be completed, and there is a lag of about 8-10 years between initial plantings and full production for oil palm trees. Still, as can be seen in Figure 1, the public estates are still the largest source of palm oil in Indonesia. In fact, until 1992, most palm oil in Indonesia came from public estates During the up-coming five years, some of the responsibilities the government assumed under Pir-trans will be handed over to newly formed cooperative organizations under the KKPA. The system is still relatively new and may evolve once the program is fully operational. Many in the palm oil industry are only vaguely aware of the program and few have concrete plans. An exception is P.T. Smart, which has one 6,000 hectare project under way in Lampung and two more in preparation for Riau and Kalimantan Selatan. Under current arrangements, a developer must establish a separate company in partnership with a cooperative of smallholders. The developer is responsible for supplying the development capital and the cooperative provides the land as its contribution to the company. The newly established company is eligible to draw on a loan from an "executing bank" at a rate of 11 percent during construction and establishment of the trees and 14 percent after the trees have matured. The 14 percent rate includes a 3 percent fee which is paid to the cooperative partner to cover administrative costs. In turn, the "executing bank" is eligible to borrow from the Bank of Indonesia at a concessionary rate of 4 percent. Since the spread is large between the BOI rate and the borrowing rate, developers have an incentive to establish their own executing bank. The development site itself follows the nucleus estate approach common under Pir-trans. Smallholder plots can range from 1 to 5 hectares, although land for alternative crops need not be located at each 6 housing site as under Pir-trans. To date, the share of total land devoted to smallholders versus the nucleus estate remains a minimum 80 percent. Cost of Crude Palm Oil Production Indonesia is the lowest cost significant producer of palm oil in the world. Comparing production costs across different types of vegetable oil is difficult, since many oils such as soybean oil or rapeseed oil are jointly produced with meals used as animal feed. In addition, the fruit of the oil palm contains both a fleshy mesocarp from which palm oil is recovered, and a seed or kernel from which an oil and meal are also recovered. Estimating the cost of production for oil palm requires making assumptions about the value of the kernel by-product as well. (See Figure 2.) Still, only soybean oil from Argentina and Brazil is produced at a lower cost than palm oil in Indonesia and only when soybean meal prices are at average levels or above. Comparative studies, based on engineering techniques, place the cost of production of palm oil for new projects in Indonesia at $200/ton. However, a recent paper based on field costs nine oil palm estates owned by Socfindo (International Planters Conference, October 24-26, 1994) suggests that the costs may be much lower. Table 2 provides the average costs for establishing new palm plants and maintaining the immature plants. Table 3 provides cost of production data for mature plantations, including depreciation and overhead. For Socfindo, the cost of production for crude palm oil, ex-factory, was a remarkable $127/ton in 1993. International palm oil prices (in constant 1990 prices) averaged $290/ton in 1990, the historic low, and averaged well over $600/ton in 1995 -- providing a substantial level of profitability. Figure 3 provides the distribution of costs for a mature palm oil plantation. Depreciation on the fixed initial investments constitutes the largest component of cost- roughly 26 percent of total costs. Variable costs, which determine the shutdown point for palm-oil producing estates averaged less than $100/ton for the Socfindo estates. Annex 1 provides a more complete description of production costs. 7 Market Concentration in the Refining Industry Through direct ownership and affiliation, five large refiners organized into two alliances influence more than 60 percent of the refining capacity in Indonesia and control the most popular name-brand cooking oils. While alternatives exist for consumers, including coconut-based cooking oil, this concentration still raises the issue of oligopolistic pricing. Table 4 provides the share of refining capacity for the Big Five Refiners. Together they represent over 61 percent of the industry and market the leading brand-names in cooking oil. A theoretical measure of market power can be derived by taking the market share of the Big Five and dividing it by the sum of the supply elasticity of competitors weighted by the remaining market share minus the (negative) elasticity of demand'. The measure yields the percentage by which the monopolist should raise prices above marginal costs. (Akiyama and Larson, 1994) Using an elasticity of demand of 1.6 (Larson, 1990) and supply elasticities ranging from 1 to 2 yields a market power measure ranging from 26 percent to 31 percent. (Table 5.) In other words, if the Big Five Refiners were to collude, they may well be able to increase domestic prices roughly 26-31 percent above competitive levels. However, the statistical evidence of monopolistic pricing is inconclusive. Calculations of ex-factory cooking oil prices when compared to import parity prices reveal that from the reforms of 1991 to the introduction of the export tax in September 1994, ex factory prices averaged about 14 percent above import parity prices. (Figure 4) Still, the lack of import restrictions are also likely to mitigate the domestic market power of the Big Five. For example, as the elasticity of supply for competing imports increases, the market power of the Big Five goes to zero, regardless of their large market share. Further, monopolistic pricing is frequently characterized by stable-but-high prices. However the time series on prices indicates no difference between the coefficient of variation of international prices of olein from Malaysia and domestic wholesale prices for CPO-based cooking oil. (See Figure 5.) The measure of market power is given by share where share is the share of the Big Five e (I- share)- Ed refiners, es, and Ed are the price elasticities of supply for competitors and demand respectively. 8 111 Market Interventions Background Prior to the export deregulation in June 1991, the palm oil subsector was subject to a number of policy interventions including administered prices and a single marketing chain. The policy objectives were at times contradictory goals of maintaining inexpensive supplies of cooking oil at stable prices and promoting exports. Recent interventions by the Bulog and continued allocations of PTP-origin palm oil are best understood in the context of historic interventions. An understanding of past policy interventions also helps explain why recent marketing interventions raise fears of a re-regulation of the industry. Cooking oil is one of the 'Nine Essential Commodities' for Indonesian consumers. Recent and past interventions were intended to ensure adequate supplies of cooking oil for consumers at affordable prices. Tomich and Mawardi (1995) trace regulations intended to impose a crude palm oil (CPO) price ceiling back to 1973, but note that it was not until 1978 that effective regulations were instituted to establish a domestic price ceiling for CPO and to allocate supplies of CPO to Indonesian firms through quantitative export restrictions. At the time, more than two-thirds of CPO supplies came from the government-owned PTPs. Allocations of CPO supplies from public and private estates were administratively directed to specific firms for domestic processing or for export. Because of the complex nature of the allocation process, four separate palm oil prices were administered by the late 1980s. All CPO produced by state-owned plantations, including oil originating with smallholders located around the nucleus estate, had to be marketed through the Joint Marketing Board (KPB-Medan). Foreign-owned plantations (PMA firms) were required to allocate a portion of their production to domestic market operations and provide a portion of their production to KPB-Medan. Domestically owned plantations (PMDN firms) were not subject to domestic allocations and were not required to market CPO through KPB-Medan. As a result, there was one price for CPO exported directly by PMA and PMDN plantations; a second price for CPO 9 exported through KPB-Medan; a third price allocated to domestic processors; and a fourth price was set for imported CPO. Tomich and Mawardi analyze the effects of the policy interventions from 1978 to 1987 and concluded that the intervention policies harmed both consumers and producers. From 1978 to 1987, the combination of export taxes, domestic price ceilings and allocation requirements generated an -9 percent average nominal rate of protection for the palm oil estates. Consumer price data limited the analysis to a period in 1981 to 1987, but during that period Indonesian consumers paid roughly 6-12 percent above import parity for domestic cooking oil. Tomich and Mawardi estimated the total cost to producers and consumers for 1982-87 at Rp 800 billion for consumers and Rp 387 billion for producers. Current Policy Issues Since the removal of trade restrictions on palm oil on June 3 1991, domestic prices have been determined by events in the larger global market for fats and oils. Although Indonesia is a large producer of palm oil and coconut oil, Indonesia produces only 5-6 percent of the annual global market of 90 million tons of fats and oils. International vegetable oil prices are notoriously volatile and movements in international prices are quickly reflected in domestic prices. (See Figure 6.) Further, the consumption pattern of domestic vegetable-oil based cooking oils has a significant seasonal component during December through March. (See Figure 7.) Cooking oil is viewed as an essential commodity because of its historically significant role in the Indonesian diet. Further because of the dominant position of palm oil among cooking oils (Table 6), and because of its position as the most affordable of cooking oils, the recent rally in international prices raised concerns over domestic prices levels. Anticipation of historically high international prices during the holiday season led to additional calls for market interventions. Growth in incomes has resulted in a diversified household budget with less importance given to cooking oil-- even among the poor. Cooking oil comprises 1.4 percent of the CPI and 4 percent of the household budget of the poorest 20 percent of the I0 rural population. As a result, the 21 percent increase in the prices of cooking oil in 1994 only contributed 0.3 points to the inflation rate. Further, the costs to the poorest consumers of the increase in palm oil was equivalent to a 0.4 percent decrease in their household income. It is unlikely, with average incomes growing at more than 6 percent, that the price increase generally created a burden for consumers. Still, the issue retains political and social significance due in part to the historic importance of cooking oil to the diet and the history of government intervention in the market. The Government of Indonesia intervenes in the marketfor palm oil in using three instruments: 1) a variable-rate export tax introduced in September 1994; 2) Bulog operations which included a CPO buffer-stock and govemment-subsidized imports of olein; 3) Continued directed sales of about 80 percent of production from state-owned estates (PTPs) to domestic markets at allocation prices which are at times below market prices. For reasons explained below, only the variable export tax has had a demonstrable effect on domestic prices. Further, because of the current structure of the market, buffer stock operations, subsidized imports, and domestic allocations at below-market prices represent transfers that effect profits, but not final market prices. In short, these instruments can only have limited and transitory influence since domestic prices are determined by international prices and trade flows. A. Export Tax The variable-export tax is linked to FOB prices for CPO and three CPO products: refined, deodorized, and bleached palm oil (RBD PO), crude olein, and RBD olein. The price levels are announced by the Ministry of Trade monthly, and are based on average spot prices. The level of the tax calculated by applying a schedule of average tax rates to the difference between the price announced by the Ministry of Trade and a floor price set in the tax code. Taxes are then assessed on a per-ton basis according to product type regardless of the price actually contracted. (This feature reduces the incentives to under- invoice.) Stearin which is lower-valued and represents about 20.5 percent of CPO by weight is excluded from export taxes as are other minor by-products. Table 7 provides 11 the tax schedule and Table 8 provides a calculation of the actually taxes imposed since September 1994. Annex 2 provides an example of the monthly decree which fixes the export tax for crude CPO and the CPO products. The tax is modeled on a similar policy in Malaysia and is designed to tax windfall profits during boom periods. Cost of production for CPO in Indonesia is generally estimated at less-than $200/ton. When international prices remain below $435/ton, no tax is levied on exports. As international prices rise from $435 to $800/ton, average tax levels rise from zero to 18 percent. As a result, the tax does not generate a large burden on the profitability of producing crude palm oil.2 The construction of the tax code does create two anomalies, both of which can be remedied. First, because of the way the tables are written, the tax rate does not smoothly increase. In fact, for some values, the tax actually declines slightly as international prices rise. This kinked tax schedule is illustrated in Figure 8. More importantly, the marginal tax rates between CPO and the various CPO-based products are determined independently. As a result, the processing margins can and do differ from international levels. Because of the independence of the tax rates on products from the underlying tax rate on crude palm oil, processors cannot know their processing margins until the tax is announced. In short, the current structure of the tax distorts the market signals for processing and generally lowers the incentives to process oil domestically. Also, the incentives or disincentives to process fluctuate widely. In fact, because of the tax, margins can and have been negative. This point is illustrated in Figure 9 which maps the spread between the price of olein and the price of crude. The true processing margin is determined simultaneously between the price of the crude and the price all of the processed products (olein, stearin, etc.). However, as can be seen by the graph, the tax has generally lowered the spread between the price of crude and olein discouraging local processing in favor of off-shore processing. 2 To see how the tax works consider the August 31, 1994 decree given in Annex 2. Using average prices in August, the decree states that the September tax will be based on an FOB price for CPO of $548/ton. The tax is then calculated as 48 percent of the difference between the FOB price and the floor price, or .48 x ($548-$435) = $54.24/ton. 12 Further, the inability of processors and traders to predict the effect of the tax on margins impedes many common methods of managing price risk. Forward contracts up to 45 days have evolved in Indonesia in recent years. Normally, these contracts, based on a Rotterdam price, allow processors to sell their CPO-based products forward as they purchase their crude CPO, locking in profits. However, since the tax is fixed on the last day of the month for the up-coming month, the processor cannot calculate his margin in advance and can only use intra-month risk management techniques. Below, several reasons are given for reconsidering the export tax. However if the export tax remains in place, the two anomalies created by the tax code can be remedied by: 1) re-writing the schedule in terms of rates based on the FOB price rather than rates on the difference between the FOB price and the floor price; 2) basing the export tax for all products on the CPO content of the item. For example, in November, the FOB price of palm oil was $578/ton and the export tax was set at around $63/ton. By setting the export tax for RBD olein at $46/ton (73 percent of the CPO tax since one ton of CPO produces on average .73 tons of olein), the stearin tax at $15.44 (24.5 percent) and the tax on the remaining products at $1.56/ton (2.5 percent), the tax will neither discourage nor encourage the domestic processing. The export tax generally has been effective in lowering domestic ex-factory, wholesale, and retail prices for cooking oil. Figure 10 plots the ex-factory and retail prices of cooking oil derived from palm oil with the import parity price of RBD olein. (Palm-oil based cooking oil is a more refined version of RBD olein.) The ex-factory cooking oil price mirrored the import parity price of olein from the liberalization of the palm oil market in June 1991 until the imposition of the export tax in September, 1994. Since then, the local ex-factory price has shifted downward and has averaged less than the olein import parity price. The relationship between the cooking oil and the olein price has been unstable with both positive and negative margins. This is in part due to the backward looking nature of the export tax calculation. Since the export tax for any given month is based on the observed international price for the previous month, the changes in the tax rate will lag changes in the spot price. Further, since the tax rate is also progressive, the 13 relationship is even further complicated. Still, on average, the tax has resulted in the expected outcome, as can be seen in Table 9. The average tax rate went from zero to just under 16 percent for RBD olein, while the ratio of the import parity price of olein and the ex-factory price of palm oil based cooking oil dropped 16 percent, from a 1.14 to 0.98. In other words, the spread above import parity dropped from a positive 14 percent to a negative 2 percent. Also, the average mark-up between the domestic wholesale and retail price of cooking oil has been unaffected by the import tax, averaging 19 percent prior to the export tax and 20 percent following the imposition of the tax. The incidence of the taxfalls primarily on producers, most of which are off-Java, and about 22 percent of which are smallholders. With the margins along the processing chain unaffected by the export tax, the incidence falls on producers. The tax therefore transfers income from palm oil growers-smallholder, private, and public estates and transfers that income to consumers, mostly urban consumers, mostly on Java. Unfortunately, the domestic price for most crude palm oil is not directly observed. Prices on domestic crude oil marketed by the Joint Marketing Office (JMO), the marketing arm of the state plantations, are available. As shown later, the JMO has sometimes been directed to supply local processors at less than export equivalent prices. However, the ratio of the JMO crude price to the ex-factory palm-oil based cooking oil price has remained steady at about 71 percent following the introduction of the export tax. (See Table 9.) Spreads did increase somewhat as international prices boomed (Figure 11); however, large spreads occurred before and after the tax and may more linked to JMO directives than a more general market based phenomena. A small spreadsheet model, available from the author, was constructed to measure the welfare effects of the export tax. The results are summarized in Tables 10 and 11. The model is described in Annex 3. The analysis was based on international and domestic prices for January and November 1995. The results are sensitive to the relative international prices and the processing margins. January was near the high end of the boom and November near the low end. Together the two simulations bracket the likely welfare effects of the tax. Generally, the government and consumers benefit from the tax 14 at the expense of the plantation sector. Further, export revenues are significantly depressed. The tax lowers domestic prices which increases domestic consumption as consumers choose more palm oil over coconut oil and other consumables than they would at international prices. Under the base-line scenarios, a demand elasticity of -1.6, taken from an econometric model (Larson, 1990) was used, although an alternative elasticity of -0.9 was also used to test the sensitivity of the results. When intemational prices were high as in January, the tax resulted in an almost 24 percent increase in domestic demand, (when compared to a no-tax high-domestic price alternative scenario) diverting supplies otherwise exported. On an annualized basis, export revenues were lowered by $US 384 million and plantation revenue fell by nearly $US 400 million ($US 120 million from smallholders). Local refiners gain volume, but lose revenue under this scenario. Consumers gain $US 164 million in consumer surplus and the government gains about $US 182 million in government revenue. Using a less elastic demand schedule and lower price level gives more conservative measure of the welfare effects. Still, using these conservative assumptions, the export tax results in an annual $US 277 million loss for plantations, including a $US 83 million loss to smallholders. The loss to producers is equivalent to about 1% of agricultural GDP. Consumers would gain $US 123 million in consumer surplus or about 66 cents per consumer. The government would pick up $US 126 million in tax revenue. Refiners would take a lower margin, but would gain revenues due to an increase in volume. Total net welfare falls by $US 10 million. In addition, export revenues drop by '$158 million. B. Directed Domestic Sales While private plantations are free to dispose of their products according to the dictates of the market, palm oil from the PTPs must be marketed through the Joint Marketing Office. In addition, roughly 80 percent of the palm oil must be sold domestically. The public estate sector does not own processing facilities, so the oil is sold as crude. Generally, the JMO is free to pursue the highest possible domestic price. 15 However, the private sector is not similarly restricted and private sector activity keeps the domestic market in competitive equilibrium with international prices. Consequently, under normal circumstances, the JMO will receive a competitive price, despite the restriction that it must sell domestically. Conversely, eliminating both the restriction that all PTPs must market through the JMO and lifting the restriction that a certain portion of sales must be for the domestic market, would also have little to no effect on domestic prices. However, occasionally, as in thefirst quarter of 1995, the JMO is directed to offer crude to the domestic refiners at below-market prices. The episode was not long-lasting, as can be seen in Figure 12. Figure 12 graphs the difference between the price for domestic sales and the export price as well as the export tax for crude palm oil. Normally, the two vertical bars should be about equal. In December 1994, the JMO was able to take advantage of local shortages to do better than expected. However in January and February 1995, the office was directed to sell at lower prices and did so. Since domestic market prices are determined by international prices (net of export taxes), selling into the domestic market at reduced prices can have no lasting effect on domestic prices-the transfer is intra-marginal. This is shown graphically in Figure 13. If the JMO is required to sell at Pd rather than Pw an amount represented by S 1, those purchasing the crude are still free to export the crude themselves, or use the crude to displace oil that they would otherwise purchase. Since the oil is not consumed in crude form, the policy results in a direct transfer from the producers of the oil, the government- owned PTPs and their smallholder partners, to whoever purchases the crude-primarily large agribusiness. Despite the good intentions of the directive, consumers are not made better off. The amount of the transfer is represented by the shaded rectangle defined by the Pw, Pd and the line at S 1. Since monthly sales data is not available, it is not possible to exactly calculate the cost of the policy to the public estate sector. However, average prices and sales can be used to give some indication. From September 1994 to August 1995, the spread between the export price and domestic sales price for JMO sales averaged about $17.27/ton more 16 than the export tax. The $17.27 average includes several months when the JMO was able to do better in its domestic sales than the export price net of the export tax The domestic sales price may be below the border equivalent due to transport; however even with a generous assumption of $2.50/ton for transport, the difference remains $14.77. Since annual estate production is about 1.8 million tons, this difference amounts to about $26.6 rnillion in lost revenue . It is unclear how much of this difference was due to directed sales. However the estimate is probably a conservative measure of the cost to estates of marketing through the IMO. Since the PTPs are publicly owned, the primary effect of the directed marketing through the JMO is a transfer of $26.6 million from the public estates to the domestic purchasers of PTP crude. However roughly 18 percent of the crude is produced by smallholders who suffer a loss of about $4.8 million. C. Bulog operations. In July, 1995 the National Logistics Agency (Bulog) announced the start of a buffer stock operation designed to bring the price of domestic cooking oil down from about Rp 1,600 to Rp 1,410 by September 1995. The operations were expected to cut large-scale vendors out of the distribution line, bringing products directly from producers to small-scale vendors and retailers. The buffer stock, made up of directed sales (half from the PTPs and half from large private plantations), was expected to build up to 75,000 tons of CPO. Cooking oil demand in Indonesia contains a significant seasonal component, with consumption running 10 to 20 percent higher during December, January and February during the New Year and Idutl Fitri holidays and the buffer stock was intended to prevent price run-ups during the seasonal increase in demand. In July, nine private CPO producers agreed to provide allocations of CPO totally 37,500 tons to the Bulog. (The allocations are given in Table 12.) With domestic prices running around Rp. 1,387, the private producers agreed to a sales price of around Rp 1,235. PTPs were directed to provide a similar amount. S55.5 million (Rp 125 billion) was set aside as an interest-free load from Bank Indonesia to finance the purchases. During the subsequent months however, the firms made partial deliveries to the Bulog as 17 international prices remained high. By September, the Bulog had accumulated around 16,000 tons-- 10,000 tons from the PTPs and 6,000 from the private estates. Prices dipped briefly in the early fall and some additional stocks were accumulated. However, with prices falling below Rp 1,235 and producers anxious to sell to the Bulog at the agreed-upon price, the Bulog suspending the buffer-stock operation with stocks at 20,000 tons at the beginning of November. With the suspension of the CPO stocking, the Bulog switched to stock-piling olein, purchasing about 86,000 tons of crude olein from Malaysia. Since the Bulog has access to interest-free loans, it can import the olein at lower-than-market cost. Further, if needed, the olein can be sold into the domestic market at below-market prices. In addressing temporary shortages, the import of olein has advantages over stockpiling CPO, since the olein can be converted into cooking oil more quickly. However, there are limitations to the influence the olein imports are likely to have on the domestic market. First, since domestic prices are still determined by international prices less export taxes, the Bulog cannot influence the domestic price of olein over an extended period. Olein purchased cheaply can simply be exported for profit, or substituted for domestic supplies which are then exported. Second, some of the temporary shortages in olein supplies may be an unintended consequence of the current tax schedule which has discriminated against the local production of olein. As explained above, this comes from the fact that the tax for the palm oil products are not based on the CPO content of the products, thereby changing the relationship between the domestic CPO price and the domestic olein price-to the detriment of local processing. The spread between CPO and crude and RBD olein are given in Table 13, along with the implied tax rate on the spread. The implied tax is calculated as the difference between the spread in international markets and the domestic spread. At times, the implicit tax on processing has exceeded 100% resulting in negative margins. 18 IV Long-term Development Issues. Land procurement and titles Oil palm trees produce fruit on a continuous basis, with seasonal variations. Once ripe, the fresh fruit bunches must be processed quickly to prevent a build-up of acid in the oil. Fruit which has not been crushed within 48 hours has limited value. Palm oil plantations are usually built around a processing facility, which, in turn, requires the leasing or purchase of large contiguous tracts of land. Smallholder production may appear once an estate has been established. In fact, smallholder development was a requirement to qualify for many of the government investment programs. However, the process of identifying and acquiring land remains a major impediment to establishing new estates. This process is made more difficult from the fact that very little of the land is titled. Once a plantation company has identified a potentially suitable site, the company begins a two-pronged approval process. The company first files an application with the Director General of Estates for a location permit. The location permit also requires the approval of the local governor, and an application is also sent to the local government at the same time. The estate company conducts a location study which it provides to both the local and central government. Once both applications are approved, the central and local forestry agencies conduct a review of the project's impact. Once this review process is complete, the complicated process of identifying settlers and providing compensation to those settlers is begun. Since the land is infrequently titled, these negotiations can be complicated and intractable. Following the negotiations, the land is typically leased for 30 years with an option to renew, rather than purchased outright. The lack of clear title certainly builds a barrier to investment in tree crops. However, the implication for smallholders is much broader. Lack of title inhibits transfers of ownership in general, and smallholders who may wish to migrate to better opportunities may have to abandon valued properties. Settlers, who have gained partial rights, but not title, to land in nucleus estates may be similarly tied to those development projects. 19 Direct Investment and a Potential Role for the World Bank The Government of Indonesia has always either invested directly or provide incentives for new palm oil plantations in Indonesia. Given the profitability of palm oil in Indonesia and the comparative advantage of the country in providing vegetable oil to the rapidly growing world market, the needforfurther incentives in the fonr of subsidized loans is questionable. The local plantation companies are well capitalized and some have direct links with large multinational companies. Further, many of the large Malaysian plantations have recently looked to Indonesia for new investment opportunities, as land and labor costs have limited the returns to new projects in Malaysia. Still, establishing new plantations is an expensive and risky venture, requiring large initial outlays of capital, with long lead times before generating income. Talks with domestic and foreign plantation companies suggested three impediments to further investment. First, as already discussed, is the uncertainty associated with the land procurement process. Second, for some areas, the transportation infrastructure is inadequate. Third, many investors, especially foreign investors, are uncertain about the extent of current and future government interventions in the palm oil market. Some of this arises from a misunderstanding of Indonesian policies. For example, in a paper presented at the April 1995 Kuala Lumpur Commnodity Exchange Price Outlook Forum, a delegate speculated that the Bulog would require private producers to contribute 25-30 percent of their output to the logistical agency (Hwa, 1995). Currently, the incentives provided by inexpensive credit have been effective in providing new capital flows to the palm oil sector. At the same time, the private capital market is mature enough to take on an increased role mitigating the need for government subsidies. The Bank can assist by helping to address directly the impediments to private sector investment through 1) land titlement programs; 2) investments in infrastructure; and 3) addressing issues of policy risk. The Bank has past experience in project lending for land titlement and infrastructure in Indonesia. Issues of policy risk have been addressed primarily through dialogue with the government on policy issues. In other countries in other sectors, the 20 Bank has entered into partnership with governments to provide explicit guarantees against non-commercial risk to private sector investors. The GOI may well want to discuss with the Bank how such schemes could be used as an alternative to subsidized lending. Under interest-subsidy schemes, the GOI takes on the risk that private borrowers will be unable to repay for any reason. Under a guarantee, neither the Bank nor the Government of Indonesia would shoulder any commercial risk. Instead, the guarantees would target directly uncertainties over policies. Conclusions During the last twenty years, the history of the palm oil industry in Indonesia is one of evolution from government sponsorship and market interventions to private sector initiative in response to international price signals. The evolution of the market from public to private sector, while substantial, is incomplete. Investments in new oil palm estates receive preferential financing terms. Further, marketing interventions aimed at reducing inflation and assisting consumers remain but with unintended consequences. Of the intervention tools, the export tax appears effective in the domestic price of crude palm oil and ultimately the cost of refined cooking oil from palm oil. However, because of substantial gains in income, cooking oil is of limited importance in the household budget of even the poorest consumer in Indonesia. As a result although the issue itself is important politically and socially, the gains to consumers from the tax are not significant economnically, averaging less than a dollar per consumer per year. The export tax transfers up to $99 million from producers to consumers and the government by depressing exports. Since the tax is only brought to bear when profits are unusually high, the export tax does not create an unmanageable burden on the sector. However most production occurs off-Java and 22 percent of the growers are smallholders. As a result, the tax runs counter to the government's development priorities. Since the advantages to consumers is limited, the government should drop the tax. 21 The structure of the tax does create a real burden on processors and, if the tax is not dropped, it should be changed to allowv international price signals for processing services to reach domestic processors. Because the tax rates on palm oil products are determined independently of the underlying price of crude, the marketing margins for processors cannot be known in advance, precluding effective risk management. Additionally, the structure of the tax discourages local processing. If the tax is not repealed, the tax rate for processed palm oil products should be based on the crude oil content of those products. The other forms of interventions -- Bulog interventions and restrictions on JMO sales-- are ineffective in lowering domestic prices and create uncertainty for investors. These interventions should be eliminated. The processing market is quite concentrated with two alliances among five large processing groups controlling more than 60 percent of the market. Still, while the potential for oligopolistic pricing exists, the statistical evidence is equivocal. The interest subsidies provided to private investors are an indirect instrument for overcoming the risks and uncertainties associated with establishing estates with a smallholder component. The evolution of the palm oil sub-sector from heavily public to primarily private may be accomplished by targeting the obstacles to private investment directly. The Bank can play a role in that process by designing projects that address l)land titlement, 2) rural infrastructure; and 3) policy risk. 22 Bibliography Akiyama, Takamasa and Donald F. Larson. 1994. "The Adding-Up Problem: Strategies for Primary Commodity Exports in Sub-Saharan Africa" World Bank Working Paper Series, Number 1245. Washington, DC: World Bank. Hwa, Oo Leng. 1995 "Fundamental Analysis of the Palm Oil Market" presented at the Kuala Lumpur Commodity Exchange 1995/96 Palm and Lauric Oils Price Outlook Forum. Kuala Lumpur. Larson, Donald F. 1990. "The Indonesian Vegetable Oils Sector: Modeling the Impact of Policy Changes," World Bank Working Paper Series, Number 382. Washington, DC: World Bank. Tampubolon, F.H., B.A. Jones, R. Sitepu, A. Balot. 1994. "Production Costs and Cost Management in Commercial Oil Palm Plantations of P.T. Socfin Indonesia (Socfindo)," presented at the International Planters Conference, Jakarta. Tomich, T.P. and M. S. Mawardi. 1995. "Evolution of Palm Oil Trade Policy in Indonesia, 1978-191." Elaeis 7:1. pp. 87-102. World Bank, Indonesia: Agricultural Transformation Challenges and Opportunities (Washington, D.C., 1992) 23 Annex 1: Average oil palm fresh fruit bunch production costs for nine Socfindo estates Cost Categpry 1991- 1992 1993 Rp/ton $US/ton Rp/ton $US/ton Rp/ton $US/ton UPKEEP ...... Imperata control 172.2 0.09 190.7 0.09 160.9 0.08 Weeding 1,840.0 0.92 1,908.1 0.93 2,103.7 1.00 Manuring 5,372.9 2.70 5,865.0 2.84 5,090.6 2.41 Pruning 929.7 0.47 992.5 0.48 938.5 0.44 Other upkeep 3,009.8 1.51 3,069.3 1.49 3,227.1 1.53 TOTAL UPKEEP 11,324.6 5.69 12,025.6 5.83 11,520.8 5.46 HARVESTING Harvesting 5,050.7 2.54 5,351.5 2.60 5,601.1 2.65 Transport to mill 2,997.8 1.50 3,039.2 1.47 3,134.3 1.49 TOTAL HARVESTING 8,048.5 4.04 8,390.7 4.07 8,735.4 4.14 PROCESSING Processing 4,932.2 2.48 5,018.5 2.43 5,172.6 2.45 Maintenance 5,206.3 2.61 4,210.4 2.04 3,970.3 1.88 TOTAL PROCESSING 10,138.5 5.09 9,228.9 4.47 9,142.9 4.33 GENERAL EXPENSES 8,525.8 4.28 9,653.3 4.68 8,869.7 4.20 PACKING 80.5 0.04 62.1 0.03 68.7 0.03 TOTALEX-FACTORY 38,117.9 19.14 39,360.6 19.09 38,337.4 18.17 FOR. 584.4 0.29 506.5 0.25 536.0 0.16 FOB 280.9 0.14 274.9 0.13 329.9 0.16 FIXED COST HEAD-OFFICE 4,799.3 2.41 5,380.4 2.61 4,872.7 2.31 TOTAL CASH COST 43,782.5 21.98 45,522.3 22.08 44,126.0 20.91 DEPRECIATION 11,593.0 5.82 12,451.3 6.04 15,105.4 7.16 TOTAL BOOK COST 55,375.4 27.80 57,973.7 28.12 59,231.4 28.07 Source: Socfindo 24 Annex 2: Text from Export Decree THE IMPOSITION OF EXPORT TAX ON CRUDE PALM OIL (CPO), REFINED BLEACHED DEODORIZED PALM OIL (RBD PO), CRUDE OLEIN AND REFINED BLEACHED DEODORIZED OLEIN (RBD OLEIN) (Decree of the Minister of Finance No. 439/KMK.01 7/1994 dated August 31, 1994) THE MINISTER OF FINANCE, a. That with a view to controlling the selling price of cooking oil on the domestic market, it is deemed necessary to impose export tax on CPO, RBD PO, Crude olein and RBD Olein; b. That it is necessary to regulate the imposition of export tax on CPO, RBD PO, Crude olein and RBD Olein in a decree of the Minister of Finance. In view of: I . Government Regulation No. 1/1982 on the realization of exports, imports and the flow of foreign exchange (Statute Book of 1982 No. 1, Supplement to Statute Book No. 321 0) as already amended by Government Regulation No. 24/1985 (Statute Book of 1985 No. 32, Supplement to Statute Book No. 3291); 2. Presidential Decree No. 96/M11993; 3. The Decree of the Minister of Finance No. 738/KMK.00/1991 dated July 29, 1991 on the customs procedure in the export sector. The Decree of the Minister of Finance No. 291/KMK.01/1 994; 4. The Decree of the Minister of Finance No. 534/KMK.013/1992 dated May 27, 1992 on the rates of and the procedure for payment and depositing of export tax and or export surcharges. Taking into account: 1. The letter of the Minister/State Secretary No.B-166/M.Sesneg, 8/1994 dated August 26, 1994; 2. The letter of the Minister of Trade No. 580/M/V111194 dated August 30, 1994. DECIDES: To stipulate: THE DECREE OF THE MINISTER OF FINANCE CONCERNING THE IMPOSITION OF EXPORT TAX ON CRUDE PALM OIL (CPO), REFINED BLEACHED DEODORIZED PALM OIL (RBD PO), CRUDE OLEIN AND REFINED BLEACHED DEODORIZED OLEIN (RBD OLEIN). Article 1. Hereinafter referred to as: 1. Floor prices are highest export prices which are not subject to export tax. 2. Export prices are FOB prices which are announced by the Minister of Finance monthly. Article 2. (1) Crude palm oil (CPO), refined- bleached deodorized palm oil (RBD PO), crude olein and refined bleached deodorized olein (RBD olein) shall be subject to export tax. (2) The export tax as meant in paragraph (1) shall be imposed if the price of cooking oil on the domestic market is above Rp 1,250/kg. Article 3. (1) The method of calculating the export tax to be paid for the respective commodities as meant in Article 2 paragraph (1) shall be as follows: 25 The volume multiplied by the tariff, times (the price of the relevant export commodity minus the floor price), times the foreign exchange rate. (2) The amounts of export tax shall be calculated on the basis of the rates contained in the attachment to this decree. Article 4. The Minister of Finance shall announce the (FOB) export prices of the respective commodities at the end of each month on the basis of average prices on the international market over the last 2 (two) weeks. Article 5. The procedure for the payment and depositing of export tax shall be according to the provisions in as stipulated in the Decree of the Minister of Finance No. 534/KMKO13/1992. Article 6. This decree shall come into force as from September 1, 1994 with the provision that the deadline for exports which are not subject to export tax shall be August 31, 1994 as proved by BIL on Board. For public cognizance, this decree shall be announced by publishing it in the State Gazette of the Republic of Indonesia. Stipulated in Jakarta. On August 31,1994. THE MINISTER OF FINANCE, sgd. MAR'IE MUHAMMAD. 26 ATTACHMENT RATES OF EXPORT TAX NO PRICES US$/MT EXPORT TAX RATES/MT I. CRUDE PALM OIL (CPO) 1. Floor Price 435 0% 2. FOB Price: a. Above435 up to 470 60% x (HE- HD) b. Above470 up to 505 56% x (HE- HD) c. Above505 up to 540 52% x (HE- HD) d. AboveS40 up to 575 48% x (HE- HD) e. Above575 up to 510 44% x (HE- HD) f. Above 610 40% x (HE-HD) II. REFINED BLEACHED DEODORIZED PALM OIL (RBD PO) 1. Floor Price 460 0% 2. FOB Price: a. Above460 up to 500 60% x (HE- HD) b. Above500 up to 540 56% x (HE- HD) c. Above540 up to 580 52% x (HE- HD) d. Above580 up to 620 48% x (HE- HD) e. Above620 up to 660 44% x (HE- HD) f. Above660 40% x (HE - HD) III. CRUDE OLEIN (CRD OLEIN) 1. Floor Price 465 0% 2. FOB Price a. Above 465 up to 510 75% x (HE- HD) b. Above 510 up to 555 70% x (HE- HD) c. Above 555 up to 600 65% x (HE- HD) d. Above 600 up to 645 60% x (HE- HD) e. Above 645 up to 690 55% x (HE- HD) f. Above 690 50% x (HE- HD) 27 NO PRICES US$/MT EXPORT TAX RATES/MT VI. REFINED BLEACHED DEODORIZED OLEIN (RBD OLEIN) 1. Floor Price 500 0% 2. FOB Price a. Above500 up to 550 75% x (HE- HD) b. Above550 up to 600 70% x (HE- HD) c. Above600 up to 650 65% x (HE- HD) d. Above650 up to 700 60% x (HE- HD) e. Above700 up to 750 55% x (HE- HD) f. Above750 50% x (HE- HD) Note: MT = Metric Ton. HE = Export Price, HD = Floor Price. EXPORT PRICES OF CRUDE PALM OIL (CPO), REFINED BLEACHED DEODORIZED PALM OIL (RBD PO), CRUDE OLEIN AND REFINED BLEACHED DEODORIZED OLEIN (RBD OLEIN) FOR EXPORT TAX CALCULATION (Decree of the Minister of Finance No. 440/KMK.017/1994 dated August 31, 1994) THE MINISTER OF FINANCE, Considering: that for the calculation of export tax on CPO, RBD PO, crude olein and RBD olein as meant in the Decree of the Minister of Finance No. 439/KMKO17/1994 dated August 31, 1994t it is necessary to stipulate export prices of the said commodities in a decree of the Minister of Finance. In view of: The Decree of the Minister of Finance No. 439/KMKO17/1994 dated August 31, 1994. DECIDES: To stipulate: THE DECREE OF THE MINISTER OF FINANCE CONCERNING EXPORT PRICES OF CRUDE PALM OIL(CPO), REFINED BLEACHED DEODORIZED PALM OIL (RBD PO), CRUDE OLEIN AND REFINED BLEACHED DEODORIZED Of FIN (RD OLEIN) FOR EXPORT TAX CALCULATION. 28 Article 1. The (FOB) export prices of CPO, RBD PO, crude olein and RBD olein for the calculation of export tax as meant in the Decree of the Minister of Finance No. 439/KMKO17/1994 dated August 31, 1994 for the month of September 1994 shall be fixed as the following: a. CPO US$ 548/MT b. RBD PO US$ 591/MT c. Crude Olein US$ 612/MT d. RBD Olein US$ 642/MT Article 2. This decree shall come into force as from September 1, 1994. Stipulated in Jakarta. On August 31, 1994. THE MINISTER OF FINANCE, sd. MAR'E MJHAMMAD, BN. 5604/560517-9-1994 29 Annex 3: Model description Because palm oil is a tree crop, supplies of palm oil are determined by the stock of trees which in turn are determined by past investments. Vintage approaches which measure cohorts of trees from earlier investments are effective in forecasting supplies. However, for the purpose of the model used for analyzing the welfare effects of the export tax, supplies are treated as predetermined and fixed. There are several reasons for this choice. The shut-down point for palm oil estates in Indonesia is probably around $US 100/ton or less. The tax begins when prices reach $435/ton. Since production costs are below $200/ton, the tax only enters into the investment decision when prices are well above the shut-down point and profit rates are in excess of 100%. The tax may reduce expected profits and therefore investment and future supplies beginning in 2000 when the 1996 investment begin to yield. However, this effect is likely to be swamped by larger policy and market issues. The government policy of providing loans at below-market rates certainly has a greater impact on profitability, given the long maturation process, than the tax. It is also likely that other barriers like inadequate infrastructure and difficulties in securing leases to large contiguous tracks of land are binding constraints to new investments rather than insufficient profits. Indeed, these factors probably help explain why profit rates are so high. With supplies fixed and prices determined by intemational prices net of taxes, the model is driven through the demand function. As domestic prices drop, the demand for olein raises as consumers substitute palm oil for coconut oil. The price of coconut oil is unchanged by the export tax, remaining at intemational levels. The demand for olein equation was derived using the elasticity of demand for palm oil estimated by Larson (1992) and passing a log-linear demand schedule through point defined by the November price (and under an alternative scenario the January price) and the consensus prediction of domestic demand this year -- 2.4 million tons (crude equivalent.) -- then solving for the intercept. A 0.78 conversion rate was used to convert crude to olein resulting in the following demand equation: 30 DoIeM = 41489 ( pdo.estic) -1. 6 The demand for olein generates a derived demand for crude oil. Because of transport costs and more than adequate domestic processing capacity, olein imports are rare. For the purposes of the modeling exercise, the processing is done locally and the demand for olein is converted into the derived demand for crude: D'de = D°"' /.078 Exports are then the residual from the domestic supply of 4.4 million tons. Consumer surplus changes are measured as the integral of the log-linear demand function evaluated with and without the export tax: AiCS =(Dn°larPnorar - DrP"ao)/(I + Li) Tax revenue is calculated by taking the exports times the export tax; export revenue is calculated by taking the export price times exports; and producer income is taken as production times the domestic price. Changes to refining revenues are calculated by taken the domestic after-tax margins times the demand for crude with the tax minus the international margins times the demand for crude without the tax. 31 Table 1: Palm oil production in Indonesia, 1975-1994 (tons). Year Public Estate Private Estate Smaliholder Total 1975 271,171 126,082 - 397,253 1976 286,096 144,910 - 431,006 1977 336,891 120,716 - 457,607 1978 336,224 165,060 - 501,284 1979 438,756 201,724 760 641,240 1980 498,858 221,544 770 721,172 1981 533,399 265,616 1,045 800,060 1982 598,653 285,212 2,955 886,820 1983 710,431 269,102 3,454 982,987 1984 814,015 329,144 4,031 1,147,190 1985 861,173 339,241 43,016 1,243,430 1986 912,306 384,919 53,504 1,350,729 1987 988,480 352,413 165,162 1,506,055 1988 1,102,692 454,495 156,148 1,713,335 1989 1,184,226 597,039 183,689 1,964,954 1990 1,247,156 788,506 376,950 2,412,612 1991 1,360,363 883,918 413,319 2,657,600 1992 1,489,745 1,076,900 699,605 3,266,250 1993 1,469,156 1,370,272 582,021 3,421,449 1994 *) 1,785,315 1,410,030 899,138 4,094,483 Source: Directorate General of Estates 32 Table 2: Socfindo establishment costs and up keep for new palm oil plantings 1991 1992 1993 New Plantings Extension ($US/ha.) 1,406 1,305 1,361 Replanting ($US/ha.) 1,114 1,188 1,239 Upkeep (immature plants, $/ha.) 303 335 325 Source: Socfindo Table 3: Average cost of production for palm oil for Socfindo estates in 1993 Rp./ton FFB US$/ton FFB $USAton CPO Upkeep for plants 11,520.8 5.46 24.82 Harvesting 8,735.4 4.14 18.82 Processing 9,142.9 4.33 19.70 Transport, packing 934.6 0.44 2.01 General estate expenses 8,869.7 4.20 19.11 Headquarters 4,872.7 2.31 10.50 Depreciation 15,105.4 7.16 32.54 Ex-Factory costs 39,203.4 18.58 84.45 Total cash costs 44,076.1 20.89 94.95 Total including capital 59,181.5 28.05 127.49 Source: Socfindo 33 Table 4: Capacity and capacity share for Big Five palm oil refiners Annual Capacity thousand tons capacity share ..................................................................................................... ................... .......... ....................................................................... ............. Hasil Karsa Group PT. Singa Mas Jaya Perdana 325.00 6.3% PT. Asap Abadi 400.00 7.7% PT. Hasil Kesatuan 147.88 2.8% PT. Hasil Abadi Perdana 88.80 1.7% sub-total 961.68 18.5% ..................................................................................................... ................................................... Musim Mas Group PT. Musim Mas 380.00 7.3% PT. Siringo-Ringo 90.00 1.7% PT. Mega Surya Mas 152.00 2.9% PT. Bina Karya Prima 255.00 4.9% sub-total 877.00 16.9% ........................................................................................................................................................ Sinar Mas Group PT. IvoMasTunggal 212.00 4.1% PT. Sinar Meadow 30.00 0.6% PT. Mulyo Rejo 118.80 2.3% PT. Smart Corporation 271.00 5.2% sub-total 631.80 12.2% Salim Group PT. Sawit Malinda 45 00 0.9% PT. Sayang Heulang 210 00 4.0% PT. Inti Boga Sejahtera 210 00 4.0% sub-total 465 00 8.9% Bukit Kapur Group PT. Bukit Kapur Rekasa 180 00 3.5% PT. Sinar Alam Permai 70 00 1.3% sub-total 250 00 4.8% ........................................................................................................................................................ TOTAL 3,185.48 61.3% Source: Bulog 34 Table 5: Market power calculation Market Share of the Big Five 0.61 0.61 Elasticity of demand 1.60 1.60 Elasticity of supply (others) 1.00 2.00 Market power 31% 26% Source: World Bank Table 6: Production and supply of cooking oil from crude coconut and palm oi. Year Production Import Export Supply Coconut Palm Coconut Palm Coconut Palm Coconut Palm 1982 432 575 1 0 14 168 419 407 1983 432 376 0 0 0 0 432 376 1984 473 668 0 0 35 0 438 668 1985 517 498 0 0 23 0 494 498 1986 545 514 0 0 5 0 540 514 1987 575 725 0 0 118 0 457 725 1988 567 888 0 0 207 0 360 888 1989 589 948 0 0 197 0 392 948 1990 651 1,055 0 0 194 0 457 1,055 1991 656 993 7 0 198 0 465 993 1992 654 1,654 11 0 351 0 314 1,654 1993 661 1,431 34 0 258 0 437 1,431 Source: Food Balance Sheet for Indonesia, CBS 35 Table 7: Tax schedule for palm oil and palm oil products CRUDE PALM OIL (CPO) Floor Price 435 FOB Price: Tax rate on Above Up to Export price nminus floor price 435 470 60% 470 505 56% 505 540 52% 540 575 48% 575 510 44% 610 40% REFINED BLEACHED DEODORIZED PALM OIL (RBD PO) Floor Price 460 FOB Price: Tax rate on Above Up to Exportprice nminus floor price 460 500 60% 500 540 56% 540 580 52% 580 620 48% 620 660 44% 660 40% CRUDE OLEIN (CRD OLEIN) Floor Price 465 FOB Price: Tax rate on Above Up to Export price minus floor price 465 510 75% 510 555 70% 555 600 65% 600 645 60% 645 690 55% 690 50% CRUDE OLEIN (CRD OLEIN) Floor Price 500 FOB Price: Tax rate on Above Up to Export price minus floor price ............ .........................p ........ .................................... ................... .................................... ................... .............. .......... 500 550 75% 550 600 70% 600 650 65% 650 700 60% 700 750 55% 750 50% Source: Ministry of Finance 36 Table 8: Export tax for crude palm oil and palm oil products CPO (US$/ton) RBD PO (US$/ton) Crude Olein (US$/ton) RBD Olein (US$/ton) Year/ Month Floor Export Tariff Export Floor Export Tariff Export Floor Export Tariff Export Floor Export Tariff Export Price Price Rate Tax Price Price Rate Tax Price Price Rate Tax Price Price Rate Tax 1994 Sep 435 548 9.9% 54.20 460 591 10.6% 62.90 465 612 14.4% 88.20 500 642 14.4% 92.30 Oct 435 583 11.2% 65.10 460 613 12.0% 73.40 465 631 15.8% 99.60 500 661 14.6% 96.60 Nov 435 594 11.8% 70.00 460 624 11.6% 72.20 465 629 15.6% 98.40 500 659 14.5% 95.40 Dec 435 686 14.6% 100.40 460 743 15.2% 113.20 465 717 17.6% 126.00 500 747 18.2% 135.90 1995 Jan 435 662 13.7% 90.80 460 678 12.9% 87.20 465 650 15.7% 101.80 500 680 15.9% 108.00 Feb 435 598 12.0% 71.70 460 637 12.2% 77.90 465 613 14.5% 88.80 500 641 14.3% 91.70 Mar 435 631 12.4% 78.40 460 687 13.2% 90.80 465 673 17.0% 114.40 500 703 15.9% 111.70 Apr 435 653 13.4% 87.20 460 714 14.2% 101.60 465 695 16.5% 115.00 500 725 17.1% 123.80 May 435 584 11.2% 65.60 460 627 11.7% 73.50 465 636 16.1% 102.60 500 666 15.0% 99.60 Jun 435 576 10.8% 62.00 460 613 12.0% 73.40 465 605 13.9% 84.00 500 635 13.8% 87.80 Jul 435 610 12.6% 77.00 460 643 12.5% 80.50 465 631 15.8% 99.60 500 681 15.9% 108.60 Aug 435 620 11.9% 74.00 460 650 12.9% 83.60 465 638 16.3% 103.80 500 668 15.1% 100.80 Sep 435 566 11.1% 62.90 460 598 11.1% 66.20 465 589 13.7% 80.60 500 619 12.5% 77.40 Oct 435 557 10.5% 58.60 460 594 10.8% 64.30 465 578 12.7% 73.50 500 608 11.5% 70.20 Nov 435 578 10.9% 62.90 460 605 11.5% 69.60 465 590 13.8% 81.30 500 620 12.6% 78.00 Average 603 11.9% 72 641 12.4% 79 632 15.4% 97 664 14.8% 99 Source: Ministry of Finance and World Bank 37 Table 9: Effects of the export tax on selected variables Average July '91 to Augut'94 ..September '94 to October '95 .................................................................................................... .. ....... ..... ..................................................................................... .............................. .. Tax Rate 0% 16% Ratio of ex-factory cooking oil to olein import parity 1.14 0.98 Retail cooking oil over wholesale price 0.19 0.20 Share of JMO crude to ex-factory cooking oil price 0.72 0.71 Source: World Bank Calculations Table 10: Tax effects on selected prices, November 1995 International prices: Malaysia, Fob Domestic price Tax Rate $USAton ............................ ...................... .................... Crude Palm Oil (CPO) 578 515 11% Refined Palm Oil (RBD PO) 605 535 12% Crude Olein (CRD Olein) 590 509 14% Refined Olein (RBD Olein) 620 542 13% .....................I........................................................................................................... ............................ Spreads ..................................................................................... ................................................................ **RB.DPO-CPO 27 20 25% CRD-Olein-CPO 12 -6 153% RBD Olein-CPO 42 27 36% Source: World Bank Calculations 38 Table 11: Welfare effects of the export tax Scenarios January November November Demand (million tons) With Tax baseline baseline low elasticity Domestic demand RBD Olein 1.75 1.33 1.41 1.55 Derived CPO demand 2.40 1.82 1.94 2.13 CPO export 2.00 2.58 2.46 2.27 Change in Tax revenue (million$) 182 126 126 Consumer surplus (million $) 165 123 129 per capital consumers surplus ($) 0.84 0.63 0.66 Export earnings (million $) -384 -269 -158 share of agricultural GDP -1.4% - 1.0% -0.6% Refiner revenue (million $) -99 -74 13 Plantation revenue (million $) -400 -277 -277 as share of agricultural GDP -1.5% -1.0% -1.0% smallholder revenue (million $) -200 -83 -83 as share of agricultural GDP -0.7% -0.3% -0.3% Net welfare (loss) -152 -102 -10 share of agricultural GDP -0.6% -0.4% 0.0% Source: World Bank Calculations Table 12: Buffer stock allocations of crude palm oi tons Sinar Mas Group 9,000 Salim Group 8,500 Sucofindo 5,000 Raja Garuda Mas 3,500 Tolam Tiga Indonesia 3,000 Lonsum Indonesia 2,600 Astra 4,000 Duta Permai 900 Indecda 1,000 Total 37,500 Source: Bulog 39 Table 13: Spreads between process products and crude palm oil RBD CPO - CPO Crude olein - CPO RBD olein - CPO Date Domestic World tax Domestic World tax Domestic World tax Sep-94 34.30 43.00 20% 30.00 64.00 53% 55.90 94.00 41% Oct-94 21.70 30.00 28% 13.50 48.00 72% 46.50 78.00 40% Nov-94 27.80 30.00 7% 6.60 35.00 81% 39.60 65.00 39% Dec-94 44.20 57.00 22% 5.40 31.00 83% 25.50 61.00 58% Jan-95 19.60 16.00 -23% -23.00 -12.00 -92% 0.80 18.00 96% Feb-95 32.80 39.00 16% -2.10 15.00 114% 23.00 43.00 47% Mar-95 43.60 56.00 22% 6.00 42.00 86% 38.70 72.00 46% Apr-95 46.60 61.00 24% 14.20 42.00 66% 35.40 72.00 51% May-95 35.10 43.00 18% 15.00 52.00 71% 48.00 82.00 41% Jun-95 25.60 37.00 31% 7.00 29.00 76% 33.20 59.00 44% Jul-95 29.50 33.00 11% -1.60 21.00 108% 39.40 71.00 45% Aug-95 20.40 30.00 32% -11.80 18.00 166% 21.20 48.00 56% Sep-95 28.70 32.00 10% 5.30 23.00 77% 38.50 53.00 27% Oct-95 31.30 37.00 15% 6.10 21.00 71% 39.40 51.00 23% Nov-95 20.30 27.00 25% -6.40 12.00 153% 26.90 42.00 36% Avg. 30.77 38.07 17% 4.28 29.40 79% 34.13 60.60 46% Source: World Bank Calculations 40 Figure 1: Palm oil production in Indonesia by type of producer Palm oil production 1,800 1,600 _ _ _ l 1200 * * _ l --':'- .200 I _* _Pubiic Estate] _ ° _ 8 0 0 _k _| _| _| _ O * 3 * * .Private Estate 800-_______________ -E 600)o | | | , L | 1 | 1 | ] 1 1 1 1 11 4E S mn allholder 400 ...lIII p 200 I0 0 0v0 0 0' 0 0 0 0 OC, X o o o Source: Director General of Estates Figure 2: Selected oil palm products Oil palm products Source: World Bank Figure 3: Composition of production costs for mature palm oil plantation. Cost of CPO production, 1993 Depreciation Upkeep for plants 19% 26% Harvesting I leadquarters 15% 8% Ceneral estat Pcessing expensies Transport, packing 15% Source: Socfindo Figure 4: Cooking oil and import parity prices. Prices for palm-oil based cooking oil I,800 1,600 1,400 - 1,20() : ;: 0 0 ^@ ., t; >t§t t palm-based cooking oil, ex t. 1.000o factory = 800 01c/ ' m << " F '< 7 : 0 0 t: ... .OIin import parity 400 200 0 .. . ....I . '~ So 1rce IWorl Bank Source: World Banhk Figure 5: Variability of selected vegetable oil prices. Price variability of cooking oils, July 91-August 93 16% 14% 12% (%) 8% 6% 4 2% 2% 0% Olein, palm oil, palm oil, coconut Malaysia ex wholesale oil, FOB factory wholesale Source: World Bank Figure 6: Prices for Malaysian olein, FOB and domestic palm cooking oil International and domestic prices 2,000 1,800 ----: --,.- 1,600 A 1,400 | 1,200 --____ r sl W a -s tsI+C***t_*z-- ~+t p -L. J1Malaysian olcin t 1,000 -*-. palm cooking oil, retail 600 400 *,, r '- - 200 - - e M rs - s Source:WorldBank - Source: World Bank Figure 7: Seasonal variation in cooking oil consumption Monthly consumption of cooking oil 250 200 - | 0t :i ;:0 i0 ; i : S150 1 l X l i 50 o 4 I i v > ~~~< < g tX Source: Central Bureau of Statistics Figure 8: Tax schedule for crude palm oil Tax rate 15% __ _ I0% $400 1450 $500 S550 S600 S650 FOB price for crude palm oil Source: World Bank Calculations Figure 9: Olein and crude palm oil spread Spreads between the crude olein price and the price for crude palm oil 70.00 60.00 __ 50.00 40.00 0 -20.00 l - | - Source: World Bank Calculations Figure 10: Domestic prices and o/ein import parity price _ IE ~~~~~~~Selected palm oil prices 1,600 _- . 1,400 _.- sX 1,200 - 10.00 W , 8,00 - _:. palii-based cooking oil, ex 600 __| factoryI 400 _* palrn cookhng oil, rstail1 200 _ _ -- 2 0 0 0 0 0 0 0 0 0 0 0 [ a C C --__ ___ _ _ _ __._ Source: World Bank Figure 11: Export price minus domestic price for JMO crude Spread, ex-factory cooking oil and JMO crude 600 500 -_ 400_ _L 31200 j|ex-factory, crude spread 100 °, ol °,oo 0 a, 0, 0 w ea a 0 : ~ ~ C n Iz LO LO EOs. Source: World Bank Figure 12: Joint Marketing Board prices and the tax Joint Marketing Board Export-Import Price Spread and the Export Tax 400 350 300 t ,, 250 .I I **[ :;:t|f | i: : 7 _: titt S . | JMO Export- Dorestic Price 200 M I sa 1 5 0 : R R > _ :li. m m m _ m:;S, CPOtax 150 100 * 50 i VL LO U) in U') U') LO 0) 0 0 0 $ $ $ 0 0, ,0 0) Source: JMB and World Bank Figure 13: Directed sales transfer income but do not effect prices price 4 Supply Pw I____ Pd domestic demand Si Sd quantbty Policy Research Working Paper Series Contact Title Author Date for paper WPS1638 Private Pension Funds in Hungary: Dimitri Vittas August 1996 P. Infante Early Performance and Regulatory 37642 Issues WPS1639 Income Insecurity and Franck Wiebe August 1996 J. Israel Underemployment in Indonesia's 85117 Informal Sector WPS1640 Labor Regulations and Industrial Alejandra Cox Edwards August 1996 M. McIntosh-Alberts Relations in Indonesia 33750 WPS1641 Poverty and Inequality During M. 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