In November 2021, the European Commission (EC) published a proposal for a regulation to minimise EU-driven deforestation and forest degradation. A trilogue is underway among the EC, Council and Parliament to reach an agreement on the final text of the regulation. According to the EC proposal, select agricultural commodities –beef, cocoa, coffee, palm oil, soy, wood and some related products – may only be placed on the EU market (or exported from the EU) if they are:
- deforestation-free;
- produced in accordance with the legislation of the country of production; and
- accompanied by a due diligence statement.
The regulation sets mandatory due diligence requirements on operators. It requires them to collect information on the exact location of production and conduct risk assessment and mitigation measures.
The regulation has the potential to accelerate the transition towards sustainable, deforestation-free supply chains. However, a major uncertainty about the Regulation’s impact is how commodity traders will respond. In particular, it is unclear the extent to which they will be able to apply EU standards (deforestation-free and legally produced commodities) across their entire operations and choose to do so; or if they will divert non-compliant volumes towards other, less stringent markets. This market leakage and the dominance of less regulated demand-side markets may limit the regulation’s impact on reducing forest loss.
To shed light on this, researchers from the NewGO programme at EFI interviewed commodity traders and supply chain specialists from the cocoa, palm oil and soy sectors to better understand how commodity traders are likely to adapt their operations in response to new due diligence requirements. They also assessed what factors (e.g. financial, logistical) are likely to influence these changes.
Summary of perceived likelihood of different strategies considered by traders
Legend: green: likely strategy; yellow: somewhat likely strategy; red: unlikely strategy.
*Not a deliberate strategy but an expected outcome of the EU Deforestation Regulation.
Traders likely to segregate supply chains, send their compliant volumes to the EU
Generally, across the three supply chains, informants do not expect traders to cease or reduce supply to the EU or shift their business to other commodities owing to their economic interests to continue engaging with the EU market. Instead, traders will likely implement the due diligence requirements with at least some of their existing suppliers. However, because due diligence and full traceability are seen as challenging and costly, traders are likely to segregate their supply chains. Deforestation-free, legally produced and traceable volumes will supply the EU market, while non-compliant volumes will be redirected to other markets.
In the cocoa sector, the EU is an important market, importing about half of the cocoa produced globally. Traders indicate they are very likely to implement the new due diligence requirements with part or all of their existing suppliers. However, they identify the following challenges: the lack of data on individual cocoa farm polygons and the high percentage of cocoa sourced indirectly with less traceability (representing 40–60% of interviewed traders’ supply). Cocoa traders indicate that instead of implementing the due diligence requirements across all their supply chains, they would likely only do so for cocoa destined to the EU, the United States and potentially the United Kingdom. According to traders, this would not represent a significant change from their current operations, as these markets have a higher demand for sustainably sourced cocoa compared to other consuming countries.
While segregation is expected to reduce the amount of deforestation attributed to EU consumption, the redirection of non-compliant commodities to non-EU markets may severely limit the regulation’s impact on reducing deforestation in producing regions, particularly in contexts where other markets can absorb non-compliant supply.
Farmer in a cocoa plantation in Ecuador.
Consolidation of traders and exclusion of smallholders are potential unintended effects
The regulation may reinforce a segregation of commodity markets. In the palm oil sector, meeting the new due diligence requirements may reinforce an already segregated global palm oil supply chain, with 90% of the EU’s palm oil imports being sustainably certified in 2020.
A consolidation of traders operating in the Brazilian soy sector is also expected. Respondents believe that most traders will not be able to adapt their supply base in their current sourcing areas to ensure that the EU is supplied with soy only from compliant farms. This is owing in part to the relatively limited EU demand for soy from Brazil and the difficulties associated with segregating and transporting potentially low volumes of compliant soy. According to respondents, logistics and supply chain infrastructure (e.g. warehouses, export facilities) are not currently designed to operate with these smaller volumes, and therefore segregating EU-compliant soy would jeopardise cost efficiency.
It is expected that traders will also engage in other strategies to facilitate compliance, including simplifying their supply chains and sourcing from lower-risk suppliers. This could lead to some producers, particularly smallholders, being excluded from the EU market, especially in the cocoa and palm oil sectors where smallholders make up a significant proportion of producers.
According to respondents, actors in the cocoa sector are likely to adapt their supply base to reduce risk and thus costs. This may lead to the exclusion of high-risk suppliers (e.g. independent smallholders, indirect suppliers, those located near protected areas) from the supply chain. Instead, this may favour cooperatives and larger farmers, which may be better able to implement the due diligence requirements and can be more easily monitored by traders.
Similarly, in the palm oil sector, it is anticipated that traders will restructure their supply base to supply the EU market with palm oil from lower risk suppliers (e.g. large plantations) and provide non-EU markets with higher-risk supply (e.g. from smallholders), resulting in a shrinking of their supplier base. Traders favour this strategy because of insufficient levels of traceability from smallholders, the predicted high costs of traceability in complex supply chains with a high number of suppliers, and their ownership of fixed assets.
Deforestation in Malaysia for oil palm plantations.
Costs drive traders’ response to new due diligence requirements
Respondents perceive that compliance with the future due diligence requirements will be challenging and costly for traders. Costs and supply chain infrastructure and logistics are the key factors influencing traders’ strategic choices in response to the upcoming regulation.
Respondents predict that the regulation is likely to result in cost increases for the provision of the three commodities to the EU market. Respondents from the cocoa and palm oil sectors noted that the required collection of traceability information (e.g. mapping all suppliers and their geolocation data) will be a major cost driving factor. In the cocoa sector, traders estimated the cost per tonne for a traceability system would be between 0.5% and 2% of recent cocoa price (USD 2248 per ton) . This is consistent with findings from the impact assessment of the regulation. It is also in line with a 2020 study on the costs of implementing physical traceability and zero deforestation criteria for soy and palm products in the French animal feed sector, which estimated additional costs for consumers would be between 0.09% and 0.6%.
Informants from the palm oil and soy sectors referenced logistics and supply chain infrastructure that are ill adapted for compliance (e.g. commodity processing facilities that are not built for segregation) as other central cost driving factors that could inhibit the operation of economically efficient, segregated supply chains. For instance, one trader estimated that segregation of soy into smaller volumes of compliant soy could require transport with smaller vessels, which could increase freight prices by up to 35–40% per vessel, resulting in total prices up by 5% or USD 400–500 M per year.
Pouring soy bean into tractor trailer.
Who will bear these costs? Respondents predicted differently how the costs of compliance might be distributed in the supply chain (e.g. among producers, traders and EU consumers). But traders were suggested most frequently, followed by consumers and producers. Additional studies are needed to develop a better understanding of the full impact of the future due diligence requirements on different supply chains, incremental costs and price increases.
In sum, to minimise cost increases and achieve compliance in the most economically efficient way, respondents suggest that traders would likely segregate their supply of compliant commodities to the EU from other markets, as opposed to applying new market requirements across their supply regardless of destination market. As this segregated approach could severely limit the regulation’s impact on reducing total deforestation in producing regions, complementary policies and local partnerships will be needed to increase the regulation’s effectiveness, as well as to mitigate its negative impacts on the livelihoods of smallholder farmers and on smaller traders. Jurisdictional approaches that bring government together with actors along the supply chain to work towards a shared vision of sustainability are promising complements to regulatory efforts to tackle deforestation.
Read the policy brief:
O’Brien, L., Cramm, M., Foster, M., Buchholz, F., Wunder, S., Tegegne, Y.T., 2022. Exploring how commodity traders’ strategies can influence the forest conservation effects of the proposed EU regulation on deforestation-free products. Policy brief. European Forest Institute. DOI: https://doi.org/10.36333/rs3
